CHAPTER 1

Linear Equations and

Their Interpretative
Applications

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 Introduction
Linear equations are equations whose terms
(parts separated by plus, minus, and equal
signs) are a constant or a constant times one
variable to the first degree.
The following are all examples of linear
Equations involving two variables:
1. 2x + 5y = -5 2. –x + ½ y = 0
3. 2s – 4t = - 2 4. 2k +2 = 5n
The following are examples of equations
which are not linear:
1. 2x + 3xy = 7 2. X2 + Y + 3x = 16
3. 𝑋 1/2 + 2y=8 4. 2x + 3xy – 4y = 10
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 1. Linear Functions
• Linear functions are the relationship between
dependent and independent variables.
• Y = m x + b. slope intercept form of a line.
– y- Is the dependent variable
– x- Is the independent variable
– b- Is the Y intercept (the value of y when
the value of x is 0)
– m- Is the slope
• Y – Intercept is the value of y when x = 0.
• X- Intercept is the value of x when y = 0
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 Applications of Linear Equations
• Four application areas of linear equations.
(1) Linear cost – output relations analysis
(2) Linear revenue – output relation analysis
(3) Linear profit - output relation analysis and
(4) Break –even analysis
Manufacturing businesses
• Those businesses engaged in production of
goods and services from the resources
available for them.

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 A. Linear cost Functions
• Fixed costs are costs that have to be met no
matter how much or how little of the
commodity are produced; that is they do not
depend on the level of production.
– Examples include rents, interest on loans and
bonds and management salaries.
• Variable costs are costs that depend on the
level of production (that is on the amount of
commodity produced);
– Examples include material costs and labor costs
are examples of variable costs.
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 TOTAL COSTS = VARIABLE COSTS + FIXED COSTS
Assumption of linear cost function
– Constant unit variable cost
– All cost involved in the production of goods
and services is known
– Fixed cost remains constant
Total cost equation
Total cost = Total variable cost + Total fixed cost
TC or C (Q) = TVC + TFC
TC or C (Q) = V Q + TFC
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Example 1:
The variable cost of processing 1kg of coffee beans is $
0.50 and the fixed costs per day are $300.
a. Give the linear cost equation.
b. Draw its graph.
c. Find the cost of processing 100 kg of coffee
beans in one day.
Answer:
a) TC = 0.5Q + 300
b) Cost Total Cost Line

Fixed Cost Line

Quantity
C) 350
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 EXAMPLE 2
If the total factory cost (y) of making X units of a product is
given by Y = 3x + 20, and if 50 units are made,
a) What is the variable cost (VC)?
b) What is the total cost (TC)?
c) What is the variable cost per unit (VC/unit)?
d) What is the average cost per unit (AC/ unit)?
e) What is the marginal cost of the 50th unit?
Answer:
a) Birr 150
b) Birr 170
c) Birr 3
d) 170/50 = Birr 3.40
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e) MC = 3 8
 B. Linear Revenue Functions
• Total revenue = (price) (quantity sold)
• TR or R(Q)= PQ
Example (1)
A firm sells a single product for $ 65 per unit.
a) Construct the revenue function in terms of
quantity sold, Q
b) Plot the graph
c) What is the total revenue of selling 200 units of
output? Answer
a) R = 65Q b)

C) TR= 200 x 65 = 13,000

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 C. Linear profit functions
• Profit for an organization is the difference between total
revenue and total cost.
Profit = Total revenue – Total cost
P(Q) = R (Q) – C (Q)
Example: A firm sells a single product at $65 per unit.
Variable costs per unit are $20 for materials and
$27.50 for labor. Annual fixed costs are $ 100,000.
a) Construct revenue, cost & profit functions in
terms of quantities produced and sold.
b) Show graphically the equations.

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Solution
a) If the product sells for $65 per unit, total revenue is
computed by using the function
Revenue Function=> R (Q) = 65Q
C (Q) = 20Q + 27.5 Q + 100,000
Cost Function =>C (Q) = 47.5Q + 100,000
Thus the profit function is computed as
Profit Function => P (Q) = R (Q) – TC
P (Q) = 65Q – (47.5Q + 100,000)
P (Q) = 17.5 Q – 100,000 Profit area
TR/TC Loss Area Total Revenue Line
Total Cost line
Fixed Cost line
Q
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D. Break Even Model
Is identifying the level of operation or level of
output that would result in a zero profit/zero loss.
Total Revenue = Total Cost
Assumptions
• The selling price per unit of output is constant.
• The variable cost for producing one unit is known
and constant.
• The periodic fixed cost is constant in relevant range
• Price per unit of output is greater than the variable
cost per unit of out put.

