UNIT ONE

LINEAR EQUATIONS AND THEIR

INTERPRETATIVE APPLICATIONS

Unit Objectives
After a thorough study of this unit, you will be able to:

• Understand basic concepts of linear equations and functions.

• Develop acquaintance of graphic representation of linear equations.
• Compute and formulate slope and equation of a line.
• Systematically apply the linear equation algebra and geometry in solving real world
situations.

Unit Introduction

In the face of changing business environment, organizations encounter diverse set of problems

and challenges as well as prospects. Consequently, managers are expected to make appropriate

decisions and take actions that enable the organization take advantages and overcome

difficulties. In making such decisions and actions, one may required to apply mathematical

tools and quantitative techniques. Correspondingly, it is not uncommon to face so many cases

demanding the application of mathematics of linear algebra and geometry in making a viable

decision that enhance the achievement of organizational objectives. In other words, there are

various subjects of decision of which relation to one another is at least approximated and

explained by linear equations, for instance, sales volume can be linearly related to

advertisement expense. The same holds true between output level and number of employees

engaged on some activity and cost of production. Furthermore, demand for and supply of a

given product can be well approximated and explained by a linear equation. In

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such real business instances, the concept and interpretative application of linear equations

have a considerable importance.

Cognizant to the above fact, we need to be well acquainted with the fundamentals of linear
equations algebra and geometry as related to its business application. This chapter, therefore,
is dedicated to our study of linear equations. To this end, the unit is organized in to two
sections. In the first section, you will learn about basic concepts of linear equations and their
graphic representation and then you will proceed to the application of mathematical concepts
of linear equations in solving business problems.

Section One: Linear Equations, Functions and Graphs Section Objectives:

Up on completing this section, you will be able to:
- Identify the mathematical expression for linear equations and functions.
- Plot graph of a linear equation and compute slope and distance between two points.
- Understand three approaches of developing equation of a straight line.

Section Overview:

1.1 Basic Concepts of Linear Equations and Functions

1.2 Graph of a Linear Equation
1.3 The Distance between Two Points
1.4 Developing Equation of a Line

1.1 Basic Concepts of Linear Equations and Functions

An equation is a statement of equality, which shows two mathematical expressions are equal.
Equations always involve one or more unknown quantities that need to be solved. Among the
different types of equations, linear equation is the one that we are going to deal with in some

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detail. Linear equations are equations whose terms1 are a constant times a variable to the first
power. Accordingly, equations that can be transposed to the form,

a1 x1+ a2 x2+ ...+ an xn = c

are said to be linear equations.

Where, a1, a2, a3, ... an and c are constants

x1, x2, x3, .xn are variables (unknown quantities)

a1 x1, a2x2, . an xn and c are the terms of the equation

(terms of a linear equation represent the parts separated
by plus, minus, and equal signs)

As it occurs in many business application cases, a linear

equation may involve two variables, x and y, and
constants a, b, and c in which case the equation relating
x and y takes the form,
ax+by=c
The following are all examples of linear equations.
2x + 3y = 9, 3x - 9y + z = 23, 4y + 7.5x - 11 = 14

On the other hand, 4xy + 7x = 8 is not a linear equation

because the term 4x y is a product of a constant and two
variables. Likewise 5x2 + 3y = 25 is not linear because
of the term 5x2 which is a constant times one variable to
the second - power.

Dear student, we observe many business situations in

which linear relationships arise. Consider the following
example.

Example 1.1

Assume that Ethiopian Electric Power Corporation

charges Birr 0.55 per kilowatt-hour consumed and a
fixed monthly charge of Birr 7 for rent of electric meter.
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Terms of a linear equation represent the parts
Ifofy equation that are
is the total separatedcharge
monthly by plus,and
minus,
x isandthe
equal signs. of
amount
kilowatt-hours consumed in a given month, write the
equation3for y in terms of x.
Solution

The total monthly charge will be, 0.55 times the number of monthly KWh consumption plus
Birr 7 for meter rent.

Thus, using the symbols given, y = 0.55x + 7

The equation of this example is linear with two variable x and y. In such linear equations, we
need to note that the constants can be positive or negative, and can be fractions when graphs of
these equations is plotted it will be a straight line. This is the reason for the term equation.

Linear Functions: functional relationship refers to the case where there is one and only one
corresponding value of the dependent variable for each value of the independent variable. The
relationship between x and y as expressed by
y = 0.55x + 7.
is called a functional relationship since for each value of x (independent variable), there is a
single corresponding value for y (dependent). Thus if we write y as expression involving x and
constants x is called the independent variable, then the value of y depends upon what value we
may assign to x and as a result it is called the dependent variable. Therefore, a linear function
refers to a linear equation, which does have one corresponding value of dependent variable for
each value of the independent variable.

Exercise 1.1

Suppose that a car rent company charges Birr 65 per hour a car is rented. In addition, Birr 150
for insurance premium. Write the equation for the total amount charged by the company in
terms of the hours the car is rented.

1.2 Graph of a Linear Equation

Linear equations in two variables can be plotted on a coordinate plane with two dimensions.
Such equations have graphs that are straight lines. This means that the graph of the
relationship between the variables takes the form of a straight line. Any straight-line graph can
be sketched by plotting just two points which satisfy the linear equation and then joining

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them with a straight line. Now let us further develop this approach by considering the
following example.

Example 1.2

Sketch the graph of the equation 2y - 3x = 3.

Solution
To plot the graph, you may arbitrarily select two values for x and obtain the corresponding
values for y. Therefore, lets set x = 0. Then the equation becomes 2y - 3(0) = 3.
That is, 2y = 3
y = 3/2
This means that when x = 0, the value of y is 3/2. So, the point with coordinates (0, 3/2) lies
on the line of 2y - 3x = 3.
In the same way, let y = 0. Then the equation becomes -3x = 3.
That is, x = 3/-3 = -1.
This means, when y = 0, the value of x is -1. So, the point with coordinates (-1, 0) lies on the
line of equation 2y - 3x = 3. These two points are plotted on the coordinate plane with
horizontal “x - axis” and vertical “y-axis” as follows.

Fig 1.1 Linear Equation Graph

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Exercise 1.2

Find two coordinate points that satisfy the equation 3x + 4y = 24. Then, using the two
coordinate points plot the graph of the given function.

1.3 The Distance between Two Points

The distance between two points is the length of a straight-line segment that joins the points.
To determine the length of a given segment in coordinate geometry, algebraic procedures are
applied to the x - and y coordinates of the end points of the segment. Distance on horizontal
and vertical line segments are used in the computation of the distance. Distance on a vertical
segment (also called vertical separation) is found by computing the positive difference of the
y- coordinates of the end points of the segment. Distance on the horizontal segment (also
called horizontal separation) is found by computing the positive difference of the x-coordinate
of the end points of the segment.

Thus, given two points (x1, y1) and (x2, y2), the quantity / x2 - x1 /, is called the horizontal
separation of the two points. Further, the quantity / y 2 - y1 / is the vertical separation of the
two points.

Example 1.3

Given the points A (-5, 7), B (-3, -9), C (-5, 15), D (12, 6), find the horizontal and vertical
distance of the segment,
a. AB b. AD c. BD

Solution
a. The horizontal distance (Separation) of the points A (-5, 7) and B (-3, -9) is given by
Horizontal distance = / x2 - x1 /
= /-3-(-5)/
= /-3+5/ = 2
Vertical distance = / y2 - y1 /
= / -9 - 7 /

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 /-16/ = 16
b. Horizontal distance = / X2 - xi/

/ 12 - (-5)/
12+ 5/ = 17
Vertical distance AD = / y2 - y1 / = / 6 - 7 /
= /-1 / = 1

c. Horizontal distance BD = / x2 - x1/ = /12- (-3)/

= / 12+3/ = 15
Vertical distance BD = / y2 - y1/ = / 6- (-9)/
= / 6 + 9/ =15

Exercise 1.3

Find the vertical and horizontal separation of the following points.

a. (5, 7) and (-3, 2)
b. ( 5, - 3) and (-11, -7)
c. (6, 2) and (6, -4)
d. (3, 4) and (9, 4)
Dear student, as you recall all lines in a coordinate plane are not vertical and/or horizontal.
Hence, in case the segment is slant to any direction the actual distance between (x 1, y1) and
(x2, y2) may be calculated from Pythagoras’ Theorem, using their horizontal and vertical
separations.

Y“

B (x2, y2)

A (x1, yO C (x2, y2)

Fig 1.2 Places of Coordinates

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In the above diagram, AB2 = AC2 + BC2.
That is, the distance d between point A and B is given by:
d2 = (horizontal separation) 2 + (vertical separation) 2
d2 = (x2 - x1)2 + (y2 - y1)2
d
=>/(x2 - x1)2 + (T2 - T1)2

Example 1.4

Calculate the distance d between the points (5, -3) and (-11, -7).

A/(X2 - x1)2 + (y - y1)2

Solution
d = V(-11 - 5)2 + (-7 (-3))2

d= V256 +16 = V272 16.5

That is, d =
d=

Example 1.5

The coordinates of three cities, A, B, and C, forming a triangle are A (30, 20), B (30, 160),
and C (150, 70) in miles. What will be the total distance traveled if one goes from A to B,
then B to C, then back to A?

Solution
Total distance traveled = d = (A to B) + (B to C) + (C to A). Therefore, given the
distance formula above, the total mites raveled can be computed as follows:
d = ^j((30-30)2 + (160-20)2) + ((150-30)2 + (70 -160)2) + ((30-150)2 + (20-70)2

d =^19,600 + (14,400 + 8100) + (14400 + 2500 )

d = -^59,000
d=
242.8992

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Exercise 1.4

Find the distance between the points given below.

a. (5, 10) and (11, 8)
b. (0, 0) and (9, 12)
c. (-2, -5) and (3, -4)
d. (4, 7) and (6, -5)

1.4 Developing Equation of a Line

We have three alternative forms of developing the equation of a straight line. These are, slope-
intercept form, slope-point form, and two-point form. Let us consider these approaches
further.

The Slope - Intercept Form

Dear students, before considering slope intercept form of developing equation of a line lets
have a brief look at the concept of slope or gradient. Slope is a measure of steepness or
inclination of a line and it is represented by the letter m. the slope of a non-vertical line is
defined in several ways. It is the rise over the run. It is the change in y over the change in x.
Thus, given coordinates of two points (x1, y1) and (x2, y2)
Slope = m = RiSL = Zl—ZL , Where, x1 ^ X2
Run x2 - x

If the value of the slope is positive, the line rises form left to right. If the slope is negative, the
line falls from left to right. If the slope is zero, the line is horizontal. If the slope is undefined
then the line is vertical.

Dear student, please consider equally ranged graph and try to find slope of any coordinates on
the graph before reading the next example.

Example 1.6
Obtain the slope of the straight-line segment joining the two points (8, -13) and (-2, 5).

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Solution
m _ y2 - Yi _ 5 - (-13) = J8_
x2 x - 2 - 8 -10
-

Therefore, the line that passes through these two points falls downwards
from left to right. On the other hand, if the equation of a line is given, then
the slope can be determined more simply. Thus, if a liner equation is
written in the form y = m x + b, “m” is the slope and “b” is often referred
as the intercept term and it is the value at which the straight line intercepts
the Y-axis.

Example 1.7

An agent rents cars for one day and charges Birr 22 plus 20 cents per mile
driven.
a. Write the equation for one day’s rental (y) in terms of the number of
miles driven (x).
b. Interpret the slope and the y - intercept.
c. What is the renter’s total cost if a car is driven 100 miles? What is the
renter’s cost per mile?

Dear student, please try to solve the above example before going to the
solution!

Solution
Given fixed (constant) cost of Birr 22 = b Slope = m = 20 cents = Birr 0.2
y = Total cost for one day rental x = Number of miles driven
a. The equation
y = m x + b y = 0.2x + 22

b. Interpretation
The slope, m = 20 cents (Birr 0.2) means that each additional mile driven
adds 20 cents to total cost. b = Birr 22 is the fixed cost (the amount to be
paid irrespective of the mile driven). Hence, it will be the total cost when
no mile is driven.
c. Total cost of driving 100 miles (x = 100)

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 = 0.2 (x) + 22
Total cost of the renter = 0.2 (100) + 22
= 20+22 = Birr 42
Cost per mile when x = 100 miles is given by total cost of driving 100
miles divided by 100 miles. Putting it in equation form,
^ , Total Cost
Cost per mile =-
Total Number Miles Driven

= 42 + 100 = Birr 0.42

Example 1.8

Write 8x - 2y - 6 = 0 in slope intercept form and determine slope and y-intercept of the
equation. In addition, find the coordinates of x- and y-intercept.

Solution
We proceed to isolate y with a coefficient of one on the left-hand side of the equation to
obtain;
y = m x + b form finally.
Thus, 8x - 2y - 6 = 0 is equivalent with
8x - 2y = 6
-2y = -8x + 6
-2y = -8x + 6 -2 -2 -2
y = 4x - 3
Therefore, y = 4x - 3 is an equation in the y = m x + b form that is, 4 is the slope and -3 is the
y-intercept of the line. Further, the x-intercept is found by setting y = 0. Thus, the value of x
when y=0 is,
y = 4(x) - 3 0 = 4(x) - 3 = -1
The x intercept coordinate is (3/4, 0). In the same manner, we can obtain the y-intercept
coordinate is (0, -3).

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Exercise 1.5

It costs Birr 2500 to set up the presses and machinery needed to print and bind a paper back
book. After setup, it costs Birr 2 per book printed and bound.
a. Write the equation for the total cost of making a number of books
b. State the slope of the line and interpret it.
c. State the y-intercept of the line and interpret it.

The Slope - Point Form

In this form, we will be provided with the slope and a point on the line, say (x 1, y1). Then, we
determine the intercept from the slope and the given point and develop the equation.

Accordingly, the expression we need further is the equation that is true not only for the point
(x1, y1) but also for all other points say (x, y) on the line. Therefore, we have points (x 1, y1) and
(x, y) with slope m. The slope of the line is y - y 1 / x - x1 and this is equal for all pair of points
on the line. Thus, we have the following formula for slope-point form:

y -y
=m
X - Xj

Alternatively,

y - y1 = m (x - x 1)

Example 1.9

Find the equation of a line that has a slope of 3 and that passes through the point (3, 4).

Dear student, please try to solve the example before you go to the solution part.

Solution
Given m = 3 and (x1, y1) = (3, 4). By substituting these values in the formula
y - y 1 = m (x - x 1)
We will obtain y - 4 = 3 (x - 3).

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Then, y - 4 = 3 x - 9
y = 3 x - 9 + 4 y = 3 x - 5.
In another approach, y = m x + b where (x, y) = (3, 4)
y = 3x + b 4 = 3(3) + b 4 = 9 + b
4 - 9 = b = - 5 is the y-intercept.
Thus, y = 3x - 5 is the equation of the line.

Exercise 1.6

If the relationship between total cost (y) and the number of units made (x) is linear and if cost
increases by Birr 3 for each additional unit made and if the total cost of making 10 units is
Birr 40, find the equation of the relationship between cost and number of units made.

The Two — Point Form

In this case, two points that are on the line are given and completely used to determine
equation of a straight line. In doing so, we first compute the slope and then use this value with
either points to generate the equation. Taking two points designated by (x 1 - y1) and (x2 - y2)
and another point (x, y), we can develop the expression for the equation of the line as follows.

y - y1 _ y2 - y
x - xx x2 - x

Therefore, (y - y 1) (x 2 - x 1) = (y 2 - y 1) (x - x 1)
is the expression for the two-point form of generating equation of a
straight line.

Example 1.10

A publisher asks a printer for quotations on the cost of printing 1000 and
2000 copies of a book. The printer quotes Birr 4500 for 1000 copies and
Birr 7500 birr for 2000 copies. Assume that cost (y) is linearly related to
13 (x).
the number of books printed
 a. Write the coordinates of the given points
b. Write the equation of the line

Solution
Given the values
x 1 = 1000 Books y1= Birr 4500
x 2 = 2000 books y2= Birr 7500

a. Coordinates of the points are:

(x1, y1) and (x2, y2)
Thus, (1000, 4500) and (2000, 7500)

b. To develop the equation of the line, first let’s compute

the slope.
m = V2 - vi
x2 - X1

= 7500 - 4500
2000 - 1000
= 3000 - 1000 = 3

Then, consider the formula of two-point form of developing equation of a line as given by,
y - V1 = V2 - V1 x - x1 x2 - x1

We have obtained the value for the slope m = 3 as it’s expressed by

y 2 - y - *2 - *1.

Subsequently, by substitution this value in the above formula will result in;

y-y=3 * - *

Then, y - y1 = 3(* - *1)

In continuation, substitute the value (1000, 4500) in place of X 1 and y2 in the equation y
- y1 = 3 (x - X1). As a result, you will obtain,

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 y - 4500 = 3 (x - 1000) y - 4500 = 3x - 3000 y = 3x - 3000 +
4500
y = 3x + 1500 ...........................is the equation of the line.

Exercise 1.7

As the number of units manufactured increases form 100 to 200, manufacturing cost increases
form 350 birr to 650 birr. Assume that the given data establishes relationship between cost (y)
and the number of units made (x), and assume that the relationship is linear. Find the equation
of this relationship.

Section Two: Applications of Linear Equations Section Objectives:

After a thorough study of this section, you will be able to:
- Solve out real world business problems by relating and applying your concept and
mathematical approaches of dealing with linear equations.
- Conduct linear cost-output relations analysis, break-even analysis and market equilibrium
analysis as main areas of business application.

Section Overview:

1.5 Linear Cost - Output Relations Analysis

1.6 Market Equilibrium Analysis
1.7 Break - Even Analysis

1.5 Linear Cost - Output Relations Analysis

As of the very beginning, we aimed at developing our understanding on the interpretative

application of linear equations in business. Consequently, our interest and purpose in this

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section is to learn how we can approximate and relate the mathematical terminology and
technique of linear equations in addressing real world business issues. In dealing, we are
going to consider three application areas of linear equations. These are the linear cost -output
relations analysis, break - even analysis, and market equilibrium analysis. In this particular
section, we will consider these application areas to some detail.

Dear student, can you list different types of cost that make up the total cost in business
operations?

In order to grasp the concept of linear cost output relations, let us consider the relationship
among different types of cost on the following a coordinate plane.

Total
cost

Fig 1.2.1 Classifiaction of costs

Definitions

Fixed cost is a cost component that does not change with the number of units produced. The
variable cost is a cost component that varies with the number of units produced. Then at each
level of production, total cost is the summation of fixed cost and variable cost. Marginal cost
is the additional cost incurred in producing one more unit of output.

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17
 iv.
FC = the fixed cost remains constant at any level of production. Thus, 10 is the
fixed cost.
v. VC/unit = Variable cost ^ Number of units
= 5(Q) = 5(10) = 5
Q 10

Example 1.12

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?

Dear student, please slove this example before you see the solutions given below.

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

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

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 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 50 th unit is equal to the additional cost in
producing the 50th unit.
Therefore, MC= ATC = 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

Exercise 1.8

If total factory cost, y, of making x units of a product is y = 10x + 500 and if 1,000 units are
made:
a. What is the variable cost?
b. What is the total cost?
c. What is the variable cost per unit?
d. What is the marginal cost of the last unit made?

1.6 Break - Even Analysis

Dear student, can you define break even point and its analysis? Please try!

Break-even analysis is an economic theory that states that profits arise from the excess of total
revenue over total cost.
This is, Profit = Total Revenue - Total Cost

In the application of break-even analysis, there are two important concepts we need to
distinguish. These are the break-even point and break-even chart. The break-even point

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(BEP) is the volume or level of output resulting in neither a loss nor a profit. It is a point at
which revenue and cost are equal. The break-even chart is a convenient means of graphically
describing the relationship between cost and revenues at different levels of output.

In business concept, we have two cases of applying break-even analysis based on the type of
business activity under consideration. The first case is break-even analysis for manufacturing
companies. The other is for retail businesses. The distinction between the two cases is that
manufacturing companies usually state their cost equation in terms of quantity (output) as
their business involves producing and selling. In such a case, the break-even point is
commonly computed in terms of output level. On the other hand, as retail businesses are
concerned with purchase and sell of merchandise, they state their cost equation in terms of
revenue, which is the same as the Birr (dollar) volume of sales. Thus, the break-even point is
commonly computed in terms of break-even level of sales (dollar sales volume).

Dear student, let us consider the two cases to some detail here below.

Case 1: Break-Even Analysis for Manufacturing Businesses

In this case, we shall consider a manufacturer who produces q units of a product and sells the
product at a price of p per unit. In proceeding, let us specify the symbols to be used in our
study of the case before hand.
C = total cost of producing and selling q units
q = number of units produced and sold
v = variable cost per unit made (assumed to be constant)
FC = fixed cost (constant amount)
P = Selling price per unit
R = total revenue received, which is equal to sales volume in terms of dollar or birr.

The cost function then is given by:

(1)
C = v q + FC ...
and,
Revenue = Price per unit x Number of units sold

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 R
= p q.................................(2)

Thus, if the manufacture is to break - even on operations, which is to

neither incur loss nor earn profit, revenue (2) must equal cost (1).

That is, at break - even

p q = v q + FC........................(3)
You may now solve equation (3) for the production volume q;
p q = v q + FC p q - v q = FC
q (p - v) = FC
FC
q=
p-v

Thus, the Break - Even Quantity denoted by qe, is given by;

FC
qe
p-v

To further our understanding of break-even analysis, let us consider the following break-even
chart.

O
o
§
<
D
PH

R= p qe and
C = v qe + FC

Fig 1.2.2 Break Even Point (BEP) and other points

Dear student, what did you observe from the above figure?

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Observations: From the above break - even chart, we observe certain important points.
i. As such, the total revenue line passes through the origin and hence has a y-intercept of
zero while the total cost line has a y - intercept which is equal to the amount of the fixed cost.
ii. The fixed cost line which is parallel to the quantity axis (x - axis) is constant at all levels
of output.
iii. To the left of the break - even point the revenue line is found below the cost line and
hence any vertical separation indicates a loss while to the right the opposite is true.
iv. The total variable cost, which is the gap between the total cost and the fixed cost line
increases as more units are produced.
v. Important linear cost - output expressions (equations):
• C = v q + FC
• R
=pq

• Average Revenue (AR) = R ^ q = p q ^ q = p

• Average Variable Cost (AVC) = v q ^ q = v = Slope (m)
• Average Fixed Cost (AFC) = FC ^ q
• Average Cost = C ^ q = AVC + AFC
• Profit ( T ) = R - C

Example 1.13

A book company produces children’s books. One time fixed costs for Little Home are
$12,838 that includes fees to the author, the printer, and for the building. Variable costs
amount to $14.50 per book the books are then sold to bookstores around the country at $39.00
each. How many books must be printed and sold to break-even?

Solution
Given, v = $14.50 FC = $12,838 p = $39
Let q = the number of books printed and sold Thus, C = v q + FC

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 C = 14.5q + 12,838 is the cost equation.

The revenue (R) is also given by,

R=pq

= 39q
Then to obtain the quantity of books to be printed and sold to break-even, you need to equate
the R and C equations.
39q = 14.5q + 12,838 39q - 14.5q = 12838 24.5q = 12838
q = 12838/24.5
q = 524 books must be printed and sold to break - even.

Example 1.14

A manufacture has a fixed cost of Birr 60,000 and a variable cost of Birr 2 per unit made and
sold at selling price of Birr 5 per unit. Required:
a. Write the revenue and cost equations
b. Computer the profit, if 25,000 units are made and sold
c. Compute the profit, if 10,000 units are made and sold
d. Find the breakeven quantity
e. Find the break-even birr volume of sales
f. Construct the break-even chart

Solution
Given the values,
FC = Birr 60,000 , v = Birr 2 , p = Birr 5
a. Revenue equation = p q
R = 5q
Cost equation = v q + FC C = 2q + 60,000

b. Level of production = q = 25,000 units Thus, R= 5q = 5 x 25,000

23
 R = Birr 125,000 Likewise, C = v q + FC
C = (2 x 25,000) + 60,000 C = 50,000 + 60,000 = Birr 110,000 Then,
Profit = R - C
7= 125,000 - 110,000 7 = Birr 15,000

c. Level of production = q = 10,000 units Thus, R = 5q = 5 x 10,000

R = Birr 50,000

Likewise, C = v q + FC
= 2 (10,000) + 60,000 = Birr 80,000

Then, Profit = R - C
7= 50,000 - 80.000 7 = (Birr 30,000)
The manufacturer losses Birr 30,000 at 10,000 units level of production.

d. The break-even quantity is given by;

FC _ 60,000 p 60,000 20,000 Units are required to be produced to break-

9e
-v 5-2 3
even on operation.

e. The break - even birr volume of sales can be simply obtained by substituting the break -
even quantity in the revenue (R) equation. This is,
R = 5q

Substituting qe in place of q will result in,

R = p qe = 5 x 20,000 R = Birr
100,000

24
 f. In sketching break - even chart, first we need to find x - and y - interests for both the
revenue and cost equations. To this end, considering the cost equation, C = 2q +
60,000 we can obtain; the y - intercept (at q = 0) = FC = Birr 60,000.

Therefore, the cost equation arises from the point 60,000 on the y- axis (cost and revenue
axis). Alternatively, in a simple way, the total cost line starts at the point of fixed cost.

On the other hand, the graph for the revenue originates from the origin because the
revenue at zero production level is zero. Further, the two lines crosses each other at the
BEP which has a coordinate of (20,000, 100,000), the 20,000 units on the quantity
axis (x - axis) and Birr 100,000 on cost revenue axis (y - axis).

Revenue

qe = 20,000 Number of units (q)

Fig 1.2.3 Solved example of BEP

Note: The BEP coordinate is given by (qe, p qe)

25
Exercise 1.9

Suppose a company has a fixed cost of Birr 35,000 and a variable cost of Birr 1.75 per unit for
its products. Let us further consider that selling price is Birr 2.70 per unit.
a. Write the revenue and cost equations of the company.
b. At what level of output is the company break-even?
c. What is the amount of revenue when the company produces 300,000 units?
d. Plot the break-even chart and show the break-even point.

Case 2: Break - Even Analysis for Retail Businesses

Retail businesses and other financial managers are more likely think of break-even analysis in
accounting terms. In this case, we shall consider a retailer or company that purchase products
and sell them at a price above the cost. The difference between the purchase cost and retail
price is known as ‘markup’. Markup is the component of profit but not exactly the same as
profit. Thus, certain costs must be deducted to obtain the profit.

Example 1.15

An item that costs Birr 860 is priced to sell at Birr 940. Calculate the markup.

Solution
Given the values, Cost = Birr 860 and Retail price = Birr 940 Markup = Retail Price - Cost =
940 - 860 Markup = Birr 80
Markup is viewed in one of the following two ways: as a percentage of retail price or as a
percentage of cost.

a. Markup as a Percentage of Retail Price

The markup percentage on retail price is also called ‘margin’ in financial

statements is given by

26
 Margin = Markup Retail
Price

therefore,
A/r . Markup 92 - 70 22 „01/1 .n/
Margin =--— =-= — = 0.314 or 31.4%
Retail Price 70 70

b. Markup as a Percentage of Cost

Markup as a percentage of cost is

given by Markup Percentage =

MarkUP
^osf x 100%
Example 1.16

Assume an item that cost Birr 40 is made available for sale at a price of Birr 48. Find the
markup percentage on cost.

Solution
Markup Percentage = MarkUu>^osf x 100%

= 48 - 4^ x100%

= 8/40 x 100%
= 20%

Exercise 1.10

Naif supermarket purchases an item at Birr 115 and resells it at a price of Birr 128.
a. Compute the markup.
b. Compute the margin or markup as a percentage of retail price.
c. Compute markup as a percentage on cost.

27
Dear student considering the above concept about markup let us proceed to determining the
break-even level of sales.

Driving the Break-Even Level of Sales

Let us symbolize some important components of the formula. Thus, consider the equation
y = m x + b , where y = represent the total cost
m = represent the variable cost per dollar of
sales x = represent the sales volume (Revenue) m
x = total variable cost 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

xe (1 - m) _ b 1 -
m1-m

Thus,
1-m
Or,

28
 Fixed Cost
xe
1 - Variable Cost Per Dollar of Sales

Example 1.17

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.
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 = 0.55 + 0.05
= 0.60 Taking these values, we can solve out the problem
a. The equation
y = m x + b y = 0.6 x + 56.000

b. Break-even volume of sales

29
 b
Xe
1-m

Xe 56,000 _ 56,000
1 - 0.60 ~ 0.4
= Birr 140,000

c. 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 - (0.6x200,000 + 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

30
Remark:

i. The break-even chart for sales volume is plotted in the same manner with chat of
loran-even quantity except the x-axis in the former case represents dollar amount
of sales volume (revenue).
ii. In the above diagram we note that the break-even point coordinates are equal for both
x and y axis since at this point the cost and the revenue amount are equal and both
are expressed in terms of monetary (dollar) sales.
iii. In the break even sales volume computation, the cost equation, y = m x + b, is given
in terms of sales volume (Revenue) which is represented by x but, in case of
competing the break-even quantity, in the cost equation y = m q + b, q represents
the number of items or units produced. Thus, do not confuse x and q in the former
and later cases respectively.

