UNIT 1: LINEAR EQUATIONS AND THEIR INTERPRETATIVE APPLICATION

Contents
1.1.Linear Equations, Functions and Graphs

1.1.1. Developing equation of a line

1.1.2. Special formats

1.2.Application of linear equations

1.2.1. Linear cost-output relationships: Variable Cost, Fixed cost, Total Cost,

Average Cost, Marginal Cost , Total Revenue and Total Profit

1.2.2. Break-even analysis : Model and Solution

1.2.3. Market Equilibrium Analysis

1.3.Summary

 Introduction
Mathematics, old and newly created, coupled with innovative applications of the rapidly

evolving electronic computer and directed toward management problems, resulted in a new

field of study called quantitative methods, which has become part of the curriculum of

colleges of business. The importance of quantitative approaches to management problems is

now widely accepted and a course in mathematics, with management applications is included

in the core of subjects studied by almost all management students. This manual develops

mathematics in the applied context required for an understanding of the quantitative approach

to management problems.

1.1.Linear Equations , Functions and Graphs

Equation: - A mathematical statement which indicates two algebraic expressions is equal.

Example: Y = 2X + 3

Algebraic expressions: - A mathematical statement indicates that numerical quantities are

linked by mathematical operations.

Example: X + 2

Linear equations: - are equations with a variable & a constant with degree one.

- Are equations whose terms (the parts separated by +, -, = signs)

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 - Are a constant, or a constant times one variable to the first power

Example: 2X – 3Y = 7

- The degree (the power) of the variables is 1

- The constant or the fixed value is 7

- The terms of the equation are 2X and 3Y separated by – sign

However 2X + 3XY = 7 isn’t a linear equation, because 3XY is a constant times the product

of 2 variables.

* No X2 terms, No X/Y terms, and no XY terms are allowed.

- Linear equations are equations whose slope is constant throughout the line.

- The general notion of a linear equation is expressed in a form Y = mx + b where m =

slope, b = the Y- intercept, Y = dependent variable and X = independent variable.

If Y represents Total Cost, the cost is increased by the rate of the amount of the slope m.

Y rise  fall Y Y
Slope (m) =   2 1 if X1  X2
X run X 2  X1

Slope measures the steepness of a line. The larger the slope the more steep (steeper) the line

is, both in value and in absolute value.

Y Y m = undefined

+ive slope

m=0

-ve slope

X X

- A line that is parallel to the X-axis is the gentlest of all lines i.e. m = 0

- A line that is parallel to the Y-axis is the steepest of all lines i.e. m = undefined or

infinite.

The slope of a line is defined as the change-taking place along the vertical axis relative to

the corresponding change taking place along the horizontal axis, or the change in the

value of Y relative to a one-unit change in the value of X.

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 1.1.1. Developing Equation of a Line
There are at least three ways of developing the equation of a line. These are:

1. The slope-intercept form

2. The slope-point form

3. Two-point form

1. The slope-intercept form

This way of developing the equation of a line involves the use of the slope & the intercept to

formulate the equation. Often the slope & the Y-intercept for a specific linear function are

obtained directly from the description of the situation we wish to model.

Example # 1

Given: Slope = 10, and

Y-intercept = +20, then

Slope-intercept form: the equation of a line with slope = m and Y-intercept b is

Y = mx + b

Y = 10X + 20

Interpretative Exercises
#1: Suppose that the Fixed cost (setup cost) for producing product X be br. 2000. After

setup it costs br. 10 per X produced. If the total cost is represented by Y:

1. Write the equation of this relationship in slope-intercept form.

2. State the slope of the line & interpret the number

3. State the Y-intercept of the line & interpret the number

#2. A sales man has a fixed salary of br. 200 a week In addition; he receives a sales commission

that is 20% of his total volume of sales. State the relationship between the sales man’s total

weekly salary & his sales for the week.

Answer Y = 0.20X + 200

2. The slope point form

The equation of a non-vertical line, L, of slope, m, that passes through the point (X1, Y1) is:

defined by the formula Y – Y1 = m (X – X1)

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 Y – Y1 = m (X – X1)

Example #1  Y – 2 = 4 (X – 1)

Given: slop = 4 and Y – 2 = 4X - 4

Point = (1, 2) Y = 4X – 2

3. Two - point form

Two points completely determine a straight line & of course, they determine the slope of the

line. Hence we can first compute the slope, then use this value of m together with either point

in the point-slope form Y – Y1 = m (X – X1) to generate the equation of a line.