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Break Even formula
TR = TC. Sine TR =PQ and TC =VQ +FC
PQ = VQ + FC
PQ* = VQ* + FC
PQ* – VQ* = FC
Q* (P - V) = FC
𝐅𝐂
𝐐 ∗=
(𝐏 − 𝐕)

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Example 1
A group of engineers is interested in forming a company
to produce smoke detectors. They have developed a
design and estimate that variable costs per unit, including
materials, labor, and marketing costs, are Br.22.50. Fixed
costs associated with the formation, operation, and
management of the company and the purchase of
equipment and machinery total Br.250,000. They
estimate that the selling price will be Br.30 per detector.
a) Determine the number of smoke detectors which must
be sold in order for the firm to break even on the
venture.
b) Preliminary marketing data indicate that the firm can
expect to sell approximately 30,000 smoke detectors
over the life of the project if the detectors are sold for
Br.30 per unit. Determine expected profits at this level
of output.
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Solution
a) The total revenue function is represented by the
equations
R (Q) = 30Q
The total cost function is represented by the equation
C (Q) = 22.50Q + 250,000
The break-even condition occurs when total revenue
equals total cost, or when
R (Q) =C (Q)
For this problem the break-even point is computed as
30Q* = 22.50Q* + 250,000
7.50Q* = 250,000
Q* = 33,333.33 units
b) With sales projected at 30,000 smoke detectors,
π= 7.5(30,000) – 25,000 = 225,000 – 250,000
= -25,000
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2. Merchandising (retail) businesses
Retailers are businesses engaged in buying and
reselling of goods and services. These firms
purchase products and resell them at a price, that
is, presumably above the cost.
Cost functions of Retailers
Suppose that an item that cost (purchased at) $ 130
is priced to sell at $200. The Mark-up the
difference between selling price (retail price) and
purchasing cost is $ 70.
Mark up = purchasing Costs – retail (selling prices)
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For comparability in different items, Markup is viewed
in one of two ways:
1) As a function of the cost, and
2) As a function of retail price
In the current example the mark up as the function of
cost is
𝑀𝑎𝑟𝑘 𝑈𝑝 70
= = 0.54 = 𝟓𝟒 %
𝐶𝑜𝑠𝑡 130
Margin is the percentage of mark up as of retail price
In our example this is:
𝑀𝑎𝑟𝑘 𝑈𝑝 70
𝑀𝑎𝑟𝑔𝑖𝑛 = = = 0.35 = 𝟑𝟓 %
𝑅𝑒𝑡𝑎𝑖𝑙 𝑃𝑟𝑖𝑐𝑒 200

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This means that 35 percent of the retail price of $200
is margin and the other 65 percent of $200 which
0.65(200) = $130 is the purchasing cost (cost of goods
sold).
Purchasing cost (cost of goods sold) = 0.65 (X)
Total variable costs = Purchasing Costs + Additional Variable costs

Continuing our example, if the company incurs selling

expenses, which it budgets at 10 percent of the volume
of sales (x), that is selling expense (additional variable
costs) = 0.1x if the company budgets fixed expense at
$12,000, then
y = ((0.65𝑥 + 0.10𝑥) + 12,000)
y = 0.75𝑥 + 12,000
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Thus for example at a sales volume (total revenue) of
$60,000 cost will be:
Y (TC) = 0.75 (60,000) +12,000
Y (TC) = 57,000
And profit before taxes will be:
𝝅 = 𝑻𝑹 − 𝑻𝑪
𝝅 = 𝟔𝟎, 𝟎𝟎𝟎 − 𝟓𝟕, 𝟎𝟎𝟎
= 𝟑, 𝟎𝟎𝟎
Driving the Break-Even Level of Sales
𝒀 = 𝒎𝒙 + 𝒃
Where: Y = total cost , m= VC/unit
x = revenue and b= Fixed Cost
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At break even, revenue is equal to cost.
That is, y = x.
Further, at break – even, the amount of dollar sale is
equal to the cost, thus the break – even level of sales
(xe) is equal to y and x.
Therefore, y = x = xe
𝒀 = 𝒎𝒙 + 𝒃
𝒙𝒆 = 𝒎(𝒙𝒆) + 𝒃
𝐛
𝐗𝐞 =
(𝟏 − 𝐦)
𝐅𝐢𝐱𝐞𝐝 𝐂𝐨𝐬𝐭
𝑿𝐞 =
(𝟏 − 𝐕𝐚𝐫𝐢𝐚𝐛𝐥𝐞 𝐂𝐨𝐬𝐭 𝐩𝐞𝐫 𝐃𝐨𝐥𝐥𝐚𝐫 𝐨𝐟 𝐬𝐚𝐥𝐞𝐬)

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Example
Suppose that in making a budget for next year’s
operations top management of Hirmata Business
Group has set a sales goal of Birr 200,000 per week.
Margin is to be 45% of retail price and other variable
cost is estimated at Birr 0.05 per birr of sales. Fixed
cost is projected at Birr 56,000.
Required:
a) What is the linear sales-cost equation?
b) What is the breakeven volume of sales in birr per week?
c) What is the company’s profit if sales goal is attained?
d) What is the company’s profit if it sells merchandise that
worth Birr 100,000?
e) Plot the company’s cost-sales model.
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Answer:
a) Y = 0.6 x + 56.000
b) Br 140,000
c) Profit Br 24,000
d) Loss Br 16,000
e) Cost-sales model

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