Exercise 1.11

A company expects fixed cost of Birr 23,400. Margin is to be 52% of retail, and variable
cost in addition to cost of goods is estimated at birr 0.07 per dollar of sales.
a. Write the equation relating sales and costs.
b. Find the break-even birr of sale.
c. What will be profit on sales of Birr 62,500?
d. Make the break-even chart.

Exercise 1.12

If variable cost per dollar of sales remains at last year’s level of $ 0.40 and given fixed
cost of $3600 for this year as compared to $3000 of the last year, how much
greater will this year’s break-even level be than last year’s?

1.7 Market Equilibrium Analysis

The third major area in to which the concept of linear algebra and geometry applied is in
the analysis of market equilibrium. Market equilibrium analysis is concerned with
the supply and demand of a product in a case they are linearly related.

31
• Demand of a product: is the amount of a product consumers are willing and able to buy at
a given price per unit. The linear demand function has a negative slope (falls downward
from left to right as shown in the figure below) since demand for a product decreases as
price increases.

• Supply of a product: is the amount q, of a product the producer is willing and able to
supply (make available for sell) at a given price per unit, p. A linear supply curve or
function has a positive slope (rises upward from left to right as shown in the figure below)
and the price and the amount of product supplied are directly related. This is because of
the fact that suppliers are more interested to supply their product when the selling price
increases.

• Market equilibrium: shows a market price that will equate the quantity consumers are
willing and able to buy with the quantity suppliers are willing and able to supply. Thus, at
the equilibrium,

Graphically,

Demand (DD) = Supply (SS)

Market equilibrium point

Fig 1.2.5 Market Equilibrium Point

Quantity (q)

Example 1.18

Suppose the supply and demand equation for a given product on a given day reveal the
following.
Demand (DD): P = 300 - 15q
Supply (SS): P = 500 + q

32
a. Find the market equilibrium price and quantity.
b. Plot the demand and supply equation on a graph.

Solution
a. First, let us compute the equilibrium quantity for the given supply and demand
functions.
Hence, at equilibrium: DD = SS
3000 - 15q = 500 + 5q -15q - 5q = 500 - 3000 -20q=-2500
q = -2500 - -20 q = 125 units
The market equilibrium quantity is 125 units.

Now, we progress to find the equilibrium price for the supply and demand function of the
given product. In the same manner with the above one, we can obtain the market
equilibrium price by simply substituting the market equilibrium quantity in either of the
supply or demand equations. Thus, let us take the supply function of P = 500 + 5 q. Then
substitute market equilibrium quantity of 125 units in place of q.
P = 500 + 5(125)
P = 500 + 625 P = Birr 1125

You will obtain the same result (i.e. Birr 1125), if you take the demand function of P =
3000 - 15 q and substitute q = 125.

b. Graph of demand and supply function: In plotting the graph, first we need to get the x
and y intercept for both the supply and demand equations. The y - intercept for demand
equation is obtained by setting q = 0 in the equation P = 3000 - 15q. Thus, P = 3000 -
15(0) = 3000
Therefore, (0, 3000) is the y-intercept. Likewise, the x intercept is obtained by setting P =
0 in the equation P = 3000 - 15q. Consequently,
0 = 3000 - 15q
15q = 3000 = 3000 - 15
q = 200

33
 The point (200, 0) is the x-intercept of the demand function. The same procedure is to
be followed in computing the x and y intercept for the supply function of P = 500 + 5q.
The y - intercept is the value of P when q = 0.

Therefore, P = 500 + 5(0)

P = 500
The y - intercept is the point with coordinate of (0, 500). In the same manner, the x -
intercept is the value of q at P = 0.
Thus, 0 = 500 + 5q
-5q = 500 = 500 - - 5
q = -100
Hence, the x - intercept is given by the point (-100, 0). Off course, the graph (the
straight line) of the supply function is also passes through the equilibrium point of
(125 units, 1125 birr). Thus, we do not need to extend the line to the negative
direction.

Fig 1.2.6 Solved Example of Equilibrium Point

Example 1.19
The market demand curve for a product is given by:
DD: P = 200 - q
SS: p = 50 + 0.5q

34
a. Find the excess demand at a price of Birr 80.
b. Find the excess demand supply at a price of Birr 130.
c. Find the equilibrium price and quantity.

Solution
a. Given DD: P = 200 - q and P = Birr 80
Thus, at a price of Birr 80 the quantity q, demanded is computed by substituting 80 in
place of p in the given function, P = 200 - q.
80 = 200 - q 80 - 200 = -q -120 =-q
q = 120 units
This implies, at the price of Birr 80, the supply will be 120 units. Now we progress to
computing the amount of supply at a price of p = 80.
Thus, SS: P = 50 + 0.5q
80 = 50 + 0.5q 80 - 50 = 0.5q
q = 30 ^ 0.5 = 60 units.
In this case, also if the price is Birr 80, the supply will be only 60 units. Therefore, in
computing the excess demand, we take the difference between the demand and supply
for the product.

Accordingly, Excess Demand = Demand — Supply

= 120 units - 60 units = 60 units.

Thus, if the price is Birr 80, there will be an excess demand for 60 units of the product.

b. Following the same procedure with the above case (i.e. item a), we can find out the
excess supply for the product at a price of Birr 130. Accordingly, given demand
function DD: P = 200 - q, we substitute Birr 130 in place of p to get the quantity
demanded at the said price.
Thus, DD: p = 200 - q
130 = 200 - q

35
130 - 200 = - q
q = 70 units.

Therefore, at selling price of Birr 130, the demand is 70 units. On the

other hand, the supply at a price of Birr 130 is obtained by,
SS: P = 50 + 0.5 q
130 = 50 + 0.5 q 130 - 50 = 0.5 q
0.5 q = 80
q = 160 units Then, the Excess Supply is attained by:

Excess Supply = Supply — Demand

= 160 units - 70 units = 90 units.
In general, at selling price of p = 130 the excess supply is equal to 90
units.

c. As we have seen earlier, equilibrium is attained when DD = SS.

That is, 200 - q = 50 + 0.5 q
200 - 50 = 0.5 q + q 150 = 1.5 q
q = 150 ^ 1.5 = 100 units.
Hence, at equilibrium the quantity demanded will be 100 units. In
parallel, by substituting this value (100 units) in either of the supply
or demand functions, we can obtain the equilibrium price. Let us take
the demand function, DD: P = 200 - q and then substitute 100 in place
of q, to obtain
P = 200 - 100 P = 100 Birr.
Therefore, the market equilibrium price is Birr 100.

Dear Student, can you summarize what market equilibrium means?

36
 Remark

As we have observed in above example, if we set a price which is less than the
equilibrium price, for instance, Birr 80 in the above example (case a), it will result in excess
demand. In other words, the quantity consumers want to buy will be higher than what can be
made available by suppliers. Conversely, if we set a price which is greater than the
equilibrium price, for instance Birr 130 in the above example (case b), it will result in excess
supply. That is, there will be less demand for the product to clear the supply on the market. In
sum, the quantity demanded and price of a product are inversely related. That means, as price
increases, the quantity demanded will decrease and may not be vice versa. On other hand, the
selling price and the product supplied are directly related. That means as price increases the
quantity supplied will increase too and may not be vice versa (i.e. the opposite may not be
true).

Exercise 1.13

Kalifa Plc. is a national distributor of Dell Computers. The selling price and quantity of
computers distributed are linearly related. Further, the company’s market analyst found out
the following demand and supply functions for a particular year.
Demand (DD): P = 3500 - 2q
Supply (SS): - q = 950 - p
a. Find the excess demand for computers at a price of Birr 1400.
b. Find the excess supply of computers at a price of Birr 2100.
c. Find the market equilibrium quantity.
d. Find the market equilibrium price.
e. Sketch the demand and supply functions.

37
Unit Summary

Dear student, with confidence, you have already acquired knowledge about the concepts and
the interpretative applications of linear equations, functions, and graphs in business. In this
unit, we have considered the managerial applications of linear algebra and geometry so far. In
so, we have considered that linear equations are mathematical expressions written in the form
of

y=mx+b

The graph of such equation on coordinate plane is a straight

line. As a result, we understand that the slope of the line is
constant for any given points on the line. The slope of a
straightline m, given two points on the line with coordinates of
(x1, y1) and (x2, y2) is expressed by the equation

yi - y
m=
x2 - Xi

Further, we have considered how to compute the distance between two points on a coordinate
plane. Subsequently, approaches of developing equation of a line are discussed in the present
unit. Above all, we have seen the interpretive applications of linear equations in the second
section of the unit. These are analysis of linear cost-output relations, break-even analysis, and
market supply and demand equilibrium analysis. In the next unit, we will advance with the
study of the matrix algebra and its application in solving business problems and backing
management decisions that further organizational interests.

38
Self-Check Review Problems I

1. A grocery sells soda to its customers by purchasing from brewery factories. It purchases a
bottle of soda at Birr 2.45 and sells at Birr 3.00. The grocery has a monthly fixed cost of
Birr 1100 for rent, salary and utilities. Variable costs other than cost price of soda are
estimated at Birr 0.15 per soda of sales.
Required:
a. What monthly fixed sales volume lead to breakeven? Interpret the result.
b. How many bottles of soda have to be sold to breakeven? Interpret the result.
c. What should be the monthly breakeven sales volume if monthly fixed costs were Birr
2350?
d. Plot the breakeven chart for the grocery?

2. The management of the company that manufactures surfboards has fixed costs (at zero
output level) of Birr 2000 per day and a total cost of Birr 38000 per day at a daily output
of 200 boards.
Required:
a. Assuming the total cost per day, C (q) is linearly related to the total output per day, q,
write an equation for the cost function.
b. What is the total cost for an output of 12 boards per day?
c. Graph the cost function.
d. Write the new cost equation if the company has fixed cost of Birr 3000 per day and total
cost per day at an output of 200 boards of Birr 51000.

3. A financial analyst is studying the introduction of two new conveyor systems: the basic
and deluxe. The basic system has a variable operating cost of Birr 16 per unit and annual
fixed cost of Birr 104,000. In contrast, the deluxe system has a variable cost of Birr 12.8
and fixed cost of Birr 134,400. The company sells its products for Birr 22 per unit.
Required:
a. Which of the two systems would be more profitable for the firm if sales are expected to
average 35,000 units per year?
b. How many units must the company sell to breakeven if the deluxe system is selected?

39
c. At what sales volume level will management be indifferent between the basic and
deluxe systems?
d. Suppose the basic system requires the purchase of additional equipment that is not
reflected in the preceding figures which costs Birr 64,000. How many units must
the company sell to earn a profit of Birr 56,000 if the basic system is selected?

4. The projected profit of a hi-tech recording disks retailer is Birr 200,000 for the
current year based on sale volume of 200,000 units. The company has been selling
the disks for $16 each; variable costs consist of the Birr 10 purchase price and Birr
2 handling cost. The retailer’s annual costs are Birr 600,000.
Required:
a. Calculate the breakeven point for the current year in units.

b. What will be the company’s profit for the current year if there is a 10% increase in
projected unit sales volume?
c. Management is planning for the coming year when it expects that the unit
purchase price of the disks will increase by 30%. What volume of dollar sales must
the retailer achieve in the coming year to maintain the current year’s profit if the
selling price remains constant at Birr 16?

5. Suppose JYB Grain Company produces home flourmills, which it sells for Birr
150. Variable costs to produce and sell the mills are Birr 139 and the annual fixed
costs total Birr 84,500. What is the company’s breakeven point? Comment on the
optimal strategy the company should adopt.

6. A supplier will only start to supply T-shirt when a price greater than Birr 15 per
unit is available. The company will only then increase output by 6 units for every
Birr 1 increase in price.
Required:
a. Write the equation of the supply function.
b. Plot the supply function.

7. Hinessa Spare Parts shop has incurred expenses, which are partly fixed and partly
variable with the number of parts ordered. For the order of 100 parts, Hinessa is
charged

40
Birr 280 per order. An order expense is Birr 240 and for 200 parts ordered. Find cost per
order for 175 parts.

8. ALM Company sold 80,000 units earning a profit of Birr 100,000. The total variable
cost (excluding commission expense) is Birr 400,000. Moreover, the company incurred a
commission expense of Birr 40,000 at a 5% rate.
Required:
a. Develop the total cost equation.
b. Find the breakeven revenue and quantity.

9. On average summer day in a large city, the pollution index at 8:00 a.m. is 20 parts per
million, and it increases linearly by 15 parts per million each hour until 3:00 p.m. Let f(x)
be the amount of pollutants in the air x hours after 8:00 a.m.
Required:
a. What is the air pollution index at 1:00 p.m.?
b. Graph the function for 0 < x < 7.

10. Mega figures fixed cost at Birr 92,000 and variable at Birr 2.10 for each book
produced. The book is sold to distributors for Birr 15 each.
Required:
a. How many units must be sold for the publisher to breakeven?
b. The publisher finds that rising prices for the paper increase due variable cost to Birr
2.70 per book and if Mega continues to sell the books for Birr 15 how many books must
they sell now to make a profit?
c. If Mega wants to start making a profit at the same production level as before the cost
increase, how much should they sell the book now?

41
References
1. Ann, J. Hughes 1983. Applied Mathematics: For Business, Economics, and the social
Science.
2. Barnett, A. Raymond and Ziegler, R. Michael. 1989 Essentials of College Mathematics
for Business and Economics, Life Science and Social Science. 3 rd ed.
3. Bowen, K. Earl, Prichett, D. Gordon, and Saber, C. John 1987. Mathematics with
Applications in Management and Economics. 6 th ed., Richard Irwin Inc., USA.
4. Bradley, Teresa and Patton, Paul December 1999. Essential Mathematics for Economics
and Business. Jon Wiley and Sons.
5. Dexter, J. Booth and John, K. Turner 1996. Business mathematics with Statistics.
6. Orema, M and Agarwal, K. 1988. Quantitative Techniques. Kings Books, Delhi.
7. Ronald J. Hershberger and James J. Reynolds, Mathematics Applications.
8. Uohra, N, 1998. Quantitative Techniques in Management. Tata McGraw Hill, New Delhi.

42
 UNIT TWO
MATRIX ALGEBRA AND ITS APPLICATIONS

Unit Objectives

After studying this unit, students should able to understand and be acquainted with the
following:

• Be able to know the definition and meaning of a matrix.

• Be able to know what dimension of a matrix is and the main categories of matrices.

• Develop an insight towards basic operations in matrix (transposition, addition, subtraction

and multiplication) and the techniques.
• Develop know-how towards inverse of a matrix and ways of inverting a matrix.
• Develop an insight towards application areas of matrix algebra.
• Be able to handle large linear systems using matrix algebra.
• Be able to undertake markov chain analysis with the help of matrix algebra.

In general, the major objective of this unit is to enable students to have an insight and
exposure in matrix algebra manipulation, and thereby enabling them to impart knowledge of
applying the technique in handling real life problems.

Unit Introduction

It is evident that managerial problems are amenable to quantification thereby calling up for the
application of mathematical models. Of the various quantitative techniques, this unit tries to
introduce students of business stream about major topics in matrix algebra. The chapter deals
with basic concepts of matrix algebra, dimension and types of matrices, matrix operations and
techniques, inverse of a matrix and major applications including solving system of linear
equations and markov chain analysis.

43
In total, this part of the module introduces students of business stream about matrix algebra
principles and ways of applying them in handling real life business problems at individual or
organizational level scientifically.

Dear student! What do you know about matrix algebra? Why we learn matrix?

SECTION ONE: MATRIX CONCEPTS

Section Objectives

Up on completing this section, you will be able to:

• Know the definition and meaning of a matrix.
• Know dimension of a matrix and basic types of matrices.
• Develop an insight towards basic operations in matrix and the techniques.
• Develop know-how towards inverse of a matrix
• Build an insight on matrix algebra principles and concepts.

2.1 Why we learn matrix?

There are three major reasons for learning matrix:

1. Matrices are used to handle large linear systems
2. Matrices are used to solve complex linear equations
3. Matrices are an effective means for summarizing voluminous business data.

Definition of a Matrix

A matrix is a rectangular array of numbers, parameters, or variables each of which has a

carefully ordered place within the matrix. The numbers (parameters or variables) are referred
to as elements of the matrix. The numbers in the horizontal like are called rows; the numbers
in a vertical line are called columns. It is customary to enclose the elements of a matrix in

44
parentheses, brackets, or braces to signify that they must be considered as a whole and not
individually.

A matrix is often denoted by a single letter in bold face type. The first subscript in a matrix
refers to the row and the second subscript refers to the column.

Dear student, can you guess how values in matrix are arranged?

A general matrix of order m x n is written as:

X x12 x
1n
xn
x22 x2n
x 21
-

Matrix X above has m rows and n columns or it is said to be a matrix of order (size) m x n
(read as m by n).

Example:

A a11 a12 a13

a 21 a22 a 23
a 31 a 32 a33

3x3

Here A is a general matrix composed of 3x3 = 9 elements, arranged in three rows and three
columns. The elements all have double subscripts which give the address or placement of the
element in the matrix; the first subscript identifies the row in which the element appears and
the second identifies the column. For instance, a23 is the element which appears in the second

45
row and the third column and a32 is the element which appears in the third row and the second
column.

2.2 Dimensions and Types of Matrices

Dimension of a matrix is defined as the number of rows and columns.

Based on their dimension (order), matrices are classified in to the following types:
A. A row matrix: is a matrix that has only one row and can have many columns.

E .g. A = 2 5 7 is a row matrix of order 1x3.

B. A column matrix: is a matrix with one column and can have many rows.
1
Eg. B =
2
is a column matrix of dimensions 3x1.
v. j
6

1 4 3b
C. A square matrix: is
' -s a matrix with
r equal
"N number of rows and columns.
;D= 5
61 J 2 6 2 2
b8J;E=
E.g. C = - J 8 J; E = 8 6 9
J

D. A diagonal matrix: is a square matrix where its all non- diagonal elements are zero.

E.g. x
2006 0
is a diagonal matrix of order 3x3.
00 0
11
J
E. A scalar matrix: a square matrix is called a scalar matrix if all its non- diagonal
elements are zero and all diagonal elements are equal.
6 0 0
r
E.g. Y = Z=
2 0 0 6 0
2 6
0 0 0
J J

46
F. A unit matrix (Identity matrix): is a type of diagonal matrix where its main diagonal
elements are equal to one.

r.
i 0 0
E.g. B = 0 1 0
0 0

G. A null matrix (zero matrix): a matrix is called a null matrix if all its elements are zero.

^0 0 0 ^ 0 0 0
E.g. A = 000

H. A symmetric matrix: a matrix is said to be symmetric if A = Af.

r
8 2 1
2 3 4

v1 4 5
>

I. Idempotent matrix: this is a matrix having the property that A2 =A.

2 2 1
E.g. If A ; then AA=
3 3 3
3
2 1
L
2
1 V3 3J

Dear distance learner, what do you conclude about the relationship of scalar matrix and
diagonal matrix? And about unit matrix and scalar matrix?

Remark:
4- It is seen above that every scalar matrix is a diagonal matrix; whereas a diagonal matrix
need not be a scalar matrix. Every unit matrix is a scalar matrix; whereas a scalar matrix need
not be a unit matrix.

47
2.3 Matrix Operations and Properties

1. Matrix equality: two matrices are said to be equal if and only if they have the same
dimension and corresponding elements of each matrix are equal.
3 0c c3 -4 "3 0
-< > B = -< cC=c >-
-4 1 0 1 -4
1 -S V J V J

4- A ± B; A = C; B ± C.

2. Transpose of a matrix: If the rows and columns of a matrix are interchanged the new
matrix is known as the transpose of the original matrix. If the original matrix is
denoted by A, the transpose is denoted by A' or At. Transposition means interchanging
the rows or columns of a given matrix. That is, the rows become columns and the
columns become rows.

E.g B
c3 5 6 9
J 0 11 13 8
_6 8 3 4 c

The transpose of matrix B, denoted by B' or Bf is given as: ^

3 0 6 ^
Bt= <5 11 8 >
6 13 3
9 8 4
v. j
The dimension of B is changed from 3x4 to 4x3.

A 1 1 0 2
3
3 4 8
< 0 4
2 (2x3)
8
(3x2)

48
Properties of the transpose

The following properties are held for the transpose of a matrix:

^ Property 1: (At)t =A
^ Property 2: (aA) = aAl, where (a) is a scalar (a1 = a)
^ Property 3: (A+B)1 = Ax +
^ Property 4: (AB) = BW
3. Addison and subtraction of matrices: Two matrices A and B can be added or subtracted
if and only if they have the same order, which is the same number of rows and
columns. That is, the number of columns of matrix A is equal to the number of
columns of matrix B, and the number of rows of matrix A is equal to the number of
rows of matrix B. Two matrices of the same order are said to be conformable for
addition and subtraction. The sum and subtraction of two matrices of the same order is
obtained by adding together or subtracting corresponding elements of the two
matrices.

If A= (aij) and B= (bij), then C = A+B is the matrix having a general element of the form;
Cij = aij + bij. D = A-B > Cij = aij - bij .

Example:

f S' ■x
A= 2 o B= 3 6
► -< ►
-5 6 4 1

" 2+3 0+6 ' "56

>< >-
A+B = -5+4 6+1 = f-
VJ

"1 5' " 10 2 "

> 6 7 >- B= >-
ll

.8 9. f-
00

4- A+B is not defined, since orders of A and B are not the same.
V

49
Properties of matrix addition

a. Commutative law: A+B = B+A

E.g. A = 2 3 B =' 4 3' C =' 1 5'

-< ►- ► -<
3
1 0 2 1 6

r *N
2+4 3+3 < 4+2 3+3 <
66
y
=B+A << =
A+B =
=< <
1+2 0+1 2+1 1+0 V. J 31

b. Associative law: (A + B) + C = A + (B + C)
<6 6' "\ r *\
1 5 7 11
-< <+“ << = -<
(A+B)+C =
1
.3 < <3 6< <67>

r "N /r
A+ (B+C) = 2 3 4 3 f1 51
■< <+^ yy-
y+
0 2 1
1 J sL J 36
J

23 58' -
-J

J
<=-
>- + *
i
r 57 f-

o -J
A_
50
 c. Existence of identity: A+ 0 = 0 + A = A.
Note: The subtraction (difference) of two matrices of the same order is obtained by
subtracting corresponding elements.

Referring to the above matrices given in (a);

233 f- -2 0
A-B=
m
f-
m = ^r J
rr,
= l
B-A = J1 0 J
'4
3 13
v_ 2
J - --
S'
3
<N
'
v_
J
J= J
4-2 3-3
► =
S'

2 J 0
>
' J 2 1 J J = J 1-2 0-1 J
1
J J

2 1 1 0 2-1[ = 1-0 1 1
1 -1 -1
4- A-B ^ B-A, thus matrix subtraction is not commutative.

r r
-2 0 15 -3 -5
(A-B)-C = < J - -< >■ >■ >
36 -4 -7
-1 -1
V- V.

r
s' 43 r "N
23 15
A-(B-C) = < y < >
J - -J
21 36
J
J0. v.

m 3 -2 r
tr,
<N
- =J
t- J25
4- (A-B) -C ^ A- (B-C) ; matrix subtraction is not associative.
>lh
Remark: 1 0 v._
• A+B = B+A and (A+B) +C= A+ (B+C) ^ matrix addition is both commutative and
associative.

51
 A-B ^ B-A and (A-B) - C ^ A- (B-C) ^ matrix subtraction is neither commutative
nor associative.

4. Matrix Multiplication
Two matrices A and B can be multiplied together to get AB if the number of columns in A
is equal to the number of rows in B.

A B
nxs
mxn

Inner dimension

Outer dimension

• If two matrices have the same inner dimension, then we can get the product of the
matrices. The resulting matrix will have a dimension equal to the outer dimensions of the
two matrices. There are two types of matrix multiplication: multiplication by a scalar and
multiplication by a matrix.

i. Scalar multiplication: in this type of multiplication, we multiply the scalar by each

element of the given matrix.
"\
3 4 0 2
E.g. If B 1 5
►
3 4 1
V- J

"3 4 0 "15 20 0"

(5). B = (5)
1 2 5 > < 5 10 25
1 5
3 4 15 20
J J

ii. Multiplication by a matrix: multiplication by a matrix can be performed if the

number of columns in the first matrix is equal to the number of rows in the second
matrix. In this type of multiplication, we always multiply each row of the first matrix by
each column of the second matrix and sum the resulting outcome.

52
E.g. 1 2 3 2 14
A
: 401 B
3x2) 30 5 (2x3)

Then, A x B r
(1x2)+(2x3) (1x1) + (2x0) (1x4) + (2x5)
< >
(3x2) + (3x1) + (4x0) (3x4) + (4x5)

v(4x3) J
(0x1) + (1x0) (0x4) + (1x5)

(0x2)+(1x3)
^8 1 14

J 15 32
(3x3)
3 5 j

3 0
Dear student, can you show whether matrix multiplication is both communicative and
associative or not?

Properties of matrix multiplication

Property 1: The distributive law is valid in matrix

multiplications. A (B+C) = AB + AC (B+C)A = BA + CA

Property 2: The associative law is valid in matrix

multiplication.

(AB)C = A(BC) = ABC

Property 3: If I is an identity matrix, then;

AI = IA =A

53
In general, as long as the order of the matrix is maintained, matrix multiplication is
associative, but matrix multiplication is not commutative except for:
a) The multiplication of a matrix with an identity matrix; i.e. A.I = I. A =A
b) The multiplication of a matrix with its inverse; i.e., A.A -1 = A-1.A = I

Solved problems
1. Interest at the rates of 0.06, 0.07 and 0.08 is earned on respective investments of
$3000, $2000 and $4000.
a) Express the total amount of interest earned as the product of a row vector by a
column vector.
b) Compute the total interest by matrix multiplication.

Solution:
Given: Let the interest rate matrix be I and investment matrix be B.
a) I = f 0.06 0.07 0.08 1 3000
1
(1x3) J ;
B 2000

4000 (3x1)

4- Total interest = (Interest rate matrix) (Investment matrix) = I.B.

IB = { 0.06 0.07 0.08 ^ 3000 ^

200

0
(0.06x 3000) + (0.07x2000) + (0.08x4000)
400

0
Total interest = f 640 f (1x1) = 5
640

2. Finfine Furniture Factory (3F) produces three types of executive chairs namely A, B
and C. The following matrix shows the sale of executive chairs in two different cities.

54
 Executive chairs

A B C
Ci 400 300 200
Cities ■* >
100
C2 300
200 J(2x3)

If the cost of each chair (A, B and C) is Birr 1000, 2000 and 3000 respectively, and the
selling price is Birr 2500, 3000 and 4000 respectively;
a) Find the total cost of the factory for the total sale made.
b) Find the total profit of the factory.

Solution:

Given: Let the quantity matrix be q

Let the price matrix be p Let
the unit cost matrix be v;

a) 400 300 200 " 1500 ' ^1000

II p= V=
cr >-
3000 >- 2000 L
„ 300
200 100 „
4000 3000

4- Total cost = (unit cost) (Quantity)

" 400 300 200 " 1000

-< >■
. 2000
J300 200 100 „
3000

1,600,000

1,000,000

Total cost = Birr 1,600,000 + Birr 1,000,000 = Birr 2,600,000

55
 b) Total profit = Total Revenue - Total Cost

Total Revenue = (price) (quantity)

r 400
"N 300 200 "1500 '
<
-< 3000 >
100
s. 300
200 _
2,300,000 4000
►
1,450,000
Total Revenue = Birr 2,300,000 + Birr 1,450,000 = Birr 3,750,000

Profit = Birr 3,750,000 - Birr 2, 600,000

= Birr 1,150,000

Exercise 2 -1
1. Find a and b if a+ba-b 73
s -N s

*
► -<
1 2
1 2 f ..
2. Classify the following matrices:

o
a
) r 10 i b) c)o d) -2
S’ S’ "N 1 -1 3 }
3. A = 1 2 -3 -2 LJ -< > - 3
01 000
}3
4 }and B = } 1 -5 f find A + B. o

5 6 43 o
J J
o _J „5,
'023'
4. If A -< 12 1 4 and B 7631 ; find the value of 2A + 3B.

43
"8 4' s
5. If A = and B =
3 2
-< >* ►
7
3 J 1 5
Find the matrix x such that 2A +4B - 3x = 0.

56
 J"2 1 0" J1 2 -1
6. If A =
-< -1 > and B = -2
1 2 0 1
3 2
0 1 J 1 1 J

Find A-B and B-A.

7. Given the matrices:

/•V ^1 -2
A= 1 3 03
<0 3 >B
2 0 -lj ; Determine where possible:
0 4
J
a) AB
b) BA
c) 2A

8. Verify whether AB = BA for matrices:

A= r
2 1 0 1 2 -1
and B =
-<1 -1 2 > < -2 0 1
3
0 1 1
1
V J 2,

r ■N "1 > r >

9. Given: 1 -2 3
8 -2 4 -3 1
II
- O
< -9 9 9 >B= 5 6 -4 II 6 2 -1
<
6 9
-3 7 -9 8 0 -4 3
V J J

Show that; i) A(B+C) = AB + AC ii) (A+B)C = AC + BC.

r s' '2'
10. Given: A = 7 5 - 4 9 10
B= < > C=J 6r
-< 1 3 >- 265
J „7^
^
8
J
6

Show that matrix multiplication is associative; that is (AB)C = A(BC).

