CHAPTER ONE

LINEAR EQUATIONS AND THEIR INTERPRETATIVE APPLICATIONS

1.1 The Concept of Linear Equations
There are various types of decisions that need mathematically supported knowledge in our day
to day life. Managers make many managerial decisions that need much investigation and
analysis which need the skill and knowledge of mathematics. This chapter has a general purpose
of familiarizing with linear equations, functions and their applications in business and
economics.

Linear equations are equations whose terms are a constant or a constant times one variable to
the first degree. A linear equation is an equation with one degree and whose graph is straight
line and whose slope is constant throughout the line.
Characteristics of linear equations
Some of the peculiar characteristics of linear equation are listed below:
 Linear equations have variables with only one degree (power).
 The product of two variables should not avail in the linear equation.
 The graphs of linear equations are straight line
 The coefficients of the linear equations all should be different from zero

General Form of Linear Equations

Linear equation with two variables
A linear equation involving two variables “x” and “y” has the standard form:
ax + by = c
Where a, b and c are real numbers and a and b cannot both equal zero
The following are all examples of linear Equations involving two variables:
2x + 5y = -5 –x + ½ y = 0 2s – 4t = - 2 2k +2 = 5n
The following are examples of equations which are not linear:
2x + 3xy = 7 X2 + Y + 3x = 16 X1/2+ 2y=8 2x + 3xy – 4y = 10
Linear equation involving n variables x1, x2, x3 … xn has the general form:
a1x1 + a2x2 + a3x3 + . . . + an xn = b
this is called standard form of a line involving n variables
Where a1, a2, a3 . . . an and b are real numbers and not all a1, a2, a3 . . . an are equal to zero.
The following are examples of linear equations involving more than two variables:
3x1 – 2x2+ 5x3 = 0 and –x1 + 3x2 – 4x3 + 5x4 – x5 + 2x6 = -80
The linear Equations can also be expressed as: Y = mx + b slope intercept form of a line.
Where; y is the dependent variable, x is the independent variable, b is the y intercept and m is
the slope

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 Dependent and Independent variables

The relationship between y and x expressed by y = mx + b is called a functional

relationship, because for each value of x, there is one and only one corresponding value
for y. X is called the independent variable and is plotted on the horizontal axis. Which
means the value of y depends upon what value we assign to x. in other way of saying
the movement of y depends on the movement of x, and for that reason y is called the
dependent variable, which is plotted on the vertical axis. Thus, when we plot points, the
values of x can be chosen independently, but the corresponding values of y depend on
the values chosen for x.
For example, XYZ manufacturing Company produces shoes using inputs such as leathers, labors,
etc. Therefore, the firm incurs costs which are varying with the level of shoes produced.
The dependent variable in this case is total production cost because it is increasing with
number of Shoes produced whereas the independent variable in this example is the number of
shoes produced.
Slope: slope is defined as the rate of change in the dependent variable for a unit change in the
independent variable. Any straight line, with the exception of vertical lines, can be characterized
by its slope. Numerically, the slope of a straight line is the ratio of the rise (or fall) to the run
between two points on the line, where rise or fall is the vertical separation and the run is the
horizontal separation of the two points. The slope of a line is quantified by a real number and
can be computed by dividing the change in the dependent variable(Y) by the change on the
independent variable (X). The sign of the slope (number) indicates whether the line is rising or
falling. The magnitude (absolute value) of the slope indicates the relative steepness of the line.
The slope tells us the rate at which the value of y changes relative to changes in the value of x.
the larger the absolute value of the slope, the steeper the angle at which the line rises or falls.
The slope of the line may be positive, negative, zero or undefined. The slope of the line is
computed by dividing change in the dependent variable over change in the independent
variable.

 Y intercepts and X intercept

Y – Intercept is the value of y when x = 0. Whereas

X- Intercept is the value of x when y = 0
Determine the slope, x intercept and y intercept of the following linear equations.

