The Criterion of Economic Choice

Abstract

This paper outlines the method of determining the economic choice which is believed to be universally applicable, mathematically rigorous, and quantitatively correct to the extent permitted by the accuracy with which component items of cost can be forecast. It introduces no drastic innovations, and may be described simply as a better organization of well-established principles. However, it does demonstrate that a number of generally accepted conclusions and procedures are unsound. It points out the advantages of distinguishing between selecting the economic choice and capital budgeting; it discusses difficulties that arise when analysts attempt to solve problems in the first category by applying techniques appropriate to the latter. The paper demonstrates that the economic choice is the alternative having minimum present worth of revenue requirements; i.e., the revenues needed to earn a rate of return acceptable to investors after paying all expenses. It describes the solution to problems in engineering economy in two steps: 1. Determining which alternative is most economic, and by how much. 2. Selecting the most desirable plan, in the light of step 1, plus other factors not reducible to dollars. It is shown that this approach is equally appropriate for regulated utilities and nonregulated industry. The paper also discusses practical applications of this technique to long-range estimates as they are encountered in system planning, as well as means of anticipating the effect of future changes in price levels.