11. Find the transpose of the following matrices:

57
 a) A = b) B ={ 4 6 8 l c) C = { 6 }
2

d) D = ^ e) X ^
3 5 7 1 2 3 4
>
9 1 2 < 2 3 4 1 >

y 3 4 2 1
6 8 4
V J
4 1 1 2
r "N r
x= 1
-2 y= 2 -3
3 -1
-<-4 0 6 > -<4 0 -6 >

1 3 -3 ; find x + y.
-1 -2
V 2 y y

Determinant of a matrix

Definition: the determinant is a single number or scalar and is found only for square matrices.
If the determinant of a matrix is equal to zero, the determinant is said to vanish and the matrix
is termed singular.

1.Let A = (1x1), then the determinant of A denoted by |A| or det A is a11.

an
i.e det A=| A| = /an/
r
2. Let A = an a12
a21 a22 ( 2x2)
V. y
A=
a11 a12

a21 a22 is known as a determinant of order two

and its value is given as: |A| = ana22 - ana21.

58
 m
CfQ

ON ^ A= 6 4 - 6(9)-7(4)=26
>
II _J
[l 9 J
3. L et A ^aii ai72 ai3 9
a2i a22 a23
va3i a32 a33

A=
aii ai2 ai3
a2i a22 a23 is called a third order determinant
a3i a32 a33

a22 a23 a2i a23 a2i a22

A + aii a32 a33 - ai2 a3i a33 +ai3 a3i a32

- aii (a22 a33 - a32 a23) - ai2 (a2i a33-a3ia23) + ai3 (a2ia32-a3ia22)

E.g. Let A = [i 2 41
-<0 -i 0,
-2 0 3 Find | A .

i 2 4 -i 0 00 0 -i
0 -i 0 = +i -2 +4
-2 0 3 03 -2 3 -2 0

= 1 (-1x3 - 0x0) -2 (0x3- (-2x0)) + 4 (0x0 - (-2x-1)) =

-3 -0 -8
= -_H

59
Note: The value of determinant of 2nd order is equal to the product of the elements along the
principal diagonal minus the product of the off diagonal elements.
The value of determinant of 3rd order is equal to the summation of three products. To derive
the three products:

Let A = a11a12 a 13
-< a 21a22 a 23
a 31a 32 a 33

i) Take the first element of the first row an, and mentally delete the row and column in which
it appears. Then, multiply an by the determinant of the remaining elements.

ii) Take the second element of the first row an and mentally delete the row and column in
which it appears. Then, multiply an by -1 times the determinant of the remaining
elements.
iii) Take the third element of the first row an, and mentally delete the row and column in
which it appears. Then, multiply an by the determinant of the remaining elements.

Minors and Cofactors: The element of a matrix remaining after the deletion process from a
sub-determinant of the matrix is called a minor. Thus the minor Mii is the determinant of the
sub-matrix formed by deleting the ith row and jth column of the matrix.

Given : A
a 11 a12 a13
■< a a22 a23
21 a 31 a a33
32
Here, /mu/ is the Minor of an, /mn/ the minor of an and /mn/ the minor of an.

/mu/ = a22 a23

= a22 a33- a32 a23

a32 a33

60
/mi2/ a2i a23
- a2i a33 - a3ia23
a3i a33

/mi3/ a2i a22

- a2i a32 - a3i a22
a3i a32

aii ai2
Given : A -
a 2i a22

/mii/ - / a22/ - a22 ; /m2i/ - /ai2/ - ai2

/mi2/ - / a2i / - a2i ; /m22/ - /aii/ - aii

Example:
If A f2 1

l0 4 ; then,

The minor of aii (/mii/), the element in the first row and first column is; /mii/ - /4/ - 4
The minor of ai2, /mi2/ - 0 The minor of a2i, /m2i/ -i The minor of a22, /m22/ - 2 4

4- The cofactor (Cij) of the element aij of the matrix A is the minor of aij multiplied by (-
i)i+j ; so that if i+j is even, the cofactor and the minor are equal, and if i+j is odd, the
cofactor is the negative of the minor.
4- The adjoint of A is the transpose of the cofactor matrix of A.
Taking the above example, the cofactors are computed as follows:

6i
Cii = cofactor of aii (the element in the first row and first column)
= /mn/. (-1)1+1 = 4(-1)2 = 4

C12 = /m12/. (-1)1+2 = 0(-1)3 = 0

C21= /m21/. (-1)2+1 = (1). (-1)3= -1

C22 = /m22/. (-1)2+2 = 2(-1)4 = 2

The cofactor matrix denoted by C, is given by:

c11 c12 4 0
C=■ >=■
c21 c22 -1 2

4- Adjoint of (A), which is the transpose of the cofactor matrix (c* ) is given by

Adjoint (A) = c = I 4 -1

02

Given: A = ■ 1 1 11
21 - 2 -1
1
0
The minor of a11 *• /mn/ = -1 2
=1
0 -1

The minor of a12 *■ /m12/: 2 2

-4
1 -1

The minor of a13 / m13/ 2 -1

1 0 =1

62
The minor of a 21 / m2i/ 11

0 -1 1

The minor of a22 / m22/ = 1 1

-2
1 -1

The minor of a23 *- / m23/ = 1 1

-1
10

The minor of a31 /m31/

3
1 1 -1 2

The minor of a32 _/m32/

1122 0

The minor of a33 _/m33/

112 -3

-1
The cofactor matrix is given by:
*\
C= cn c12 c13 1 4 1
-<
c21 c22 c23 V 1 -2 1 >
c31 c32 c33 -
3 0 3

Adjoint (A) = ct = 1 1 1 3
4 -2 0
-
1 1 3

63
2.4 Inverse of a Matrix

In scalar algebra, the inverse of a number is that number which, when multiplied by the
original number, gives a product of 1. Hence, the inverse of x is simply 1/x; or in slightly
different notation, x-1. In matrix algebra, the inverse of a matrix is that which, when multiplied
by the original matrix, gives an identity matrix. The inverse of a matrix is denoted by the
superscript “-1”. Hence, AA"1 = A-1A = I.

Note that: A matrix must be square to have an inverse, but not all square matrices have an
inverse. The necessary and sufficient condition for a square matrix to possess its inverse is
that /A/ f 0.

Finding the inverse of a matrix requires the concept of row operations to be performed. The
row operations are the following:
a. Multiply or divide a row by a non- zero constant;

If A = f 2 3 ]
| 6 9 f multiply row one (Ri) by -2 to get matrix B.

Then, B = -4 -6 [
6 9J

Divide row two (R2) by 3 to get matrix C. Then, matrix

C 2 3
2 3

b.
Add a multiple of one row to another row;
If A = 1 2 multiply R1 by 2 and add to R2 to get matrix x.
f3 4f

Matrix X
1

64
5
 C. Interchanging of rows;

If A
102 Interchange Ri and R2 ( Ri R2 ) ; to
4 get matrix D.

2 4
D=
10

N.B: The first row elements in the original matrix become second row elements in the new
matrix and vice versa.

Dear distance learner! Do you know the three most important methods to find inverse of a
matrix?

The most important methods to find inverse of a given matrix include the following:

1. Gauss- Jordan Inversion method

2. The zero-first method
3. The cofactor technique

Dear student! Now let us look at each of the inversion methods one by one.

I. Gauss- Jordan Inversion Method

This method was developed by a mathematician called Gauss and it was named so
by the founder. The Gauss- Jordan inversion method starts by writing the given
matrix at the left and the corresponding identity matrix next to it, at the right.
Then, select and carryout row operations that will convert the given matrix in to an
identity matrix and apply the same operations to the matrix at the right
simultaneously. When the left or the given matrix becomes an identity matrix, the
matrix at the right will be the desired inverse matrix.

65
i.e. I A/I . Apply Elementary Row Operation (ERO) | I/A -1 Example: Find the
inverse of the following matrix using the Gauss- Jordan method.

3 2
A=
1 1

Solution
Steps:
1st: write the given matrix at the left and the corresponding identity matrix at the
right; '3 2 1 0
A/I | = -|
11 01

N.B: corresponding identity matrix for 2x2 matrix is of dimension 2x2.

2nd/•: Interchange R1 and R2;

32 10 '11 01
>• ^
-<
™ ■<
11 01 32 10I
>- to R2;
3rd: Multiply R1 by -3 and add the result -

-3 R1 -3
+ = -3 -3 0 = 3 2 1
0
R2
0 -1 1 -3

The resulting matrix is given by:

|1 1 01"
-< >-
0 -1 1 -3
4 : Simply add R2 entries to R1
th

entrie
KI
ll -1 1 -3
0
+
R1= 1 1 01
1 0 1 -2

66
The resulting matrix is given by:
1
0 1 -2 1
-3 i
0
-1 1

5th: Multiply R2 by -1;

(-1) (R2) = 0 1 -1 3

The resulting matrix is given by;

10 1 -2

>
01 -1 3

Dear student! Have you noticed that the original matrix is converted in to identity matrix and
the corresponding identity matrix to inverse matrix?

Thus; the inverse matrix A, denoted by A-1 is given as:

A-1 r
1 -2
-1 3"
Check! A.A-1 = - 1 I
A" . A

S’ r "N
-2 1
3 2 >> 1 0
-< *- >-
>=
11 1J -1 3 L0 1J
V-
Example: Find the inverse of B 2 2 3
0 1 1
4 0 3

Solution:
1st ^ write the given matrix at the left and the corresponding identity matrix at the

2 2 3 1 0 0

{ B/I
I 0
4
1
0
1
3 0
0 1
0
0
1

67
N.B: The corresponding identity matrix for a 3x3 square matrix is of dimension 3x3.
2nd ^ Divide R1 by 2 (or multiply R1 by /);
R2/2 = 2/2 2/2 3/2 1/2 0/2 0/2
= 1 1 3/2 / 0 0

r
The resultant matrix is: 1 3/2 / 0 0
1
0 1 1 0 1 0
1
4 0 3 0 0 J

3rd ^ Multiply Ri by -4 and add to R3 (-4Ri + R3);

-4Ri = -4 -4 -6 -2 0 0
+
R3 = 4 0 3 0 0 1
0 -4 -3 -2 0 1

The resultant matrix is: r

1 1 3/2 / 0 0"

■< 0 1 1 0 1 0f
0 -4 -3 -2 0 1

4th ^ Multiply R2 by -1 and add to R1 (-1R2+R1);

(-1)R2 = 0 -1-10 -10

+

R1 = 1 1 3/2 / 0 0
1
0 / / -1 0
The resultant matrix is given by:

r "N
1 0 / / -10
-< 0 1 1 0 1 0

10 -4 -3 -2 0 1\

68
5th ^ Multiply R2 by 4 and add to R3 (4R2 +R3);

4R2 = 0 4 4 0 4 0
+ 0 -4 -3 -2 0 1
R3 0 0 1 -2 4 1

The resultant matrix is given by:

'1 0 / / -1 0
"0 0
1 1 0 1 ►
.0 0 1 -2 4 1-

6th ^ Multiply R3 by -1/2 and add to R1 (-1/2 R3 + R1);

-1/2 R3 = 0 0 -1/2 1 -2 -1/2

+
R1 = 1 0 / / -1 0
"1 0 0 3/2 -3 -12

The resultant matrix is green by:

-
3/2 -3
1 0 0 1/2"
0 1 1 0 1 0
0 0 1 -2 4 1
Multiply R3 by -1 and add to R2 (-1R3+R2);
7th ^

(-1) R3 = 0 0 -1 2 -4 -1
+

R2 = 0 1 1 0 1 0
0 1 0 2 -3 -1

69
The resultant matrix is green by:

0 0 3/2 -3 -1/2 -
1 0 2 -3
1►
00 1 -2 4

Thus; B-1 = 3/2 -3 -1/2

-<2 -3 -1 >
-2 4 1

Dear student! Have you understand that the elementary row operations converted the original
matrix (B) in to an identity matrix (I) and the corresponding identity matrix to the desired
inverse (B-1)? Dear student! Reanalyze the above two examples to justify the situation.

Exercise 2 - 2

1. Find the inverse of the following matrices using the Gauss - Jordan method.

A
=12 3

2. Write the expanded matrix form of a 2 by 3 general matrix.

3. If matrix p is 1 by 2 and we have py = q, where q is a 1 by 1 matrix:
a. What are the dimensions of matrix y?
b. Write the expanded vector form of the equation.
c. Write the usual algebraic form.

4. Find the inverse of A 4

' 3
2 1

70
The Zero - first method

In using this method, first find zeros in the off-diagonal followed by ones in the main
diagonal.

Example;

If C C 2 3 "3

< >
4 7 ; Find C-1 using zero -first method.

Solution:

1st ^ Write the augmented matrix; (C/I)

2 3
1001
7

2nd ^ To translate the off- diagonal element in the send row and first column (i.e., 4) in to
zero; the elementary row operation is; -2R1 + R2;

-2R1 = -4 -6 -2 0

+
R2 = 4 7 0 1
0 1 -2 1

The resultant matrix is; "23 10"

>-
-2 1
0 1 V. J

3rd ^To translate the remaining off - diaconal element (i.e., 3) in to zero; the elementary row
operation is; -3R2+ R1;

71
 -3R2 = 0 -3 6 -3
+

Ri = 2 3 1 0
2 0 7 -3

"2 0 7 -3

The resultant matrix is; ►

.0 1 -2 1.

4th ^ To translate the main- diagonal entry (i.e., 2) in to one; the elementary row operation
is; R1/2;

R1/2 = 1 0 7/2 -3/2

The final resultant matrix is given
-1 0 7/2 -3/2
by:
-< >-
-0
1 -2 1

Thus; C-1 = 7/2 -3/2

<
-2 1

Check: C.C-1 = C-1 = I

"2 3 ' ► ■< 7/2 -3/2 >- " 1 O

■< J

< V

t-
.4 7- -2 1- O 1

72
Example: Find the inverse of the following matrix by using the zero - first method.

r0 -1 1 ~\

D= -1 1 2
1 0 -2 J
Solution:

1st ^Write the augmented matrix;

"0 -1 1 1 0 0
1 -1 1 2 0 1 0

1 0 -2 0 1 0

N.B: the corresponding identity matrix for a 3x3 matrix is of dimension 3x3.

2nd ^Interchange R1 and R3;

The resultant matrix is given by; 1 0 -2 0 0 1'
<-1 1 2 0 1 0f
. 0 -1 1 1 0 0.

3rd ^ Add R1 to R2;

R1 = 1 0 -2 0 0 1
+
R2 = -1 1 2 0 1 0

0 1 00 1 1
The resultant matrix is given by:
1 0 -2 0 0 1
0 1 0 0 1 1
0 -1 1 1 0 0

73
 4th ^ Add R2 to R3;
R2 = 0 1 0 0 1 1
+
R3 = 0 -1 1 1 0 0

0 0 1 1 1 1

The resultant matrix is given by:

p 0 -2 0 0 1■
0 1 0 0 1 1
0 0 1 1 1 1

5th ^2R3 + R1 ;
2R3 = 0 0 2 2 2 2
+
R1 = 1 0 -2 0 0 1
1 0 0 2 2 3

The resultant matrix is given by: "1 0 0 2 23

-< 0 1 0 0 1 1
0 0 1 1 1 1
V.

Thus; D-1 = 2 2 3
0 1 1
1 1 1■

D-1 D = I

■0 "2 3
-1 1 2 " 1 0 0 4
>
>- . >> ■
-1 0■
1 2 -< 0 1 1 = <0 1
1
1 0 -2 J 1 . 0 0 1.
74
Exercise 2 - 3

Find the inverse of the following using the zero -first method;

a) f 2 1 3
A= f 3 1 2
12 f
3

b) 3 2 c)
3 3
C D
1 5 4 4

III. The Cofactor Technique

This method involves computation of minors, cofactors and the adjoint matrix in order to
find the inverse of a given matrix.

Formula wise; the inverse of a given matrix A is given by:

A-1 = 1/ A (Adj. A)

Dear student! Remember the computation of a determinant; minors; cofactors and adjoint of a
matrix in the previous sections of the chapter.

N.B:

- The minor of aij is the determinant of a given matrix; say A with row i and column j
eliminated.
- The cofactor Cijof the

- The adjoint of A isthe

r
1 -2 3
Example; If A = " 2 3 -1
-3 1 2 ; Find its inverse using the above formulae.

75
Solution:

an = 1 and its cofactor cn = (-1)1+1 3 -1 7

1 2

a12= -2 and its cofactor c12 = (-1)1+2 2 -1 -1

-3 2

ai3 = 3 and its cofactor C13 = (-1)1+4 11

2 3 -3

1
Similarly; C21= 7; C22= 11; C23= 5, C31= -7; C32= 7 and C33=7.
Adjoint of matrix A, Adj. (A) = the transpose of the cofactor matrix (C t).

Cofactor matrix; ' c11c12 c13 ' '7 -1 11

O ►
c21c22 c23 7 11 5 1
II =“
c31c32 c33 < -7 7 7-

7 7 -7
Adj. (A) = Ct = -1 11 7 ►
11 5 7

Determinant of matrix A; det (A) = 1x7 - 2x1 +3x11

= 38
Then, A-1 = (Adj (A))
A

i7 7 -7 " 7/38 7/38 -7/38

1/38
-1 7 >- = -<-1/38 11/38 7/38 >
« 11
i 11 5 7i J1/38 5/38 7/38 i

76
Exercise 2 - 4

Find the inverse of the following using the cofactor technique;

a)
'1 1 1' b)
C=. \1 -
2 -1 2 x=
► 1
1 0 -1 1
1

Dear Student! What do you conclude about inverse of matrix?

77
SECTION TWO: MATRIX APPLICATIONS

Section Objectives

Up on completing this section, you will be able to:

• Develop an insight towards application areas of matrix algebra.

• Handle large linear systems using matrix algebra.
• Undertake markov chain analysis with the help of matrix algebra.

2.5 Solving System of Linear Equations

A system of linear equations can be solved by the following three methods using matrix
algebra:

a) Cramer’s rule ( the determinant method)

b) The inverse method
c) The Gauss- Jordan method

Let us see each of the three methods one by one.

a) Cramer's Rule:
This method sometimes called the determinant method; works according to this formula:

Xi = /Ai/; where xi = indicates the variables we want to solve for.

/A/ /Ai/ = is the determinant obtained by putting the right-hand side of the
system in place of the column of coefficients of the variable whose solution is needed; and

/A/ = is the determinant of the system.

78
Given a system of equations:
i) aiix+ai2y = bi ^ algebraic form
a2ix+a22y = b2

The above system of equations can also be rewritten in expanded matrix form as follows:

-\

' aii ai2 ' -

O-
\

_J J

►.- II
- a2i a22 -- (-
b2
V_
Matrix of coefficients column vector of column vector of
denoted by A variables (X) constants (B)

Using Cramer’s rule, the solution is given by:

bi ai2 aii bi
X
b2 a22 ; and Y = a21 b2
A A

Example; x- y = 1 = ' 1 -1 ' 'x' ’1 ^ matrix expression

►
-. ►=
x+ y = 2 -
- -
1 1 V. J -y- -2-

Then, x= 1 -1
21
A

1 -1
21
3/2
1 -1
11

79
 y= 11 11
1/2
12 12
Ml 1 -1

11

ii) Given a system of equations:

aiix+ ai2y+ ai3z = bi a2ix+
a22y+ a23z = b2 a3i
x+a32y+ a33z = b3

Expanded form:

^aii ai2 P? >x> > bi '

u>
_J

a2i a22 a23 >- • y >> = > b2 f

a3i a32 a33 >z> b3
V. A J B

Then; the value of x is given by:

bi ai2 ai3 aii bi
ai3
a2
b2 a22 a23 a2i b2
3
a3
aiib3 ai2a32 ai3a33 ;y= a3i b3 3
aii ai2 ai3
a2i a22
a2i a22 a23
a3 a33
a3i
2 a3i a32 a33

aii ai2 bi
a2i a22 b2
a3i a32 b3
aii a22 ai3

a2i a22 a23

a3
a3i a32 3

80
Example; Solve using Cramer’s rule:
2x + y - z = 0 x + y + z = 0 y - z = 1

Expanded form of the above system is:

"2 1 -1 "N 'x '0
J1 1 1 J. - y -=- 0-
0 1 -1 J
z 1
A X B

(N
+ 1 1 -1 11 +(-1) 1 1
II
0 1 = -4
1 -1 0 -1

Thus; x = 0 1 -1
1 1 -1
0 1 1 = 2/-4 = -1/2
A

Y= 2 0 -1
1 0 1 = -3/-4 = 3/4
0 1 -1
A

Z 2 1 0
1 1 0
= -1/4
0 1 1
A

81
b) The Inverse Method:

It is used to find the solution of linear equations when the number of equations is equal to the
number of variables (i.e. for square matrices only).

Consider the following system of linear equations:

anx1+ a12x2+ aox3 = b1 a21x1+ a22x2+ a23x3 = b2 a31x1 + a32x2+ a33x3 = b3

These equations can be expanded as:

f
a11 a12 a13 x1
£
V_

a21 a22 a23 - . x2 * - b2

a31 a32 a33 x3 b3
J

Matrix of coefficient column vector of column vector of (A) Variables (x) constants (B)

4- Therefore; AX = B

If we multiply the above equation by A-1, we get (A-1A) (x) = A-1B IX = A-1B, but A-1A =
I; therefore; IX =X Thus; X = A-1B

Because we know matrix B, we need to find A-1, which we know how to obtain. If we
find the inverse, we multiply it by vector B, and the outcome will be the solution. In total,
in using the inverse method to find the solution of linear equations:
1st Find the inverse of the coefficient matrix.
2nd Multiply the inverse with the column vector of constants.

Example:
Solve the following equations using the inverse method.

a) 2xi + 3x2 = 17 xi + 2x2 =10

82
b) x+2y-3Z=11
3x+2y+Z=1
2x+y -
5Z=11
Dear student, please try to solve these examples before going to the solution part.

Solution :

a) 1st Write the expanded form;

J
"2 3 " " X1 '
J2. . X2 . \
O _J

2nd Find the inverse of the coefficient matrix;

r
23 10
12 01
V J
=> Interchange R1 and R2;
"1 2 01'
.2 3 10,

^ -2R1 + R2;
-2 R = -2 -4 0 -2
+
R2 = 2 3 10
0 -1 1 -2

The resultant matrix is given by:

"1 2 0 1"
-2
0 -1 1
J

^Multiply R2 by -1;

-1(R) = 0 1 -1 2

83
 The resultant matrix is given by:

"1 0 2 -3 '
f. 0 1 -1 2 .

Thus, the inverse of the coefficient matrix is: f

2 -3 "'I . -1 2 „
3rd Multiply the inverse by the constant matrix;
X= A-1B

' xr ^2 -3 ^ f 17 f '4"
>>
. X2. -1
2 0
3
J _j J
Therefore, Xi = 4 and X2 = 3.

b) 1st => write the expanded form;

r r ~\
r ^ X 11
1 2 -3
3 21 Y 1
L2 1 -5 J fZJ J
11

2nd ^Find the inverse of the coefficient matrix;

r A
1 2 -3 1 0 0
321 01 0
V 2 1 -5 1J
00

^ -3R1+ R2 ;
-3R1 = -3 -6 9 -3 00
+
R2 3 2 10 10
0 -4 10 - 3 10

84
The resultant matrix is given by:
r
1 2 -3 1 00
0-4 10 -3 10
^ -2Rl+R.3 ; 21 -5 0 01
v j

-2R1= -2 -4 -2
6 0 0
+
R3= 2 1 -5 0 0 1
0 -3 1 -2 0 1

The resultant matrix is given by: r1 2 -3 1 0 0

0 -4 10 -3 1 0
0 -3 1
1 -2 0
V J
^ R2/2 + R1;
R2/2 = 0 -2 5 -3/2 / 0
+
R1 = 1 2 -3 10 0
1 0 2 -//
0

r
The resultant matrix is: 1 02 -/ / 0
-<0 -4 10 -3 1 0
0 -3 1 -2 0 1

^ -R2/4;
-R2/4= 0 1 -5/2 % - / 0

The resultant matrix is given by: 1 0 2 -/ / 0

>
0 1 -5/2 % -/ 0
0 -3 1 -2 01
^3R2+R3;
3R2= = 0 3 -15/29/4 -%
0
+
R3= 0 -3 1-2 0 1
0 0 -13/2 / -3/4 1

85
The resultant matrix is: 1 0 2 - // 0
0 1 -5/2 %-H 0
«. 0 0 13/2 H-% 1 .

^ -2/13R3
r 10 2 -/ / 0
01 -5/2 %-H 0
00 1 -1/26 3/26 -2/13

^ 5/2 R3+R2

5/2 R3 = 0 0 5/2 -5/52 15/52 -10/26

+

R2 = 0 1 -5/2 % -1/4 0
0 1 0 17/26 -1/26 -5/13

The resultant matrix is given by:

1 0 2 -/ /0"

0 1 0 17/26 1/26 -5/13

0
0 1 -1/26 3/26 -2/13 ^

^ -2R3+R1;
-2R3= 0 0 -2 1/13 -3/13 4/13
+
R1= 1 0 2 -/ / 0
1 0 0 -11/26 7/26 4/13

The final resultant matrix is given by:

10 0 -11/26 7/26 4/13
1 01 0 17/26 1/26 -5/13
0
0 1 -1/26 3/26 -2/13^

86
3rd ^Multiply the inverse (A-1) with the constants matrix (B); i.e. X=A" 1B;

'X' f -11/26 7/26 4/13 ^ f 11 '

Y = 17/26 -7/13 -5/13 * 1

.Z„ V -1/26 3/26 -2/13 _y 11

LJ

r
x -1

y = 3 So, x = -1, y= 3, and z = -2

z -2

c) The Gauss-Jordan Method:

This method works through several operations to reduce a given matrix of coefficients of a
system equation in to an identity matrix. It is used to find the solution of linear equations:
i) When the number of equations (m) is equal to the number of variables (n); i.e. m = n.
ii) When the number of equations (m) is greater than the number of variables (n); i.e., m>n.
iii) When the number of equations (m) is less than the number of variables (n); i.e., m<n.

4- It applies the concept of row operations both on the coefficient matrix (A) and the column
vector of constants (B) in order to convert them to an identity matrix (I) and the solution
matrix (S) respectively.

That is, (A/B) row operations (I/S)

----

87
i. Number of equations (m) equals number of variables (n)

The intention to convert (A/B) to (I/S) when the number of equations (m) equals the number
of variables (m) will result in:
1. Unique solution if the coefficient matrix has an inverse.
2. An infinite solution if the elements in the last row are all zeros including the constants’
column.
3. No solution if there is a row that is all zeros except in the constants’ column. Example-1:
Solve the following system of two equations:

2x1 + 3x2 = 5 x1 + x2 = 3

Solution:

Form the augmented matrix A consisting of the coefficients of x 1 and x2 and the column of the
right-hand side of the above system. That is,

(A/B) = .23 5

11 3
J

As mentioned, we want to reduce the coefficient matrix in to an identity matrix of dimension

2 x 2; this can be done through the following operations:

Multiply the first row by ('A), keeping the second row intact, and yields:

"1 3/2 5/2 '

v. 1 1 3.

88
The first element of the first row is (1); accordingly, the first row is the pivotal row to perform
the operations with. We need now to make the first element of the second row (0). To do so,
we keep the first row intact, multiply it by (-1), and add the result to the second row, which
yields:
"1 3/2 5/2 '
v. 0 -/ /,

Now, we need to convert the (-/) in to (1) to create a pivotal row. This can be done by
multiplying the second row by (-2); keeping the first row intact yields:
" 1 3/2 5/2 '
.0 1 -1 ,

Again, we want to convert the (3/2) in to (0). To do so, we keep the second row intact (the
pivot), multiply it by (-3/2), and add the result to the first row, which yields:

"1 0 4"

0 1 -1 ,

As can be seen through several operations, we reduce the coefficient matrix in to an identity
matrix of dimension 2x2. The last column of the above matrix is the solution for xi and X 2,
respectively.

Example -2 :

X+Y = 2
2X+2Y = 4

Solution:

1st ^ write the expanded form;

r _J '2"
22 Y 4

89
 r
A/B * 11 2
VJ
22 4
J
2 ^ -2Ri + R2;
nd

-2Ri = -2 -2 -4
+

R2 = 2 2 4
000

The resultant matrix is given by:

2"
0 Infinite solution since the last row entries are all zeros.
0 0-

Dear Student! Notice that, no row operations can convert matrix A in to an identity matrix.
So, no further operation is required. The bottom row entries (all being zero) indicate the case
of an infinite solution.

