Economic Systems Analysis and Assessment: Cost, Value, and Competition in Information and Knowledge Intensive Systems, Organizations, and Enterprises

412 Pages·2011·3.767 MB·English

by  Andrew P. Sage, William B. Rouse(auth.), Andrew P. Sage(eds.)

ECONOMIC SYSTEMS ANALYSIS
AND ASSESSMENT
ffirs 14February2011;14:44:50
WILEY SERIES IN SYSTEMS ENGINEERING
AND MANAGEMENT
Andrew P. Sage, Editor
A complete list of the titles in this series appears at the end of this volume.
ffirs 14February2011;14:44:50
ECONOMIC
SYSTEMS ANALYSIS
AND ASSESSMENT
Cost, Value, and Competition in
Information and Knowledge
Intensive Systems, Organizations,
and Enterprises
Andrew P. Sage
DepartmentofSystemsEngineeringandOperationsResearch,
GeorgeMasonUniversity,
Fairfax,VA22030-4444
William B. Rouse
TennenbaumInstitute
SchoolofIndustrialandSystemsEngineering,
CollegeofComputing,
GeorgiaInstituteofTechnology,
Atlanta,GA30332
JOHNWILEY&SONS,INC.
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LibraryofCongressCataloging-in-PublicationData:
Sage,AndrewP.
Economicsystemsanalysisandassessment/AndrewP.Sage,WilliamB.Rouse.
p. cm.(cid:1) (Wileyseriesinsystemsengineeringandmanagement;54)
ISBN978-0-470-13795-6(hardback)
1. Microeconomics. 2. Systemanalysis. I. Rouse,WilliamB. II. Title.
HB172.S1272011
338.501—dc22 2010042299
PrintedinSingapore
10 9 8 7 6 5 4 3 2 1
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CONTENTS
PREFACE ix
CHAPTER1 INTRODUCTIONTOECONOMICSYSTEMSANALYSISAND
ASSESSMENT:COST,VALUE,ANDCOMPETITIONININFORMATION
ANDKNOWLEDGEINTENSIVESYSTEMS,ORGANIZATIONS,AND
ENTERPRISES 1
1.1. Introduction 1
1.2. AFrameworkforSystemsEngineeringandManagement 2
1.3. TheoryoftheFirm 14
1.4. TheoryoftheConsumer 17
1.5. TheInteractionoftheTheoriesofFirmsandConsumers:Microeconomic
ModelsofEconomicActivity 18
1.6. WelfareorNormativeEconomics 26
1.7. ProgramandProjectManagementEconomics 29
1.8. ContemporaryIssuesConcerningInformationandInformationTechnology
Economics 30
1.9. EconomicPitfallsintheEngineeringofSystems 35
1.10. Summary 41
CHAPTER2 PRODUCTIONANDTHETHEORYOFTHEFIRM 43
2.1. Introduction 43
2.2. TheProductionFunction 44
2.3. MultiproductFirmsandMultiproductProductionFunctions 61
2.4. ClassicTheoryoftheFirm 62
2.5. ImperfectCompetition 81
2.6. Summary 88
CHAPTER3 THETHEORYOFTHECONSUMER 95
3.1. Introduction 95
3.2. EconomicUtilityTheoryandItsAxioms 95
3.3. PropertiesofUtilityFunctions 100
3.4. TheFundamentalProblemoftheConsumer 102
3.5. SensitivityandSubstitutionEffects 120
3.6. Summary 130
v
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vi CONTENTS
CHAPTER4 SUPPLY(cid:1)DEMANDEQUILIBRIAANDMICROECONOMIC
SYSTEMSANALYSISANDASSESSMENTMODELS 137
4.1. Introduction 137
4.2. BasicSupply(cid:1)DemandEquilibriumforaSingleGood 139
4.3. GeneralSupply(cid:1)DemandEquilibriumConditions 170
4.4. ExtensionstoGeneralEquilibriumtoIncludeMarketInterdependencies 184
4.5. MicroeconomicModels 196
4.6. Summary 198
CHAPTER5 NORMATIVEORWELFAREECONOMICS,DECISIONS
ANDGAMES,ANDBEHAVIORALECONOMICS 205
5.1. Introduction 205
5.2. ParetoOptimalityunderPerfectCompetitionConditions 206
5.3. ExternalEffectsandImperfectCompetition:PublicGoods 218
5.4. ExternalEffectsandImperfectCompetition:NonindependentProductionand
Consumption 229
5.5. WelfareMaximizationandSocialChoice 238
5.6. Summary 241
CHAPTER6 COST(cid:1)BENEFITANDCOST(cid:1)EFFECTIVENESSANALYSES
ANDASSESSMENTS 251
6.1. Introduction 251
6.2. TheTimeValueofMoney 253
6.3. IdentificationofCostsandBenefits 274
6.4. TheIdentificationandQuantificationofEffectiveness 283
6.5. Summary 289
CHAPTER7 COSTASSESSMENT 297
7.1. Model-BasedParametersforProductivity 301
7.2. EarlyModelsforEstimationofCosts,IncludingEffortandSchedule 303
7.3. TheConstructiveCostModel 310
7.4. Summary 337
CHAPTER8 APPROACHESTOINVESTMENTVALUATION 343
8.1. Microeconomics 344
8.2. TheInvestmentProblem 348
8.3. InvestmentValuation 350
8.4. Summary 359
CHAPTER9 REALOPTIONSFORINVESTMENTVALUATION 361
9.1. NatureofOptions 361
9.2. OptionPricingTheory 364
9.3. OptionCalculator 367
9.4. StrategicMetrics 372
9.5. InvestmentDecisionMaking 374
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CONTENTS vii
9.6. Value-CenteredR&D 378
9.7. Summary 379
CHAPTER10 CONTEMPORARYPERSPECTIVES 383
10.1. Introduction 383
10.2. EvolutionaryEconomics 383
10.3. PathDependenceandNetworkEffects 384
10.4. IntellectualCapital 385
10.5. ValueofInformation 387
10.6. InvestinginHumans 388
10.7. Summary 390
INDEX 393
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PREFACE
The purpose of this book is to provide a background in the fundamentals of
economicsystemsanalysisandassessmentthatisappropriateforengineersand
managersconcernedwiththesystemsengineeringandmanagementofsystems
that are generally information technology intensive. It isassumed that readers
of this book will have previously studied mathematics through calculus and
differential equations, and that they have some background in linear algebra.
Nopriorbackgroundinmathematicalprogrammingoreconomicsisassumed,
