Major links between economic and technical practice.

Osiceanu, Sanda ; David, Oana

Abstract: There is a major link between economic and technical practice. This mean that all technical projects involve economic and ecological aspects concerned opportunity cost, profit, externalities, economic analysis and so on. The aim of the paper is to present, briefly, economic concepts that an engineer need to know before a new project will begin or in the production process of an old economic good.

Key words: economy, engineering, cost, profit, externalities

1. INTRODUCTION

The engineering economy is the application of certain principles of economics to the problems of engineering related investments (Newnan, 1988). Today, this simple definition needs to be widened, as the subject itself has widened over the years. To economics must be added mathematics.

When more complicated problems are encountered (planning the entire transport system of a country, for example) sociology, anthropology, urban planning and other disciplines must be combined with economics and mathematics in order to arrive at satisfactory solutions.

A broad view should be taken, by including disciplines other than engineering and economics, that an optimal solution of the problem can be determined. Let us imagine in which a cross-town freeway is proposed in a major city. The engineering and economics studies completed, the city government is called upon to decide whether or not the project will be built (Steiner, 1992). A member of the city government asks a question concerning the effect of the proposed freeway on the form of the city.

Investment means using resources to create an addition to the facilities at the present in existence. In the previous example a certain number of kilometers of urban freeway are to be added to the existing kilometers. If we decide to divide the economy of a nation into two parts, public and private, the freeway investment is a public project because the necessary funds will come from public monies. Investment from an economist's standpoint is the diversion of resources from consumption to uses that will better the efficiency of the production process. Consumption is postponed so that more consumption will be possible in the future.

Investment and capital goods resulting from it are measurable in terms of the amount of human effort required to produce them. Unfortunately, an objection is apparent when one inquires into the case of a capital good immediately available for use as soon as produced in distinction from one that must be stored for a time before it can be used.

In general, investment requires a forgoing of consumption. It is measurable in terms of the consumption forgone and it is not always directly measurable by the amount of labor involved in making the investment good. Evidently, benefits of an investment must exceed costs if the investment is to be approved. The value of capital goods is measured not only by their first costs but also by how long they will last.

Investments in engineering works are made in order to solve a problem (Riggs & West, 1986). A river must be crossed, for example. A bridge must therefore be built. Imagine that the alternative designs consist of one in steel and one in reinforced concrete. There are mutually exclusive investments because only one of the alternatives proposed will be built. It would make no sense to build both alternatives.

A department of transportation of a society is confronted with proposals for a number of highway projects. Building one of them does not in any technical way preclude building another. Some of them will qualify for construction and be built, others will not.

The point is that there is no technical relation between the projects that will be built and those for which there will be insufficient funds to built. They are all mutually independent investment projects.

Usually, a list of proposed projects is presented with the supposition that not all the projects on the list will be built because available funds will not suffice to cover the cost of the whole list. A capital budget must normally be met. Therefore, certain projects on the list will be built and others will not, but the total cost of those that are constructed must fall within the limitations of the money available, the budget.

Projects may also be mutually independent. For example, take machinery and the buildings to house it. The machinery and its buildings must be analyzed together, if an investment in one assumes an investment in the other. Or they may be analyzed separately, recognizing that although the machinery cannot be properly used without buildings to house it, the buildings themselves may have other uses, as warehouses for example.

The division of an economy into the public and private sectors and investments under the same classification depend on the source of funds of the projects concerned (Lipsey & Chrystal, 1995).

2. PRIVATE VERSUS PUBLIC INVESTMENTS

Private investments are controlled by private persons and private firms for private gain. A company, for example, is considering a replacement of a production lathe with another, more efficient. The only point considered is the effect of the new lathe on the profits of the company. The attitude taken here is characteristic of investment in the private sector.

Private sector investments are not generally infrastructural, that is, they are not concerned with investment in roads or education or the judicial system or any other area whose purpose is to give support to the operation of a society.

Public investment covers such a wide range that it is difficult to define exhaustively. Its main characteristic is that its funding is public. Some other points of difference between public and private investment may help to understand its nature.

In public investment, the desired and result is to benefit society. The relative difficulty of estimating the gain is evident immediately as we compare public investment to private. Public investment is sometimes on a much grander scale than the private sector can manage.

Political realities often rule out participation in large projects by private companies. A change of regime can cause abandonment of support for a project with such attendant losses as only a government can stand. This is not to say that all large projects must be performed by governments. There is no doubt, however, that governments tend to take on larger projects than private firms generally do.

Infrastructural projects are almost always public. The sewer system of a city is the public's concern and so are its streets. Roads and highway, the educational and judicial systems and all their buildings are almost all public. Ports and airports are largely publicly owned and operated. National defense establishments and their many projects are in the public sectors. Analysis of public projects must be judgment by social costs and social benefits.