Example-3 :
X+Y+Z = 4 5X-Y+7Z = 25 2X-Y+3Z = 8

Solution:

1st ^ Expanded form;

r1 1 1 'X 'X' 4

5 -1 7 Y 25
Z 8
2 -1 3
J k. J s. J

90
 1 1 1 4^
2nd ^ [ A / B] = 5 -1 7 25
^ 2 -1 3 8J

3rd ^ Apply row operations to convert [A / B] ^ [i / S] ^ -

5Rl + R2;
-5RI = -5 -5 -5 -20
+
R2 = 5 -1_7 25
0-6 2 5

The resultant matrix is: f1 1 1 4^

0 -6 2 5
2 -1 3 8
J
^ -2R1+R3;

-2RI= -2 -2 -2 -8

+
R3= 2-138 0-310

The resultant matrix is: r1 1 1 4

0 -6 2 5
0 -3 1 0
j
^ R2/-6;
r1 1 1 41

0 1 -1/3 -5/6
^0 -3 1 0
>

91
^ -R2+ Ri;

-R2 = 0 -1 1/3 5/6

+
R1 = 1 1 1 4
29/
1 0 4/3 4

The resultant matrix is: r1 0 4/3 29/4

0 1 -1/3 -5/6
0 -3 1 0J

^ 3R2 + R3:
3R2 = 0 3 -1 -5/2
+
R3 = 0 -3 10
00 0 -5/2

The resultant matrix is: S'

1 0 4/3 29/4
0 1 -1/3 -5/6 ^ No solution
0 0 0 -5/2
A

Dear student! You have noticed that bottom row entries are all zeros except the constants’
column (which is -5/2) resulting in no solution case.
ii. Number of equations (m) greater than number of variables (n)

The intention to convert [ A / B] ^ [i / S ] will result either in:

1. An n by n identity matrix above m-n bottom rows that are all zeros, giving the unique
solution.
2. A row that is all zeros except in the constants’ column indicating that there are no
solutions.
3. A matrix in a form different from (1) and (2) indicating an unlimited solution.

92
 Example-1
2xi -3x2 = 6
xi +5x2 = 29
3xi - 4x2 =
11
Solution:

1st ^ write the expanded form;

r "N
2 -3 xi 6
>-. 29 \
1 5 >- = -<
-
3 -4 J x2 11

2nd ^ Apply row operations;

r "\
2
-3
6
1 5 29
11
3 -4
J
=> Interchange R1 and R2; ^1 5 29
-3
-< 2 6

>> 3 -4 11 >
|
=>2Ri+ R2 ;

1 5 29
* 0 -13 -52 >
> 3 -4 11 >

^R2/-13 ;

1 5 29
0 1 4
3-4 11
J

93
 ^ -5R2+ Ri;

-V

1 0 9
<0 1 4 >
3 - 1
J
4 1
^-3R1 + R3 ;

r 0 9
1
0 1 4

-16
0 -4
J

^ 4R2+R3 ;

1 0 9
< 0 1 4 ^ Unique solution
0 4
0 0 Thus; X1 = 9, and
X2
Example-2;
2X1+X2 = 30
X1+ 2x2 = 24
4x1+5x2 = 72

Solution:
1st ^ Expanded form;

2 1 X1 30
S1 >- S- = 24 S
2 X2
-< -
-4 5- X3 72

2nd ^ Apply row operations;

A/B -2 1' - 30
-< 1 2 >=- 24
72
4 5 ^J

94
=> Interchange Ri and R2;

r "N
1 2 24
2 1 30
4 5 72
J

^ -2Ri + R2;

r 2 24
1
0- 3 -18
4 5 72
J

^ -4Ri + R3;

r
1 2 24
0 -3 -18
0 -3 -24
J

^ R2/-3;

'1 2 24
0 1 6
-24
0 -3
J

^ -2R2+ Ri;
"1 0 12 "
0 1 6
-24
0 -3
J

^ 3R2 +R3;

1 0 12
0 1 6 ^ No solution
.0 0 -6

95
iii. Number of equations (m) less than number of variables (n)

The attempt to convert matrix (A/B) ^ (I/S), when m <n, will result either in:

1. A row which is all zeros except in the constant column, indicating that there are no
solutions.
2. A matrix in a form different from (1), indicating that there are unlimited number of
solutions.
Example;
4x1 + 6x2 - 3x3 = 12 6x1+9x2 - 9/2x3 = 20

Solution:
12
1st ^ 4 6 -3
>
6 9 -9/2 20

2nd ^R1/4;

3/2 -3/4
r 1 3
1
9 -9/2 20 j

1 6

3rd ^ -6R1+R2;

r ^ No solution case!
13/2 -3/4 3
-< >
0 00 2

96
Exercise 2-5

1. Solve the following using the Cramer’s rule;

a. 5xi+3x2 =13 b. xi+x2+3x3 =3 c. 2xi+4x2 = 7

4x2=11 xi+x3 = 2 4xi+3x2 =1

4xi+2x2+3x3 =5

2. Solve the following using the inverse method; a. 2x+z

= 3 b. 3xi + 2x2 = 6 c. xi+x2+3x3 = 3

3x+5y+7z =1 xi+3x2 = 5
xi+x3 = 2
3z = 7 4xi+ 2x2+3x3 =5

3. Solve the following using the Gauss-Jordan method;

a. xi+x2+3x3 =3 b. 2x2 = 4

xi+2x2+x3 =2 xi+3x2 = 5

4xi+2x2+3x3=5

Solving Word Problems

Steps:

1. Represent the unknown quantities by letters.

2. Translate the quantities from the statement of the problem and form an algebraic expression; then, set up an

equation.

3. Solve the equations for the unknowns.

4. Check the findings as per the statement in the problem.

Example-1

A manufacturer produces two products p aid q. Each unit of product p requires in its production 20 units of raw

material A and 10 units of raw material B whereas each unit of product q requires 30 units of raw material A and

50 units of raw material B. There is a limited supply of only 1200 units of raw material A and 950 units of raw

material B. How

97
many units of P and q can be produced if the manufacturer is to exhaust the supply of raw
materials (to operate at full capacity).

Solution:

Given: Raw materials Type of Products Availability

P q
A 20 30 1200
B 10 50 950

Step-1: Let x and y represent the number of units of product P and q to be produced
respectively at full capacity.

Step 2: Formulate the equations:

Raw material A: 20x+30y =1200 => 2x+3y =120 Raw material B: 10x+50y = 950 => x+5y =
95

Step 3: Solve the equations:

Let us apply the Gaussian method;

Expanded form:

r^ r "N
\ 120
23 x
15 y 95
/
■V. LJ

(A/B)^ (I/S)

23 120

15 95 J

98
 ^ Interchange Riand R2;

r
15 95 -\

23 120

^ -2R1+R2;

15 95
rp
0 -70
J

^ R2/-7;

15 95

01 10

^ -5R2+R1;

^1 0 45 ^

V0 1 10
^

r
x^~r^ 45 ^x = 45 units

yJ JJ 10 ^ y = 10 units

Step -4: Cross- Checking

• 20x+30y =1200
20(45)+30(10) =1200
1200 =1200

99
 10x+50y=950
10(45)+50(10)=950
950= 950 ✓

Example -2
Attendance records indicated that 1600 people attended a football game and the total ticket
receipt was 2800 birr.
The admission price was 1.50 birr for students and 2.50 birr for others.
Determine the number of students and non-students who attended the game.

Dear student, please try to solve the above example before going to the next solution.

Solution:
Given: Attendants Total
Students Non-students receipt
Admission price....... 1.50 birr 2.50 birr 2800 birr
Number of People - - 1600

Step -1: Let S and N represent the number of students and non - students who attended the
same respectively.

Step- 2: Develop the equations;

Number of people: S+N = 1600 Receipt : 1.50 S+ 2.50 N = 2800

Step- 3: Apply the Gaussian method;

r "\
1 1^ 'S' 1600
1.52.5 N 2800
V J LJ k. J

100
 ^ [A / B] ^ [I / S]
r11 1600 ^

^1.5 2.5 2800 ^

^ -1.5 Ri + R2 ;

r ~\
1 1 1600
0 1 2800
V J

^ -R2 + Ri ;

r ~\
1 0 1200
0 1 400
V J
r ~\ r ~\
S 1200
N 400
J => Number of students(S) = 1200.
v J
Number of non-students (N) = 400
Total = 1600

Example -3

A mixture containing X - pounds of ingredient A, Y- pounds of ingredient B and Z -

pounds of ingredient C is to be made. The mixture is expected to have a weight of 5
pounds and contains 1500 units of vitamin and 2500 units of calories. The vitamin and
calorie content of the three ingredients is shown below.

Ingredient Number of Units of Units of

s pounds Vitamin Calories
Per pound per pound

A X 500 300
B Y 200 600
C Z 100 700

101
Determine how many pounds of each ingredient should be in the 5 pound mixture.

Solution:
Let pounds of ingredient A be X

B"YC
"Z

Equations: x+y+Z = 5 .....Weight of the mixture

5x+2y+Z =15...............Vitamine
3x+6y+7Z = 25..............Calories

Solve using matrix algebra;

r r
n 5 5
1 1 X 1 1 1
5 2 1 Y 15 * 5 2 1 15
3 7 Z 25
6 3 6 7
V J LJ J 25
^
* -5R1+R2;

r 1 1 1 5

0 -3 -4 -10
V 3 6 7 25J

* -3R1+R3;

11 1 5
0 -3 -4 -10
0
V
3 4 10 J
* R2/-3;

r
1 1 1 5

0 1 4/3 10/3

0 3 4 10 J
102
^ -3R2+R3;

11 1 5
10/
4/3
01 3
0
V
0 0 0 J
^ -R2+R1;
r1 0 -1/3 5/3 >
0 1 4/3 10/3 => Unlimited solution case!
0
0 0
V 0
v

2.6 Markov Chain Analysis

Definition: Markov analysis is the process of determining future occurrences depending on

present occurrences. It is a continuous process by which an outcome at each stage is
determined from the previous outcome by applying a certain fixed proportion.

There are two important data of the model:

a) The set of transition probabilities, and
b) The current or initial state

Based on these inputs, the model makes two predictions:

i. The probability of the system being in any state at any given time (i.e., state probability).
ii. The long run or steady state or equilibrium probability.

The markov model is based on the transitional probability describing a situation that changes
between two stages. The first occurs at time (t-1), and the second stage takes place at time (t).
In other words, the current probability of a certain state depends on the probability of the
immediate preceding state only.

103
 The markov model has various applications in business and economics. For example, it
can be applied to a model where customers are buying products from two different stores
and where managers are interested in knowing how these customers change stores or
continue buying from the same store over the long run. Also, the markov model can be
applied to a situation where people migrate from region to region between time (t-1) and
(t).

Dear student! What do you know about transition probabilities, stages, states, regular
transition matrix, steady state matrix, absorbing and non- absorbing chains?

States, Stages and Transitional Probabilities

Imagine the following table of probabilities:

State at the end of stage “t”

1 2 3_4.................n

1 P11 P12 P13 Pl4.......................P1n

State at the P23 P24.......................P2n
2 P21 P22
end of stage
“t-1” 3 P31 P32 P33 P34.......................P3n

n Pnl Pn2 Pn3_Pn4..........................Pnn

The table reveals some technical concepts. The first concept is the state concept such as state
1, 2, and so forth, which means that the system is in a certain category or condition. For
example; it is sunny today (stage t-1) and will be cloudy to morrow (Stage t). The second
concept is the stage concept. The table shows that there are two stages; stage t-1 and stage t.
This means that if stage t-1 represents yesterday, stage t represents today (or a future day).
Similarly, if stage t-1 represents the month of May, stage t indicates the month of June (or a

104
future month). The third concept is the transition probabilities, Pij. Pij, i =1, 2....n and j =1,
2....n, which represent the probabilities that the system will change from state i to state j
during stage t. For example, P12 reflects the probability that the system will change from state
1 to state 2 during stage t. Similarly p23 reflects the probability that the system will change
form state 2 to state 3 during stage t. In fact, this is the reason why the probability matrix P,
where

P11 p12 p13 pi4... ...............p1n

.
P= P21 P22 P23 P24.. ...............P2n
..
P31 P32 P33 P34.. .................
.. P3n
j
is called the transition
pn1 pn2 matrix. pn3 pn4 Pnn

The transition matrix, which is a stochastic matrix, is a square matrix of dimension nxn with
the following properties:

i. All the elements Pij must be between 0 and 1 (i.e. pij >0), and
ii. The sum of each row must equal 1.

The fourth technical concept that the table of probabilities provides is the concept of a system.
In markov analysis, the system consists of all the states along with their transition
probabilities, provides is the concept of a system. In markov analysis, the system consists of
all the states along with their transition probabilities, Pij.

Example:

Assume a weather record showing that it will be sunny to tomorrow with a probability of 70
percent if it is sunny today; otherwise it will be cloudy tomorrow if it is sunny today. Also, the
record shows that the probability that it will be cloudy tomorrow 50 percent of the time if it is
cloudy today; otherwise it will be sunny tomorrow if it is cloudy today. The task is to
formulate the transition probability matrix, taking in to consideration the two states of sunny
and cloudy. The transition probability is shown below. The table

105
reveals two stages: today (t-1) and tomorrow (t). The transition probabilities reflect two states:
Cloudy and sunny.

Tomorrow
Sunny Cloudy

Today Sunny 0.70 0.30

Cloudy 0.50 0.50

As can be seen, each entry of the transition matrix is between zero and one, and each entry can
be described as follows.

The probability 0.70 represents the probability that it will be sunny tomorrow if it is sunny
today. The probability of 0.30, which is (1-0.70), reflects the probability that it will be cloudy
tomorrow if it is sunny today. The probability of 0.50 represents the probability that it will be
sunny tomorrow if it is cloudy today. The entry, 0.50, represents the probability that it will be
cloudy tomorrow if it is cloudy today.

Stated differently, these transition probabilities are actually conditional probabilities. If S

represents the event sunny, and C represents the event cloudy, then given that the state cloudy
has occurred today, the probability of being sunny tomorrow (or P(S/C) is equal to 0.70; this
is called a conditional probability. Similarly, P(C/C) is the conditional probability of cloudy
tomorrow given it is cloudy to day, which is equal to 0.50.

The transition (conditional) probabilities can be described by probability trees. Given that it is
sunny today, the probabilities that it will be sunny or cloudy tomorrow are 0.70 and 0.30,
respectively, as shown in the following:
Sunny
0.7 /
^ 0.30 Cloudy
Sunny -

Given the state that it is cloudy today, the probabilities that it will be sunny or cloudy
tomorrow are 0.50 and 0.50 respectively, and this is shown below:

106
 Sunny
0.50

Cloudy 0 50
Cloudy

The transition probabilities for the above problem are shown in the following transition
diagram:

0.30

Example:

Assume that a market is shared by two cigarette brands namely Rothmans and Nyala. The
Ethiopian Tobacco Corporation conducted a market survey and has concluded the following
information about the proportion of smokers who stay with the same brand or change brands
in consecutive months.

- Of the smokers who bought Rothmans last month, 80% buy it again and 20 percent change
to Nyala this month.
- Of the smokers who bought Nyala last month, 40% buy it again and 60% change to
Rothmans this month. If for a sample of 1000 smokers, 400 buy Rothmans and 600 buy Nyala
in the first month of observations, what figure can we expect for the second, third and fourth
months?

107
 Solution:

This month

Rothmans Nyala
Last month
=> Transition
Rothmans probabilities

Nyala

Rothmans Nyala
*400 => Current or initial state vector

4- Remarks:
S The elements in the main-diagonal indicate brand loyalty.
S The elements in the off-diagonal indicate shifting of customers.
S The rows indicate the proportion of those retained and lost by a given brand.
S The column elements indicate the proportion of customers retained and gained by a
given brand.

Let R => represents Rothmans N => represents Nyala => The expected figure in the
second month:
(Current state) (Transition probabilities)

R N R N R N
>
r A
r r >
400 600 R 0.8 0.2 = 680 320
V J N 0.6 0.4 J
V J

108
 The expected figure in the third month:
S’ "'V

r
State of second month
v J Transition probabilities^

R N R N R N
r
r r "N
680 320 R 0.8 0.2 = 736 264
V J LJ
N 0.6 0.4
J

=> The expected figure in the four month:

Third month state probability

V. J Transition probabilities

R N R N R N
r r r "\
736 264 R 0.8 0.2 = 747 253
V J J

N 0.6 0.4 J

Markov Chain Formula:

V
ij(n) = Vij(n-1) p Where;
Vij(n) = the state probability at the nth period
Vij(n-1) = the state probability at the (n-1)th
period P = the transition probability

109
Taking the above example, if we continue the process; the state probabilities for the
following consecutive months will be:

Month Rothmans Nyala

5 ....................................749.44 250.56
6 ..................................749.888 250.112
7 ...................................749.9776 250.0224
8 ...................................749.99552 250. 00448
9 ...................................749.999104 250.0008964

* 250
n ~750

Pre-multiplying P with ( 750 250 ) gives us: r

~\ r r
750 250 0.8 0.2 <=> Steady
750 250
state
v J J probability
0.6 0.4
V. J
Note: Finding the steady state probability using the above pre-multiplication of the rounded
figure is cumbersome and time taking.

In reality, it is very difficult to find the steady state transition matrix by multiplying the P
matrix by itself many times. The alternative approach for finding the steady state matrix is to
do the following:

S = SP

For the steady state matrix (S) of two states only, we have:

110
 r
Si S2 ^Pii P12 ^
Si S2
J
^21 P22 y

r A
For the above example, P= 0.8 0.2

0.6 0.4
j

Then; r ~\ r
r
S1 S 2 v J 0.6 0.4 S1 S2
v J
0.8 0.2
vJ

After performing the required multiplication, we obtain;

-0.2S1+ 0.6 S2 = 0.................ei

0.2 S1+ (-0.6 S2) = 0..............e2
S1
+ S2 =1 .......................e3 The sum of the rows
in the state vector equals 1.

This is a system of three equations but two unknowns. As the first two equations are
linearly dependent, one of the equations has to be dropped. Assume, the second
equation is dropped, the system becomes;
-02S
1 + 06 S2 = 0 Solve S!+S2=1 simultaneously!

Multiply the second equation by 0.2;

-0.2S1 + 0.6 S2 = 0 Solve simultaneously!

0.2Si + 0.2S2 =
0.20+0.80S2 = 0.2
S2 = 020 = 025 0.80

111
Then, substituting S2 = 0.25 in to any one of the equations,
Si = 0.75.
Therefore; (Si S2) = (0.75x100 0.25x100) = (750 250), which is the steady state vector.

Example:

The market for a particular product is shared by three department stores: X, Y and Z. A
market survey has produced the market transition table below which describes the proportion
of customers who buy at the same store again or change stores in consecutive months.

From/To X Y Z
X 0.6 0.2 0.2
Y 0.1 0.6 0.3
Z 0.2 0.6 0.2

Required:
a. Find the share of the market which each store would command at the steady state.
b. If the sample of 4000 people is assumed to be customers of the three stores, calculate the
number of customers who used each store at the steady state.

Solution:

a) Let Vi, V2 and V3 represent the steady state vector;

At the steady state:(V1 V2 V3). (P) = (V1 V2 V3)

Then, 0.2 0.2

(V1 V2 V3) . 0.1 0.6 0.3 £ V3)

11
V J0.2 0.6 0.2

112
 After matrix multiplication, we obtain the following;

O.6V1+ 0.1V2 + 0. 2V3 = V1 ^ -0.4V1+ 0.1V2 +0.2V3 = 0...........e1

0.2V1+ 0.6V2 + 0.6V3 = V2 ^ 0.2V1-0.4V2 +0.6V3 = 0..............e2

0.2V1 + 0.3 V2 + 0.2V3 = V3 ^ 0. 2V1+ 0.3V2 - 0.8V3 = 0..........e3

V1+ V2 + V3 =1........................................................................e4

Equate ejand e4 -0.4V1 +

X (0.4) 2 +0.2V=1
V1+V+V3
0.1V 3=0

- 0.4V1+ 0.1V2 + 0.2V3 = 0 0. 4V1+ 0.4

V?. + 0.4V3 = 0

0.5V2 + 0.6V3 = 0.4..................... .............e5

Equate e2 and e4

X (-0.2) 0.2V1-0.4V2 +0.6V3 = 0 V1+ V 2 + V3 =

1 0.2V1 -0.4V2 + 0.6V3 = 0 -0.2V1-

0.2V2- 2V3 = -0.2

-0.6V2 + 0.4V3 = -0.2................... ...............e6

Equate e5and e6
0.5V2 + 0.6V3 = 0.4
X(0.6)
X (0.5)

-0.6V2 + 0.4V3 = -0.2 0.3V2+0.36V3+ =

0.24 -0.3 V + 0.2V3 = -0.1 0.56V3 = 0.14

V3 = 0.14 = 0.25
0.56

113
Substitute V3 = 0.25 in e6;
Then, -0.6 V2 + 0.4V3 = -0.2 ^ -O.6V2 + 0.4 (0.25) = -0.2
-O.6V2 =-0.3 V2 = -0.3 = 0.50
-0.6
Substitute V2 = 0.5 and V3 = 0.25 in e4;
Then; Vi +V2 +V3 =1 ^ Vi +0.50+0.25 =1
Vi=1-0.75= 0.25
(Vi V2 V3) = (0.25 0.5 0.25) => Steady state vectors

b) Total number of people = 4000

^ Customers of store x at the steady state = 0.25x 4000 ^ Customers of

store y at the steady state = 0.5x 4000 = ^ Customers of store z at the
steady state = 0.25x 4000 : =
1000
2000
=
1000

114
Exercise 2- 6

1. At a point in time, 1 percent of the population uses a drug and 99 percent do not. In a
year, 1/10 of one percent of non - users become users, but all users remain users.

(a) What will be the percent of users and non- users after one transition?
(b) What is the steady state vector?

2. A division of the ministry of public health has conducted a sample survey on public
attitude towards the use of condom. For the survey, the division concluded that currently
only 20 percent of the population uses condom and every month 10 percent of non-users
become users whereas 5 percent of the users discontinue using. Based on this information;

(a) What will be the percentage of users from the total population after just two months?
(b) What will be the proportion of users and non- users at the steady state?

3. A college of business has three departments: Economics; Accountancy and Finance,

with the following transition probabilities:

Economics Accounting Finance

Economics 0.30 0.30 0.40

Accountancy 0.01 0.89 0.10
Finance 0.25 0.20 0.55

If the initial distributions of students are (200 500 600), respectively,

(a) Find the distribution after two years.
(b) Find the long - run probabilities for each department and the long -run distribution of
students.

115
UNIT SUMMARY

Dear distance learner! We have seen about types of matrices, matrix operations, inverse of a
matrix, ways of finding an inverse and applications of matrix algebra. The following gives the
summary of major points.

The equality of matrices is assured by equality of corresponding elements of the same

dimension. Matrix addition and subtraction is defined for matrices of the same dimension but
matrix multiplication is defined by considering the equality of inner dimensions.
As long as the order of the matrix is maintained, matrix multiplication is associative and the
distributive law holds true, but matrix multiplication is not commutative except for: the
multiplication of a matrix with an identity matrix and the multiplication of a matrix with its
inverse.

^ Inverse of a matrix is defined only for square matrices.

^ Inverse of a matrix is unique.
^ If matrix B is the inverse of matrix A, then matrix A is the inverse of matrix B.
^ Every square matrix may not have an inverse. If a matrix has no inverse, then it is said to be
singular and if a matrix has an inverse, it is said to be invertible or non- singular.

Matrix algebra is applied in solving system of linear equations and in undertaking markov
chain analysis.

116
SELF-CHECK REVIEW PROBLEMS II

1. A manufacturer makes two types of products: X and Z at each of two different locations A
and B. The materials used to make each of the products are steel, glass and plastic.
Suppose it takes three units of steel, one unit of glass, and two units of plastic to make one
unit of product X; and four units of steel, one - half unit of glass and three units of plastic
to make one unit of product Z. Suppose further that steel, glass and plastic cost birr 10, 2,
and 3 per unit, respectively at location A. At location B, steel, glass, and plastic cost 9, 3
and 4 per unit, respectively. Using matrix algebra, find the material cost of making one of
each product at each of the two locations.

2. A person wants to mix ‘nech teff and ‘sergegna teff.

‘Nech teff costs 2.00 birr per kilogram and ‘sergegna Teff costs 1.50 birr per k.g. The person
has 425 birr and wants to mix a total of 250 kilograms of teff. How many kilograms of
each type of teff should the person buy to come up with desired mixture?
(a) Write the problem as a system of linear equations?
(b) Solve it using Gaussian method.

3. A manufacturer produces three products: A, B, and C. Each unit

of products A, B and C requires the following amounts of time in hours in each of
the indicated departments

products
Department A B C

Machining 0.2 0.3 0.5

Assembly 0.4 0.2 0.4
Painting 0.1 0.5 0.2

Suppose that the total time available per week in each department is 105 hours, 116 hours and
83 hours respectively. Determine the number of units of each product to be produced in a
week use up all the available time.
(Use the Gaussian method).

117
4. There are two competing brands of soap in a market. The brands are Saba and Zaap. A
survey was undertaken to determine the extent customers swich-over from one brand to
another every month. The survey identified that every month only 45% of customers of
zaap in the previous month continue to purchase Zaap and 45 % of Saba in the previous
month become customers of Zaap Moreover, it was identified that the two brands have a
constant total customers of 1000 and no one stops purchasing one or the other brand. At
present the number of customers of Saba and Zaap is 400 and 600 persons respectively.

(a) What will be the number of customers of Saba and Zaap after two transitions?
(b) What share of the market will each brand have in the long run?

5. Chabude manufacturing co. produces three products: A, B, and C. The profits for each
unit sold of A, B, and C are birr1, 2, and 3 respectively. Fixed costs are 17,000 birr per
year and the costs of producing each unit of A, B, and C are birr 4, 5, and 7 respectively.
Next year a total of 11,000 units of all three products is to be produced and sold and a total
profit of 25,000 birr is to be realized. If cost is to be 80,000 birr, how many units of each
of the products should be produced next year? (Use the inverse method).

6. There are two dry cleaning houses in Jimma town. They are Ambassador and Zenith dry
cleaning. The current market share of Ambassador and Zenith is 40% and 60%
respectively. Every quarter 20% of the customers of Ambassador Switch to Zenith and the
remaining 80% remain loyal. Whereas 35% of customers of Zenith switch to Ambassador
and the remaining 65% remain loyal.

a) Construct the transition matrix of the problem.

b) Determine the market shares of Ambassador and Zenith after one quarter and after two
quarters.
c) Determine the steady state market shares.

7. A population of 200,000 customers makes the following purchase during a year 2004.
40,000 purchase brand -x, 70,000 brand-y, and 90,000 purchase neither brand. From a market
study, it is estimated that of those who purchase brand-x, 80% will purchase it again next
year, 15% will purchase brand-y next year , and 5% will purchase neither

118
 brand. Of those who purchase neither brand, 20% will purchase brand-x next year, 15%
will purchase brand-y next year and 65% will purchase neither brand next year.

a) Assume the population grows by 10% in each two year, what is the number of
population who purchase brand-x, brand-y, and neither brand by the year 2006?
b) If the purchasing pattern continues, will the market stabilize? What will stable
distribution be?
8. Ato Elias invests in M, N, and L rated bounds. The average yield is 8%, 6%, and 7% on

bonds M, N and L respectively. Twice as much is invested in L as N bonds. Moreover, the

total annual return for all three types of brands is birr2, 800. How much is invested in each
type bonds if the total investment is :

a) Birr 35,
000
b) Birr 40,
9. Find the inverse of the following matrix using Gauss-Jordan method;
000
r 2 8 -ii ^

-1 -5 7

V1 2 3 J
10. Find the inverse of the following matrix using the zero-first method;

r 2 0 3 1 "N 0 3 3 4
5 3 0 1
2344

11. Solve the following using the Gauss-Jordan method;

a) 3x1-2x2+4x3 = 15

4x1 - 8/3x2 + 16/3x3 = 20

b) 6x1+5x2 = 20
9x1+15/2 x2 =30
36/5 x1+ 6x2 = 24

119
REFERENCES

1. Barnett Raymond A. and Ziegler Michael R, Essentials of College Mathematics for

business and Economics, life science and social science, 3rd ed., 1989
2. Bowen Earl K et. Al, Mathematics with applications in Business and Economics,
1987
3. Ann j. Hughes, Applied Mathematics: For Business, Economics, and the social
Science, 1983.
4. Ronald E. Larson and Bruce H. Edwards, Finite Mathematics with Calculus, 1991
5. Ronald J. Harshbager and James J. Reynolds, Mathematics Applications.
6. Ronald J. Harshbager and James J. Reynolds, Finite Mathematics, 3 rd Ed.
7. Hole Poul G., Finite Mathematics and Calculus with Applications to Business,
1974.
8. Dexter j Booth and John K Turner, Business mathematics with Statistics, 1996, and
other relevant Books are recommended as reference.
9. Teresa Bradley and Paul Patton, “ Essential Mathematics for Economics and
Business’, Jon Wiley and Sons, December 1999.

120
 UNIT THREE
INTRODUCTION TO LINEAR PROGRAMMING

Unit Objectives
By the end of studying this unit, you will be able to:

• Know the technicalities of formulating linear programming problems in both cases of

minimization and maximization.
• Understand the meaning and concepts of linear programming.
• Develop familiarity with the graphical method for solving linear programming problems.
• Determine the optimal solution for linear programming problems by using the systematic
technique of simplex approach.

