Rational Decision Making: Assemble Relevant Data.

To make a good decision, one must first assemble good information. In addition to all the published information, there is a vast quantity of information that is not written down anywhere but is stored as individuals' knowledge and experience.There is also information that remains ungathered. A question like "How many people in your town would be interested in buying a pair of left-handed scissors?" cannot be answered by examining published data or by asking anyone person. Market research or other data gathering would be required to obtain the desired information.

From all this information, what is relevant in a specific decision-making process?

Deciding which data are important andwhich are notmaybe a complextask.The availability of data further complicates this task. Some data are available immediately at little or no cost in published form; other data are available by consulting with specific knowledgeable people; still other data require surveys or research to assemble the information. Some data will be of high quality-that is,precise and accurate,while other datamay rely onindividual judgment for an estimate.

If there is a published price or a contract, the data may be known exactly. In most cases, the data is uncertain. What will it cost to build the dam? How many vehicles will use the bridge next year and in year 20? How fast will a competing firm introduce a competing product? Howwill demand depend on growth in the economy? Future costs and revenues are uncertain, and the range of likely values should be part of assembling relevant data.

The problem's time horizon is part of the data that must be assembled. How long will the building or equipment last? How long will it be needed? Will it be scrapped, sold, or shifted to another use? In some cases, such as for a road or a tunnel, the life may be centuries with regular maintenance and occasional re-building. A shorter time period, such as 50 years, may be chosen as the problem's time horizon, so that decisions can be based on more reliable data.

In engineering decision making, an important source of data is a firm's own accounting system. These data must be examined quite carefully. Accounting data focuses on past information, and engineering judgment must often be applied to estimate current and future values. For example, accounting records can show the past cost of buying computers, but engineering judgment is required to estimate the future cost of buying computers.

Financial and cost accounting are designed to show accounting values and the flow of money-specifically costs and benefits-in a company's operations. Where costs are directly related to specific operations, there is no difficulty; but there are other costs that are not related to specific operations. These indirect costs, or overhead, are usually allocated to a company's operations and products by some arbitrary method. The results are generally satisfactory for cost-accounting purposes but may be unreliable for use in economic analysis.

To create a meaningful economic analysis, we must determine the true differences between alternatives, which might require some adjustment of cost-accounting data. The following example illustrates this situation.

EXAMPLE:

The cost-accounting records of a large company show the average monthly costs for the three-person printing department. The wages of the three--departmentmembers and benefits, such as vacation and sick leave, make up the first category of direct labor. The company's indirect or overhead costs-such as heat, electricity, and employee insurance-must be distributed to its various departments in some manner and, like many other firms, this one usesfloor space as the basis for its allocations.


The printing department charges the other departments for its services to recover its $18,000 monthly cost. For example, the charge to run 1000copies of an announcement is:


The shipping department checkswith a commercial printer which would print the same 1000 copies for $22.95. Although the shipping department needs only about 30,000 copies printed a month, its foreman decides to stop using the printing department and have the work done by the outside printer. The in-house printing department objects to this. As a result, the general manager has asked you to study the situation and recommend what should be done.

SOLUTION

Much of the printing department's output reveals the company's costs, prices, and other financial information.

The company president considers the printing department necessary to prevent disclosing such information to people outside the company.

A review of the cost-accounting charges reveals nothing unusual. The charges made by the printing department cover direct labor, materials and supplies, and overhead. The allocation of indirect costs is a customary procedure in cost-accounting systems, but it is potentially misleading for misleading for decision making, as the following discussion indicates.


The shipping department would reduce its cost from $793.50 to $688.50 by using the outside
printer. In that case, how much would the printing department's costs decline?We will examine
each of the cost components:

1. Direct Labor. If the printing department had been working overtime, then.the overtime could be reduced or eliminated. But, assuming no overtime, how much would the saving be? It seems unlikely.thata printer could be fired or evenput on less.than'a 40~hourwork week. Thus, although there might be a $228 saving, it is likely that there will be no reduction in direct labor.

2. Materials and Supplif?s.There would be a $294 saving illmaterials aIldsupplies. ~ ~

3. Allocated Overhead Costs: TherewiU be no reduction"inthe prirlting.dePartm~nt's monthly $5000 overhead, for there will be 110reduction in departmentf:lOOl:space. (Actually, of course, theremay be a slight reductionin the AfII1:SpO~er~,g§ls!fth~l?ri1l,Wt~d~l?artInent does less work.)

The firm will save $294 in materials and.supplies ancll)1ayorillay not save $228 in direct labor if the printing department no longer does the shipping departament work. The maximun saving would be $294 + 228 =  $522. But if the shipping departament is permited obtain its printing from the outside printer, the firm must pay $688.50 a month.



The saving from not doing the shipping departInent work in the printing deparrtanebt would not.exceed $522,and it. probably would be only $294, The result would bea net increase in cost to the firm. For this reason, the shipping department should be discouraged from sending itsprintirig to the outside printer.

Gathering cost data presents other difficulties. One way to look at the financial consequences--costs and benefits-of various alternatives is as follows.

-Market Consequences. These consequences have an established price in the marketplace. We can quickly determine raw material prices, machinery costs, labor costs, and so forth.

-Extra-Market Consequences. There are other items that are not directly priced in the marketplace. But by indirect means, a price may be assigned to these items. (Economists call these prices shadow prices.) Examples might be the cost of an employee injury or the value to employees of going from a 5-day to a 4-day,40-hour week.

-Intangible Consequences. Numerical economic analysis probably never fully describes the real differences between alternatives. The tendency to leave out consequences that do not have a significant impact on the analysis itself, or on the conversion of the finaldecision into actualmoney, is difficult to resolve or eliminate.

How does one evaluate the potential loss of workers' jobs due to automation?What is the value of landscaping around a factory? These and a variety of other consequences may be left out of the numerical calculations, but they should be considered in conjunction with the numerical results in reaching a decision.

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