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3.

Applications of Linear and Quadratic


Functions (2): Revenue, Cost and Profit
Functions; Break-even Analysis
Tony U
University of Macau

Outline

1 Revenue Functions
2 Cost Functions
3 Profit Functions
4 Break-even Analysis
5 Summary

Revenue Functions

Revenue Functions
If total sales revenue, R, and the number of units sold, x, are
linearly related, then the sales revenue function is R(x) = px
where x 0 and p is the unit selling price of the product.
If a firm sells n products, and let xi = number of units sold for
product i , and pi = unit selling price of product i , then
R(x1 , x2 , . . . , xn ) = p1 x1 + p2 x2 + + pn xn
or simply
R=

n
X
i =1

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pi xi

Cost Functions

Cost Functions

Total Cost = Total Fixed Cost + Total Variable Cost


Total fixed cost includes all costs that must be paid no matter
how few or how many units of product are produced, including
rent, insurance, taxes, etc.
Total variable cost includes all costs that vary in direct
proportion to the number of units of product produced,
including material costs, labor costs, other costs directly
attributed to the cost of product.

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Cost Functions

If total cost, C , and the number of units produced, x, are linearly


related, then the cost function is C (x) = vx + F where x 0, v is
the variable cost per unit produced and F is the total fixed cost.
If a firm produces n products, and let xi = number of units
produced for product i , vi = variable cost per unit of product i
produced and F is the total fixed cost, then
C=

n
X

vi xi + F

i =1

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Profit Functions

Profit Functions

If we assume that both the revenue function and cost function are
linear, then the profit function or the profit generated by producing
x units of the product, is also a linear function of x.
P(x) = R(x) C (x),
or
P(x1 , x2 , . . . , xn ) = R(x1 , x2 , . . . , xn ) C (x1 , x2 , . . . , xn )

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Profit Functions

C , R and P are only defined for nonnegative real numbers


In most cases x must be nonnegative integers. However, in
practice, it is customary to allow x on nonnegative real
numbers
Slope of the profit function: marginal profit or the addition to
total profit from selling the next unit of product

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Profit Functions

Example 1
A company produces a product which it sells for $55 per unit.
Each unit costs the firm $23 in variable expenses, and fixed costs
on an annual basis are $400,000. If x equals the number of units
produced and sold during the year.
a. Formulate the linear total revenue function.
b. Formulate the linear total cost function.
c. Formulate the linear profit function.
d. What does annual profit equal if 10,000 units are produced
and sold during the year?
e. What level of output is required in order to earn zero profit?
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Profit Functions

(a) Formulate the linear total revenue function.

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Profit Functions

(a) Formulate the linear total revenue function.


Sol. R(x) = 55x.

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Profit Functions

(a) Formulate the linear total revenue function.


Sol. R(x) = 55x.
(b) Formulate the linear total cost function.

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Profit Functions

(a) Formulate the linear total revenue function.


Sol. R(x) = 55x.
(b) Formulate the linear total cost function.
Sol. C (x) = 23x + 400000.

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Profit Functions

(a) Formulate the linear total revenue function.


Sol. R(x) = 55x.
(b) Formulate the linear total cost function.
Sol. C (x) = 23x + 400000.
(c) Formulate the linear profit function.

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Profit Functions

(a) Formulate the linear total revenue function.


Sol. R(x) = 55x.
(b) Formulate the linear total cost function.
Sol. C (x) = 23x + 400000.
(c) Formulate the linear profit function.
Sol. P(x) = R(x) C (x) = 32x 400000.

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Profit Functions

(d) What does annual profit equal if 10,000 units are produced and
sold during the year?

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Profit Functions

(d) What does annual profit equal if 10,000 units are produced and
sold during the year?
Sol. x = 10000, then the annul profit is
P(10000) = 22(10000) 400000
= 80000.

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Profit Functions

(d) What does annual profit equal if 10,000 units are produced and
sold during the year?
Sol. x = 10000, then the annul profit is
P(10000) = 22(10000) 400000
= 80000.
(e) What level of output is required in order to earn zero profit?

