Engineering Economic Analysis provides a systematic framework for making choices among competing courses of action, particularly for problems where economic factors are significant. Its primary application is for intermediate-level problems and the economic aspects of complex problems that cannot be solved mentally and warrant serious effort.

1. The Rational Decision-Making Process

A structured, logical method is employed to select the best alternative. The process consists of nine distinct, though often iterative, steps:

1. Recognize the Problem: Identify that a decision-making opportunity exists.
2. Define the Goal or Objective: Clearly state the desired outcome or task.
3. Assemble Relevant Data: Gather facts, identify uncertainties, and determine the time horizon. This includes differentiating between market, extra-market, and intangible consequences. Data from a firm’s accounting system must be used carefully, as allocated overhead costs may not reflect the true differences between alternatives.
4. Identify Feasible Alternatives: Generate a comprehensive list of potential solutions, including the “do-nothing” option.
5. Select the Criterion for Choosing the Best Alternative: Establish a standard for what constitutes the “best” outcome. This is typically an economic criterion.
6. Construct the Model: Merge the objective, data, alternatives, and criterion into a mathematical or logical model.
7. Predict the Outcomes for Each Alternative: Forecast the consequences of each course of action.
8. Choose the Best Alternative: Select the option that best meets the criterion, considering both numerical and intangible factors.
9. Audit the Results: Compare actual outcomes against projections to improve future analyses and ensure projected benefits are realized.

1. Classification of Problems

Decision problems can be classified by their complexity:

• Simple Problems: Situations with straightforward solutions that require minimal time and effort (e.g., paying with cash vs. credit).
• Intermediate Problems: Primarily economic problems that require careful analysis (e.g., selecting equipment for a new assembly line). This is the primary domain of engineering economic analysis.
• Complex Problems: A mixture of economic, political, and humanistic elements where economic analysis informs a decision that also considers noneconomic forces (e.g., multinational corporate strategy).

1. Core Economic Criteria

The selection of an economic criterion depends on the constraints of the problem. All problems fall into one of three categories: