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Session 1239 .— - .

Moving Beyond Time Value of Money: The Application of Macroeconomic Theory to Capital Investment Decision-Making

Peter M. Boerger Purdue University

1. Introduction Considering that the two fields share the same word root, an outsider to the field of engineering econ- omy might assume that the fields of macroeconomics and engineering economy are closely related and have ex- perienced significant cross-fertilization. In fact, as those who practice in the field of engineering economy will attest, this assumption would be far from the truth.

Engineering economy texts are written with little or no mention of macroeconomic theory. Most books introduce engineering economy through linking it to the notion of a “decision” and then launch right into time value of money methods. There is nothing wrong with this approach if in fact macroeconomics has nothing to offer in furthering the work of engineering economy, however that assumption is wrong.

This paper will show that there is theory from macroeconomics which is relevant to the engineering eco- nomic problem. As such, engineering economists can improve their investment choices if they incorporate that theory into their decision models. The justification of this statement and an approach to applying it are the sub- stance of this paper.

The notion of applying macroeconomic principles to engineering economy is not totally new. Horowitz, in response to a request to review the status of engineering economy in 1976 called for engineering economists to 3 apply recent economic developments to their task. This paper can be seen as expanding on Horowitz’s call.

2. Why the Divide? Why is it that engineering economy and macroeconomics are so separated? Part of the reason is the dif- ference in their objectives. Engineering economy seeks to help firms improve their capital investment decisions. Macroeconomics in contrast has a broader goal; it is concerned with understanding how resources are allocated in an economy. From appearances, these look like quite disparate objectives and so the lack of communication between the fields seems understandable.

However, upon closer examination we see that these fields are closer than they first appear. Macroecon- omics accomplishes its goal in part through developing an understanding of how firms make decisions. This looks closer to the engineering economic objective which provides decision-making models. It might be said that this similarity is illusory in that the engineering economic approach to decision-making is “normative,” tell- ing firms how they should behave, while macroeconomics is “positive,” concerned with how rational firms do behave. However, the way firms should behave is exactly how rational firms do behave, so the two fields do not

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Boerger, P. M. (1996, June), Moving Beyond Time Value Of Money: The Application Of Macroeconomic Theory To Capital Investment Decision Making Paper presented at 1996 Annual Conference, Washington, District of Columbia. 10.18260/1-2--6198