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Profit Functions

(d) What does annual profit equal if 10,000 units are produced and
sold during the year?
Sol. x = 10000, then the annul profit is
P(10000) = 22(10000) 400000
= 80000.
(e) What level of output is required in order to earn zero profit?
Sol. Let P(x) = 0, then the level of output is
32x 400000 = 0
x

= 12500.

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Profit Functions

Example 2

A manufacturer sells his product at $5 per unit. In this company,


variable costs are estimated at 40 percent of total revenue, and
fixed costs are constant at $3,000.
a. Find the total cost function (in terms of the number of units
of product produced and sold).
b. Find the profit function and interpret the meaning of its slope.

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Profit Functions

(a) Find the total cost function (in terms of the number of units of
product produced and sold).

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Profit Functions

(a) Find the total cost function (in terms of the number of units of
product produced and sold).
Sol.: Cost function = fixed cost + variable cost,
C (x) = 3000 + 40%(5x)
= 2x + 3000.

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Profit Functions

(a) Find the total cost function (in terms of the number of units of
product produced and sold).
Sol.: Cost function = fixed cost + variable cost,
C (x) = 3000 + 40%(5x)
= 2x + 3000.
(b) Find the profit function and interpret the meaning of its slope.

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Profit Functions

(a) Find the total cost function (in terms of the number of units of
product produced and sold).
Sol.: Cost function = fixed cost + variable cost,
C (x) = 3000 + 40%(5x)
= 2x + 3000.
(b) Find the profit function and interpret the meaning of its slope.
Sol.: P(x) = R(x) C (x), since R(x) = 5x,
P(x) = 5x (2x + 3000)
= 3x 3000
Slope of profit function is 3 that means the marginal profit is $3,
the profit increases by $3 by selling the next unit of product.
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Profit Functions

Most revenue and cost functions (and thus the profit functions)
may not be linear and may actually take the form of quadratic
functions, especially if the price is variable.
Reminder: Revenue = Unit selling price Number of units sold
N.B.: The revenue function may be expressed in terms of quantity
sold, R(q) , or in terms of selling price, R(p) .

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Profit Functions

Example 3
The weekly demand function for a particular product is
q = f (p) = 2400 15p where q is stated in units and p is stated
in dollars.
a. Determine the quadratic total revenue function, where R is a
function of p, or R(p) .
b. What is the concavity of the function?
c. What does total revenue equal at a price of $50?
d. How many units will be demanded at this price?
e. At what price will total revenue be maximized?

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Profit Functions

(a) Determine the quadratic total revenue function, where R is a


function of p, or R(p).

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Profit Functions

(a) Determine the quadratic total revenue function, where R is a


function of p, or R(p).
Sol.: R(p) = p q,
R(p) = pq = 2400p 15p 2 .

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(1)

Profit Functions

(a) Determine the quadratic total revenue function, where R is a


function of p, or R(p).
Sol.: R(p) = p q,
R(p) = pq = 2400p 15p 2 .
(b) What is the concavity of the function?

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(1)

Profit Functions

(a) Determine the quadratic total revenue function, where R is a


function of p, or R(p).
Sol.: R(p) = p q,
R(p) = pq = 2400p 15p 2 .

(1)

(b) What is the concavity of the function?


Sol.: The coefficient of p 2 is negative, so R(p) is concave down.

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Profit Functions

(a) Determine the quadratic total revenue function, where R is a


function of p, or R(p).
Sol.: R(p) = p q,
R(p) = pq = 2400p 15p 2 .

(1)

(b) What is the concavity of the function?


Sol.: The coefficient of p 2 is negative, so R(p) is concave down.
(c) What does total revenue equal at a price of $50?

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Profit Functions

(a) Determine the quadratic total revenue function, where R is a


function of p, or R(p).
Sol.: R(p) = p q,
R(p) = pq = 2400p 15p 2 .