 By having two coordinate of a line we can determine the equation of the line.

 Y Y 
Two point form of linear equation: (Y – Y1) =  2 1  X  X 1 
 X 2  X1 
Example #1 given (1, 10) & (6, 0)
0 10  10
First slope =    2 , then
6 1 5

Y – Y1 = m (X – X1)  Y – 10 = -2 (X – 1)

Y – 10 = -2X + 2

Y = -2X + 12

1.1.2. Special formats

a) Horizontal & vertical lines

When the equation of a line is to be determined from two given points, it is a good idea to

compare corresponding coordinates because if the Y values are the same, the line is

horizontal & if the X values are the same the line is vertical.

Example: 1 Given the points (3, 6) & (8, 6) the line through them is horizontal because

Both Y-coordinates are the same i.e. 6

The equation of the line becomes Y = 6, which is different from the form Y = mx + b

If the X-coordinates of the two different points are equal:

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 Example: (5, 2) & (5, 12) the line through them is vertical, & its equations is X = 5 i.e. X is

equal to a constant. If we proceed to apply the point slope procedure, we would obtain the

following.
12  10 2
Slope (M) =    & if m =  infinite the line is vertical & the form of the
55 0

equation is: X = constant

b) Parallel & perpendicular lines ( and)

Two lines are parallel if the two lines have the same slope, & two lines are perpendicular if

the product of their slope is –1 or the slope of one is the negative reciprocal of the slope of

the other.

However, for vertical & horizontal lines, (They are perpendicular to each other), this rule of

M1 (the first slope) times M2 (the second slope) equals –1 doesn’t hold true. i.e. M1 x M2  -1

Example: Y = 2X – 10 & Y = 2X + 14 are parallel because their slope are equal i.e. 2

Y = 3/2X + 10 & Y = -2/3X + 100 are perpendicular to each other because the
3 2
multiplication result of the two slope are –1 i.e. x  1
2 3
c) Lines through the origin
Any equation in the variables X & Y that has no constant term other than zero will have a

graph that passes through the origin. Or, a line which passes through the origin has an X-

intercept of (0, 0) i.e. both X and Y intercepts are zero.

1.2. Application of linear equations

1.2.1. linear cost - output relationships: – Variable Cost , Fixed Cost , Total Cost ,

Average Cost , Marginal Cost , Total Revenue and Total Profit

TR/TC profit Formula: TC = TVC + TFC

Or TP region TR = PQ

TC TR TP = TR - TC

Loss T

region E BEP = PQ – (VC + FC)

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 TVC H

A F G FC = PQ – Q.VC - TFC

TC

TFC = Q (P – VC) - FC

B C D G(No of units)
Where Q = units

produced & units

sold in revenue

TC = Total Cost

FC = Fixed Cost

VC = Unit variable

Cost

Interpretation of the graph:

1. The vertical distance between AB, FC, GD is the same because Fixed Cost is the

same at any levels of output.

2. There is no revenue without sales (because Total Revenue function passes through the

origin), but there is cost without production (because of Fixed Cost) & the TC

function starts from A & doesn’t pass through the origin.

3. Up to point T, Total Cost is greater than Total Revenue  results in loss. While at

point T, (Total Revenue = Total Cost) i.e. Breakeven. (0 profit), & above point T, TR

> TC  +ve profit.

4. TFC remains constant regardless of the number of units produced. Given that there is

no any difference in scale of production.

5. As production increases, Total Variable Cost increases at the same rate and Marginal

cost is equal with Unit Variable Cost (MC = VC) only in linear equations.

6. As production increases TC increases by the rate equal to the AVC = MC (average

cost equal to marginal cost)

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 7. AVC is the same through out any level of production, however Average Fixed Cost

(AFC) decreases when Quantity increases & ultimately ATC decreases when Q

increases because of the effect of the decrease in AFC.

8. As Quantity increases TR increases at a rate of P. and average revenue remains

constant.

TR P. Q
AR =  = P  AR = P in linear functions
Q Q

1.2.2. Break- even Analysis

Break-even point is the point at which there is no loss or profit to the company. It can be

expressed as either in terms of production quantity or revenue level depending on how the

company states its cost equation.

