Economic Decision-Making

Lecture 3Shahid Iqbal

Economic decision-making is a means of choosing a course of action among several alternatives.

The six steps in the economic decision- making process are:

1) Defining the problem

2) Identifying choices

3) Evaluating the advantages and disadvantages of each choice

4) Choosing one choice

5) Acting on the choice

6) Reviewing the decision

Solve a problem

Problem: Adjust the foundation of a house

Choices: Ignore the problemContact companies located in the same cityContact companies located in the next cityContact companies located in other cities

Rational Decision- making ProcessWhich Car to Lease? Saturn vs. Honda

1. Recognize a decision problem

2. Define the goals or objectives3. Collect all the relevant

information4. Identify a set of feasible

decision alternatives5. Select the decision criterion to

use6. Select the best alternative

Need a car

Want mechanical security Gather technical as well as financial dataChoose between Saturn and HondaWant minimum total cash outlaySelect Honda

Engineering Economic Decision’s Process

Manufacturing

Planning Investment

Profit

Role of Engineers in Business

Create & Design

• Engineering Projects

Analyze

• Production Methods• Engineering Safety

• Environmental Impacts• Market Assessment

Evaluate

• Expected Profitability• Timing of Cash Flows• Degree of

Financial Risk

Evaluate

• Impact on Financial Statements• Firm’s Market Value

• Stock Price

Predicting the Future

1- Estimating a Required investment

2- Forecasting a product demand

3- Estimating a selling price

4- Estimating a manufacturing cost

5- Estimating a product life

Accounting Vs. Accounting

Evaluating past performance

Accounting

Evaluating and predicting future events

Engineering Economy

PastPresent

Future

Two Factors in Engineering Economic Decisions

The factors of time and uncertainty are the defining aspect of any engineering economic decisions

A Large-Scale Engineering Project• Requires a large sum of investment• Takes a long time to see the financial outcomes• Difficult to predict the revenue and cost streams

Types of Strategic Engineering Economic Decisions in Manufacturing Sector

1- Service Improvement

Customer Service and Maintenance

Example - Healthcare Delivery

Which plan is more economically viable?

• Traditional Plan: Patients visit each service provider.

• New Plan: Each service provider visits patients

patient

service provider

2- Equipment Replacement

Equipment Replacement Problem

• Now is the time to replace the old machine?

• If not, when is the right time to replace the old equipment?

3- New Product and Product Expansion

New Product and Product Expansion

• Shall we build or acquire a new facility to meet the increased demand?

• Is it worth spending money to market a new product?

4- Cost Reduction

Cost Reduction

• Should a company buy equipment to perform an operation now done manually?

• Should spend money now in order to save more money later?

Types of Strategic Engineering Economic Decisions in Service Sector

1- Commercial Transportation

2- Logistics and Distribution

3- Healthcare Industry

4- Electronic Markets and Auctions

5- Financial Engineering

6- Retails

7- Hospitality and Entertainment

Decision Trees

Planning Tool

• Enable a business to quantify decision making

Useful when the outcomes are uncertain

Places a numerical value on likely or potential outcomes

Allows comparison of different possible decisions to be made

Limitations of Decision Trees

How accurate is the data used in the construction of the tree?

How reliable are the estimates of the probabilities?

Data may be historical – does this data relate to real time?

Necessity of factoring in the qualitative factors

1- Human resources

2- Motivation

2- Reaction

3- Relations with suppliers and other stakeholders