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Developing Linear Equations (determining the Equation of a straight line)
There are three conditions from which we can drive or develop linear equation.
1. Slope and intercept.
In this case the slope and the y intercepts are known and you are required to develop the linear
equation from these two information. The easiest situations one in which you know the slope m
and y intercept (0, k) of the line representing an equation. To determine the linear equation in
this almost trivial case, simply substitute m and k into the slope intercept form. If you are
interested in stating the equation in the standard form, simply rearrange the terms in the slope
intercept equation.
Example 1
Determine the equation of the straight line which has a slope of -5 and a y intercept of (0, 15)
Solution
Substituting values of m = -5 and k =15 into Equation.
Y = -5x + 15
Restated in the form of Equation, an equivalent form of this equation is
5x + y = 15
Example2
Determine the equation of the straight line which has a slope of 0.5 and a y Intercept of (0, 0)
Solution
Substituting m = 0.5 and k = 0 in to Eq. gives:
Y = 0.5 x +0 Y = 0.5X

2. Slope and one point

The second condition is that the slope and one point, the value of x and y, are known. Another
possibility for a line is that you may know the slope and also one member of the solution set
(i.e., the coordinates of one point on the line). In the last case we said that knowing the slope
and the y intercept of an equation allows you to write out the slope-intercept form directly. In
this section we talk of knowing the slope and one point-but not the y intercept. Any point which
lies on a line should satisfy the slope intercept equation. If we substitute the known slope m and
the coordinates of the point into Eq. we can solve for k. At this stage we would have m, the slope,
and k, the y coordinate of the y intercept; the equation of the line would follow directly. Let’s
illustrate this with a few examples.

Example1
Given that the slope of a straight line is -2 and one point lying on the line is (2, 8), we can
substitute these values into the Eq., yielding
8 = (-2) (2) + k 12 = k
Knowing that m = -2 and k = 12 leads directly to the slope intercept equation

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 Y = -2x + 12
And, as before, we can rewrite this equation in the equivalent form 2x + y = 12
Example 2
If the slope a straight line is zero and one point lying on the line is (5, -30) the
Equation of the line can be found by first substituting the zero slope and coordinates
(5, -30) into Equation -30 = (0) (5) + k -30 = k
Since we know that m = 0 and k = -30 the slope intercept equation is y = 0x + (-30) y = -30
3. Two points
A more likely situation is that some data points have been gathered which lie on a line and we
wish to determine the equation of the line. Assume that we are given the coordinates of two
points which lie on a straight line.
We can determine the slope of the line by using the two point formula. As soon as we know the
slope the y intercept can be determined by using either of the two data points, and proceeding
as we did in the last section.
Example
To determine the equation of the straight line which passes through (3, 2) and (4, 4), we
substitute the coordinates in to the two-point formula, resulting in:

m= =2

Substituting m = 2 and the coordinated (3, 2) into Equation it yields:

2= 2(3) + k 2= 6+k K=-4
Thus, the slope-intercept form of the equation is: Y = 2x -4
Solution sets for linear Equations
Given a linear equation having the form Y = mx + b, the solution set for the equation is the set of
all ordered pairs (x, y) which satisfy the equation. Using set notation the solution set S can be
specified as:

S = {( x, y) / y = mx + b}

Verbally this notation states that the solution set S consists of elements (x, y) such that the
equation Y = mx + b is satisfied. For any linear equation, S consists of an Infinite number of pairs
of values (x, y) which satisfy any linear equation.
Example: Given the equation 4y = -2x + 16, Find any point of values which satisfies the
equation.
Arbitrarily take x = 4, substituting x = 4 in to the equation we have
4y = -2(4) +16 4y = -8 + 16 4y = 8 y=2
Thus, (4, 2) is one of the points of values satisfying 4y = -2x +16.
Again assume x =5 and substituting in to the equation we have

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4y = -2(5) + 16 4y = -10 + 16 4y = 6 y = 3/2 Thus, (5, 3/2) is one of the solution
sets.
Again assume x=0 and substituting in to the equation we have
4y= -2(0) +16 = 4 Thus, (0, 4) is the other points of values satisfying 4y = -2x + 16
So (4, 2), (5, 3/2) and (0, 4)……….are the solution sets of the equation.
Graph of two variable linear Equations
A linear equation involving two variables has a graph which is a straight line in two dimensions.
In order to graph this type of linear equation, you only need to:
(1) Identify the coordinates of any two points which lie on the line,
(2) Connect the two points with a straight line, and
(3) Extend the straight line in both directions as far as necessary or desirable for your purposes.
The coordinates of the two points are found by identifying any two members of the solution set.
Example:
The graph of the equation 4y = -2x + 16 is found by first identifying any two pairs of values for x
and y which satisfy the equation.
Letting x = 0 the corresponding value for y is 4 and letting y = 0 results in
x = 8. Thus, (0, 4) and (8, 0) are two members of the solution set and their graphical
representation is indicate by the two points in Fig 1.1.
Graph of Linear Equation 4y = -2x + 16
Y
4y = -2x + 16
(0, 4)
(8, 0)
X

