Chapter One

Linear Equations and their Applications in Business

Introduction
Thus, after studying this unit you should be able to:
 define algebraic expression, equation and linear equation;
 explain the different ways of formulating or developing equations of a line;
 understand the breakeven point and its application;
 define the cost output relationship; and
 Explain the different cost elements.

1.1 Concepts of Linear Equations

Before you proceed directly to the concept of linear equations there are some basic terms you
have to understand. The definitions of algebraic expression, algebraic sum, terms, constant
coefficients, and equations are given below.

Definition 1.1 An algebraic expression is an expression formed only from combination of

numbers and variables by using the operations addition, subtraction multiplication
division, exponentiation (rising to powers) or extracting the roots.
2x  3
For example 3x, x  2, 5 x 2 y, 2x  5, etc, are algebraic expressions.
1  5x 2

Definition 1.2 An algebraic expression consisting of parts connected by plus or minus signs is
called algebraic sum and each of the parts together with the sign preceding it is
called a term.
For example, 2 xy  6 x 2  3 y is an algebraic sum, where as 2 xy, 6 x 2 , and  3 y are terms.
Observe 2 is the numerical coefficient of xy , 6 is the numerical coefficient of x 2 , –3 is the
numerical coefficient of y and comely the numerical coefficients are called coefficients.
Definition 1.3 An equation is a mathematical expression, which indicates two algebraic
expressions that are equal.
For example y  2 x  3, 3x  2  5 y  7 etc, are equations.

Definition 1.4 A linear equation with two variables is equation of the form ax  by  c , where
a, b, and c are fixed real numbers, with x and y being variables (or unknowns.
Note 1. In the above form of equation of a line both a and b cannot be zero at the same time. If
a  0 and b  0 , then the linear equation will become 0  c , which is either a true or
false statement.
2. The powers of the variables are one and the variable can only be multiplied with a
constant.
Example 1.1 From the linear equation 2 x  3 y  7 , you can observe that:
- The degree (the power) of the variables is 1.
- The constant term or the fixed value is 7.

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 - The terms of the equation are 2 x and 3 y separated by – sign. However, 2 x  3xy  7 is
not a linear equation, because 3 xy is a constant times the product of two variables.
- Linear equations in two variables are equations whose slope (that is; the rate of change of
one variable with respect to the other) is constant throughout the line. If the general
notion of a linear equation is expressed in the form y  mx  b where y  dependent
variable and x  independent variable, then m  slope , b  the y-intercept..

y rise  fall  y 2  y1
Slope ( m ) =   , if ( x1 , y1 ) and ( x 2 , y 2 ) are two distinct points on the
x run x 2  x1
line with x1  x 2 .
Slope measures the steepness of a line. If the slope is larger positive, the more steep (steeper) the
line is. If the slope is smaller negative, the more shallow (shallower) the line is.

y y
+ ive slope m  undefined

x x

y y
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 is undefined.
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 in business analysis the slope is
the change in the value of the dependent variable y relative to a one-unit change in the value of
the independent variable x .

1.2. Developing equation of a line

Now you will learn how you can obtain equation of a line depending on the information you
have. You will start with your geometric knowledge of similarity of triangle and two distinct
points uniquely determine the equation of the line that passes through them. The other forms of
equation of a line are the consequence of this as you will observe after a while.

There are at least three ways of developing the equation of a line depending on information at
hand, these are:

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 1. Two-point form
2. The slope-point form
3. The slope-intercept form
1. Two-Point Form

From geometry, it is known that two distinct points on a line completely determine a unique
straight line. Let P1 ( x1 , y1 ) and P2 ( x 2 , y 2 ) be two distinct fixed points on a line with x1  x 2 . Let
P( x, y ) be any movable point on the line, then
From similarity of triangles P P1 AP  P1 BP2
P2
AP BP2 y
Which implies,  P
P1 A P1 B
y  y1 y 2  y1 x

x  x1 x 2  x1 P1 A B
y 2  y1
y  y1  ( x  x1 ) ……… (1.1)
x 2  x1
Equation (1.1) is the two-point form of equation of a line.