Manufacturing companies usually state their cost equation in terms of quantity (because they

produce and sell) where as retail business state their cost equation in terms of revenue

(because they purchase and sell)

Case 1: Manufacturing Companies

Consider a Company with equation

TC = VC + FC / Total cost = Variable cost + Fixed cost

TR = PQ/ Total Revenue = Price x Quantity

At Break-even point, TR = TC i.e TR – TC = 0

PQ = VC + FC where Qe = Breakeven Quantity

PQ – VC.Q = FC FC = Fixed cost

Q (P – VC) = FC P = unit selling price

FC
Qe = VC = unit variable cost
P  VC

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 TR

TC/TR TC

FC
Qe =
P  VC

Example #1 A manufacturing Co. has a Total Fixed Cost of Br. 10,000 & a Unit Variable

Cost of Br. 5. if the co. can sell .What it produces at a price of Br. 10,

a) Write the Revenue, cost & Profit functions

b) Find the breakeven point in terms of quantity and sales volume

c) Show diagrammatically the Total Revenue, Total Cost, Total Profit, Fixed Cost and

Variable Costs.

d) Interpret the results

Answer

a) TC = VC + FC TR = PQ Profit() = TR – TC

TC = 5Q + 10,000 TR = 10Q = 10Q – (5Q + 10,000)

= 5Q – 10,000

b) At break even point TR = TC

10Q = 5Q + 10,000

5Q – 10,000 = 0
10,000
Qe =
5
Qe = 2000 units

i.e. Breakeven Quantity is 2000 units

Sales volume = 2000 X 10 = 20,000 br.

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 25000 TR = 10Q 

20000 TC = 5Q + 10000 TVC = 5Q

15000 TVC T = 5Q - 10000

10000

5000 TFC

1000 2000 3000 4000 5000 Q (no. of units produced

& sold)

-5000 -

-10000 -

Interpretation:
When a co. produces & sells 2000 units of output, there will not be any loss or gain (no

profit, no loss)

 The effect of changing one variable keeping other constant

Case 1 - Fixed cost

Assume for the above problem FC is decreased by Br. 5000, Citrus Paribus (other things

being constant)
5000
TC = 5Q + 5000  Qe = = 1000 units
5
TR = 10Q

Therefore, FC   Qe  FC & Qe have direct relationship

FC   Qe 

Case 2-Unit variable cost

Assume for the above problem UVC decreased by 1 br. Citrus Paribus (keeping other thing

constant)

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 10000
TC = 4Q + 10000  Qe =  1,667 units
6
TR = 10Q

Therefore, VC   Qe  VC & Qe have direct relationship

VC   Qe 

Case 3- Selling price

Assume for the above problem selling price is decreased by br. 1, Citrus Paribus,
10000
TC = 5Q + 10,000  Qe =  2500 units
4
TR = 9Q

Therefore P   Qe  Price and breakeven point have indirect relationship

P   Qe 

In the above example a company has the following options (to minimize its breakeven point

and maximize profit).

- decreasing FC

- decreasing unit VC

- increasing the unit selling price

And if the organization is between option 2 & 3, it is preferable to decrease the unit variable

cost because if we increase the selling price, the organization May loose its customers & also

decreasing the FC is preferable.

TR

TC

TFC

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 Qe Q

Finding the quantity level which involves profit or loss

FC  0
BEP = , any Q is related to the cost , profit----
P V

 = TR – Tc Where: BEP = breakeven point

 = PQ – (VC.Q + FC)  = Profit

 = (P.Q – VC.Q) – FC TR = Total revenue

 = Q (P – VC) – FC TC = Total cost

   FC FC  
 for any qty level Q  Q = Quantity
P  VC P  VC

C = Unit variable cost

Example #1 For the above manufacturing co. if it wants to make a profit of 25000 br. What

should be the quantity level?

FC  
TR = 10Q Q= when there is , the quantity produced &
P V

sold have to be greater than the

Breakeven quantity
10,000  25000
TC = 5Q + 10,000 =
10  5

 = 25,000 = 7000 units

Q=?

If it expects a loss of br. 5000 what will be the quantity level.

FC  VC 10,000  5000
Q=  * when there is loss, the qty produced & sold
P VC 10  5

should be less than the BEQ

Case 2 Merchandising /Retail Business

Breakeven Revenue = BEQ X P

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Assume a bus. Firm with product A has the following cost & revenue items.