Unit Introduction

A large number of decision problems faced by a business manger involve allocation of

resources to various activities with the objective of increasing profits or decreasing costs, or

both. When resources are in excess, no difficulty is experienced. Nevertheless, such cases are

very rare. Practically in all situations, the managements are confronted with the problem of

scarce resources. Normally, there are several activities to perform but limitations of either of

the resources or their use prevent each activity from being performed to the best level. Thus,

the manger has to take a decision as to how best the resources be allocated among the various

activates.

The decision problem becomes complicated when a number of resources are required to be
allocated and there are several activities to perform. Rule of thumb, even of an experienced
manger, in all likelihood, may not produce the right answer in such cases. The decision
problems can be formulated and solved as mathematical programming problems.

121
Section One: Basic Concepts

Section Objectives:

After covering this section, you will be expected to:

- Know the meaning of linear programming.
- Identify the conditions that should be fulfilled to apply linear programming.

Section Overview:

3.1 Defining Linear Programming Model

3.2 Requirements to Apply Linear Programming

3.1 Defining Linear Programming Model

Linear Programming (LP) is a mathematical process that has been developed to help
management in decision-making involving the efficient allocation of scares resources to
achieve a certain objective. Diagrammatically,

122
 LP is a method for choosing the best alternative from a set of feasible
alternatives.

3.2 Requirements to Apply Linear Programming

To apply LP, the following conditions must be satisfied. These will be discussed next:
a. There should be an objective that should be clearly identified and measurable in
quantitative terms. Example, maximization of sales, profit, and minimization of costs etc.
b. The activities to be included should be distinctly identifiable and measurable in
quantitative terms.
c. The resources of the system which are to be allocated for the attainment of the goal should
also be identifiable and measurable quantitatively. They must be in limited supply. These
resources should be allocated in a manner that would trade off returns on investment of
the resources for the attainment of the objective.
d. The relationship representing the objective and the resource limitation considerations
represented by the objective function and the constraint equations or inequalities,
respectively, must be linear in nature.
e. There should be a series of feasible alternative courses of actions available to the
decision-maker that is determined by the resource constraints.

When these stated conditions are satisfied in a given solution, the problem can be expressed
in algebraic form called linear programming problem (LPP), and then solved for optimal
decision. We first illustrate the formulation of linear programming problems and then
consider the method of their solution.

Section Two: Formulation of Linear Programming Model Section

Objectives:
After covering this topic, you will be in a position to:
- Identify the goal of the problem in terms of the objective function.
- Identify the limited resources problem in terms of inequality.

123
- Translate the problem from verbal form to standard mathematical statements showing all
the objective and available scarce in supply of resource.

Section Overview:

Problem Modeling: the Maximization Case Problem Modeling: the Minimization Case

0
Assumptions Underlying Linear Programming General Statement of Linear
Programming Problem

3.3 Problem Modeling: The Maximization Case

Problem Formulation or Modeling is the process of translating the verbal

statement of a problem in to mathematical statements. Formulating model is an art that

can only be measured with practice and experience. Even though every problem has
certain unique features, most problems have common features. Therefore, some
general guidelines for model formulation are helpful. Next, you will have the
illustration of some general guidelines by developing mathematical model for some
given problems. Consider the following example.

Example 3.1

A firm is engaged in producing two products, A and B. Each unit of product A requires
two Kgs of raw material and four labor hours for processing whereas each unit of
product B requires three kg of raw material and three hours of labor of the same type.
Every week the firm has an availability of 60 kgs of raw material and 96 labor hours.
One unit of product A sold yields Birr 40 and one unit of product B sold yields Birr 35
as profit.

Formulate this problem as a linear programming problem to determine as to how many

units of each of the products should be produced per week so that the firm can
maximum the profit. Assume that there is no marketing constraint so that all that is
produced can be sold.

124
The objective function: the first major requirement of linear programming problem (LPP) is
that we should be able to identify the goal in terms of the objective function. This function
relates mathematically the variables with which we are dealing in the problem.

For our problem, the goal is the maximization of profit, which would be obtained by
producing (and selling) the products A and B. If we let x 1 and x2 represent the number of units
produced per week of the products A and B respectively, the total profit, Z, would be equal to
40 x1 +35x2 is then, the objective function, relating the profit and the output level of each of
the two items. Notice that the function is a linear one. Further, since the problem calls for a
decision about the optimal values of x1 and x2, these are known as the decision variables.

The constraints: As has been laid, another requirement of linear programming is that the
resources must be in limited supply. The mathematical relationship which is used to explain
this limitation is inequality. The limitation itself is known as a constraint.

Each unit of product A requires 2 kg of raw material while each unit of product B needs 3 kg.
The total consumption would be 2x2 and 3x2, which cannot be the total the availability of 60
kg every week. We can express this constraint as 2x1 and 3x2 < 60. Similarly, it is given that a
unit of A requires 4 labor hours for its production and one unit of B requires 3 hours. With an
availability of 96 hours a week, we have 4 x1 and 3x2 < 96 as the labor hour's constraint. It is
important to note that for each of the constraint, inequality rather than equation has been used.
This is because the profit maximizing output might not use all the resources to the full leaving
some unused, hence the < sign. However, it may be noticed that all the constraints are also
linear in nature.

Non-negativity Condition: Quite obviously, x1 and x2, being the number of units produced,
cannot have negative values. Thus both of them can assume values only greater than or equal
to zero. This is the non-negativity condition, expressed symbolically as x 1 > 0 and x2, > 0.
Now we can write the problem in complete form as follows.

Maximize Z = 40 X1 + 35 X2, Profit

Subject to
2X1 + 3X2 < 60 Raw material constraint
4X1 + 3X2 < 96 Labor hours constraint

125
 Xi, X2, > 0 Non-negativity restriction

Dear student, mention and discuss components of linear programming problems.

3.4 Problem Modeling: the Minimization Case

Dear student, can you guess the differences between maximization and minimization
problems?

Consider the following example Example 3.2

The agricultural Research institute has suggested to a farmer to spread out at least 4800 kg of a
special phosphate fertilizer and no less than 7200 kg of a special nitrogen fertilizer to raise
productivity of crops in his fields. There are two resources for obtaining these mixtures A and
B. Both of these are available in bags weighing 100 kg each and they cost Birr 40 and Birr 24
respectively. Mixture A contains phosphate and nitrogen equivalent of 20 kg and 80
respectively, while mixture B contains these ingredients equivalent of 50 kg each.

Write this as a linear programming problem and determine how many bags of each type the
farmer should buy in order to obtain the required fertilizer at minimum cost.

The Objective Function: In the given problem, such a combination of mixtures A and B is
sought to be purchased as would minimize the total cost. If x 1 and x2 are taken to represent the
number of bags of mixtures A and B respectively, the objective function can be expressed as
follows:

Minimize Z = 40x1 + 24 x2 Cost

The constraints: In this problem, there are two constrains, namely, a minimum of 4800 kg of
phosphate and 7200 kg of nitrogen ingredients are required. It is known that each bag of
mixture A contains 20 kg and each bag of mixture B contains 50 kg of phosphate. The
phosphate requirement can be expressed as 20x1 + 50x2 > 4800. Similarly, with the given

126
information on the contents, the nitrogen requirement would be written as 80 xi + 50x2 >
7200.

Non-negativity condition: As before, it lays that the decision variables, representing the
number of bags of mixtures A and B, would be non-negative. Thus xi > 0 and X 2 > 0.

The linear programming problem can now be expressed as follows:

Minimize Z = 40xi + 24 x2 Cost

Subject to
20xi + 50x2 > Phosphate requirement
4800 80xi + 50x2 Nitrogen requirement
> 7200 xi, x2 > 0 Non negativity restriction

3.5 General Statement of Linear Programming Problem

In general, linear programming problem can be written as

Maximize Z = cixi + c2x2.........+ Cn xn Objective Function

Subject to
aiixii + a22 x2 +.............................+ ain x n < bi
a2ixi + a22 x2 +.............................+ ain x n < b2
ami xi + am2 x2 + ............................+ amn < xn bm
xi, x2, ............................., Xn > 0

Where cj, aij, bi (i = 1, 2,............, m; j = 1,2,......n) are known as constants and

x’s are decision variables c’s are termed as the profit coefficients aij’s the technological
coefficients b’s the resource values

i27
In shorter form, the problem can be written as:

n
Maximi
ze Z= I
cj xj
Subject to Z= I cij ajjxj
i=1
< bi

j=l
for i = 1, 2...m
xi > 0
j = 1, 2............., n

Where the objective is to minimize a function, the problem is,

Minimize Z = I cj xj
i=1

n
Subject to Z = I aij xj> bi
[ i=i]

for j =1,2,.........n
In matrix notation, a LPP can be expressed as follows:

Maximization Problem Minimization Problem

Maximize Z = cx Minimize Z = cx
Subject to Subject to
ax < b ax > b
x’ > 0 x’ > 0

Where, c = raw matrix containing the coefficients in the objective function, x = Column
matrix containing decision variables, a = Matrix containing the coefficients in
the constraints, b = Column matrix containing the RHS values of the
constraints

Although, generally, the constraints in the maximization problems are of the < type, and the
constraints in the minimization problems are of > type , a given problem might
contain a mix of the constraints, involving the signs <, >, and /or =.

128
3.6 Assumptions Underlying Linear Programming

A linear programming model is based on the assumptions of proportionality, additively,

continuity, certainty, and finite choices. These are explained here next.

1. Proportionality: A basic assumption of linear programming is that proportionality exists

in the objective function and the constraint inequalities. For example, if one unit of a
product is assumed to contribute Birr 10 toward profit, then the total contribution would
be equal to 10x1 where x1 is the number of units of the product. For 4 units, it would equal
Birr 40 and for 8 units it would be Birr 80, thus if the output (and sales) is doubled, the
profit would also be doubled. Similarly, if one unit takes 2 hours of labor of a certain type,
10 units would require 20 hours, 20 units would require 40 hours....and so on. In effect,
then, proportionality means that there are constant returns to scale and there are no
economies of scale.

2. Additively: Another assumption underlying the linear programming model is that in the
objective function and constraint inequalities both, the total of all the activities is given by
the sum total of each activity conducted separately. Thus, the total profit in the objective
function is determined by the sum of the profit contributed by each of the products
separately. Similarly, the total amount of a resource used is equal to the sum of the
resource values used by various activities.

3. Continuity: It is also an assumption of a linear programming model that the decision

variables are continuous. Therefore, combinations of output with fractional values, in the
context of production problems, are possible and obtained frequently. For example, the
best solution to a problem might be to produces 5% units of product B per week.
Although in many situations we can have only integer values, but we can deal with the
fractional values, when they appear.

4. Certainty: A further assumption underlying a linear programming model is that the

various parameters, namely, the objective function coefficients, the coefficients of the
inequality/equality constraints and the constraint (resource) values are known with
certainty. Thus, the profit per unit of the product, requirements of materials and labor per

129
 unit, availability of materials, labor etc. are given and known in a problem involving these.
The linear programming is obviously deterministic in nature.

5. Finite Choices: A linear programming model also assumes that a limited number of
choices are available to a decision maker and the decision variables do not assume
negative values. Thus, only non-negative levels of activity are considered feasible. This
assumption is indeed a realistic one. For instance, in the production problems, the output
cannot obviously be negative, because a negative production implies that we should be
above to reverse the production process and convert the finished output back in to the raw
materials!

Dear student, would you summarize the assumptions and components of LPPs? Please
also indicate the main differences between maximization and minimization problems.

Section Three: Solution Approaches to LPPs Section Objectives:

Upon completion of this section, you will be able to:
- Solve Linear Programming Problems with two variables using the graphic approach.
- Solve Linear Programming Problems using the simplex algebra approach.

Section Overview:

3.7 Approaches of Solving LPPs

3.8 Graphical Solution to Linear Programming Problems
3.9 Algebraic Simplex Method

3.7 Approaches of Solving LPPs

Now we shall consider the solution to the linear programming problems. They can be solved
by using graphic method or by applying algebraic method, called the Simplex Method. The

130
graphic method is restricted in application - it can only be used when two variables are
involved. Nevertheless, it provides an intuitive grasp of the concepts that are used in the
simplex technique. The simplex method, whereas is the mathematical technique of solving
linear programming problems with two or more variables.

3.8 Graphical Solution to Linear Programming Problems Topic Objectives:

After studying this topic, you will be capable of:
- Identifying the problem including the decision variables.
- Covert the inequalities in to equations and draw a graph that include all the constraints.
- Identify the feasible area of the solution that satisfies all constraints.
- Identify the corner points (coordinates) in the feasible region.
- Determine the value of the objective function by using the corner points (coordinates).
- Identify the optimal point and interpret the result to be obtained.

3.8.1 Steps in Graphic Method of Linear Programming Problems

To use the graphic method, the following steps are needed:

i. Identify the problem - determine the decision variables, the objective function, and the
constraints.
ii. Draw a graph including all the constraints and identify the feasible region.
iii. Obtain a point on the feasible region that optimizes the objective function -optimal
solution.
iv. Interpret the results.

Note: Graphical LP is a two-dimensional model.

131
 3.8.2 The Maximization Problem

This is the case of Maximize Z with inequalities of constraints in < form.

Example 3.3

Consider two models of color TV sets; Model A and B, are produced by a company to maximize profit. The profit
realized is $300 from A and $250 from set B. The limitations are

a. Availability of only 40 hrs of labor each day in the production department,

b. A daily availability of only 45 hrs on machine time, and

c. Ability to sale 12 set of model A.

How many sets of each model will be produced each day so that the total profit will be as large as possible?

Resources used per unit

Constraints Model A Model B

Maximum Available
(X1) (
X2 )
Hours
Labor Hours 40
2 1

Machine Hours 3 45
1

Marketing Hours 1 0 12

Profit $300 $250

Solution
1. Formulation of mathematical model of LPP Max

Z=300Xi +250X2 St:

2Xi +X2< 40

Xi +3X2< 45 l Lp Model
Xi < 12

Xi, X2 >0)

132
2. Convert constraints inequalities into equalities

2Xi + X2 = 40 Xi + 3X2 = 45 Xi = 12

3. Draw the graph by finding out the x- and y-intercepts

2Xi +X2 = 40 ==> (0, 40) and (20, 0) Xi +3X2 = 45 ==> (0, 15) and (45, 0) Xi =

12 ==> (12, 0)

Xi , X2 =0

Fig. 3.3.1 Graphical Solution of LPP. (Maximization Problem)

4. Identify the feasible area of the solution which satisfies all constrains. The shaded region in the above graph

satisfies all the constraints and it is called Feasible Region.

5. Identify the corner points in the feasible region. Referring to the above graph, the corner points are in this case

are:

A (0, 0), B (0, 15), C (12, 11) and D (12, 0)

133
6. Identify the optimal point.

Corners Coordinates Max Z = 300 Xi +250X2

A (0, 0) $0
B (0, 15) $3750

C (12, 11) $ 6350 (Optimal)

D (12, 0) $3600

7. Interpret the result. Accordingly, the highlighted result in the table above implies that 12
units of Model A and 11 units of Model B TV sets should be produced so that the total
profit will be $6350.

Example 3.4
A manufacturer of Light Weight mountain tents makes two types of tents: REGULAR tent and
SUPER tent. Each REGULAR tent requires one labor-hour from the cutting department
and 3 labor-hours from the assembly department. Each SUPER tent requires 2 labor-hours
from the cutting department and 4 labor-hours from the assembly department. The
maximum labor hours available per week in the cutting department and the assembly
department are 32 and 84 respectively. Moreover, the distributor, because of demand, will
not take more than 12 SUPER tents per week. The manufacturer sales each REGULAR
tents for $160 and costs $110 per tent to make. Where as SUPER tent ales for $210 per
tent and costs $130 per tent to make.

Required:
a. Formulate the mathematical model of the problem
b. Using the graphic method, determine how many of each tent the company should
manufacture each week so as to maximize its profit?
c. What is this maximum profit assuming that all the tents manufactured in each week are
sold in that week?

134
 Solution

1. The LP Model:

Labor Hours per Tent

Maximum Labor-hours

Department REGULAR (X1) SUPER(X2) Available per Week

Cutting department 1 2 32
Assembly department 3 4 84
Selling price per tent $160 $210
Cost per tent $110 $130

Profit per tent $50 $80

The distributor will not take more than 12 SUPER tents per week. Thus, the manufacturer
should not produce more than 12 SUPER tents per week.

Dear student, please formulate the mathematical model based on the information in the above
table before going to the solution part.

Let Xi = The No of REGULAR tents produced per week.

X2 = The No of SUPER tents produced per week.

Xi andX2 are called the decision variables.

f
Max.Z = 50X J+80X2 St:

X j+2 X 2< 32 Cutting department

LP Model
3 X j+4 X 2< constraint Assembly
84 X 2 < 12 department constraint
X!,X2 > 0 Demand constraint Non-
V
negativity constraints

135
2. The Corners and Feasible Solution:

Corners Coordinates Max Z=50 X1 +800X2

A (0, 0) $0
B (0, 12) $960

C (8, 12) $1360

D (20, 6) $1480

E (28, 0) $1400

3. The Interpretation:

The manufacturer should produce and sale 20 REGULAR tents and 6 SUPERS tents to get a
maximum weekly profit of $1480.

Dear student, try to solve the above example by adding 5 to each coefficient and 10 to the
right hand side values of the constraints.

3.8.3 The Minimization Problem

In this case, we deal with Minimize Z with inequalities of constraints in > form Example 3.4
Suppose that a machine shop has two different types of machines; Machine 1 and Machine 2,
which can be used to make a single product. These machines vary in the amount of product
produced per hr., in the amount of labor used and in the cost of operation. Assume that at least
a certain amount of product must be produced and that we would like to utilize at least the
regular labor force. How much should we utilize on each machine in order to utilize total costs
and still meets the requirement?

136
 Resource Used
Minimum Required Hours
Items
Machine 1 (Xj) Machine 2 (X2)

Product produced/hr 20 15 100

Labor/hr 2 3 15
Operation Cost $25 $30

Solution
1. The LP Model:
Min.Z = 25 X1+30X2
St:
20 X j+15 X 2> 100 2
>- LP Model
X j+3 X 2> 15 XX2 >
0

Dear student, can you graph the above constraints? Please try to do so before going to the
solution part.

2. The Graph of Constraint Equations:

20Xi +15X2=100 ==> (0, 20/3) and (5, 0)

2X1 + 3X2=15 ==> (0, 5) and (7.5, 0)
X1, X2 = 0

Fig 3.3.2 Graphical Solution of LPP. (Minimization Problem)

137
3. The Corners and Feasible Solution:

Corners Coordinates Min Z— 25 Xi + 30X2

A (0, 20/3) 200

B (2.5, 3.33) 162.5 (Optimal)
C (7.5, 0) 187.5

0
Since our objective is to minimize cost, the minimum amount (162.5) will be selected.

Xi = 2.5 X2 = 3.33 and Min Z= 162.5

- In maximization problems, our point of interest is looking the furthest point from

the origin (Maximum value of Z).

- In minimization problems, our point of interest is looking the point nearest to the origin
(Minimum value of Z).

Exercise 3.1

A company owns two flourmills (A and B) which have different production capacities for
HIGH, MEDIUM and LOW grade flour. This company has entered contract supply flour to a
firm every week with 12, 8, and 24 quintals of HIGH, MEDIUM and LOW grade respectively.
It costs the Co. $1000 and $800 per day to run mill A and mill B respectively. On a day, mill
A produces 6, 2, and 4 quintals of HIGH, MEDIUM and LOW grade flour respectively. Mill
B produces 2, 2 and 12 quintals of HIGH, MEDIUM and LOW grade flour respectively. How
many days per week should each mill be operated in order to meet the contract order most
economically. Solve the problem graphically.

138
Exercise 3.2

Use graphical method to solve the following LPP

1. Max.Z = 7/4Xi+3/2X2 2. Max.Z = 3X1+2X2

St: St:

8 X1+5X2 < 320 -2X1+3X2 < 9

4Xi+5X2 < 20 X1-5X2 > -20
X1, X2 > 0
X1 > 15 X2> 10
X1, X2 > 0

3. Max.Z=3X1+2X2 4. Max.Z=X1+X2

St: St:
X1-X2 < 1 X1+X2 < 1
X1+X2> 3 -3X1+X2> 3
X1, X2> 0 X1, X2> 0

5. Max.Z=6X1-4X2 6. Max.Z=X1+1/2X2
St: St:

2X1+4X2 < 4 3X1+3X2 < 12

4X1+8X2> 16 5X1 < 10
X1, X2 > 0 X1 + X2 > 8

-Xi + X2 > 4
X1, X2 > 0

139
3.9 Algebraic Simplex Method

Topic Objectives:

After learning this topic, you can:

- Formulate the linear programming model
- Standardize the problem or convert the inequality constraints is to equality by introducing
slack variable and artificial variable
- Obtain the initial simplex tableau that represents the data.
- Construct the initial simplex tableau and test for optimality.
- Calculate the replacement ratio and determine the leaving or outgoing variable.
- Calculate the value of Cj - Zj and precisely and determine the incoming or entering
variables.
- Identify the pivot raw, pivot column, pivot element and calculate the replacement raw.
- Derive the revised tableau for improved solution.
- Determine the optimal solution for the given problem.

The graphical method to solving LPPs provides fundamental concepts for understanding the
LP process. However, the graphical method can handle problems involving only two decision
variables (say Xi and X2). In 19940’s George B.Dantzig developed an algebraic approach
called the Simplex Method, which is an efficient approach to solve applied problems
containing numerous constraints and involving many variables that cannot be solved by the
graphical method. The simplex method is an ITERATIVE or “step by step" method or
repetitive algebraic approach that moves automatically from one basic feasible solution to
another basic feasible solution improving the situation each time until the optimal solution is
reached at. The simplex method starts with a corner that is in the solution space or feasible
region and moves to another corner improving the value of the objective function each time
until optimal solution is reached at the optimal corner.

3.9.1 The Maximization Problems

> Maximize Z with inequalities of constraints in ‘<’ form

140
Example 3.5

Solve the problem using the simplex approach

Max. Z = 300xi +250x2 Subject to:
2x1 + X2 < 40 (Labor)
X1 + 3x2 < 45 (Machine)
X1 < 12 (Marketing)
X1, X2 > 0

Solution

Step 1 Formulate LP Model:

- It is already given in the form of linear programming model.

Step 2 Standardize the problem:

Convert constraint inequality into equality form by introducing a variable called Slack
variable. A slack variable(s) is added to the left hand side of a < constraint to covert the
constraint inequality in to equality. The value of the slack variable shows unused resource. A
slack variable emerges when the LPP is a maximization problem. Slack variables represent
unused resource or idle capacity. Thus, they do not produce any profit and their contribution
to profit is zero. Slack variables are added to the objective function with zero coefficients.

Let that si, s2, and S3 are unused labor, machine, and marketing hrs
respectively. Max.Z=300X1 +250X2 + 0 S1 +0 S2+ 0 S3 St:

2 X1+X2 +0S1 = 40
Standardform
X1+3X2 +0S2 = 45
X1 + +0 S3= 12
X1 , X2, S1, S2, S3 > 0

141
Step 3 Obtain the initial simplex tableau:

To represent the data, the simplex method uses a table called the simplex table or the simplex
matrix. In constructing the initial simplex tableau, the search of the optimal solution begins at
the origin indicating that nothing can be produced. Thus, first assumption, No production
implies that xi =0 and X2=0

==>2 xi+x2 + si +0 S2+ 0 S3= ==> x1+3x2 +0 s1 + s2+ 0 s3= 45

40 2(0) +0 + si +0 S2+ 0 S3= 40 0 +3(0) + 0s1 + s2+ 0 s3= 45
si= 40 - Unused labor hrs. s2= 45 - Unused machine hrs.

==> x1+0s1 +0s2+ s3= 12 0 +0s1 +0 s2+

s3= 12 s3= 12 - Unused Marketing
hrs.

Therefore, Max. Z=300xi +250x2 + 0 s1 +0 s2+ 0 s3

=300(0) +250(0) + 0(40) +0(45) + 0(12)
=0

Remark

In general, whenever there are n variables and m constraints (excluding the

nonnegativity), where m is less than n (m < n), n — m variables must be set equal
to zero before the solution can be solved algebraically.
a. Basic variables are variables with non-zero solution values.
Or: Basic variables are variables that are in the basic solution. Basic variables have 0
values in the Cj - Zj row.
b. Non-basic variables are variables with zero solution values.
Or: Non-basic variables are variables that are out of the solution.

==> n = 5 variables (xi, x2, s1, s2, and s3) and m = 3 constraints (Labor,
Machine and Marketing constraints), excluding non-negativity.

142
Therefore, n - m = 5 - 3 = 2 variables (xi and X2) are set equal to zero in the 1st simplex
tableau. These are non-basic variables. Three Variables (si, S2, and S3) are basic variables (in
the 1st simplex tableau) because they have non-zero solution values.

Step 4 Construct the initial simplex tableau:

To set up the tableau, we first list horizontally all the variables contained in the problem. Here,
there are five variables: x1, x2, s1, s2 and s3. Next, the coefficients in the constraint equations
are written listing vertically the coefficients under their respective variables. It may be noted
that each of the slack variables appear only in one equation. Therefore, the coefficient of each
of the slack viable is taken to be zero in all the equations except the one in which it appears.
After putting the coefficients, the constraint values are mentioned on the right hand side
against the rows. Finally, the row titled indicates the coefficients of the various variables in
the objective function, mentioned respectively in the various columns representing the
variables.

Initial simplex tableau

.§ 3
■B a 5ig
a O
*5 *53

a
O 'C a
a
^’*2* 55
O^
^a
•a «c ^uo a
il
.+s 5
fj ^a
j ffi♦i
300 250 0 0 0 ' Profit per unit row

_SV r jXi\ X2 Si S2 S3 Q f

40
2 1100 1=20
0 0 £5 £5
R2= 45 Constraint
K* 45
1 3010 equation rows

0 S3 1 0001 12 Leaving Row

Zj 0
0 0 0 0 250 0 0 0 0 Gross Profit row
Cj - Zj300 Net Profit row
/Indicator row/

I
Entering Column (Pivot Column)

Step 5 Choose the “incoming” or

“entering” variables:

143
The entering variable is the variable that has the highest positive value in the Cj - Zj row also
called as indicator row. Alternatively, the entering variable is the variable that has the highest
contribution to profit per unit.

a. X1 in our case is the entering variable because it has the highest positive c-z value.
b. The column associated with the entering variable is called key or pivot column ( X1 column
in our case )

Step 6 Choose the “leaving “or “outgoing” variable:

In this step, we determine the variable that will leave the solution for X1 (or entering variable)

Remark

• The row with the minimum or lowest positive (non-negative) replacement ratio shows the
variable to leave the solution.

Replacement Ratio (RR) = Solution Quantity (Q)

Corresponding values in pivot column

Note: RR > 0

- The variable leaving the solution is called leaving variable or outgoing variable.

- The row associated with the leaving variable is called key or pivot row (s3 column in
our case)
- The element that lies at the intersection of the pivot column and pivot row is called
pivot element(No 1 in our case)

Step 7 Derive the revised tableau:

For improved solution using the information obtained earlier, another tableau is derived
where in the various elements are obtained as given here.

144
a. Divide each element of the pivot row (including bi) by the pivot element to get the
corresponding values in the new tableau. The row of values so derived is called the
replacement raw.

b. For each row other than the pivot row,

- Divide each element of the pivot row by the pivot element to find new values in the key or
pivot row.
- Perform row operations to make all other entries for the pivot column equal to zero.

2nd simplex tableau

Cj 300 250 0 0 0
X2
SV X1 S1 S 2 S 3 Q

0 S1 0 1 1 0 -2 16 R'i=16
33
0 S2 0 3 0 1 -1 R'2=11

300 X1 1 0 001 12
R'3=Undefined
Zj 300 0 0 0 300 0 0 -300 3600
Cj - Zj0 250

3rd simplex tableau

T

145
 Cj 300 250 0 0 0

SV X1 X2 S1 S2 S3 Q Elementary
0 S1 0 0 1 -1/3 -5/3 5 Row Operations
R”I=R'I-R'2
250 X2 0 1 0 1/3 -1/3 11
300 X1 R"2=R2/3
1 0 0 0 1 12
Zj 300 250 0 250/3 650/3 6350 R"3=R'3
Cj - Zj 0 0 0 -250/3 -650/3

Since all the Cj - Zj < 0, optimal solution is reached at and this tableau is the final
one. Therefore, Xx=12, X=11, St=5 and Max Z=6350

Example 3.6

A Juice Company has available two kinds of food Juices: Orange Juice and Grape Juice. The
company produces two types of punches: Punch A and Punch B. One bottle of punch A
requires 20 liters of Orange Juice and 5 liters of Grape Juice. 1 Bottle of punch B requires 10
liters of Orange Juice and 15 liters of Grape Juice. From each of bottle of Punch A a profit of
$4 is made and from each bottle of Punch B a profit of $3 is made. Suppose that the company
has 230 liters of Orange Juice and 120 liters of Grape Juice available.

Required:
a. Formulate this problem as a LPP.
b. How many bottles of Punch A and Punch B the company should produce in order to
maximize profit? (Using the simplex method)
c. What is this maximum profit?

Dear student, please try to solve the above example before going to the next step.