Example1.2 Given two points P1 (1 , 10) and P2 (6 , 0) on a line with

x1  1, y1  10, x 2  6 , and y 2  0 , then from (1.1)
y 2  y1
y  y1  ( x  x1 )
x 2  x1
0  10
y  10  ( x  1)
6 1
y  10  2( x  1)
Therefore, y  2 x  12 is the equation of the line.

Interpretative Exercises
Exercise one
A salesman has a basic salary and, in addition, receives a commission which is a fixed
percentage of his sales volume. When his weekly sales equal is Birr 1000, his total salary is Birr
400. When his weekly sales equal Birr 500, his total salary is Birr 300. Determine his basic
salary and his commission percentage and express the relationship between sales and salary in
the form of an equation.

2. The slope-point form

This way of developing the equation of a line involves the use of the slope (m) and the point
P1 ( x1 , y1 ) on the line to formulate the equation.
From equation (1.1) the expression on the right hand side will give us the slope ( m ) of the line to
be:

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 y y 2  y1
m 
x x 2  x1
Therefore, the equation of the line will be:
y  y1  m( x  x1 ) ……… (1.2)

Example 1.3 Given the slope of a line to be m  4 and the line passes through the point P1 (1 , 2)
, then find the equation of the line.
Solution From point-slope form of equation of a line.
y  y1  m( x  x1 )
y  2  4( x  1)
Therefore, y  4 x  2 is the equation of the line.

Exercise two
A salesman earns a weekly basic salary plus a sales commission which is 20% of his total sales.
When his total weekly sales total Birr 1000, his total salary for the week is 400. Derive the
formula describing the relationship between total salary and sales.

3. The slope-intercept form

This way of developing the equation of a line involves the use of the slope (m) and the y -
intercept b of the line to formulate the equation.
Since the y -intercept is the point at which x  0 , then the y -intercept has the coordinate P1 (0, b)
. Using equation 1.2, we have
y  y1  m( x  x1 )
y  b  m( x  0)
Therefore, the equation of the line will be:

y  mx  b …………... (1.3) )

Example 1.4 Given the slope of a line to be m  10 and the y -intercept 20, find the equation of
the line.
Solution By using the slope-intercept form:
y  mx  b
y  10 x  20

Exercise three
Suppose the fixed cost (setup cost) for producing x units of a product is Birr 2000. After setup it
costs Birr 10 per unit product produced. If the total cost is represented by y and x units are
produced:
1. write the equation of this relationship in slope-intercept form.
2. state the slope of the line and interpret the number
3. state the y -intercept of the line and interpret the number

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Special cases of developing the equation of a line
Now you will observe simple and short techniques of writing the equation of a line that are
parallel to the x- and y-axes. Furthermore, you will also see means by which we determine the
parallel ness or perpendicularity of two lines using their slope.

a) Horizontal and 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, then the line is
horizontal and if the x values are the same, then the line is vertical.
Example 1.5 Given the points (3, 6) and (8, 6) the line through them is horizontal because both
y -coordinates are the same i.e. 6
Since the y -coordinate of the two different points are equal, the slope m  y  6  6  0 , and y-
x 83
intercept is 6. Hence the equation of the line is y  6

Example 1.6 Given the points (5, 2) and (5, 12), the line through them will be vertical, because
both x -coordinates are the same, i.e. 5, and its equation is x  5 .

However, if we proceed to apply the point slope procedure, we would obtain

12  10 2
Slope (m) =  , which is undefined
55 0
But the line is vertical and its equation is x  5 .

b) Parallel and perpendicular lines ( and , respectively)

From geometry, we have two facts regarding parallel and perpendicular lines:
i) Two lines are parallel if they do not intersect at all.
ii) To lines are said to be perpendicular to each other if they intersect each other making
an angle of 900.

Theorem
i) Two lines with slope m1 and m 2 are said to be parallel if the two lines have the same slope
(m1  m2 ) .
ii) Two lines with slope m1 and m 2 are said to be perpendicular if the product of their slope is –1
(m1  m2  1) or the slope of one is the negative reciprocal of the slope of the other.
From geometry, vertical and horizontal lines are perpendicular to each other, even though the
slope of vertical line is not defined.