1.2 Applications of Linear Equations

In this section we shall see how we can approximate and relate the mathematical terminology
and technique of linear equations in addressing real world business issues. Application of linear
equations such as linear cost, revenue, and profit – output relationship analysis, break –even
analysis and market equilibrium analysis shall be covered. Specifically, we will consider these
application areas for manufacturing and merchandising businesses.
1. Manufacturing businesses
Manufacturing firms are those businesses engaged in production of goods and services from the
resources available for them. To produce goods and services, these firms incur cost in the form
of variable and fixed costs. As the result the summation of variable and fixed costs make up total
manufacturing (production costs). The manufacturing firms incur the costs to make profit which

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is the result of the difference between total revenue (the money collected form sell of goods and
services) and total cost (total money flowing out for the acquisition of resources).

A. Linear cost Functions

Organizations are concerned with costs because they reflect money flowing out of the
organization. These out flows usually pay for salaries, raw materials, suppliers, rent, heat,
utilities, and so forth. Accountants and economists often define total cost in terms of two
components: total variable cost and total fixed cost.
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 of fixed costs are rents, interest on loans and bonds and management salaries these
costs are expenditure that the company should incur irrespective of the production level.
Variable costs are costs that depend on the level of production (that is on the amount of
commodity produced); material costs and labor costs are examples of variable costs. The
movement of these costs is determined by the movement of output produced by the
organization. If the output level is high these costs are expected be high and if the output level is
low these costs are expected be low. In another way of saying there is direct relationship
between variable cost and output level.
These two components must be added to determine total cost.

TOTAL COSTS = VARIABLE COSTS + FIXED COSTS

Assumption of linear cost function
 Constant unit variable cost – the variable cost for each unit is the same regardless of the
number of units produced (implies constant returns to scale or no economies or
diseconomies of scale). This assumption ignores the possibility that the elements of the
production process, laborers or machines, may become more efficient as the number of
units produced increases or that buying raw materials in large quantities may result in
quantity discounts which in turn may lower the variable cost per unit produced.
 All cost involved in the production of goods and services is known
 Fixed cost remains constant over a relevant range
Total Cost Equation
Total cost = Total variable cost + Total fixed cost TC = TVC + TFC TC = V Q + TFC
Where; TC is the total cost, V is variable cost per unit or unit variable cost, Q is the amount of
production and TFC is total fixed cost.
Example 1:
The variable cost of processing 1kg of coffee beans is Birr 2 and the fixed cost per day is Birr
300.

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a. Develop the linear cost equation
b. Find the cost of processing 100 kg of coffee beans in one day
c. Draw its graph
Solution
a) TC = VQ + FC V = Birr 2 per unit and FC = Birr 300.
Therefore TC = 2Q + 300
b) Substituting Q = 100 in the equation of TC = 2Q + 300 we get
TC = 2(100) + 300
TC = Birr 500. Interpretation: The cost of processing 100kgs of coffee beans per day is Birr
500.
c) To sketch the graph of TC = 2Q + 300, let us first find two points on it.
Letting Q = 0, we have TC = 300; letting Q =200 we have TC = 2 (200) + 300 = 700.
Thus two points satisfying cost equation, TC = 2Q + 300 are (0, 300) and (200, 400).
Plotting these two points and joining them by a straight line, we obtain the graph. Note that the
relevant portion of the graph lies totally in the first quadrant because x and y are both
nonnegative quantities.
Cost TC= 2Q + 3000

TVC = 2Q
FC = 300

Quantity
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?
Solution
Given, total cost = y = 3x + 20
x = Units produced
x = 50 Units
A) Variable cost is the cost that varies with the level of production and it can be obtained by
multiplying the slope or the marginal cost with the number units produced (x).
That is, VC = m x
= 3x 50 = Birr 150

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 B) TC is the sum of fixed cost and variable cost. In the equation given y =3x + 20, the term
3x represent the VC and the constant 20 is the fixed cost. Thus
TC = y = 3x+20
= 3(50) + 20 + 150 + 20
= Birr 170
C) Variable cost per unit = vc / unit = vc / x = 150 / 50 = Birr 3
D) AC is given by total cost divided by Number of units produced. Thus,
AC/ unit = TC/ x = (VC+FC)/ x = (150 + 20) / 50 = 170 / 50 = Birr 3.40
E) The slope of a linear equation is equal to the marginal cost of any given level of
production thus, MC = 3.