Solution
Juice needed for one bottle of
Juice Punch A Punch B Juice Available

146
Orange Juice (It) 20 10 230

Grape Juice (It) 5 15 120

Profit bottle $4 $3

Let, Xi = the No of bottles of punch A produced.

X2 = the No of bottles of punch B produced.

1. LPP Model Max Z=4Xi +3X2 Subject to:

20Xi +IOX2 < 230 Orange Constraint
5Xi +15X2 < 120 Grape Constraint Xi, X2 > 0 Non-negativity
constraint
2. Standard form

Max.Z=4xi +10x2 + 0 si +0 S2 St:

20 xi+3x2 + si = 230
> Standard form
5xi+15x2 + s2+ = 120 xi , X2 , si , s2, Where,
>0
si =Unused orange juice s2 =Unused
grape juice

147
 3. Initial simplex tableau

Cj 4 300
Q/Entering column values=RR
SV Xi X2 Si S2 Q (see the above note for RR)

0 Si 20 10 1 0 230 R1=11.5

c R2=25
0
S2 5 15 0 1 120
Z. 0 000 0
Z
T
4 300
Cj - Zj
T

4. 2nd simplex tableau

Cj 4 3 00 RR

SV Xi X2 Si S2Q 23

5 —1
4 Xi 1 1/2 1/20 0 11.5

0 S2 0 25/2 -1/4 1 62.5

1/5 46
Zj 4
2 0
Cj - Zj 0 -1/5 0
1

t
5. Optimal simplex tableau

Cj 4 3 0 0

SV Xi X2 Si S2 Q

4 Xi 1 0 3/50 -1/25 9

148
3 *2 0 1 -1/50 2/25 5
Zj 4 3 0.18 0.0851
Cj - Zj 0 0 - 0.18 -0.08

Since all values of Cj - Zj are < 0 it is an optimal solution. Therefore, the units to be produced
and maximum profit are:
X1= 9 bottles of punch A X2= 5 bottles of punch B
s1 =0 s2 =0
Max Z=$51

Exercise 3.3

Solve the following LPPs using the simplex method.

1. Max.Z=3x1 +5x2 Subject to:
X2 < 6 3x1+2x2 < 18 X1, X2 >0

2. Max. Z = 20x1 +10x2 Subject to:

5x1 + 4x2 < 250 2x1 + 5x2 < 150 x1, x2 > 0

149
3.9.2 The Minimization Problem

The solution procedure for the linear programming problems that have the objective function
of the minimization type is similar to the one for the maximization problems, except for some
differences. To illustrate, let us again consider the examples.

Example 3.7

Total cost
Minimize Z= 40x1 + 24x2
Subject to:
Phosphate Requirement
20x1+ 50 x2 >
Nitrogen Requirement
4800 80 x1+ 50 x2
> 7200 X1, x2 > 0

Following the approach already discussed, we first introduce some new variables to convert
inequalities of the system in to equations. The variable required for converting a greater than
type of inequality in to an equation is called surplus variable and it represents the excess of
what is generated (given by the LHS of the inequality) over the requirement (shown by the
RHS value bi). With surplus variables, S 1 and S2 respectively for the first and the second
constraints, the augmented problem shall be:

Minimize Z= 40x1+24x2 +0S1 +0S2

Subject to:
20x1+ 50 x2- S1=
4800 80 x1+ 50 x2- S2
=7200 X1, X2, S1 ,S2>
0
Now, as soon as we proceed to the next step we experience a problem, which is like this. We
know that the simplex method needs an initial solution to get the process started. In this case,
it is easy to visualize that an initial solution does not exist because, if we let x 1 and x2 each
equal to zero, we get S1 = -4800 and S2 = -7200, which is not feasible as it violates the non
negativity restriction. In terms of the simplex tableau, when we write all the information, we

150
observe that we don not get identity because unlike in case of slack variables, the co-efficient
values of surplus variables S1 and S2 appear as minus one (-1).

To provide an initial solution, we add artificial variables in to the model. Unlike slack or
surplus variables, artificial variables have no tangible relationship with the decision problem.
Their sole purpose is to provide an initial solution to the given problem. When artificial
variables are introduced in our example, it appears as follows,

20x1+ +50-S1+A1= 4800

80 x1+50x2 —S2 + A2 =7200

Before we set up the initial tableau, a few words on the artificial variables follow. The
artificial variables are introduced for the limited purpose of obtaining an initial solution and
are required for the constraints with > type, or the constraints “=” sign. It is not relevant
whether the objective function is of the minimization or the maximization type. Obviously,
since artificial variables do not represent any quantity relating to the decision problem, they
must be driven out of the systems and must not show in the final solution (and if at all they do,
it represents a situation of infeasibility). This can be ensured by assigning an extremely high
cost to them. Generally, a value M is assigned to each artificial variable, where M represents a
number higher than any finite number. For this reason, the method of solving the problems
where artificial variable are involved is termed as the Big M Method. When the problem is of
the minimization nature, we assign in the objective function a coefficient of + M to each of the
artificial variables. On the other hand, for the problems with the objective function of
maximization type, each of the artificial variables introduced has a coefficient -M. For our
present example, the objective function would appear as

Minimize Z=40xi+24x2 + OS1+OS2 + MA1+MA2

It is significant to note that the initial solution obtained using the artificial variables is not a
feasible solution to the given problem. It only gives the starting point and the artificial
variables are driven out in the normal course of applying the simplex algorithm. A solution to
the problem which does not include an artificial variable in the basis represents a feasible
solution to the problem.

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The initial simplex tableau giving the initial solution to our problem is given in the following
table.

Simplex Tableau 1: Non optimal solution

Cj 40 24 0 0 M M
Basis X1 X2 Si S2 A1 A2 Qty RR

A1 M 20 50 -1 0 1 0 4800 96
A2 M 80 50 0 -1 0 1 7200 144
Zj 40 24 0 0 M M
Cj - Zj 40 -10QM 24 - 100M M M 0 0

1
For the minimization problem, the optimal solution is indicated when the values in the Zj-Cj
row are zero or positive. The presence of the negative Zj- Cj value and the column headed by
this variable is called, as before, the pivot column. The selection of the pivot row (and the
outgoing variable) is done exactly the same way as for the maximization problems- the row
that has the least (non-negative) quotient is our row of interest. Finally, the revised simplex
tableau is derived in the same way as discussed earlier. We proceed in this manner until
optimal solution is obtained.

In respect of our problem, the initial solution is not optimal. Here the incoming variable is x 2
while A1 is the outgoing variable. The revised tableau is given in the following table. In a
similar way we proceed until the optimal solution is found. The optimal tableau for
minimization problem is a tableau that consists in its C-Z row all zeros and positive values.
(i.e. C-Z values> 0)

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Dear student, conduct elementary row operations (ERO) to arrive at optimal solution before
going to the next solution part.
Cj 40 24 0 0 M M
Basis "XT X2 S1 S2 A1 A2 Q RR
X2 24 2/5 1 -1/50 0 1/50 0 96 240

A2 M 60* 0 1 -1 -1 1 2400 40

Zj 40 24 0 0 M M 2400
Cj -Zj 152/5- 0 -M 0
12
12 2M- 25
60M
60M 25- M

T
Simplex Tableau 3 : Non optimal Solution

Cj 40 24 0 0 M M
Basis X1 X2 S1 S2 A1 A2 Q RR
X2 24 0 1 -2/75 1/150 2/75 -1/150 80 -3000
X2 40 1 0 1/60* -1/60 -1/60 1/60 40 2400
"Zj 10 H T 0 M M 3520
Cj - Zj 0 0 38 M+ 38 75 M+ 38 75
-2
75 75

1
Simplex Tableau 4 : Optimal Solution

Cj 40 24 0 0 M M
Basis X1 X2 S1 S2 A1 A2 Q
X2 24 8/5 1 0 -1/150 0 1/50 144
X2 0 60 0 1 -1 -1 1 2400
Zj 40 24 0 0 M M 3456
Cj - ZJ 8/5 0 0 12/25 M M-12/5

According to the optimal solution, the objective function value is

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 Z=40x0+24x 144+0x2400+0x0xM+0xM=Birr 3456

The value of Si = 2400 indicates the surplus phosphate ingredient obtained by buying the least
cost mix.

Exercise 3.4

Find the optimal solution using simplex method.

1. Min Z=10xi +5x2

Subject to:
2xi + 5x2 > 150 3xi+ X2 > 120 X1, X2 > 0

2. Min Z=4x1 +5x2

Subject to:
X1 + 2x2 > 80 3x1+ X2 > 75 X1, x2 >0

3. Min Z=7x1 +9x2

Subject to:
3x1 + 6x2 > 36 5x1+ 4x2 > 64 x1, x2 > 0

Note: To get an initial feasible solution

Types of constraint Presence of variables in the initial solution mix

1. < (Slack) Yes
2. > *(Surplus) No
*(Artificial) Yes
3. = (Artificial) Yes

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Unit Summary LP: SIMPLEX METHOD

1. The standard form of LP problem should have the following characteristics:

- All the constraints should be expressed as equations by slack or surplus and/or artificial
variables
- The right hand side of each constraint should be made non-negative; if it is not, this should
be done by multiplying both sides of the resulting constraint by -1.
■ Example:
■ 2Xi+3X2-4X3+X3<r50, we multiply both sides by negative
- Three types of additional variables, namely
a. Slack Variable(S)
b. Surplus variable (-S), and
c. Artificial variables (A)
are added in the given LP problem to convert it into standard form for two reasons:
- To convert an inequality to have a standard form of an LP model, and
- To get an initial feasible solution represented by the columns of an identity matrix.

The summary of the extra variables needed to add in the given LP problem to convert it into
standard form is given below:

Presence of variables
Types of in the initial solution
Extra variables to be added
constraint Coefficient of extra variables in mix
the objective function MaxZ MinZ
< Add only slack variable 0 Yes
0
Subtract surplus variable 0 No
> and 0
Add artificial variable -M Yes
+M
= Add artificial variable -M Yes
+M

2. Test of optimality
- If all Cj - Zj <0, then the basic feasible solution is optimal (Maximization case).
- If all Cj - Zj >0, then the basic feasible solution is optimal (Minimization case).

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3. Variable to enter the basis
- A variable that has the most positive value in the Cj - Zj row (Maximization case)

- A variable that has the highest negative value in the Cj - Zj row (Minimization case) N:B-
‘Highest negative ’ values in this case refers to the negative value which is far from zero on
the number line! (E.g. -5,-10 you should take -10 as entering value)

4. Variable to leave the basis

- The row with the non-negative and minimum replacement ratio (For both maximization
and minimization cases
i.e: RR > 0

Self-Check Review Problems III

I. Use graphical method to solve the following LPP.

1. Max.Z=15X1-10X2 2. Max.Z = 2X1+X2

St: St:
4X1+6X2 < 360 X1+2X2 < 10 X1 +X2
3X1+0X2< 180 < 6 X1 - X2 < 2 X1 -
0X1+5X2< 280 2X2 < 1 X1, X2 >0
X1, X2 > 0
4. Min.Z=3X1+2X2

3. Max.Z=10X1+15X2

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 St: St:
2X1+X2 < 26 5X1+X2 > 10

2XI+4X2< 56 - Xi +X2 > 6 Xi

Xi+X2< 5 Xi, + 4 X2 > 12
X2 > 0 Xi, X2 >0

5. Min.Z=-Xi+2X2 St: 6. Min.Z=20Xi+10X2

-X1+3X2 < 26 Xi +X2 St:
< 6 Xi-X2< 2 Xi + 2X2 <40 3Xi + 4
Xi, X2 > 0 X2 > 30 4Xi+ 3X2> 60
Xi, X2 >0

7. A manufacturer produces two different models; X and Y, of the same product .The raw
materials ri and r2 are required for production. At least 18 Kg of ri and 12 Kg of r2 must
be used daily. Almost at most 34 hours of labor are to be utilized .2Kg of ri are needed for
each model X and 1Kg of ri for each model Y. For each model of X and Y, 1Kg of r2 is
required. It takes 3 hours to manufacture a model X and 2 hours to manufacture a model
Y. The profit realized is $50 per unit from model X and $30 per unit from model Y. How
many units of each model should be produced to maximize the profit?
8. A manufacturing firm produces two machine parts Pi and P2 using milling and grinding
machines. The different machining times required for each part, the machining times
available on different machines and the profit on each machine part are as given below:

Manufacturing Time Maximum Time

Required (min) Available per Week (min)
Machine Pi P2

Lathe 10 5 25,000
Milling Machine 4 10 2000
Grinding Machine 1 15 450
Profit per unit ($) $50 $100

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Determine the number of pieces of Pi and P2 to be manufactured per week to maximize
profit.

9. A person requires 10, 12 and 12 units of chemicals A, B and C respectively for his garden.
A liquid product contains 5, 2 and 1 units of A, B and C respectively per jar. A dry
product contains 1, 2 and 4 units of A, B and C per carton. If the liquid product sells for
$3 per jar and the dry product sells $2 per carton, how many of each should be purchased
in order to minimize cost and meet the requirement?

II. Use the simplex algorithm to solve the following LPP.

1. Solve the following LPP by the simplex algorithm

Min Z=6x1 +8x2
Subject to:
X1+ 2x2 > 80 3x1+ X2 > 75 X1, X2 > 0

a. What are the values of the basic variables at each iteration?

b. Which are the non-basic variables at each iteration?

2. At the 3rd iteration of a particular LP maximization problem, the following tableau is

established:

Cj

SV Xi X2 X3 Si S2 S3 Q

5 X3 -2 5
0 1 1 0 0
6 Xi 1 -3 0 0 0 112
0 S2 0 2 0 1 1 -110

Zj 6 -13 5 5 0 2i97

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 Cj - Zj 0 16 0 -5 0 -21

What special condition exists as you improves the profit and move to the next iteration?
Proceed to solve the problem for optimal solution.
3. Covert the following constraints and objective function into the standard form for use
in the simplex method
Min Z=4x1 +X2 Subject to:
3x1 + x2 = 3 4x1 + 3x2 > 6 x1 + 2x2 < 3 x1, x2 >0

4. Solve the following LPP using simplex method

Max Z=9x1 +7x2 Subject to:
2x1+ x2 < 40 x1 + 3x2 < 30 x1, x2 >0

5. Solve the following LPP to show that it has alterative optimal solutions.
a. Max Z=6x1 +3x2 Subject to:
2x1+ x2 < 8 3 X1+ 3x2 < 18

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 X2 < 3
xi, X2 >0

c. Min Z=2xi +8x2 Subject to:

5xi+ x2 > 10 2x1+ 2x2 > 14 x1+ 4x2 > 14 x1,
x2 > 0

6. Solve the following LPP to show that it

has unbounded solution.
a. Max Z = -2x1 +3x2
Subject to:
x1 < 5
2 x1 - 3x2 < 6 x1, x2 >0

b. Max Z=3x1 +6x2

Subject to:
3x1+ 4x2 > 12 -2x1 + x2 < 4 x1, x2 > 0
7. Solve the following LPP to show that it
has no feasible solution.
a. MaxZ=-2x1 +3x2 Subject to:
x1- x2 > 4 x1+ x2 < 6 x1 < 2
x1, x2 > 0

b. Max Z = 3x1 +3x2

Subject to:
2x1+ x2 < 2 3x1 + 4x2 > 12

160
xi, X2 >0

161
REFERENCES

1. Anderson, D.R and others 2003. An introduction to Management science Quantitative approaches ot

Decision Making, Melissa Acuna, USA.

2. Orema, M and Agarwal, K, 1988, Quantitative Techniques kings Books, Delhi.

3. Stwenson, W. Introduction to Management Science.

4. Taha, H, 1999. Operations Research: An Introduction. Prentice Hall, New Delhi.

5. Buffa, E and Sarin, R, 1994. Modern Production/Operations management. John Wiley and sons,

Singapore.

6. Bowen, E and Pritchett, 6, 1987. Mathematics with applications in Management and economics,

Richard Irwin inc, USA.

7. Uohra, N, 1998. Quantitative Techniques in Management. Tata Mc Graw Hill, New Delh !

162
 UNIT FOUR

EXPONENTIAL AND LOGARITHMIC FUNCTIONS

Unit Objectives

After studding this unit, students should able to understand and be acquainted with the
following:

• Be able to know the definition and meaning of exponents.

• Be able to know the basic rules of exponents.
• Develop an insight towards basic operations in exponential and logarithmic functions.
• Develop know-how towards logarithms and antilogarithms.
• Develop an insight towards application areas of exponential and logarithmic functions.
• Be able to handle problems in mathematics of finance using exponential and logarithmic
concepts.

In general, the major objective of this unit is to enable students to have an insight and
exposure towards exponential and logarithmic functions, and thereby enabling them to impart
knowledge of applying the techniques in handling real life problems, especially in
mathematics of finance.

Unit Introduction

It is evident that managerial problems are amenable to mathematical models. Of the various
functions, this unit tries to introduce students of business stream about major topics in
exponential and logarithmic functions. The unit deals with basic concepts of exponential and
logarithmic functions, basic rules of exponents, basic rules of logarithms, types of logarithms,
antilogarithms and applications areas of these functions in the business arena.

163
In total, this part of the module introduces students of business stream about basic concepts in
exponential and logarithmic functions for further application in mathematics of finance.

Dear student! What do you know about exponents and logarithms?

4.1 Basic concepts

Definition of exponential functions: The function f(x) = a x

where a>0, afl is called an exponential

function for each different constant a called the base.

4.2 Basic Rules of Exponents:

1. Any number to the power of zero is 1; a0 = 1.

E.g. 20 = 1; (8000)0 = 1, etc.

2. When multiplying two powers of the same base, always add exponents.

ax . ay = ax+y E.g. 22.24 = 22+4 = 26

3. When dividing ax by ay, simply subtract exponents.

i.e. ax/ay = ax-y E.g. 34/32 = 34-2 = 32

4. The quantity ax to the power of y is equal to axy;

i.e. (ax)y = axy

5. The base ab to the power x is equal to ax times bx;

i.e. (ab)x = ax . bx

6. The base a/b to the power x is equal to ax/bx;

i.e. (a/b)x = ax/bx

7. A base to the power -x is equivalent to one over that base to the power x;

164
 i.e. a"x = 1/ax, e.g. 3-2 = 1/32 = 1/9.

Definition of logarithmic functions: For a>0 and afl; y = logax which is equivalent to ay = x, defines
a logarithmic function.

A logarithm is simply an exponent that is written in a special way.

For example, we know that the following exponential equation is true:

32 = 9
In this case, the base is 3 and the exponent is 2. We can write this equation in logarithm form (with

identical meaning) as follows:

log39 = 2

We say this as "the logarithm of 9 to the base 3 is 2". What we have effectively done is to
move the exponent down on to the main line. This was done historically to make
multiplications and divisions easier, but logarithms are still very handy in mathematics.

There are two basic types of logarithms:

i. Common logarithms: are logarithms to the base ten. They are identified by
log10x = log x

ii. Natural logarithms: are logarithms to the base e. They are identified by: loge x = In x.

4.3 Basic Rules of logarithms:

1. Loga1 = 0; a0 = 1

2. Logaa = 1; a1 = a

3. Logamn = logam + logan ^ product rule of logarithms.

4. Loga(m/n) = logam - logan ^ quoti ent rule of logarithm s.

5. Logamp = plogam ^ power rule of logarithms.

165
6. Logca = (logba)/(logbc)

Dear student, can you summarize and give your own example of basic rules of
logarithms.

Antilogarithms:
It is the inverse of a logarithm and indicates the exponential function.
I.e. logax = y ^ antilogay = x^ ay = x.

4.4 Applications:

I. The growth of a population:

Formula: P = Po. 2(t/d; where, P = population at time t

Po = population at time t=0 d = doubling time t = number of years

Example: if country x has a population of 23,000,000 people and a doubling time of 19

years, and if the growth continues at the same rate, find the population in:
a) 10 years
b) 30 years

Compute the answer to the next million.

Solution:
Given: P0 = 23 million, d = 19 years
a) t = 10 years; P10 = P0.2(t/d)

P10 = (23,000,000)(210/19)
P10 = 33 million

b) t = 30 years; P30 = (23,000,000)(230/19)

P30 = 69 million

II. To calculate the growth of money at a compound interest:

Formula: A = p(1 + r/m)n; where,

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 A = maturity value P = principal r = nominal rate

m = compounding periods within a year n = total number of compounding

periods

Exercise 4-1:

1. Write in logarithm form: 8 = 23

2. Write in exponential form: logio 1000 = 3
3. Find b if

4. Evaluatey = 9X if x = 0.5
5. Express 82 = 64 in logarithmic form.
6. Express log 11 121 = 2 in exponential
form.
7. Determine the unknown: log 10 0.01 = x
8. Determine the unknown: log b (1/4) = -1/2

Exercise 4-2:

Find the simplified form or values of the following questions.

1. 8-1
2. (-10)-5
3. (2x + 7)-4
4. 7x-8
5.
Find the value of x if x = 25
6. Find the value of y if y = 36/33
7. What is the value of 811/2?
8. What is the value of x if x is given by 42/43?
Exercise 4-3:

1. Expand log 7x as the sum of 2 logarithms.

167
2. Using your calculator, show that log (20/5) = log 20 - log 5.
3. Express as a multiple of logarithms: log x5.
4. Find the value of the following:

b. log66
c. log10 10
d. logxx
e. loga a
5. Find the value of the following:

a) log7 1 b) log10 1 c) loge1 d) logx 1

Remark: Dear distance learner! The major aim of this unit is to remind you about
exponential and logarithmic functions for applying them in the next unit of the module
(that is mathematics of finance). Thus, further dealings of these functions are left for the
next unit.

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UNIT SUMMARY

Summary of the major formulas covered in this unit include the following.
4- f(x) = ax where a>0, a^1

4- For a>0 and a^1; y = log ax

4- Antilogay = x^ ay = x

4- P = P0.2(t/d)
4- A = p(1 + r/m)n

SELF-CHECK REVIEW PROBLEMS IV

1. Express as a sum, difference, or multiple of logarithms:

2. Express 2 loge 2 + 3 loge n as the logarithm of a single quantity.

3. Determine the exact value of:

log3 4/27

4. Solve for y in terms of x: log2X + log2y = 1

5. Solve 5x = 0.3

6. Solve the equation 3x = 12.7.

7. Solve 3 log(2x - 1) = 1

8. Find the a) compound amount, and b) the compound interest for the given investment and
rate: $15000 for 14 years at an annual rate of 5% compounded monthly using exponential
function.

169
 UNIT FIVE
MATHEMATICS OF FINANCE

Unit Objectives

After a thorough study of this chapter, you will able to:

• Understand the concept of time - value of money.
• Identify the concept and computation of simple interest.
• Compute compound interest.
• Know the concept and business application of annuities.

Unit Introduction

Mathematics of finance is concerned with the analysis of time-value of money. The

fundamental premise behind such analysis is the concept that entails the value of money
changes overtime. Putting it in simple terms, the value of one birr today is not the same after a
year. Suppose, if you deposit Birr 1000 at a bank for some period, you will find the sum
grows to a higher sum at the time of withdrawal. The rational behind is that the banks reinvest
the deposits received at some other profitable ventures and hence, it is using depositors’
money. As a result, it pays interest on depositors’ money as compensation. Thus, in one way
or another as value of money changes overtime we find a difference between the present and
future value of money. In sum, the difference arises because a rational being is assumed to
invest/use money available on productive activity that result in a higher future sum and, the
difference between the present and future value of money is referred to as time-value of
money.

Mathematics of finance has an important implication in organizations as transactions and

business dealings are mostly pecuniary. Such matters as lending and borrowing money for
various purposes, leasing materials, accumulating funds for future use, sell of bonds are some
of the cases that involves the concept of time value of money, Likewise, finance mathematics
is equally important in our personal affairs. For example, we might be interested in owning a

170
house, in financing our educational fees, having a car, having enough retirement funds etc. All
these cases and others involve financial matter. Cognizant of this fact, we proceed to the study
of mathematics of finance in this unit. In doing so, the unit is organized in to three main
sections. The first section advances to our study of simple interest and discounts. We further
explore about compound interest and annuities in the second and third sections respectively.

Dear student, do you have any concept of interest? Please try to define what interest is?

Section One: Simple Interest and Discounts Section Objectives:

After you study this section, you are expected to understand:
- How to compute simple interest
- Ordinary and exact simple interest
- Simple discounts
- Promissory notes and bank discounts

Section Overview:

5.1 Basic Concepts

5.2 Simple Interest and Its Computation
5.3 Ordinary and Exact Interest
5.4 Solving the Principal (P), Interest Rate (i) and Time
5.5 Simple Discount: Present Value
5.6 Promissory Notes and Bank Discount

5.1 Basic Concepts

In business, we usually pay some money for using services and goods. Such payments go by
various names. For instance, the money we pay for hiring a taxi is known as fair. The amount
we pay for education is called tuition fee. Likewise, the cost we pay for electric consumption
commonly called electric charge. Back to our case, we also incur cost in using money for a
certain period. This cost is referred to as interest. Thus, interest is the payment made for use

171
of the principal (money) or a fee, which is paid for having the use of money. The amount of money that is borrowed or

lent or invested or money available at hand at the beginning is called the principal and denoted by P. Interest is usually

paid in proportion to the principal and the period of time over which the money is used. The percent of the principal

that is charged for the use of the principal for a unit of time is called the rate of interest (interest rate, i). The length of

time for which the principal is borrowed, lent or invested is called the time or term of the loan and commonly how

symbolized by n. The future or maturity value, which is also denoted by F, is the sum of the principal and all the interest

earned.

Based on computation of the respective interest, there are two types of interests. These are,

i. Simple interest: it is the return on a principal amount for one time period.

ii. Compound interest: it is the return on a principal amount for two or more time period, assuming that the

interest for each time period is added to the principal amount at the end of each period and earns interest on all

subsequent periods.

5.2 The Simple Interest

Interest that is paid solely on the amount of the principal P is called simple interest. Simple interest is usually

associated with loans or investments that are short term in nature. In addition, it is always computed based on the

original principal.

The Simple Interest Formula:

The computation of simple interest is based on the following formula.

I=pin

Where, I = Simple interest (in dollars or birr)

P = Principal (in dollar, or birr) and it is the amount i = Rate of interest per period (the annual simple interest rate) n

= Number of years or fraction of one year

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In computing simple interest, any stated time period such as months, weeks or days should be expressed in terms of

years. Accordingly, if the time period is given in terms of,

i. Months, then
n= Number of months 12
ii. Weeks, then
n= Number of Weeks 52
iii. Days, then
a. Exact interest

n= Number of days 365

b. Ordinary simple interest
n= Number of days 360

Maturity value (future value) represents the accumulated amount or value at the end of the time periods given. Thus,

Future value (F) = Principal (P) + Interest (I)

Example 5.1

A credit union has issued a 3 year loan of Birr 5000. Simple interest is charged at a rate of 10% per year. The

principal plus interest is to be repaid at the end of the third year.

a. Compute the interest for the 3-year period.

b. What amount will be repaid at the end of the third year?

Solution

Given values in the problem 3 - Years loan = Principal = Birr 5000 Interest rate = i = 10% = 0.1 Number of years (n) =

3 years

a. I=pin

I = 5000 x 0.1 x 3 I = Birr 1500

b. The amount to be repaid at the end of the third year is the maturity (future) value of the specified money (Birr

5000). Accordingly, F = P + I

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 F = 5000 + 1500 F = Birr 6500

Or, using alternative approach,

F=P+I

Then, substitute I = P i n in the expression

to obtain F = P + Pin F = P (1 + in)

Consequently, using this formula we can

obtain F = 5000 (1+ (0.1x3)

F = 5000 x 1.3 F = Birr 1500

Example 5.2

A person “lends” Birr 10,000 to a corporation by purchasing a bond from the corporation. Simple interest is

computed quarterly (four times a year) at a rate of 2% per quarter, and a check for the interest is mailed each

quarter to all bondholders. The bonds expire at the end of 5 years, and the final check includes the original principal

plus interest earned during the last quarter. Compute the interest earned each quarter and the total interest, which

will be earned over the five-year life of the bonds.

Dear student, please try to solve the problem before going to the solution part.

Solution

Given values in the problem, P = Birr 10,000 i = 2% per quarter n = 5 years Required:

Interest per quarter and interest over the five-year periods Interest per quarter (one quarter) = Pin = 10000 x 0.2 x 1

= Birr 200

There, at each quarter the interest earned on Birr 10,000 is Birr 200.

174
 Interest over the five year period = pin In the case, n represents all

quarters with in 5 years. That is, n = Number of years x 4 = 5x4 = 20 Then,

Interest (I) = Pin

= 10000 x 0.02 x 20 = Birr 4000

O Remark
The interest rate of 2% is given as at a quarterly rate. Hence, in computation of the interest we shall not

change it in to annual rate. As long as the interest rate is provided in the desired time interval, we shall not make

adjustment on the rate given as well as the period. Yet, if conversion from one time interval to another is demanded, we

have to be consistent. For example, in the above example the i = 2% is for a quarter. The yearly rate will be 2x4 = 8%. By

using this annual rate, we can compute the total interest as follows.

I = Pin

= 10000 x0.08 x 5 = Birr 4000 Exercise 5.1

1. Suppose, a small handicraft enterprise has requested a two year loan of Birr 6500 from the commercial Bank of

Ethiopia. If the bank approves the loan at an annual interest rate of 7.5%,

b. What is the simple interest on the loan?

c. What is the maturity value of the loan?