Example1.7 The two lines y  2 x  10 and y  2 x  14 are parallel because their slopes are
equal, which is 2.
3 2
Solution The two lines y  x  10 and y   x  100 are perpendicular to each other because
2 3
 3   2
the multiplication result of the two slopes is –1, that is         1
 2   3
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c) Lines through the origin
Any linear equation in the variables x and y that has constant term zero will have a graph that
passes through the origin. The x -and y -intercepts of the line is also zero.

Exercise one: Applying linear equations in different forms

Please read the following problems and try to write their corresponding linear equations.
1. A printer costs a price of Birr 5000 for printing 100 copies of a report and Birr 9000 for
printing 500 copies. Assuming a linear relationship, what would be the price for printing 300
copies?
2. If the relationship between total cost and the number of units made is linear, and if cost
increases by Birr 7.00 for each additional unit made, and if the total cost of 10 units is Birr
180.00. Find the equation of the relationship between total cost ( y ) and number of units
made (x) .
3. A sales man has a fixed salary of Birr 200 a week In addition; he receives a sales commission
that is 20% of his total volume of sales. State the relationship between the salesman’s total
weekly salary and his sales for the week.

4. Determine whether the following pairs of lines are parallel or perpendicular to each other.
a) 3x  4 y  1 and 6 x  8 y  11 .
b) 5 x  2 y  4 and 2 x  5 y  15 .

Application of Linear Equations

Application of linear equations is common in the fields of Business, Economics, Management, as
well as in the social and natural sciences. The nature of linear equations in two variables will
make it simple to understand the relationship between the variables algebraically and
geometrically, as it is simple to draw the graph of linear equations on the coordinate plane.

In this section you will learn the applications of linear equations in cost-output relationship,
Break-even analysis, and Merchandising.

Linear Cost Output Relationships

Suppose the total cost (TC) of production of a product is linearly related to the number of units
of products (Q) produced and sold. Let’s denote the variable cost per unit (VC), fixed costs (FC),
total variable costs (TVC), average cost (AC), marginal cost (MC), total revenue (TR), and profit
( ) . You can observe the break-even chart (that is graphical representation of cost out put
analysis) shown below:

TC = TFC + TVC
TR = unit price  quantity = P.Q
 = TR - TC
= P.Q – (VC + FC)
=PQ – Q.VC - FC
 = Q. (P – VC) – FC

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1.3. Breakeven Analysis
In cost-output relationship company owners always need to observe the level of production that
leads them from loss to profit level. Specifically, they have to identify when this transition is
likely to take place.
Break-even point is the point at which there is neither loss nor profit to the company. It can be
expressed 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), whereas retail businesses state their cost equation in terms of revenue (because
they purchase and sell)

A ) Manufacturing Companies

Consider a Company with the equation

Total cost = Fixed cost + total variable cost
TC = FC + TVC
Total Revenue = unit price  quantity
TR = P.Q
At Break-even point, TR = TC i.e. TR – TC = 0
P.Q = VC + FC
P.Q – VC.Q = FC
Q. (P – VC) = FC
FC
Qe  , where Q e is Breakeven Quantity.
P  VC
The revenue obtained at the break-even quantity is called the break-even revenue (BER).

TC/TR TR

Profit

TC
BER
Loss

B Q
FC
Qe 
P  VC
Example 1. A manufacturing company has a total fixed cost of Birr 10,000 and a unit variable
cost of Birr 5. If the company can sell its products at a unit price of Birr 10, then
a) write the cost, revenue, and 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

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Answer
a) TC = VC + FC.
Hence the total cost function is TC= 10,000+5Q.
TR = P.Q,
Hence, the total revenue function is TR=10Q.
Therefore, the total profit functions will be
 = TR – TC=10Q– (10,000+5Q)
 = 5Q – 10,000
b) At break even point TR = TC
10Q = 5Q + 10,000
5Q = 10,000
10,000
Qe = = 2000 units
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Therefore, the breakeven Quantity is 2,000 units and the sales volume = 2000(10) = 20,000 Birr.