(1)

(b) What is the concavity of the function?


Sol.: The coefficient of p 2 is negative, so R(p) is concave down.
(c) What does total revenue equal at a price of $50?
Sol.: p = 50,
R(50) = 2400(50) 15(50)2
= 82, 500.
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Profit Functions

(d) How many units will be demanded at this price?

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Profit Functions

(d) How many units will be demanded at this price?


Sol. R(p) = 82500 and p = 50,
R(p) = pq
82500 = 50q
q = 1650.

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Profit Functions

(d) How many units will be demanded at this price?


Sol. R(p) = 82500 and p = 50,
R(p) = pq
82500 = 50q
q = 1650.
(e) At what price will total revenue be maximized?

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Profit Functions

(d) How many units will be demanded at this price?


Sol. R(p) = 82500 and p = 50,
R(p) = pq
82500 = 50q
q = 1650.
(e) At what price will total revenue be maximized?
Sol. The function is concave down, so the vertex is the maximum
point, from (1), the price pmax such that the total revenue is
maximum should be,
pmax =

2400
= 80.
30

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Break-even Analysis

Break-even Analysis

The break-even point is where the total sales revenue equals total
cost, or zero total profit; i.e.
R(x) = C (x),

or

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P(x) = 0.

Break-even Analysis

Example 4

A handbag-manufacturing firm has fixed costs of $30,000 and the


cost of labor and material is $180 per handbag. Each handbag is
sold for $420.
a. Determine the linear revenue, cost and profit functions in
terms of the number of handbags q manufactured.
b. How many handbags must be produced and sold in order to
break even?

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Break-even Analysis

(a) Determine the linear revenue, cost and profit functions in terms
of the number of handbags q manufactured.

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Break-even Analysis

(a) Determine the linear revenue, cost and profit functions in terms
of the number of handbags q manufactured.
Sol.
R(q) = 420q
C (q) = 30000 + 180q
P(q) = 240q 30000

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Break-even Analysis

(a) Determine the linear revenue, cost and profit functions in terms
of the number of handbags q manufactured.
Sol.
R(q) = 420q
C (q) = 30000 + 180q
P(q) = 240q 30000
(b) How many handbags must be produced and sold in order to
break even?

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Break-even Analysis

(a) Determine the linear revenue, cost and profit functions in terms
of the number of handbags q manufactured.
Sol.
R(q) = 420q
C (q) = 30000 + 180q
P(q) = 240q 30000
(b) How many handbags must be produced and sold in order to
break even?
Sol. Set P(q) = 0,
240q 30000 = 0
q = 125.
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Break-even Analysis

Example 5
A firms total cost function is given by the equation
C (q) = 200 + 3q, while the demand function is given by the
equation p(q) = 107 2q.
a. Write down the total revenue function in terms of level of
production, R(q).
b. Write down the profit function in terms of level of production.
c. Determine the level of production required to break even.
d. Determine the level of production that would result in
maximum profit.
e. Determine the expected maximum profit.
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Break-even Analysis

(a) Write down the total revenue function in terms of level of


production, R(q).

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Break-even Analysis

(a) Write down the total revenue function in terms of level of


production, R(q).
Sol. R(q) = qp = 107q 2q 2 .

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Break-even Analysis

(a) Write down the total revenue function in terms of level of


production, R(q).
Sol. R(q) = qp = 107q 2q 2 .
(b) Write down the profit function in terms of level of production.

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Break-even Analysis

(a) Write down the total revenue function in terms of level of


production, R(q).
Sol. R(q) = qp = 107q 2q 2 .
(b) Write down the profit function in terms of level of production.
Sol. P(q) = R(q) C (q) = 2q 2 + 104q 200.

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Break-even Analysis

(a) Write down the total revenue function in terms of level of


production, R(q).
Sol. R(q) = qp = 107q 2q 2 .
(b) Write down the profit function in terms of level of production.
Sol. P(q) = R(q) C (q) = 2q 2 + 104q 200.
(c) Determine the level of production required to break even.

