ENGR1000 Lecture 1 2010 White

8/8/2019 ENGR1000 Lecture 1 2010 White

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INTRODUCTION TO

ENGINEERING

FUNDAMENTALS OF ENGINEERINGPROJECT ECONOMICS - 1

Prepared by ProfPrepared by Prof T.M.LewisT.M.Lewis


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Introduction

Our concern here is with project economics

so we are interested in how economics

interfaces with engineering projects

We will look at using economics as a tool for

examining the feasibility of implementing a

project.


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Economic Analysis.

Economic analysis as applied to engineering is concernedwith assessing the real cost of using resources in order toestablish priorities between competing proposals. Its purposeis to provide the engineer with a means of judging the relativeeconomic merits of alternative schemes and of ensuring thatavailable resources shall be used to achieve the desired endwith the minimum expenditure of means The Institution of CivilEngineers (London)

Use economics to choose between alternative projects on the basis of thereturns that are generated and the resources that are consumed.


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What is Economics?

The study of choice and decision-making in a world

with limited resources. It explores:

1. The principles of supply and demand and how

prices are determined2. Growth and productivity

3. Global interdependence and trade

4. The interrelated roles of consumers, producers,

and government in an economic system


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Wikipedia Definition

Economics is the study of human choicebehavior and how it effects the production,distribution, and consumption of scarceresources. Economics studies how individuals andsocieties seek to satisfy needs and wants throughincentives, choices, and allocation of scarceresources.

Engineers use scarce resources, that havealternative uses, to produce goods for distributionand consumption in the market.


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EconomicsEconomics is based on a number of principles and assumptions:

1. People will normally act in a way that reflects their self-interest

2. People normally act rationally

3. People normally prefer more to less

4. People will normally choose to do things the easy (efficient)way rather than the harder (less efficient) way.

5. If we have to choose between buying from two suppliers wewill normally choose to buy from the one with the lowerprice (other things being equal)

6. If it will cost more to make something than it can be soldfor, we would not normally make it.


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Economics

Not all economic choices are clear cut.

People want food, clothing, shelter, security,transportation and entertainment for example

But they also want BETTER food, clothing,accommodation etc.

Choices become more complicated the moreoptions there are.


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Scarcity

Choice is a problem because ofscarcity.

The problem is that we want morethings than we can afford, and so wehave to make choices.

Once we have to choose, it means we

have to give something up, so scarcity ofresources leads to the need for choicesto be made.


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Scarcity

There are times when we have plenty and timeswhen we have little - sometimes, when the seine ispulled it has fish, sometimes the net is empty.

When it is full they set something aside for the timeswhen it is empty

People do not consume all they have immediately,they save some for later.

If what they have is perishable they may want toexchange it for something that is not.


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Money

In ancient times when people had a surplus theybartered what they had for what they wanted.

The world soon became too complex for bartering to

work, and besides, people wanted something moredurable - so a medium of exchange as a store ofvalue was introduced. At first it was some rare andprecious commodity (e.g. rare shells or teeth, orprecious metals silver/gold)

Nowadays it is (mainly paper) money.


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Money has no intrinsic value - simply a piece of

paper which has an agreed store of value

(sometimes has a promise to pay).

Its value depends on it being scarceIts value depends on it being scarce

This is worth abou

tUS16This is wor

th abou

tUS16


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It comes in all sorts of values

This is worth about US$16This is worth about US$16

Why is some money worth more than others?Why is some money worth more than others?

Because some money is more scarceBecause some money is more scarce


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NOTE !!!

MONEY DOESNOT HAVE A FIXED VALUE.

IT CAN VARY QUITE A LOT FROM DAY TO DAY

ESPE

CIALLY

IN

TIMES

OF HIGH IN

FLATION


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In 1980 the Zimbabwean dollar was worth more than the U.S.

dollar, with ZWD 1 = USD 1.47

INFLATION

Some countries have it worse than others: A

500,000,000,000 (500 billion) Yugoslav dinarbanknote is the largest nominal value ever officially

printed (circa 1993) .

In May 2008 ZWD 250,000,000 = US20


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In 2009 due to the effects ofhyper-inflation

3 eggs cost ZW$100 billion

Inflation rate is 11 million % per annum 20%

per hour.

Every five hours prices double!

Due to be revalued on the basis of new Z$1 for

old Z$10 billion


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Hyperinflation

The value of the currency keeps falling so

dramatically because they keep printing more

and more of it.

It is not scarce

There is no demand for it

Too much money is available and chasing thesame goods


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Interest & Inflation 1

Inflation is a measure of the increase inthe price of goods in a market

It represents a decline in the purchasingpower of money because the price ofgoods is going up.

Deflation is a measure of the decrease inprices


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Interest & Inflation 2

Interest represents a rate of growth ofmoney savings.

If you save money, interest increases itspurchasing power.

Interest increases the value of yourmoney while inflation decreases it.

The net effect is obviously important.