TR=10Q TC=10,000 +5Q

Profit
Birr 250000
2000
5Q + 10TVC=
000 5q
20000
Q
2000
 = 5Q – 10000
15000 TVC
2000
10000
2000
Loss
5000 TFC
2000
0 Q
1000 2000 3000 4000 5000
-5000 2000 2000
2000
-10000
2000

Interpretation:
When a company produces and sells 2000 units of output, there will not be any loss or gain (no
loss and no profit)

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Exercise two: application problems on the cost-output relationship
1. A record company prepares a record album with fixed costs of Birr 18,000 and variable cost
of Birr 7 per album. If the album is sold for Birr 10 each:
a) Develop the total revenue and total cost functions in terms of quantity.
b) How many records must be sold for the company to breakeven?
2. A manufacturer sells a certain product for Birr 110 per unit. Total costs consist of a fixed
overhead of Birr 7500 plus production costs of Birr 60 per unit. Based on this data answer the
following questions.
a) Write the total revenue (TR), total cost (TC), and total profit (TP) functions
b) Find the breakeven point in terms of quantity and sales volume
c) Show graphically the TR, TC, and TP.

B) Merchandising (or Retail Business)

Previously, we considered break-even analysis with respect to manufacturing companies that
usually state their cost equation in terms of quantity (because they produce and sell). Now, you
will consider break-even analysis with respect to retail businesses that state their cost equation in
terms of revenue (because they purchase and sell)
The sales volume at break-even point is referred to as break-even revenue given by:
Breakeven Revenue = BEQ X P
Assume a business firm with product A has the following cost and revenue items.
Variable cost of A = Birr100.
Selling price = Birr150
Markup = Selling price – Variable cost = 150 – 100 = 50

i. as a function of cost (that is in terms 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 (CGS)

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

Selling price
Given other selling expense = 1% of the selling price (If X is the sales revenue then the selling
expense will be 0.01X.
So, the TC equation becomes:
Y = 0.68X + FC
Where: Y is the total cost and X is sales revenue
Out of 100% selling price 68% is the variable cost of goods purchased and sold

Example 1 Suppose a retail business sale its commodities at a margin of 25% on all items
purchased and sold. Moreover the company uses 5% commission as selling expense and Birr
12,000 as a Fixed Cost. Find the Breakeven revenue for the retail business after developing the
equation

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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%
Therefore, the total cost is Y = 0.8X + 12000.
Generally the total cost for the retailer is given by
Y = mX + b, where m the variable cost per unit

Break-even revenue (BER) is obtained by making sales revenue and cost equal.
At breakeven point: TC = TR
That is: Y=X
0.8X + 12000 = X
-0.2X = -12000
Xe = 60,000 Birr
When the company receives, Birr 60,000 as sales revenue, there will be no loss or profit.
Generally, the break-even revenue will be given by:
FC FC   VC TVC
Xe  or Xe  , where m  
1 m 1 m P TR

FC  
The Break-even revenue (BER = ) method is useful, because we can use a single formula
1 m
for different goods so far as the company uses the same amount of profit margin for all goods.
FC  
However, in Break-even quantity method or BEQ = this is not possible and hence we
P V
have to use different formula for different items.
Example 1. It is estimated that sales in the coming period will be Birr. 6000 and that FC will be
Birr 1000 and variable costs Birr 3600, develop the total cost equation and the breakeven
revenue.
Solution The total cost for the retailer will be:
3600
Y= X + 1000 = 0.6X + 1000, where Y = total cost and X = total revenue.
6000
1000 1000
BER = Xe =   2500 Birr
1  0.6 0.4
At the sales volume of Birr 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 = Breakeven
revenue, P = selling price and Qe = Breakeven quantity
To change the break-even 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 variable cost (VC) by price.

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Exercise Three: Write the cost equation for the Retail Business
1. Ashenge Private Limited Company is about to start production of new products. Before the
start of the new production, it cost the company $200,000 to construct the factory building.
Once the construction is over, the cost per unit of production is estimated to be Birr 20.
Upon selling, the company will incur a 20% commission expense. Moreover, the price per
unit of products is decided to be Birr 50.
Required:
a) Construct the total cost equation in terms of quantity.
b) Determine the break-even quantity and break-even revenue.

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