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Break-even Analysis

(a) Write down the total revenue function in terms of level of


production, R(q).
Sol. R(q) = qp = 107q 2q 2 .
(b) Write down the profit function in terms of level of production.
Sol. P(q) = R(q) C (q) = 2q 2 + 104q 200.
(c) Determine the level of production required to break even.
Sol. Set P(q) = 0, the break-even points
2q 2 + 104q 200 = 0
q = 2 or

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q = 50.

Break-even Analysis

(d) Determine the level of production that would result in


maximum profit.

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Break-even Analysis

(d) Determine the level of production that would result in


maximum profit.
Sol. Let qmax be the level of production that maximized the profit,
since P(q) is concave down function, the vertex is maximum point,
qmax =

104
= 26.
4

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Break-even Analysis

(d) Determine the level of production that would result in


maximum profit.
Sol. Let qmax be the level of production that maximized the profit,
since P(q) is concave down function, the vertex is maximum point,
qmax =

104
= 26.
4

(e) Determine the expected maximum profit.

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Break-even Analysis

(d) Determine the level of production that would result in


maximum profit.
Sol. Let qmax be the level of production that maximized the profit,
since P(q) is concave down function, the vertex is maximum point,
qmax =

104
= 26.
4

(e) Determine the expected maximum profit.


Sol. The expected maximum profit is
P(26) = 2(26)2 + 104(26) 200 = 1, 152.

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Break-even Analysis

Example 6
The total cost function for producing a product is
C = f (x) = 100x 2 + 1300x + 1000, where x equals the number of
units produced (in thousands) and C equals total cost (in
thousand of dollars). Each unit of the product sells for $2000.
Using x as defined above, formulate the total revenue function
(stated in thousands of dollars) and determine
a. the level(s) of production required to break even.
b. the level of output that would result in maximum profit.
c. the expected maximum profit.

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Break-even Analysis

(a) the level(s) of production required to break even.

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Break-even Analysis

(a) the level(s) of production required to break even.


Sol. P(x) = R(x) C (x), since R(x) = 2000x,
P(x) = 100x 2 + 700x 1000,
set P(x) = 0, then the break-even points are x = 2 and x = 5.

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Break-even Analysis

(a) the level(s) of production required to break even.


Sol. P(x) = R(x) C (x), since R(x) = 2000x,
P(x) = 100x 2 + 700x 1000,
set P(x) = 0, then the break-even points are x = 2 and x = 5.
(b) the level of output that would result in maximum profit.

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Break-even Analysis

(a) the level(s) of production required to break even.


Sol. P(x) = R(x) C (x), since R(x) = 2000x,
P(x) = 100x 2 + 700x 1000,
set P(x) = 0, then the break-even points are x = 2 and x = 5.
(b) the level of output that would result in maximum profit.
Sol. The profit function is concave down, then the vertex is the
maximum point, the level of output (xmax ) that maximizes the
profit,
700
= 3.5.
xmax =
200

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Break-even Analysis

(a) the level(s) of production required to break even.


Sol. P(x) = R(x) C (x), since R(x) = 2000x,
P(x) = 100x 2 + 700x 1000,
set P(x) = 0, then the break-even points are x = 2 and x = 5.
(b) the level of output that would result in maximum profit.
Sol. The profit function is concave down, then the vertex is the
maximum point, the level of output (xmax ) that maximizes the
profit,
700
= 3.5.
xmax =
200
(c) the expected maximum profit.
The expected maximum profit:
P(3.5) = 100(3.5)2 + 700(3.5) 1000 = 225.
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Summary

Summary
Revenue function [R(x)]: Number of product sold the
selling price of the product
Cost function [C (x)]: Fixed cost + Variable Cost
Profit function [P(x)] = Revenue function [R(x)] - Cost
function [C (x)]
Break even: P(x) = 0 or R(x) = C (x)
Break even point(s): the quantity (x) such that the
break-even happens

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