2. If the above loan (exercise 5.1) is offered at a rate of 21% and is due in 3 months, what is the maturity value of the loan?

5.1.2 Solution for P, i and n

Dear students, in the computation of simple interest we might be required to find out the value of the principal, interest

rate and the time period in some cases. Such computation for

175
P, i and n is simply made by driving the formula for the unknown values from the formula we have used for simple

interest.

Example 5.3

1. How long must one leave Birr 300 invested in order to learn Birr 28 interest at 3% per year?

2. At what rate will Birr 150 produce interest of Birr 20.25 in 4.5 years?

3. What principal is required to produce interest of Birr 38.50 in two year at 3.5 % per year?

Solution

1. The question involves determining the time period which is enough to earn an interest of Birr 28 on Birr 300.

The given values in the problem are P = Birr 300 I = Birr 28 i = 3% and n = ?

I = Pin, now solve for n in this formula.

n = J_ Pi 28 28 = 4 years
300 x 0.30 9
2. Given values in the problem

P=Birr 150

i=Birr 20.25 n=4.5 years

The required value is the rate of interest.

I = pin, Solve for i

i = I = 20.25 = 20.25 = 0.03 or 3%

Pn 150x4.5 675
3. Given values in the problem

I = Birr 38.50 n =2 years I = 3.5% per year Required: Principal (P)

We can find out the value of P In the same manner with the above examples a follows. I = pin, solve for P

176
 P = Birr 550
Thus, Birr 550 is required to produce interest of Birr 38.5 in 2 years at 3.5% rate.

Exercise 5.2

Dear student, to check whether you have understood the above example try to work

out the

following problems.

1. If you are to receive a total of Birr 1000 in 3 months from an investment which

pays simple interest, what is the principle you have invested?

2. How many months will of take at 8% simple interest for Birr 2000 to grow in to

Birr 2400?

3. Find the interest rate if one borrows Birr 450 for one year and 8 months given

accumulated interact of Birr 30.

5.4 Ordinary and Exact Interest

In computing simple interest, the number of years or time, n, can be measured in

days. In

such case, there are two ways of computing the interest.

i. The Exact Method: if a year is considered as 365 days, the interest is called exact

simple interest. If the exact method is used to calculate interest, then the time is

n = number of days / 365

ii. The Ordinary Method (Banker’s Rule): if a year is considered as 360 days, the interest

is called ordinary simple interest. The time n, is calculated as

n = number of days/ 360

Example 5.4

Find the interest on Birr 1460 for 72 days at 10% interest using,

a. The exact method

b. The ordinary method

Solution

Given a) P=1460 b) P=1460

177
 P = Birr 1460 n=72/365 n= 12/360
n = 72 days i= 0.1 i=0.1
i = 10% = 0.1 I=Pin =1460*72/365*0.1=28.8 I=Pin= 1460*72/365*0.1=29.2

5.5 Simple Discount: Present Value

The principal that must be invested at a given rate for a given time in order to produce a
definite amount or accumulated value is called present value. The present value is analogous
to a principal P. It involves discounting the maturity or future value of a sum of money to a
present time. Hence, the simple present value formula is derived from the future value (F)
formula as follows.

Future Value = Principal + Interest F = P + I but I = Pin Thus, F = P + Pin

F = P (1+ in)

Then from this, solve for P.

P = F/
/1 + in

If P is found by the above formula, we say that F has been discounted. The difference between
F and P is called the simple discount and is the same as the simple interest on P.

Example 5.5

1. 90 days after borrowing money a person repaid exactly Birr 870.19. How much money
was borrowed if the payment includes principal and arch nary simple interest at 9 / %?

2. What is the present value of Birr 645 due in 2 / years if the interest rate is 3%? What is
the simple discount?

178
Solution

1. Given values in the problem,

n in ordinary method = Number of days / 360 = 90 /360 n = 0.25
F = the amount repaid = Birr 870.19 i = 9 = 9.5% = 0.095

Required:

The amount borrowed which is the same as simple present value, P.

P = F/
/1 + in
= 870.19 / (1+ (0.095 x 0.25))
P = 870.19 - 1.024 P = Birr 849.795
2. Given values in the problem,
F = Birr 645 n = 2.5 years i = 3% = 0.03 P = F/ 1+ in
P = 645/ 1+ (0.03 x 2.5)
P = 645/1.075 P = Birr 600

179
Exercise 5.4

Solve for the missing quantities.

Question Rate (i) Time

Present Value (P) Simple discount (I) Future value (F)
(n)

Birr 400 Birr 18 ? ? A years

1
Birr 600 Birr 60 ? 4% ?
2
3 ? Birr 126 Birr 1026 ? 3A years

4 Birr 474.81 ? Birr 481,93 ? 'A years

5 Birr 2510.14 ? Birr 2566.62 4 A/o ?

5.6 Promissory Notes and Bank Discount Definitions

A promissory note is a promise to pay a certain sum of money on a specified date. It is also considered as a written

contract containing an unconditional promise by the debtor called the maker of the note to pay a certain sum of

money to the creditor called the payee of the note, under terms clearly specified in the contract. Promissory note is

unconditional in a sense that it gives the maker of the note an exclusive right either to sell, borrow, or discount it

against the value of the note.

A bank discount is the amount of money received or collected after discounting a note before its due date. It is not

unusual when borrowing money from a bank that one is required to pay a charge based on the total amount that is to

be repaid (maturity value), instead of the principal used. If the maturity value is used in determining the charge for

use of money, we say that the promissory note (or simply the note) is discounted. Consequently, a charge of loan computed in

this manner is called ‘Bank Discount’ and it is always computed based on the maturity value. Bank discount is the

amount that is charged on maturity value.

Hence, the amount of money payable to the debtor or the amount that the borrower receives is called ‘Proceed.’ The

amount that the borrower is going to pay to the creditor (lender) is

180
called ‘maturity value.’ To further our understanding of this concept, let’s develop mathematical expressions (formula)

for computation of the variables at stake.

Proceed = Maturity Value - Bank Discount

Symbolically,

P= F - D, and D= Fdt

Where, P = Proceed

F = Maturity value D = Bank discount d = Rate of discount t = Time of discount

Now we can further elaborate the above formula for proceed. To begin with,

P = F - D, but D = Fdt

Therefore, P = F - Fdt = F (1 - d t)

In sum, proceeds can be calculated by

P = F (1 - d t)

For example, if Birr 1000 is borrowed at 12% for 6 months, the borrower receives the proceeds, P, and pays back F =

Birr 1000. The proceeds will be Birr 1000 minus the interest on Birr 1000. This will be:

P= 1000 - (1000 x 0.12 x 6/12) = Birr 940

Or, P = 1000 (1 - (0.12 x 6/12)

P = Birr 940

Remark

i. Proceeds are an amount received now for payment in the future. Therefore, they are analogous to

present value. Yet, proceeds are not equal to present value because the proceeds from a futures

obligation to pay are always less

181
than the present value of that obligation if, of course, the same rate of interest is used in both

adulations.

ii. Proceeds should be completed when the interest rate is stated by the qualifier word as

discount rate or a bank discount or interest deducted-inadvance, and present value should be

computed where the interest is given without such qualifiers, discount.

iii. The computation of simple interest and bank discount is the same except in the former

case principal and in the later case the maturity values are used for between trimmings the

amount discount.

Having the idea of promissory notes and bank discounts, we may now progress to consider
some illustrative problems.

Example 5.6

1. Find the bank discount and proceeds on a note whose maturity value is Birr 480 which is

discounted at 4% ninety days before it is due.

2. A borrower signed a note promising to pay a bank Birr 5000 ten months from now.

a. How much will the borrower receive if the discount rate is 6%?

b. How much would the borrower have to repay in order to receive Birr 5000 now?
Dear student, please try to solve the above problem before going to the next part.

Solution

1. Given values in the problem F = Birr 480 d = 4% = 0.04

t = 90 days or 3 months = 3/12 = 90/360 = 0.25 D = ? and P = ?

To find the value of the bank discount, we use the formula D = Fdt. Accordingly,

D = 480 x 0.04 x 3/12

D = Birr 4.8 is the amount of bank discount.

182
In the same manner, the proceed can be obtained as follows.

P= F-D or P = F (1 - d t)

P= 480 - 4.8 or P = 480 (1 - (0.04 x 0.25)

P= Birr 475.2 or P = 480(0.99) = Birr 475.2

2. Given values:

F = Birr 5000

t = 10 months = 10/12 year = 0.83 year

a. d = 6% = 0.06

Proceeds =P =?
P = F(1 - dt)

= 5000 (1 - (0.06 x 10/12)

= 5000(1 - 0.05)

P = 5000 (0.95)
P Birr 4750 is the amount that the borrower receive now.
=

b. Given d = 0.04 or 4%

t = 10 months or 10/12 = 0.83 years

P = Birr 5000

F =?

Now to find the value of F, simply we need to solve for F in the formula P = F(1- dt).

Thus, F = P - (1 - d t)

F = 5000 = 5000 / 09668

1 - (0.04 x 0.83)
F = Birr 5171.7

Exercise 5.5

1. A person signs a note promising to pay a bank Birr 1500 eight months from now and receives Birr 1350. Find the

discount rate.

2. Find the bank discount and proceeds on a 120-day note for Birr 720 bearing 5% interest if discounted at 4% 90

days before it is due.

183
Section Two: Compound Interest Section Objectives:
Upon completion of this section, you will be able to:
- Identify procedures of computing compound interest.
- Determine the compound amount of a sum of money and discounting of the same.

Section Overview:

o The Compound Interest and Its Formula o Present Value of a Compound Amount

5.7 The Compound Interest and Its Formula

As it has been highlighted earlier, compound interest involves the case where interest earned
during the earlier periods also earns interest during the later period. If, instead of being paid
when due, the interest as investment is added to the principal and the sum is used as new
principal, we say that compound interest is being used. Under this procedure, the interest for
each period is added to the principal for purpose of computing interest for the next period. The
sum to which the principal and interest on it grow during the period is called the maturity or

accumulated value of the principal . The difference between the compound amount and the principal is
called compound interest. The sum that is invested is called the present value or the principal . The time
interval between the date on which the principal was invested and the date on which it is
repaid is called the term of the investment (loan).

If an amount of money, P, earns interest compounded at a rate of I percent per period it will
grow after n periods to the compound amount F, and it is computed by the formula:

Compound amount formula: Fn = P (1 + i) n Where, P = Principal

i = Interest rate per compounding periods n = Number of compounding periods (number of
periods in

184
 which the principal earn interest)
F = Compound amount

A period, for this purpose, can be any

unit of time. If interest is compounded
annually, a year is the appropriate
compounding or conversion or interest
period. If it is compounded monthly, a
month is the appropriate period. It is
important to know that the number of
compounding period/s within a year
is/are used in order to find the interest
rate per compounding periods and it is
denoted by i in the above formula.
Consequently, when the interest rate is
Example 5.7 stated as annual interest rate and is
compounded more than once a year, the
Assume that we have deposited Birr 6000 at commercial Bank
interest of Ethiopia
rate which paysperiod
per compounding interest
is
of 6% per year compounded yearly. Assume that wecomputed
want to determine the amount of money
by the formula:
we will have on deposit (our account) at the end of 2 iyears (thewhere
= j / m, first jand secondquoted
is annual year) if
or all
interest is left in the savings account. nominal interest rate
m number of conversation periods per
Solution
year or the compounding periods per year
Give values in the problem, P = Birr 6000, j = 6% = 0.06, t = 2 years m = compounded
n = m x t, where t is the number of years
annually = i.e. only once n = m x t = 1 x 2 = 2 i = j / m = 0.06 / 1 = 0.06 Then, the required
value is the maturity or future value F = P(1 + i )n
= 6000 (1 + 0.006)2 = Birr 6000 (1.06)2 = Birr 6741.6

185
Exercise 5.8

An individual accumulated Birr 30,000 ten years before his retirement in order to buy a house
after he is retried. If the person invests this money at 12% compounded monthly, how much
will be the balance immediately after his retirement?

Solution

Given values, P = Birr 30,000, t = 10 years, i = 12% = 0.12

m = compounded monthly = 12 i = j / m = 0.12 / 12 = 0.01
n = m x t = 12 x 10 = 120 and what is required is the Future Value F.
Then, F = P (1 + i) n
= 30,000 (1.01)120 = 30,000 (1.01)120 F = Birr 99,011.61

Having the understanding of how compound interest works and computation of future value,
in subsequent example, we will consider how to determine the number of periods it will take
for P birr deposited now at i percent to grow to an amount of F birr.

Example 5.9

A newly married couple has Birr 15000 to the purchase a house. For the type of house they are
interested in buying they estimate a birr 20,000 down payment will be necessary. How long
will the money have to be inserted at 10 % compounded quarterly to grow to Birr 20,000?

Solution

Given the values, P = Birr 15000, F = Birr 20,000

m = quarterly = 4 times a year j = 10% = 0.1
i = j - m = 0.1 - 4 = 0.025

186
a. We are required to determine the period within which Birr 15000 could grow to Birr 20,000.
In accordance, given the formula F = p (1 + i) n we solve out for n.
20.000 = 15,000 (1 + 0.1)n
20.000 = 15000 (1.025)n , then divide both sides by 15,000.
20.000 - 15,000 = 1.025n 1.33 = 1.025n
Now, we shall apply the rule of logarithm we considered in the preceding chapter. Hence, we
can take the logarithm of both sides.
log 1.33 = log 1.025n

Then, applying the rule of common logarithm (logarithm in base 10 = log 10), we will find that
log 1,025n = n log 1.025

Thus, log 1.33 = n log 1.025

log 1.33
-= n
log 1.025
Using the logarithm table or scientific calculators, we obtain

0.124938736
n =-
0.1010723865

n = 11.65 or 12 days

Since we have considered the interest rate per quarter, the resulting period will be in terms of
quarters. However, if we use the annual interest rate of 10% the resulting answer will be
in terms of years.

Students, in the example above we have seen how to compute the time ‘n’ for a given sum of
money to grow to some specified amount at a specified interest rate. Further, let us
consider a problem that involves computation of unknown interest rate.

187
Example 5.10

Find the semi-annual interest rate at which Birr 1760 will accumulate to Birr 3800 in 26 years.

Solution

Given values in the problem are, P = Birr 1760 , F = Birr 3800 , t = 26

years
m = number of conversion periods in a year = twice (semi-annual) n = m x t = 2 x 26 = 52
semi-annuals
i =? (We are required to compute the semi-annual interest rate)

First, we have the compound amount formula Fn = p (1 + i) n . Then,

3800 = 1760 (1 + i) 52
Now, let us divide both sides by 1760 to obtain 3800 - 1760 = (1 + i) 52 2.16 = (1+i)52
At this point, we shall apply the logarithmic function rule. Hence, taking common logarithm
of both sides, we obtain.
log 2.16 = log(1 + i) 52 log 2.16 = 52 log (1 + i)
In further approach, let us divide both sides by 52 to obtain log 2.16 - 52 = log (1 + i)
0.334454 - 52 = log (1 + i)
0.006432 = log (1 + i)

To obtain (1 + i), we must convert the given expression to exponential function form or take
the antilogarithm of both sides. The first approach is simpler and involves few steps than the
later method. Thus, as we have seen in the fourth chapter, we know that: log a x = y is equal to
O’ = x .

Accordingly, we obtain
2Q 0.0064432 _ j + •

188
1.0149 = 1 + i
i = 0.0149 ~ 1.5% .

The rate of interest per conversion period (semi annual rate) is

1.5%. In the same way, the annual nominal rate j will be 3%,
which can be obtained by multiplying i by the number of
conversion periods per year.

Having considered the above examples, now you can further

check your understanding by working out the following
exercises.

Exercise 5.6

1. If Birr 6500 is invested at 8 'A % compound

a. Annually b. Semi annually
c. Quarterly d. Monthly,
what is the amount after 7 years?

2. At what interest rate compounded quarterly will a sum of

money double in 4 years?

3. How long will it take for Birr 4750 to accumulate to Birr

7500 at 51/3% compounded semi-annually?

4. If, in 11 years, Birr 1200 accumulates to Birr 1482, what is

the compound interest rate provided it is converted annually?

5.8 Present Value of a Compound Amount

As we have considered in the simple interest case and as

extended in the compound amount as well, future (maturity)
value is the value of the present sum of money at some future
date (time). Conversely, present value (or simply principal) is
the current birr or dollar value equivalent of the future amount.
It is the sum of money that is invested initially and that is
expected to grow to some amount in the future at a specified
rate. If we put the present and future (maturity) values on a
continuum as shown below, we can observe that they are
inverse 189
to one another. And, future value is always greater than the present value or the principal
since it adds/earns interest over specified time-period.

01 2 3... n
Present Value (P) Future Value
(Compound Amount)

P Fn (1 + i)n Fn = P(1 + i)n

(1 + i)n

Future value is obtained by compounding technique and the expression (1 + i) n

is called
compound factor. On the other hand, present value is obtained by discounting techniques and
the expression (1 + i) "n is referred to as the compound discount factor. The formula for
present value of compound amount is simply derived from compound amount formula by
solving for P.

Examples 5.11

1. What is the present value of

a. Birr 5000 in 3 years at 12% compounded annually?
b. Birr 8000 in 10 years at 10% compounded quarterly?

2. Suppose that a person can invest money in a saving account at a rate of 6% per year
compounded quarterly. Assume that the person wishes to deposit a lump sum at the
beginning of the year and have that some grow to Birr 20,000 over the next 10 years. How
much money should be deposited at the beginning of the year?

3. A young man has recently received an inheritance of birr 200,000. He wants to make a
portion of his inheritance and invest it for his late years. His goal is to accumulate Birr
300,000 in 15 years. How much of the inheritance should be invested if the money will earn
8% per year compounded semi-annually? How much interest will be earned over the 15
years?

Solution

190
1. (a) Given the values, Fn = F3 = Birr 5000, t = 3 years m = 1 (compounded annually)

n = t x m = 3 x 1 = 3 j = 12 % = 0.12

i = j / m = 0.12/1 = 0.12 and we are required to find Present Value P. Thus, P = Fn (1 + i) -n

= 5000 (1 + 0.12)-3 = 5000 (1.12-3)

= 5000 (0.7118)

P = Birr 3559

(b) Fn = F40= Birr 8000, t = 10 years , m = quarterly = 4

n = t x m = 10 x 4 = 40 , i = 10% = 0.1 , i =j / m = 0.1 / 4 = 0.025

p = ? but P = Fn (1 + i)-n

= 8000 (1 + 0.025)-40 = 8000 (1.025) -40 P = Birr 2979.5

2. Given the values, i = 6% = 0.06 , m = quarter = 4 times a year

i = j - m = 0.06 - 4 = 0.015 F = Birr 20,000 shall be accumulated t = 10 years

n = m x t = 10 x 4 = 40 interest periods P = how much should be deposited now?

P = Fn(1 + i)-n

= 20,000 (1+0.015)-40 = 20,000(1.015-40)

P = Birr 11,025.25

3. Inheritance = Birr 200,000

Fn = Birr 300,000 (the person's goal of deposit) , t = 15 years , j = 8% = 0.08 m = semi-annual = 2 times a year i = j -

m = 0.08 - 2 = 0.04

n = t x m = 15 x 2 = 30 interest periods/semi-annuals P = how much of the inheritance should be invested now? P =

Fn(1 + i)-n I = Amount of interest?

191
 = 300,000 (1+0.04)"30 = 300,000(1.04)"30 = 300,000(0.3083)
= Birr 92,490

The present value of Birr 300,000 after 15 years at 4% semi-annual interest

rate is equal to
Birr 92,490. Therefore, from the total inheritances received Birr 92,490 needs
to be deposited
now.
Amount of compound interest = Future Value - Preset Value = 300,000 -
92,490 Amount of compound interest = Birr 207,510

Dear student, now it is the time for you to practice and solve out the following
problems.

Exercise 5.7

1. If money is worth 14% compounded semi-annually, would it be better to

discharge a debt by paying Birr 500 now or Birr 600 eighteen months from
now?

2. A house is for sale at Birr 12,000 cash or Birr 6000 cash with additional
payment of Birr 3000 at the end of one year and Birr 3100 at the end of three
years. If interest is at 5% compounded annually, which is the better price for
the buyer and by how much?

3. The quoted price of an item is Birr 500 cash and Birr 500 at the end of
each year for two years. If money is worth 5% compounded annually, find the
Section Three: equivalent
Annuities cash price.
Section Objectives:
After going through this section, you will able to:
- Define and explain annuity and its types.
- Identify and compute maturity value of an ordinary annuity.
- Develop the comprehension of sinking funds payments.
- Develop acquaintance of the mathematical application of present value and mortgage
payments.

192
Section Overview:

o Introductory Concepts

o Sum of Ordinary Annuity: Maturity Value

o Ordinary Annuities: Sinking Fund Payments

o Present Value of Ordinary Annuity

o Mortgage Payments and Amortization

5.9 Introductory Concepts

Annuity refers to a sequence or series of equal periodic payments, deposits, withdrawals, or

receipts made at equal intervals for a specified number of periods. For instance, regular deposits to

a saving account, monthly expenditures for car rent, insurance, house rent expenses, and periodic

payments to a person from a retirement plan fund are some of particular examples of annuity.

Payments of any type are considered as annuities if all of the following conditions are present:

i. The periodic payments are equal in amount

ii. The time between payments is constant such as a year, half a year, a quarter of a year, a

month etc.

iii. The interest rate per period remains constant.

iv. The interest is compounded at the end of every time.

Annuities are classified according to the time the payment is made. Accordingly, we have two basic

types of annuities.

i. Ordinary annuity: is a series of equal periodic payment is made at the end of each interval or

period. In this case, the last payment does not earn interest.

ii. Annuity due: is a type of annuity for which a payment is made of the beginning of each interval

or period.

It is only for ordinary annuity that we have a formula to compute the present as well as future

values. Yet, for annuity due case, we may drive it from the ordinary annuity formula. To

193
proceed, let us first consider some important terminologies that we are going to use in dealing with annuities.

i. Payment interval or period: it is the time between successive payments of an annuity.

ii. Term of annuity: it is the period or time interval between the beginning of the first payment period and the end of

the last one.

iii. Conversion or interest period: it is the interval between consecutive conversions of interest.

iv. Periodic payment/rent: it is the amount paid at the end or the beginning or each payment period.

v. Simple annuity: is the one in which the payment period and the conversion periods coincides each other.

Following the above basic overview about annuities, we shall progress to deal with practical business problems, which

relate with determining the maturity and present values of annuities with specific application cases.

5.10 Sum of Ordinary Annuity: Maturity Value

Maturity value of ordinary annuity is the sum of all payments made and all the interest earned therefrom. It is an

accumulated value of a series of equal payments at some point of time in the future. Suppose you started to deposit

Birr 1000 in to a saving account at the end of every year for four years. How much will be in the account immediately

after the last deposit if interest is 10% compounded annually?

In attempting this problem, we should understand that the phrase at the end of every year implies an ordinary

annuity case. Likewise, we are required to find out the accumulated money immediately after the last deposit which

also indicate the type of annuity. Further, the term of the annuity is four years with annual interest rate of 10%.

Thus, we can show the pattern of deposits diagrammatically as follows.

194
 The Present The Future
0 1st 2nd 3 rd 4th

1000 1000
1000 1000
1 1

1 1
i " Birr 1000
i i i

' ' Birr 1100

I I
! Birr 1210
i___________________________________
Birr 1331
Total Future Value = Birr 4641
The first payment earns interest for the remaining 3 periods.
Therefore, the compound amount of it at the end of the term of
annuity is given by,
F = P (1 + i) n = 1000 (1 + 0.1)3 = Birr 1331 In the same manner,
the second payment earns interest for two periods (years). So,
F= 1000 (1+0.1)2 = 1210
The 3rd payment earns interest for only one period. So,
F=1000(1+0.1)1 = 1100
No interest for the fourth payment since it is made at the end of the
term.
This approach of computing Thus,
future itsofvalue
value is 1000
ordinary itself.
annuity In total,and
is complex themay
maturity value
be tiresome
amounts
in case the term is somewhat to Birr
longer. 4641.
Thus, in simple approach we can use the following
formula for sum of ordinary annuity (Future Value).

Fn R
(1 + i)n- 1
i

Where, n = the number of payment periods

i = interest rate per period R = payment per period
Fn = future value of the Annuity or sum of the annuity after n periods

Now, let us consider the above example. That is,

R = Birr 1000

195
 i = 0.1 and n=4

(1 + 0.1)4 - 1
F 1000
=
0.1

Future Value = Birr 4641

Example 5.12

1. A person plans to deposit 1000 birr in a savings account at the end of this year and an equal sum at the end of

each following year. If interest is expected to be earned at the rate of 6% per year compound semi-annually, to

what sum will the deposit (investment) grow at the time of the fourth deposit?

2. A 12-year-old student wants to begin saving for college. She plans to deposit Birr 50 in a saving account at the

end of each quarter for the next 6 years. Interest is earned at a rate of 6% per year compounded quarterly.

What should be her account balance 6 years from now? How much interest will she earn?

Solution

1. The known values in the problem are,

m = semi-annual = twice a year
R = 1000, j = 6% = 0.06 ,

i = 0.06 - 2 = 0.03
n=4

(1 + i)n -1
F4 = ? F4 = R i

= 1000 (1 + 0.03)4 -1
0.03

= 1000 [
(1.03)4 - 1/0.03 J =

1000x4. 183627
F = Birr 4183.63 2

2. R = Birr 50 t = 6

years

196
 m = quarterly = 4 times a year
n = t x m = 6 x 4 = 24 quarters
j = 6% = 0.06 i = j - m = 0.06
- 4 = 0.015

r(1 + 0.015)24 -1"

F 24 =
|_ 0.015

[
50 (1.01524 -1) 0.015 J
F24 = Birr 1431.68

Interest = Maturity Value - Sum of

Deposits = Maturity value - (24 (50))
= F24 -1200 = 1431.68 - 1200
= Birr 231.68

Exercise 5.8

1. Find the accumulated value of an ordinary annuity of Birr 65 per period for 23 periods if
money is worth 4% per period

2. If birr 500 is deposited each quarter in to in account paying 12% compounded quarterly,
a. How much is the value of deposit at the end of the 3 years?
b. How much is the value of interest for the 3 year?
c. How much interest is earned /paid at the end of the second year?

5.11 Ordinary Annuities: Sinking Fund Payments

A sinking fund is a fund into which periodic payments or deposits are made at regular interval
to accumulate a specified amount (sum) of money in the future to meet financial goals and/or
obligations. The equal periodic payment to be made constitute an ordinary annuity and our
interest is to determine the equal periodic payments that should be made to

197
meet future obligations. Accordingly, we will be given the Future Amount, F, in n period and
our interest is to determine the periodic payment, R. Then we can drive the formula for R as
follows.

(1 + i)' 1
F =R i

Multiply both sides by

i

(1 + i)n -
1
That is,

i (1 + i)n -1 i
F x- R
(1 + /)" -1 i x-
(1 + i)) -1

Then,
i
R F.
(1 + i)n -1

is the sinking found formula.

Where, R = Periodic payment amount of an annuity

i = Interest per period which is given by j ^ m j = Annual nominal interest rate m = Number
of conversion periods per year
n = Number of annuity payment or deposits (also, the number of compounding periods)
F = Future value of ordinary annuity

In general, a sinking fund can be established for expanding business, buying a new building,
vehicles, settling mortgage payment, financing educational expenses etc.

198
Example 5.13

1. A corporation wants to establish a sinking fund beginning at the end of this year. Annual
deposits will be made at the end of this year and for the following 9 years. If deposits earn
interest at the rate of 8% per year compounded annually, how much money must be
deposited each year in order to have 12 million Birr at the time of the tenth deposit? How
much interest will be earned?

2. Assume in the previous example that the corporation is going to make quarterly deposits
and that interest is earned at the rate of 8% per year compounded quarterly. How much
money should be deposited each quarter? How much less will the company have to
deposit over the 10-year period as compared with annual deposits and annual
compounding.

3. A firm wishes to establish a sinking found for the purpose of expanding the production
facilities at one of its plants. The company needs to accumulate 500,000 birr over the next
five years that earn interest at 6% compounded semi-annually.
a. How much should the firm contribute to the found at the end of each semi-annual period
in order to achieve the goal?
b. Calculate the compound interest.
c. Prepare the fund accumulation schedule.

Solution

1. Future level of deposit desired = Fn = Birr 12 million Term of the annuity = t = 10 years
Conversion periods = m = annual = 1
n = t x m = 10 x 1 = 10 annuals j = 0.08
i=j-m= 0.08 - 1= 0.08
R = the amount to be deposited each year to have 12 million at the end of the 10th year = ?
Then to obtain the value of R, we shall use the formula for sinking fund.

