Engineering Economic Analysis

6 MAKING ECONOMIC DECISIONS

Engineering economic analysis can also be used to answer questions that are personally

important.

·How to achieve long-termfinancial goals: How much should you save each month

to buy a house, retir~,offund a trip around the world? Is going to graduate school

a good investment-Will your additional earnings in later years balance your lost

income while in graduate school?

· How to compare different ways to finance purchases: Is it better to finance your

car purchase by using the dealer's low interest rate loan or by taking the rebate and

borrowing money from your bank or credit union?

· How to make short and long-term investment decisions: Is a higher salary better than

stock options? Should you buy a 1- or 2-semester parking pass?

TH,E DECISION-MAKING PROCESS

Decision making may take place by default; that is, a person may not consciously recognize

that an opportunity for decision making exists. This fact leads us to a first element in a

definition of decision making. To have a decision-making situation, there must be at least

two alternatives available. If only one course of action is available, there can be no decision

making, for there is nothing to decide. There is no alternative but to proceed with the single

available course of action. (It is rather unusual to find that there are no alternative courses

of action. More frequently, alternatives simply are not recognized.)

At this point we might conclude that the decision-making process consists of choosing

from among alternative courses of action. But this is an inadequate definition. Consider the

following:

At a race track, a bettor was uncertain about which of the five horses to bet on in the

next race. He closed his eyes and pointed his finger at the list of horses printed in the

racing program. Upon opening his eyes, he saw that he was pointing to horse number 4.

He hurried off to place his bet on that horse..

Does the racehorse selection represent the process of decision making? Yes, it clearly

was a process of choosing among alternatives (assuming the bettor had already ruled out

the "do-nothing" alternative of placing no bet). But the particular method of deciding seems

inadequate and irrational. We want to deal with rational decision making.

Rational Decision Making

Rational decision making is a complex process that contains nine essential elements, which

are shown sequentially in Figure 1-1. Although these nine steps are shown sequentially,

it is common for decision making to repeat steps, take them out of order, and do steps

simultaneously. For example, when a new alternative is identified, then more data will be

required. Or when the outcomes are summarized, it may become clear that the problem

needs to be redefined or new goals established.

The value of this sequential diagram is to show all the steps that are usually required,

. and to show them in a logical order. Occasionally we will skip a step entirely. For example,
a new alternative may be so clearly superior that it is immediately adopted at Step 4 without
further analysis. The following sections describe the elements listed in Figure1-1.