Externality means that the cost or benefit is external to the books of accounts of whatever economic entity we are talking about. Consider air pollution in a large city, it is a cost associated with power generation, automobile use and bus transportation, as well as industrial production of one kind or another. It never appears on the account books of the power company nor the bus system, nor any industrial plant and most assuredly not on the household accounts of any of the millions of automobile operators, private and public, who drive the city streets.

No one would deny that air pollution is a cost, yet nowhere does it appear. It is an external cost, as opposed to the cost of oil for the power company or operators for the bus company or gasoline for the automobile users that do appear on the books of these economic entities and thus are internal to them (McConnell & Brue, 1996).

Parents educate their children by sending them to an expensive university. In doing so they confer a benefit upon society because educated people help the society in which they live more than uneducated people do. No one appears at the door bringing a check from society that will compensate them for the benefit they have bestowed upon it.

The externalities must be included in an analysis if the analysis is to be worthwhile, but to be included they must first of all be recognized. This statement is truer of public sector studies, because in the private sector it is not to be expected that air pollution, for example, is going to be costed on the books of a taxicab company.

However, this failure of the market system should not mean that the system remain uncorrected in cases where it can be corrected, namely in public sector analysis. If you are studying the costs and benefits of an urban transport system, you should not ignore the decreased traffic congestion, a benefit that will result from a subway, even though that benefit will never appear in its totality on the books of any company or household as revenue.

In sum, externalities should be included in analysis when it is appropriate to do so, that is, when social benefits and costs are relevant.

Whenever market prices diverge from the true costs of a good or service, then a comprehensive analysis is impossible unless market prices are adjusted until they reflect true cists, that is, until they become social prices (Romer, 1996). The word "price" and "cost" are used synonymously, because in any transaction, that which a seller designates as his price is the same money amount as that which the buyer calls his cost. We have seen that certain costs do not appear in the market at all. These must be added as new items in the analysis. Thus we have two operations to perform when making a social benefit/cost analysis (adjustment of certain prices and the addition of entirely new items with their respective prices).

Social benefits and costs are defined as the total benefits and costs of an event to society as a whole.

3. CONCLUSIONS

If producing energy causes air pollution, then the cost of that air pollution must somehow be added to be kilowatt-hour of energy. Opportunity cost is one of the most important concepts in economics. If we have a choice to make between two courses of action, both beneficial to us, then, because we cannot do both, we must give up the benefits of the course of action we reject. But if we give up something, whatever it is, the pleasure we would have taken in it is lost to us. That lost pleasure may be thought of as a cost. A benefit forgone is therefore the same as a cost.

These two points being clear, it is now possible to define opportunity cost. It is the benefit forgone by choosing one mutually exclusive alternative rather than another.

In questions about replacing existing equipment, the idea of opportunity cost will be used extensively. It will also appear whenever we compare accountant's costs with those used by persons responsible for making a decision.

Opportunity cost is particularly in point when the cost of capital is considered. It is the opportunity cost of capital that will be one of our chief guides in making investment decisions. Some explanation of a different concept, and yet what most people think of when the cost of capital is mentioned, is necessary here.

Of course, the opportunity cost of capital will generally exceed the financial cost of capital because one does not normally borrow money in business affairs unless one expects to make a profit on the money borrowed.

We will see that the opportunity cost of capital, also called the discount rate, the minimum attractive rate of return and the marginal rate of return among others, plays a vital role in economic analysis.

Private investments normally have income tax consequences. Because income taxes are costs to the investors, they must be included in any economic analysis where they are significant. In the major industrialized countries, they are always taken into account.

Consider the simple case of two mutually exclusive alternative investments that have different income tax consequences. There is no question that these differential tax payments will affect a choice between the alternatives and thus must enter the economic analysis.

Some countries exist where there are no income taxes. In other countries, taxes are so minimal that they may be ignored. In others, although income tax laws exist, they are not enforced and income tax considerations are of no importance. Needless to say, the ruling consideration is the situation in the country or countries where taxes on the return on our investment will have to be paid.

4. REFERENCES

Newnan Donald G. (1988), Engineering Economic Analysis, Third Edition, Engineering Press, San Jose, California.

Steiner Henry Malcolm (1992), Engineering economic Principles, McGraw-Hill, New York.

Riggs James L., Thomas M. West (1986), Engineering Economics, Third Edition, McGraw-Hill, New York.

Lipsey R.G., Chrystal K.A. (1995), An Introduction to Positive Economics, Oxford University Press, England.

McConnell C., Brue S.L. (1996) Economics-Principles, Problems and Policies, McGraw-Hill Inc, New York.

Romer D. (1996), Advanced Macroeconomics, McGraw-Hill Inc, New York.