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Caribbean Interest Rates

What you have to pay to borrow money


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Caribbean Interest Rates

What you get for saving money


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Spreads - 2006

Countries LendingRate DepositRate Spread As % of Deposit Rate

Antigua & Barbuda 10.00 1.00 9.00 900

The Bahamas 5.50 3.17 2.33 74

Barbados 10.15 5.25 4.90 93

Belize 14.20 8.20 6.00 73Dominica 8.50 1.00 7.50 750

Grenada 8.50 1.00 7.50 750

Guyana 14.54 2.48 12.06 486

Jamaica 21.90 2.50 19.40 776

Montserrat 9.50 2.00 7.50 375

St Kitts & Nevis 8.50 1.00 7.50 650

St Lucia 9.50 1.00 8.50 750

St Vincent & Grenadines 9.50 1.00 8.50 750

Trinidad & Tobago 11.06 2.68 8.38 313

(The Difference) - Whatthe Banktakes for handling your money


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Caribbean Inflation Rates


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Effect of Inflation

Over the year of 2006 if you had savings of

$100 you would have earned interest but

prices would have gone up the net effect in:

Barbados : $5.25 7.3 = -$2.05 LOSS

Jamaica : $2.5 5.8 = -$3.30 LOSS

Trin & Tob : $2.68 8.3 = -$5.62 LOSS

Guyana : $2.48 5.2 = -$2.72 LOSS


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Exchange and Value

Why do different currencies have different values?

Because goods cost different amounts of (local)

money

The exchange rate is supposed to make the costs ofbuying things equal in every market

What costs TT$6.3 in T&T should cost US$1 in the

USA or the exchange rate is not properly in balance.

It is rarely fully in balance because there are so many

different goods to compare


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Caribbean Exchange Rates


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Money illusion

Many people think that the T&T $ is weaker than theBarbados $ because its exchange rate against theUS$ is higher in T&T (6:1) than Barbados (2:1) - but,it all depends what you can buy for TT$1 here and

what that same item costs in Barbados in B$. In other words, people tend to think of currency in

nominal, rather than real, terms this is calledMoney illusion

The value on the note is NOT as important as what itcan buy in that country.

Real value is determined by Purchasing Power


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Purchasing Power Parity CHICKENOMICS

The KFC chicken sandwich is a standard good and is availablein all the Caribbean islands.

Based on prevailing exchange rates to the US$, Guyana is thecheapest place to buy a KFC chicken sandwich in the region;

the most expensive is Cayman Islands with Barbados not farbehind i.e. their currencies are over-valued compared withthe US$.

Within the OECS, St Lucia was the cheapest with Antigua &Barbuda tying with St Kitts & Nevis for most expensive.

Guyana, Suriname and Trinidad were the only countriescheaper than the United States to buy a KFC chicken sandwich

i.e. their currencies are under-valued compared with theUS$.


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Project Economics

Our concern is with the economics ofengineering projects

We want to build the projects that deliver the

highest benefit at the lowest cost.

We need to be aware of the currencies thatwill be required, if all cannot be paid for in

local $. We need to know when the bills will have to

be paid


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Principles of Project Appraisal

In general terms the projects with which engineerstend to be involved are investmentprojects (i.e. theylast a relatively long time) in which a capital

expenditure is involved (i.e. they generate benefitsover their working life).

This usually means that there is a currentoutlay ofcash in return for an anticipatedfuture flow ofbenefits.

On public sector projects especially there will besignificant non-cash benefits


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Principles of Project Appraisal

Projects with non-cash costs or benefits must involvean economic evaluation as well as a financialevaluation: - building a school

constructing a mass-transit system developing agricultural land,

determining whether to rent or buy facilities, equipmentor services (e.g. office buildings)

building a road,

safety equipment (lights and crash barriers) on a road

determining the degree of protection against flooding,hurricanes and earthquakes.


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Effect of Time

In the broadest terms the principles of project

appraisal relate to the quantification of costs and

benefits over the life of the project.

However, it is not sufficient simply to examine thetotal amounts of these costs and benefits because of

the 'time value of money'.

Would you rather have $100 now or in five years

time? Why?

Well it is at least partly because of INTEREST


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Effect of Time

People who receive income and do not buy all thegoods to which they are entitled save, and thismoney is available for others to use in investments.

The people who refrain from consumption arecompensated for this in the form ofinterest.

Interest is a reward for choosing to abstain fromconsumption

The people who borrow have to pay interest for theuse of that money


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Interest

Interest is the price of money and is

determined by supply and demand

Supply is determined by peoples willingnessto save or their marginal time preference

rate

Demand is determined by peoples

expectations regarding profits and inflation


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Savings

Savings involve risks

You may not be around to spend it

The bank may not be around

The economy may collapse so value may be destroyed orchoice reduced

There may be local or international war

Alternative investment opportunities may be lost

Inflation rates may rise

Currency may be devalued

Hence the interest rate is a compensation for theserisks


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Time Value of Money

If you save $100 today and put it in account

earning 5% interest per annum, for one year,

how much will you have at the end of that

year?

$100 + 100*.05 = 100(1+0.05) = $105

If you leave the money there, how much will

you have at the end of 2 years?

$105 + 105*.05 = 100(1+.05)(1+.05)

=$110.25


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Time Value of Money

i = interest rate

n = number of periods (years)

P = the sum of money you start with

F = the sum of money you have in the future

This can be expressed as

F = P(1+i)n


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ENGR1000 Lecture 1 2010 White

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