although a modest exposure to undergraduate microeconomics will be very
helpful. The objectives of this book include a salient discussion of engineering
economic systems that will be relevant for those who need or desire to use the
subject matter intheir professional practice.Thisbook willalso supportthose
whomustcommunicateandbrokertheresultsofengineeringeconomicsystems
analyses and assessments between the many professionals having a stake in
definition, development, and deployment of information technology intensive
systems. Finally, this book provides a thorough grounding in investment
analysis and assessment, particularly for technology portfolios, capacity
improvementandexpansion,andmergersandacquisitionstoacquiretechnol-
ogies and/or capacity.
The book itself is comprised of five major parts as follows:
1. Microeconomics. We provide a concise overview of classic microeco-
nomicsincludingproduction and thetheory ofthefirm;theoryofthe
consumer;marketequilibriaandmarketimperfections;andnormative
or welfare economics, including imperfect competition effects and
consumerandproducersurplus.Chapters2to5containthispresenta-
tion. We also discuss some behavioral economics issues in this part,
particularly in Chapter 5. These chapters are as follows:
(cid:1) Chapter 1: Introduction to Economic Systems Analysis and
Assessment
(cid:1) Chapter 2: Production and the Theory of the Firm
(cid:1) Chapter 3: The Theory of the Consumer
(cid:1) Chapter 4: Supply(cid:3)Demand Equilibria and Microeconomic Sys-
tems Analysis and Assessment Models
(cid:1) Chapter5:NormativeorWelfareEconomics,DecisionsandGames,
and Behavioral Economics
2. Program Management Economics. We discuss economic valuation
of programs and projects including investment rates of return,
ix
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x PREFACE
cost(cid:3)benefit and cost(cid:3)effectiveness analysis, earned value manage-
ment, cost structures and estimation of program costs and schedules,
strategic and tactical pricing issues, and capital investment and
options. There is one lengthy chapter in this part:
(cid:1) Chapter 6: Cost(cid:3)Benefit and Cost(cid:3)Effectiveness Analyses and
Assessments
3. CostEstimation.Costestimationtechnologiesinvolveprecedentedand
unprecedented development, commercial off-the-shelf (COTS) soft-
ware, software reuse, application generators, and fourth-generation
languages. Contemporary cost estimation methods are evaluated in
terms of openness of underlying models, platform requirements, data
required as inputs, output, and accuracy of estimates provided by the
models. COCOMO I and II, and COSYSMO are examples of a cost
model, function point cost estimation models. Cost is estimated for
systems of systems engineering. There is a single chapter in this part:
(cid:1) Chapter 7: Cost Assessment
4. Strategic Investments in an Uncertain World. The final part of our
economic systems analysis and assessment efforts is concerned with
valuation of major investments such as technology portfolios and
large-scale capacity expansions, as well as mergers and acquisitions.
Here we provide a chapter that addresses alternative methods for
valuation of firms including Stern(cid:3)Stewart’s EVA, Holt’s CFROI,
and various competing methodologies. Chapter 9 considers option-
based valuation models including classic real option models (Black(cid:3)
Scholes) and extensions for multistage options with more robust
portfolio assumptions. Valuation of information technology intensive
enterprisesisalsoaddressed.Overall,thispartprovidesadiscussionof
valuationmethodsformanagingstrategicinvestmentsinanuncertain
world:
(cid:1) Chapter 8: Approaches to Investment Valuation
(cid:1) Chapter 9: Real Options for Investment Valuation
5. Extensions to the Work. There are many extensions possible to
economic systems analysis and assessment. There are needed exten-
sions to the classic microeconomics of economic systems analysis and
assessmenttoenablesatisfactorytreatmentoftheincreasingreturnsto
scale, network effects, and path-dependent issues generally associated
withcontemporaryultra-large-scaletelecommunicationsandinforma-
tion networks. Investing in the training and education, safety and
health, and work productivity of humans is another very important
issue. In our concluding chapter of this work, we present a very brief
discussion of these issues:
(cid:1) Chapter 10: Contemporary Perspectives
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PREFACE xi
We sincerely hope that readers find our discussions of economic systems
analysis and assessment of value to their work in systems and software
engineering, systems and enterprise management, and related areas.
Andrew P. Sage
Department of Systems Engineering and Operations Research
George Mason University
Fairfax, VA 22030-4444
William B. Rouse
Tennenbaum Institute
School of Industrial and Systems Engineering
College of Computing
Georgia Institute of Technology
Atlanta, GA 30332
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