Variable cost of A = 100 br.

Selling price = 150 br.

Markup = Selling price – Variable cost = 150 – 100 = 50

i. as a function of cost, the markup is 50/100 = 50%

ii. as a function of retail price, the markup is 50/150 = 33.3 % it is also called margin.

Margin Cost of goods sold

The cost of goods sold = 100% - 33.3 % = 66.6%  67%

Selling price CGS

Given other selling expense = 1%of the selling price i.e. 0.01X

So, the TC equation becomes:

Y = 0.68X + FC

Where: X is sales revenue

Y is total cost

Out of 100% selling price 68% is the variable cost of goods purchased & sold

Example Suppose a retail business sale its commodities at a margin of 25% on all items

purchased & sold. Moreover the company uses 5% commission as selling expense & br.

12000 as a Fixed Cost.

Find the Breakeven revenue for the retail business after developing the equation

Solution Selling price 100% Let X represents selling price

Margin 25% Y = total cost

CGS 75% FC = 12000

Comm. Exp. 5% Xe = Breakeven revenue

Total VC 80%

Y = 0.8X + 12000

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Break even revenue is obtained by making sales revenue & cost equals

At breakeven point TC = TR Y = mx + b

i.e. Y = X then, unit variable cost

FC FC   VC TVC
0.8X + 12000 = X  or where m  
1 m 1 m P TR

-0.2X = -12000

X = 60,000 br.  When the co. receives br. 60,000 as sales revenue,

there will be no loss or profit.

FC  
The Breakeven revenue (BER = ) method is useful, because we can use a single
1 m

formula for different goods so far as the company uses the same amount of profit margin for
FC  
all goods. However, in Breakeven quantity method or BEQ = it is not possible and
P V

hence we have to use different formula for different items.

Example #1 It is estimated that sales in the coming period will be br. 6000 & that FC will

be br. 1000 & variable costs br. 3600, develop the total cost equation & the breakeven

revenue.
3600
Answer: Y = X + 1000 = 0.6X + 1000
6000
Where Y = Total Cost

X = Total revenue

1000 1000
BER = Xe =   2500 br.
1  0.6 0.4

At the sales volume of br. 2500, the company breaks even.

* When the breakeven revenue equation is for more than one item it is impossible to find the

breakeven quantity. It is only possible for one item by Qe = Xe/P

Where Xe = Break even revenue

P = selling price

Qe = Breakeven quantity

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To change the breakeven revenue equation in to breakeven quantity, we have to multiple

price by the coefficient of X. likewise, to change in to breakeven revenue from Break even

quantity, we have to divide the unit VC by price.

1.2.3. Market Equilibrium Analysis

When the supply and demand curves intersect, the market is in equilibrium. This is where

the quantity demanded and quantities supplied are equal. The corresponding price is the
equilibrium price or market-clearing price, the quantity is the equilibrium quantity.

Putting the supply and demand curves from

the previous sections together. These two
curves will intersect at Price = $6, and
Quantity = 20.
In this market, the equilibrium price is $6
per unit, and equilibrium quantity is 20
units.
At this price level, market is in equilibrium.
Quantity supplied is equal to quantity
demanded ( Qs = Qd).
Market is clear.

Surplus and shortage:

If the market price is above the equilibrium price, quantity supplied is greater than quantity
demanded, creating a surplus. Market price will fall.
Example: if you are the producer, you have a lot of excess inventory that cannot sell. Will
you put them on sale? It is most likely yes. Once you lower the price of your product, your
product’s quantity demanded will rise until equilibrium is reached. Therefore, surplus drives
price down.

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If the market price is below the equilibrium price, quantity supplied is less than quantity
demanded, creating a shortage. The market is not clear. It is in shortage. Market price will
rise because of this shortage.
Example: if you are the producer, your product is always out of stock. Will you raise the
price to make more profit? Most for-profit firms will say yes. Once you raise the price of
your product, your product’s quantity demanded will drop until equilibrium is
reached. Therefore, shortage drives price up.
If a surplus exist, price must fall in order to entice additional quantity demanded and reduce
quantity supplied until the surplus is eliminated. If a shortage exists, price must rise in order
to entice additional supply and reduce quantity demanded until the shortage is eliminated.
If the market price (P) is higher than $6 (where Qd =
Qs), for example, P=8, Qs=30, and Qd=10.
Since Qs>Qd, there are excess quantity supplied in
the market, the market is not clear. Market is in
surplus.