In alternative approach, MC is the extra (additional) cost of producing one more unit of output.
Thus, the marginal cost of producing the 50th unit is equal to the additional cost in producing the
50th unit.
Therefore, MC= TC/ Q = TC of producing 50 units – TC of producing 49 units
50 – 49
= (3 (50)+20) – ( 3 (49) +20)
50 – 49
= 170 – 167 = Birr 3
1
B. Linear Revenue Functions
The money which flows in to an organization from either selling products or providing services
is often referred to as revenue. The most fundamental way of computing total revenue from
selling a product (or
service) is: Total revenue = (price) x (Quantity sold)
TR = PQ where; TR is total revenue, P is price and Q is quantity

An assumption in this relationship is that the selling price, p is the same for all units sold Q. If a
firm sells a product, where Q equals the number of units sold of a product and P equals the price
of a product Q, then total revenue function is:
Example 1: A firm sells a single product for Birr 65 per unit.
a. Construct the revenue function
b. What is the total revenue of selling 200 units of output?
c. Plot the graph.

Solution
a. If the selling price equals Birr 65 per unit, total revenue is computed by using the function
TR = PQ TR = 65Q
b. Substituting 200 in to the equation TR = 65(200) = Birr 13,000
c. To plot the graph of TR = 65Q ; let Q = 0 then TR = 0 (0, 0) is the point on line

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 TR = 65Q. And letting Q = 20 we get TR =1300. This means (20, 1300) is also on the line TR =
65Q. Therefore, show these points on Q plane and connect them by a straight line.
Total Revenue
TR = 65 Q

Quantity
C. Linear profit functions
Profit for an organization is the difference between total revenue and total cost. Stated in
equation form,
Profit = Total revenue – Total Cost
Π = TR – TC
Π = PQ - (VQ + TFC)
Π = Q (P-V) - TF
When total revenue exceeds total cost, profit is positive. In such cases the profit may be referred
to as a net gain, or net profit. When total cost exceeds total revenue profit is negative and it may
be called a net loss or deficit. When both total revenue and total cost are linear functions of the
same variable, the profit function is also a linear function of the same variables.
Example 1: A firm sells a single product at Birr 65 per unit. Variable cost per unit is Birr 20 for
materials and Birr 27.50 for labor. Annual fixed cost is Birr 100,000.
a. Construct cost, revenue & profit functions in terms of quantities produced and sold.
b. Show the equations graphically.
Solution
a) Total annual cost is made up of material costs, labor costs and fixed costs:
TC = 20Q + 27.5 Q + 100,000
TC = 47.5Q + 100,000
Similarly, if the product is sold for Birr 65 per unit, total revenue is computed by using the
function
TR = 65Q
Thus the profit function is computed as
Π = R (Q) – TC
Π = 65Q – (47.5Q + 100,000)
Π = 17.5 Q – 100,000

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B) Graph of Revenue and Cost Functions
TC/TR
Profit Area Total Revenue Line TR= 65 Q

Loss Area BEP Total Cost Line TC = 47.5Q +

100,000

Fixed Cost = 100,000

Quantity

D. Break Even Model

Break even models, a set of planning tools, is a very useful technique in managing organizations.
One significant indication of the performance of the companies is reflected by the so called
“bottom line” of the income statement for the firm that is how much profit is earned! Break even
analysis focuses upon the profitability of a firm. Break-even analysis is identifying the level of
operation or level of output that would result in a zero profit. This level of operation or output is
called the break-even point. The break-even point is a useful reference point in the sense that it
represents the level of operation at which total revenue equals total cost. Any changes from this
level of operation will result in either a profit or a loss. Break-even analysis is valuable
particularly as a short term planning tool when firms are contemplating expansions such as
offering new products or service. Similarly, it is useful in evaluating the pros and cons of
beginning a new business venture. In each instance the analysis allows for a projection of
profitability.
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.
The break-even point may be expressed in terms of volume of output, total dollar sales and
percentage of production capacity.
Let us now drive a formula for breakeven point or Q*.
TR = TC. Sine TR =PQ and TC = VQ + FC ,
PQ = VQ + FC
PQ* = VQ* + FC
PQ* – VQ* = FC
Q* (P - V) = FC

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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.
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
The alternative approach is to first write the profit function and set it equal to zero as follows:
P (Q) = R (Q) – C (Q)
= 30 – (22.50Q + 250,000)
= 7.50Q – 250,000
Setting the profit function P (Q) equal to 0, we have
7.50Q*– 25,000 =0
7.50Q* = 250,000
Q* = 33,333.33 units
Our conclusion is that given the assumed cost and price parameters (values), the firm must sell
33,333.33 units in order to breakeven.
b. With sales projected at 30,000 smoke detectors,
π= 7.5(30,000) – 25,000 = 225,000 – 250,000 = -25,000
This suggests that if all estimates hold true-price, cost and demand- the firm can expect to lose
Br.25, 000 on the venture. To further our understanding of break-even analysis, let us consider
the following break-even chart.