The price will drop because of this surplus.

If the market price is lower than equilibrium

price, $6, for example, P=4, Qs=10, and Qd=30.

Since Qs<Qd, There are excess quanitty demanded

in the market. Market is not clear. Market is in
shortage.

The price will rise due to this shortage.

Government regulations will create surpluses and shortages in the market. When a price
ceiling is set, there will be a shortage. When there is a price floor, there will be a surplus.
Price Floor: is legally imposed minimum price on the market. A transaction below this

price is prohibited.

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  Policy makers set floor price above the market equilibrium price which they believed
is too low.
 Price floors are most often placed on markets for goods that are an important source
of income for the sellers, such as labor market.
 Price floor generate surpluses on the market. Example: minimum wage.
 Price Ceiling: is legally imposed maximum price on the market. A
transaction above this price is prohibited.
 Policy makers set ceiling price below the market equilibrium price which they
believed is too high.
 Intention of price ceiling is keeping stuff affordable for poor people.
 Price ceiling generates shortages on the market, Example: Rent control.

Changes in equilibrium price and quantity:

Equilibrium price and quantity are determined by the intersection of supply and demand. A
change in supply, or demand, or both, will necessarily change the equilibrium price, quantity
or both. It is highly unlikely that the change in supply and demand perfectly offset one
another so that equilibrium remains the same.
Example: This example is based on the assumption of Ceteris Paribus.
1) If there is an exporter who is willing to export oranges from Florida to Asia, he will
increase the demand for Florida’s oranges. An increase in demand will create a shortage,
which increases the equilibrium price and equilibrium quantity.
2) If there is an importer who is willing to import oranges from Mexico to Florida, he
will increase the supply for Florida’s oranges. An increase in supply will create a surplus,
which lowers the equilibrium price and increase the equilibrium quantity.
3) What will happen if the exporter and importer enter the Florida’s orange market at
the same time? From the above analysis, we can tell that equilibrium quantity will be higher.
But the import and exporter’s impact on price is opposite. Therefore, the change in
equilibrium price cannot be determined unless more details are provided. Detail information
should include the exact quantity the exporter and importer is engaged in. By comparing the
quantity between importer and exporter, we can determine who has more impact on the
market.
In the following table, an example of demand and supply increase is illustrated.

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 In this graph, supply is constant, demand
increases. As the new demand curve (Demand 2)
has shown, the new curve is located on the right
hand side of the original demand curve.
The new curve intersects the original supply
curve at a new point. At this point, the
equilibrium price (market price) is higher, and
equilibrium quantity is higher also.

In this graph, demand is constant, and supply

increases. As the new supply curve (SUPPLY 2)
has shown, the new curve is located on the right
side of the original supply curve.
The new curve intersects the original demand
curve at a new point. At this point, the
equilibrium price (market price) is lower, and the
equilibrium quantity is higher.

In this graph, the increased demand curve and

increased supply were drawn together. The new
intersection point is located on the right hand
side of the original intersection point.
This new equilibrium point indicated an
equilibrium quantity which is higher than the
original equilibrium quantity. The equilibrium
price is also higher. It is because demand has
increased relatively more than supply in this
case.

1.3.Summary
Linear equations: - are equations with a variable & a constant with degree one or are

equations whose terms (the parts separated by +, -, = signs) or are a constant, or a constant

times one variable to the first power

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The slope of a line is defined as the change-taking place along the vertical axis relative to the

corresponding change taking place along the horizontal axis, or the change in the value of Y

relative to a one-unit change in the value of X.

There are at least three ways of developing the equation of a line. These are:

1. The slope-intercept form

2. The slope-point form

3. Two-point form

The following are the application of linear equations 1. linear cost - output

relationships(Variable Cost , Fixed Cost , Total Cost , Average Cost , Marginal Cost , Total

Revenue and Total Profit),2. Break-even point analysis (it is the point at which there is no

loss or profit to the company) 3. Market Equilibrium (When the supply and demand curves

intersect, the market is in equilibrium. This is where the quantity demanded and quantities

supplied are equal).

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