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 Revenue/ cost Profit (R > C)

Revenue

BEP

Variable cost Tot

al Cost
FC

Loss Fixed cost (FC)

(R < C)

0 Number of units (q)

qe

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.
A. Cost functions of Retailers
Suppose that an item that cost (purchased at) Birr 130 is priced to sell at Birr 200. The Mark up
is the difference between selling price (retail price) and purchasing cost is Birr 70. That is
Mark up = retail (selling prices) - purchasing Costs
Purchasing Cost = Birr 130
Retail price = Birr 200
Mark up= Retail price –purchasing cost
= 200 – 130
= Birr 70
From manager’s view point the dollar (Birr) amounts of mark up on numerous individual items,
which will vary widely, are not very useful in planning and controlling operations. What is
useful is the overall mark up percentage on all items.
For comparability in different items, Markup is viewed in one of two ways:
 As a function of the cost, and
 As a function of retail price

In the current example the mark up as the function of cost is

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On the other hand, in financial statements accountants use the concept of margin which is the
markup percentage on retail price. Margin is the percentage of mark up as of retail price
In our example this is:

This means that 35 percent of the retail price of Birr 200 is margin and the other 65 percent of
Birr 200 which 0.65(200) = Birr 130 is the purchasing cost (cost of goods sold).

We now suppose that the company in our illustration uses a margin of 35 percent on all items it
purchases, so that if the firm sells Birr x worth of merchandise (goods and services), 35 percent
of this amount is margin and 65 percent is cost. Thus, Purchasing cost (cost of goods sold) =
0.65 x
Total variable cost is the sum of purchasing cost which is the significant cost of merchandising
firms and additional variable costs which is variable costs incurred by retailers except
purchasing cost. That is:

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 Birr 12,000:

Thus for example at a sales volume (total revenue) of Birr 60,000 cost will be:
Y (TC) = 0.75 (60,000) +12,000
Y (TC) = Birr 57,000
And profit before taxes will be:
∏ = TR -TC
60,000 – 57,000
∏= $3000
Driving the Break-Even Level of Sales
Let us symbolize some important components of the formula. Thus, consider the equation
y = mx + b, where y = represent the total cost
m = represent the variable cost per dollar of sales
x = represent the sales volume (Revenue)
mx = total variable cost

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 b = the fixed cost
As we have considered in the former case, 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
Then at the break-even point, y and x can be substituted by xe in the equation of
y = mx + b.
Accordingly, xe – m (xe) = b. Now let us solve for xe.
xe = m(xe) + b
xe – m (xe) = b
xe (1 – m) = b

Thus, is the expression for Break Even level of sales

Or,

Example
Suppose that in making a budget for next year’s operations top management of KM 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.
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.
Solution
Given values, Margin = 45% = 0.45
Other variable cost = 0.05 per birr of sales
Fixed cost (b) = birr 56,000
Sales goal (Revenue R) = Birr 200,000
x = the monetary (dollar) amount of sales (sales volume)
In addition, if margin is given as 45% the remaining 55% or 0.55 represent the cost. Thus, the
variable cost per birr of sales is equal to
m = (100 % - margin percentage) + other variable cost
= (100% - 45%) + 0.05
Taking these values, we can solve out the problem
a. The equation y = m x + b

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y = 0.6 x + 56.000 = 0.55 + 0.05 = 0.60
b. Break-even volume of sales

For any amount of sales volume (Revenue) greater than birr 140,000 profit will be attained. At
the targeted level of sale, the profit will be obtained as follows.
Profit = Revenue – Cost – R-C
= 200,000 – (0.06x200,000 + 56,000) = Birr 24,000
D. Profit if the sales volume (revenue) is birr 100,000.
Profit (A) = R – C
= 100,000 – (m x + b), since cost (c) or y = mx + b
= 100,000 – (0.6 (100,000) + 56,000)
= 100,000 – (60,000 + 56,000) = 100,000 – 116,000 = (Birr 16,000)
Hence, at sales volume of birr 100,000 the company incurs a loss of Birr 16,000.
E. Graph of cost – sales model or break – even chart

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