R i
(1 + i) ” - 1

199
 0.08
R = 12,000,000
(1 + 0.08)10 - 1

0.08
R = 12,000,000
(1.08)10 -1

0.08
R = 12,000,000
1.158925

R = Birr 828,353.86

On the other hand, the amount of interest, I, is obtained by computing the difference between
the maturity value (Fn = 12,000,000) and the sum of all periodic payments made. Thus,
I = Fn - R (10)
= 12,000,000 - 823,353.86 (10)
= 12,000,000 - 8,283,538.6 = Birr 3,716,461.4

2. This is the continuation of the previous example. Thus,

Fn = Birr 12,000,000 t = 10 years
m = Quarterly = 4 times a year n = m x t = 4 x 10 = 40

j = 8% = 0.08
i = j - m = 0.08 - 4 = 0.02
R = Periodic payment at adjusted conversation or interest period?
i
R F
(1 + i)" -1

200
 0.02
R 12,000,000
(1 + 0.02)40 -1

0.02
R ■ 12,000,000
(1.02)40 -1
12,000,000 (0.016555747)

R = Birr 198,668.94

In further computation to determine the difference in amount of deposit by changing

the length of the conversion period, we see that as compared with the first case of
annual conversion period, in the quarterly conversation scheme, the corporation will
deposit R (10) minus R (40) less over the term of the annuity.

Thus, R (10) - R (40)

= Birr 828,353.86 (10) - 198,668.96 (40)
= 8,283,538.6 - 7,946,758.4 = Birr 336,780.2

3. Future financial goal of the firm = Fn = Birr 500.00 t = term

of the annuity = 5 years j = annual interest rate
m = Conversion period = Semi-annually = 2 times a year i = j ^
m = 0.06 ^ 2 = 0.03 n = t x m = 5 x 2 = 10 semi-annuals

a. R=?

0.03
R = 500,000
(1 + 0.03)30 -1

= 500,000 (0.08723050506)
R = Birr 43,615.25

201
 b. Compound Interest = Fn - (n x R)
= Fn - (R (10)
= 5000,000 - 43615.25(10) = 500,000 - 436,152.5
Interest = Birr 63,847.5

c. Fund Amortization Schedule

Period Balance Interest (Beginning Bal. x Periodic Ending Balance (Beg.
(Beginning) 0.03) Payment Bal. + Interest + R)
1st 0 0 43615.25 43615.25
2nd 43,615.25 1308.46 43615.25 88,538.95
3rd 88,538.95 2656.17 43615.25 134,810.37
4th 134,810.37 4044. 31 43615.25 182,469.93
5 th 182,469.93 5474.01 43615.25 231,559.93
6th 231,559.28 6946.78 43615.25 282,121.31
yth 282,121.31 8463.64 43615.25 334,121.31
8th 334,121.31 10,026.01 43615.25 387,841.46
9th 387,841.46 11,635.24 43615.25 443,091.95
10 th 443,091.95 13,292.76 43615.25 500,000

Now, you may practice the following exercise.

Exercise 5.9

1. Mr. Robert has a saving goal of birr 35,000 which he would like to reach 8 years from
now. During the first four years, he is financially able to deposit Birr 150 each month in
to the saving accounts. What must his monthly deposit over the last 5 years if he is to
reach the goal? The account pays 12% interest compounded monthly.

2. A machine cost a company Birr 100,000 and its effective life is estimated to be 20 years.
If the scrap (salvage) value is expected to realize Birr 5000 only, find the sum to be
invested every year at 6% per annum for 20 years to replace the machine which is

202
 expected to cost the company 25% more over its present cost? Assume that the sale of the scrap would be utilized

for meeting the cost of the machine.

5.12 Present Value of Ordinary Annuity

The present value of annuity is an amount of money today, which is equivalent to a series of equal payments in

the future. It is the value at the beginning of the term of the annuity. The present value of annuity calculation

arise when we wish to determine what lump sum must be deposited in an account now if this sum and the

interest it earns will provide equal periodic payment over a defined period of time, with the last payment making

the balance in account zero.

Present value of ordinary annuity is given by the formula:

P=R 1 - (1 + i) -n i

Where, R= Periodic amount of an annuity

i = Interest per period which is given by j ^ m j = Annual nominal interest rate m = Interest/ conversion periods per

year

n = Number of annuity payments / deposits (also, the number of compounding periods)

P = Present value of ordinary annuity

Dear students, lets consider the following examples to make our understanding of business and financial application

of present value of ordinary annuity clear.

Example 5.14

A person recently won a state lottery. The term of the lottery is that the winner will receive annual payments of birr

18,000 at the end of this year and each of the following 4 years. If the winner could invest money today at the rate of

6% per year compounded annually, what is the present value of the five payments?

203
Solution

R = Annual payments of Birr 18,000

Term of the annuity = t = this year and the following 4 years = 5 years i = 6% = 0.06

(since the conversion period per year is annual)

n=5
Present value of payments = P = ?

1 — (1
+0 —n
P R
i

18,000
P= 18,000
1 — (1 + 0.06)—5 0.06 1 — (1.06)—5 0.06

P = 18,000[4.212363785]

P = Birr 75,822.55

Example 5.15

A woman would like to borrow money from local microfinance institution which charges interest at 4% compounded

quarterly. If the woman is able to pay Birr 100 at the end of each quarter for one year,

a. How much should she receive from the institution at the time of borrowing?

b. How much interest will the woman be charged?

c. Prepare the debt repayment schedule (Amortization schedule).

Dear student, please solve the above example before reading the solution part.

Solution

Interest charge rate = j = 4% = 0.04

Periodic payment by the woman = Birr 100

Term of the annuity (debt) = t = 1 year

Conversion period per year = quarterly = m = 4

Number of periods = n = t x m = 1 x 4 = 4 periods

Interest rate per conversion periods = j ^ m = 0.04 ^ 4 = 0.01

204
 a. How much to receive now? That is, the present value of the annuities, p.
-n

P R
1 - (1
+0
i

100

P 100
1 - (1 + 0.01)-4 0.01 1 - (1.01)-4 0.01
=

= 100 (3.902)
Present Value = Birr (390.2)

Given the woman’s potential to pay Birr 100 at the end of each quarter for one year, she can

borrow Birr 390.2 at the beginning.

b. Interest charge = Total amount paid - Present value

= (R x n) - P

= (100 x 4) 390.2 = 400 - 390.2

= Birr 9.8

c. The debt repayment schedule is a table that shows a periodic status of payments that gradually

make the debt account balance zero. This table is also called amortization schedule. Now let us

proceed with preparing the schedule.

Period Periodic Payment

Beginning Balance Interest (I) (Debt x Ending Balance
(Debt) 0.01) (Debt +1 - R)
1 st Birr 390.2 Birr 3.902 Birr 100 Birr 294.102

2nd Birr 294.102 Birr 2.941 Birr 100 Birr 197.043

3rd Birr 197.043 Birr 1.97043 Birr 100 Birr 99.013

4 th Birr 99.013 Birr 0.99013 Birr 100 Birr 0

As you observe in the above amortization schedule, in ordinary annuity periodic payment the last balance becomes

zero.

205
Exercise 5.10

A sum of money invested now at 11% compounded semi-annually is to provide payments of Birr 1600 ever six

months for 6 years, the first payment is due 6 months from now.

a. How much should be invested now?

b. How much interest will the investment earn?

c. Prepare the investments periodic payment schedule?

5.13 Mortgage Payments and Amortization

Dear student, would you define mortgage and amortization?

Another main area of application of annuities in to real world business situations in general and financial

management practices in particular is mortgage amortization or payment. Mortgage payment is an arrangement where

by regular payments are made in order to settle an initial sum of money borrowed from any source of finance. Such

payments are made until the outstanding debt gets down to zero. An individual or a firm, for instance, may borrow a

given sum of money from a bank to construct a building or undertake something else. Then the borrower (debtor)

may repay the loan by effecting (making) a monthly payment to the lender (creditor) with the last payment settling

the debt totally.

In mortgage payment, initial sum of money borrowed and regular payments made to settle the respective debt relate

to the idea of present value of an ordinary annuity. Along this line, the expression for mortgage payment computation

is derived from the present value of ordinary annuity formula. Our intention in this case is to determine the periodic

payments to be made in order to settle the debt over a specified time - period.

Hence, we know that

P=R 1 - (1 + i) -n
i

206
Now, we progress to isolate R on one side. It involves solving for R in the above present value of ordinary annuity

formula. Hence, multiply both sides by the interest rate i to obtain:

P i = R [1 - (1 + i) -n]

Further, we divide both sides by [1 - (1 + i) -n] and the result will be the mathematical expression or formula for

computing mortgage periodic payments as follows.

i
R=P
1 - (1 + i) “n

Where, R = Periodic amount of an annuity

i = Interest per conversion period which is given by j ^ m j = Annual nominal interest rate m = Interest or

conversion periods per year

n = the number of annuity payments/deposits (number of compounding periods)

P = Present value of an ordinary annuity

Example 5.16

1. Emmanuel purchased a house for Birr 115,000. He made a 20% down payment with the remaining balance

amortized in 30 years mortgage at annual interest rate of 11% compounded monthly.

a. Find the monthly mortgage payment?

b. Compute the total interest.

2. Assume you borrowed Birr 11,500 from a bank to finance construction of a swimming pool and agreed to repay

the loan in 60 monthly equal installments. If the interest is 1.5% per month on the unpaid balance,

a. How much is the monthly payment?

b. How much interest will be paid over the term of the loan?

207
Solution

1. Total cost of purchase = Birr 115,000

Amount paid at the beginning (Amount of down payment) = 20% of the total cost = 0.2 x 115,000 = Birr 23,000

Amount Unpaid or Mortgage or Outstanding Debt = 115,000 - 23,000

= Birr 92,000

t = 30 years

j = 11% = 0.11 , m = 12 , i = 0.11 - 12 = 0.00916

n = t x m = 30 x 12 = 360 months

a. The periodic payment R = ?

R=P l
1 — (1
+1 )

0.00916
R = 92,000 -3 60
1 - (1 + 0.00916)

= 92,000 (0.009523233) R = Birr

876.14

b. Total Interest = (R x n) - P

= 876.14 x 360 - 92,000 = Birr 223,409.49

Over the 30 years period Emmanuel is going to pay a total interest of Birr 223,409.49, which is well more than double

of the initial amount of loan. Nonetheless, the high interest can be justified by the fact that value of a real estate is

usually tend to increase overtime. Therefore, by the end of the term of the loan the value of the real estate (house)

could be well higher than its purchase cost in addition to owning a house to live in for the 30 years and more.

2. Amount borrowed = Birr 11,500 = P n = 60 months i = 1.5% = 0.015

208
The interest rate is already given as monthly rate and it is equal to the interval of compounding and payment

periods. Thus, we are not required to divide it by the number of conversion periods.

a. Monthly Installment Payment R = ?

i
R=P
1 - (1 + i) “ ”

0.015
R = 11,500 11,500 (0.025393)
1 - (1 + 0.015) 60

R = Birr 292.02 per month

b. Total interest paid (I) = (R x n) - P

I= (292.02 x 60) - 11,500

I= Birr 6021.405

Exercise 5.11

Isayas purchased a new house for Birr 100,000. At the time of purchase, he made a down payment of Birr

30,000. Determine the monthly mortgage payment and the total interest paid if the loan is to be repaid over 20

years and interest is to be computed at 10.5% compounded monthly.

209
Unit Summary

Dear student, hopefully you are well acquainted with the overall theme of time-value of
money. As you recall, in this unit we have considered simple interest and discounts with their
respective computations. We have also seen the concept and applications of compound interest
in assessing the time - value of money. An attempt is also made to study about annuities,
which involves a series of equal payments, or deposits that are made at equal interval of
periods at a given rate of interest. In proceeding, we have considered the computation and
applications of maturity value of ordinary annuities, sinking fund payment schemes, the
present value of ordinary annuities, and mortgage payments shames. For the sake of
refreshment, the following are some of important formula that deal with mathematics of
finance.
• Simple Interest
=Pin
• Future Value Of A Simple Interest
= P (1 + i n)
• Compound Amount
= P (1 + i) n
• Present Value Of A Compound Amount
= F (1 + i) -n
• Maturity Value Of Ordinary Annuity (Fn)

Fn = R (1 + i)n- 1 i

• Sinking Fund Payment Formula

i
R=F
(1 + i)n -1

210
 Present Value Of Ordinary Annuity

P=R 1 - (1 + i) -n i

• Mortgage Payments and Amortization

i
R=P
1 - (1 + i) - n

Self-Check Review Problems V

1. A person signs a note promising to pay a bank Birr 3500 in three years. If the person receives Birr 3100 when he

signs the note, what is the bank’s discount rate?

2. Solve the following problems.

a. An employees’ Credit Union Fund pays interest at 12 % compounded monthly. How much an employee who

invests Birr 1850 now has 3 years from now?

b. Find the rate of interest compounded quarterly at which Birr 2000 will grow to Birr 5000 in 9 years?

c. How many years will it take for a sum of money to double at 6 % compounded semi-annually?

d. Find the present value of Birr 6500 payable 12 years from now with interest at 9.5% compounded annually?

3. At what rate of interest compounded semi-annually will payments of Birr 3500 per every six months for 12 years

discharge a current debt of Birr 35,000?

4. How many monthly payments will it take to amortize a debt of Birr 150,000 with payments of Birr 1800 per

month at an interest rate of 14% compounded monthly? What is the total amount paid?

211
5. Solomon is planning to join Jimma University in the year 2010 for a postgraduate study.
He will be required to pay Birr 8000 as a tuition fee upon joining the university, that is, on
November 2010. To accumulate this amount he has two combined alternative sources.
The first is his father has promised to give him Birr 4000 right by November 2010. The
second alternative is deposit to be made by him starting from November 2008 for the
remaining balance. Assume that the interest earning on the deposit is 8% compounded
quarterly.
a. Calculate the amount to be deposited by Solomon in November 2010.
b. Suppose that the interest rate on his father’s money is 10% compounded semiannually.
How much must his father deposit in November 2008 to fulfill the promised amount?
c. Compute the total interest amount to be earned from his own deposit and his father’s
money.

6. Ayisha wants to accumulate a total of Birr 150,000 after making 10 equal yearly deposits
in to her saving account at Awash Bank at the end of each year. The bank offers all
depositors 4% annual rate on saving accounts. Interest is compounded annually.
a. How much is the amount of each periodic deposit to be made by Ayisha?
b. How much interest is earned by the end of the deposit period?
c. How much is the amount of interest earned at the end of the 6th period?

7. John has purchased a house for Birr 220,000. He agreed with Jimma Municipality to pay
the loan by down payment and amortization. Accordingly, he had a sinking fund of Birr
6000 that was made at the end of each quarter for six years in an account that pays 14%
compounded quarterly before the purchase of the house. This amount is used as a down
payment. The remaining balance has to be amortized over 10 years by monthly equal
installments. If the interest charged on the loan is 12% compounded monthly;
b. What is the amount of the down payment?
c. What is the amortized total amount?
d. What is the amount of periodic installment?
e. Calculate the interest on the deposit and on repayment of the loan.

212
8. FBE buys a duplicating machine for Birr 80,000 and wants to finance the total purchase price by making equal

semi-annual payments within 8 years. Interest is charged at the rate of 12% compounded semi-annually until the

debt gets down to zero.

a. How much is the amount of each mortgage payment?

b. Calculate the total amount paid over the loan period to the seller.

c. How much interest is paid by the purchaser?

9. Sam has an opportunity to invest in an income account at 12% compounded daily. The amount invested plus

interest comes back to Sam in the form of a check at the end of each month for 8 years. How much should Sam

invest if he wants the monthly income check to be Birr 1000?

10. During a three-year period when his business was prospering, Gosa was able to deposit Birr 1500 at the end of

each month in an account earning 13% compounded monthly. The business slackened, and Gosa could not

continue the deposits. Moreover, the interest rate on his accumulated deposits fell to 7% compounded quarterly

and remained at this level for 10 years, at which time he decided to exhaust the account by withdrawing equal

amounts at the end of every 6 months for 5 years. The interest rate remained at 7% but it is compounded

quarterly over the time of withdrawals. How much did Gosa withdraw every 6 months?

213
References

1. Ann, J. Hughes 1983. Applied Mathematics: For Business, Economics, and the social
Science.
2. Barnett, A. Raymond and Ziegler, R. Michael. Essentials of College Mathematics for
Business and Economics, Life Science and Social Science. 3 rd ed., 1989.
3. Bowen, K. Earl, Prichett, D. Gordon, and Saber, C. John 1987. Mathematics with
Applications in Management and Economics. 6 th ed., Richard Irwin Inc., USA.
4. Bradley, Teresa and Patton, Paul December 1999. Essential Mathematics for
Economics and Business. Jon Wiley and Sons.
5. Dexter, J. Booth and John, K. Turner 1996. Business mathematics with Statistics.
6. Orema, M and Agarwal, K. 1988. Quantitative Techniques. Kings Books, Delhi.
7. Ronald J. Hershberger and James J. Reynolds, Mathematics Applications.
8. Uohra, N, 1998. Quantitative Techniques in Management. Tata McGraw Hill, New
Delhi.

214
 UNIT SIX
CALCULU

Unit Objectives S

After completing this unit, students expected to be acquainted with basic concepts in
differential calculus which include:

• Limit of a function
• Concept of continuity
• Rules of derivatives
• First and second derivative tests
• Rules of definite and indefinite integration
• Ways of undertaking marginal analysis
• Ways of finding total functions
• Area problems

To sum up; the major objective of this unit is to introduce and enable students of business
stream to be able to handle complex problems using advanced quantitative tools like
differentiation and integration. Here, it is expected that students will be able to undertake
marginal analysis using the concept of differential calculus for better decisions than relying on
intuitive judgment. Besides; they are supposed to know techniques of finding total functions
from the marginal functions using concept of integration for refined analysis.

Unit Introduction

It is a dried fact that the application of concepts of calculus in the business arena specially; in
marginal analysis and optimization problems is paramount. In this part of the module, basic
concepts in calculus to be seen include: concept of limit and continuity, derivatives, definite
and indefinite integration, and their major application areas in business; typically, marginal
analysis, optimization problems and area functions. In total, rules of limits and continuity,
rules of differentiation and integration as well as their interpretative applications in the
business stream are inculcated.

215
SECTION ONE: BASIC CONCEPTS OF DIFFERENTIAL CALCULUS

Section Objectives

Up on completing this section, you will be able to:

• What limit of a function is and basic limit theorems
• Concept of continuity
• Rules of derivatives
• First and second derivative tests

6.1 Differential Calculus

Dear student, please discuss what calculus and differential calculus means.

It is one aspect of calculus that measures the rate of change in one variables as another
variable changes. It broadens the idea of slope.

A function: if for every value of a variable x, there corresponds exactly one and only one value
of the variable y, we call y is a function of x, written as:
Y = f(x).

Limits:
Definition : the limit of f(x) as x —c is 1 which is written as ; lim (x) = 1, if
x^c

and only if the functional value fx) is close to the single real number 1, whenever x is close to
but not equal to c ( on either side of c).

Example-1:

For the function f(x) =x2 + 2, find the limit offx) as x approaches 1.

Solution:

216
 0.8 0.9 0.99 0.999 1 1.0001 1.001 1.01 1.1
f(x)
= +
x2 2
264 2.81 2.9801 2.998 3.0002 3.002 3.021 3.21
l- = 3 l+= 3

lim/x) = 3
X ^1

Example-2:
For the function fix) = /x/, find;
X

a. lim f(x) b. lim f(x)

x^2 x^0

Solution:

X 1.9 1.99 1.999 —

2 2.001 2.001 2.01
f(x)
=X 1 1 1 1 1 1
X

l- = 1 l+ = 1

Thus; lim f(x) = 1

X ^1

b.
X -0.999 -0.99 -0.9 0 ◄— 0.0001 0.001 0.01 0.1
=/_xl
-1 -1 -1 1 1 1 1
f(x)

l- = -1 l+ = 1

l-^ l+ ^ So, limf(x) doesn’t exist

X ^0

Exercise 6-1

217
 1. Find the limit of the function f(x) = 2x+1 as x approaches:
a) 2
b) 1
c) 0

2. Find the limit of the function f(x) = 2x2+1 as x approaches:

a) 0
b) 1
c) 3

3. Find the limit of the function f(x) = 1/(x2+1) as x approaches:

a) 0
b) 2

Limit Theorems:

1. If k is any constant , lim k = k

x —— a

E.g. lim 10 = 10
x—5

lim c = c
a—b

2. lim kf(x) = k lim f(x)

x— a x— a

E.g. lim 3x2 = 3(limx2) = 3(a2) = 3a2

x—a x—a

3. lim (f(x) +g(x)] = lim f(x) + lim g(x)

x— a x— a x—a

E.g. lim (x2-2x+3) = lim x2 - 2 lim x + lim 3

x— a x—a x— a x— a

= a2-2a +3
4. lim [f(x).g(X) ] = (lim f(x) ] (lim g(x) ]
x— a x— a x—a

E.g. lim (x+3)(X-2) = [ lim (x+3) ] [lim (x-2)

x— 2 x—2 x— 2

= [5] [0]
218
 0

5. lim [f(x)n] =[lim f(x)n]

x— a x— a

E.g. lim (x-1)5 = [lim (x-1)]5 =25 = 32

x —3 x —3

6. If lim f(x) = L and lim g(x) = m, then;

x—— a x—— a

a. If m^0, then lim [f(x)/g(x) ] = L/m

b. If m = 0 and L ^ 0, the lim [f(x)/g(x)] = doesn’t exist

c. If m = 0 and L = 0, then f(x) and g(X) have a common factor and the limit can be
evaluated after employing the process of cancellation.

Continuity of a Function

Definition: a functionf is continuous at the point x = c if:

1. lim f(x) ^ exists

2. f(c) —► is defined
3
. lim f(x)
=f(c)

Example
x2-4
Using the definition of continuity, discuss the continuity of the function f(x) x-2

at c =1 and c = 2

Solution:

At c =1, lim f(x)

x—1

X 0.9 0.99 0.999 1 1.0001 1.001 1.01 1.1

f(x) = x2-4 x-22.9 2.99 2.999 3.0001 3.001 3.01 3.1

219
 l- = 3 l+ = 3

lim f(x) =3 —limf(x) exists

x —1 x —1

f(1) =12-4 = 3 ^ /(c) is defined 1-2

limf(x)
= 3 =f(1)
x —1

Therefore;f(x) = x2-4 is continues at c

=1
x-2

At c = 2
X 1.9 1.99 1.999 2 2.0001 2.001 2.01 2.1
F(x) 3.9 3.99 3.999 4.0001 4.001 4.01 4.1
l- = 4 1+ = 4

limf(x) = 4 —It exists

x —— 2

f(2) =22-4 = 4-4 = 0= 0

2-2 0 0

limf(x)
*f(c) ^4^0
x—2

Therefore; f(x) is not continuous at c = 2.

Derivatives

Dear student, would you explain what derivatives means?

Definition: for y = f(x) we define the derivative off at x, denoted by f(x) to be;

f(x) = lim Af(x) = lim f(x+Ax)- f(x)

Ax—►O Ax Ax 0 ► Ax

220
Example-1
Find f'(x) for f(x) = 2x +4

f(x) = lim f(x+ Ax) -f(x)

Ax—> 0 Ax

1st ^ find Af(x) =

Af(x) = f(x+Ax)-f(x)
= [2(x+Ax) +4] - (2x+4)] =
2x+2Ax+4-2x-4 Af(x) = 2Ax

2nd —► find the limit: f'(x) = lim Af(x)

Ax - 0 Ax

= lim 2Ax
Ax-► 0 AX

f'(x) = 2

Example-2
For the function f(x) = 4x-x2 find f (x)
f'(x)= lim f(x+Ax) - f(x)
Ax—-► 0 Ax

1st ^ find Af(x) = 4(x+Ax)-(x+Ax)2- (4x-x2)

Ax Ax
= 4x+4Ax-x2 - 2xAx -Ax2-4x+x2 Ax
= Ax (4-2x-Ax)
Ax
= 4-2x-Ax

2nd ^ find the limit of the resulting

function
f'(x) = lim Af(x) = lim 4-2x-Ax Ax —►
0 Ax Ax—► 0
f (x) = 4-2x

221
Rules of differentiation

Dear student, please point out some rules of differentiation.

1. A constant function rule;

If f(x) = c then f (x) = 0 E.g. If f(x) = 5 then f (x) = 0

2. The power rule;

The derivative of the power function is the power times the function raised the power minus
one.

If f(x) = axn, then f (x) = anxn-1 E.g. If f(x) = x5, then f'(x) = 5x5-1 = 5x4 If f(x) =3x3, f'(x) =3x3x3-
1
= 9x2

3. The sum and difference rule;

The derivative o f the sum or difference of two functions is the derivative of the first function
plus or minus the derivative of the second function.

If f(x) = u(x) + v(x), then f (x) =u(x) + v' (x)

E.g. f(x) = 3x+8 , f'(x) =3+0= 3 f(x) = 4x-x2 ; f'(x) = 4-2x

4. The product rule ;

The derivative of the product of two functions is the first function times the derivative of the
second function plus the second function times the derivative of the first.

If f(x) = u(x). (v(x)) then;

f'(x) =u(x). v'(x) + v(x) .u'(x)
E.g. f(x) = 3x2 (4x-1), the f (x) =
3x2(4) + (4x-1) (6x)
= 12x2 +24x2-6x = 36x2-6x

222
5. The quotient rule;
The derivative of the division of two functions is the denominator times the derivative of the
numerator minus the numerator times the derivative of the denominator over the denominator
square.

If f(x) = u(x), then;

V(x)
f'(x) = v(x) .u (x) - u(x). v (x)
[V(x)] 1 2

Example

If f(x) = x2/2x-1

f(x) = (2x-1)(2x) -(x2)(2)

(2x-1)2 = 4x2-2x-2x2 4x2-
4x+1 = 2x2-2x (2x-1)2

The Use of First and Second Derivative Rules for Local Extrema

The First Derivative Test

The nature of a function with respect to its first derivative gives us three important properties

1. If f(x) > 0(is positive) on the interval (a, b), then f(x) increases and graph of f rises as
we move from left to right over the interval.
2. If f'(x) < 0 (negative) on an interval (a, b), then f(x) decreases and the graph of f falls
as we move from left to right over the interval.

223
 3. If f(x) = 0, then we get the slope of a line tangent to a curve at a point. And this point
where the first derivative is zero is known as the critical point and gives us:
i. either a maximum ( local maximum and/or global maximum )
ii. a minimum (local minimum and/or global minimum )
iii. neither maximum nor minimum of a function Example; f(x) = x2 ^ f(x) = 2x

❖ If x is negative (a, b) ^ f'(x) < 0 = the function f(x) is decreasing from left to
right.
❖ if x>0, (b, c) = f(x) >0, f(x) is increasing from left to right
❖ f'(x) = 0, 2x = 0 x = 0; At this point the function is at its minimum point.

Local extreme:

A local maximum or minimum point p is a point where f(x) takes on a maximum or minimum
value for all points in the immediate vicinity of p.
 *•
e g

a c

• points a , b, d, e f, and g are local extrema I.e. a, e, and g— local minima b, d, and f,
local maxima c = global minima (the lowest from all points)
There is no global maximum (because the function is increasing).

If f(x) has a critical point at x = p, then;

a) If p is an interval point and f(x) < 0 to the left of p and f'(x) >0 to the right of p, then
f(x) has a local minimum at x = p.
b) If p is an interval point and f'(x) >0 to the left of p and f'(x) <0 to the right of p, then
f(x) has local maximum at x=p.

Example

Given f(x) = x2 - 16x +12, [6, 10]; Find the local extrema.

1st — find the critical values

f'(x) = 2x - 16 = 0— 2x =16
x =16 = 8
2

Interval
value of f'(x) = 2x-16 -4—
[6, 10]
to the left p; f'(x) <0 4
——to the right p; f'(x) >0

225
So at x = 8 the function attains a local minimum.

Global Extrema:

It is largest or the smallest value of the function f(x) over all the values of x.
If f(x) has a critical point at x = c then;
a) f(x) attains an absolute maximum at x = c if and only if f(c) > f(x) for all values of x in
the domain of f(x).
b) f(x) attains an absolute minimum at x = c if and only if f(c ) < f(x) for all x in the domain
of f(x).
Steps in Finding Absolute Maximum and Minimum

1. Check the continuity of the function in its domain or over the interval [a, b].
2. Find the critical values in the interval.
3. Evaluate f at the end points and at the critical values found in step 2.
4. The absolute maximum f(x) on [a, b] is the largest of the values found in step 3.
5. The global minimum f(x) on the closed interval [a, b] is the smallest of the values found
in step 3.

Example

Find the absolute maximum and absolute minimum values of f(x) = x 3-12x on the
interval [-5, 5].
Solution:

Step-1: The function is continuous for all values of x.

Step-2: Find the critical values f'(x) = 3x2-12 = 0 3x2 = 12 x2 = 4
x = ±V4 = ± 2
Step-3: Evaluate the critical values and the end points over the interval
[-5, 5].

226
 X fX

-5-----------------65 -► global minimum

-2-----------------16
2-----------------16
5------------------65 ► global maximum

Second Derivative Test

Second derivative is the derivative of the derivative. For y = f(x), the second derivative of f is
given by f(x) = Dxf'(x) = d^y
dx2

In using the second derivative test for local extrema follow the following steps.
1. Find the first derivative of x, set it equal to zero and solve for the candidate values of x.
2. Find the second derivative of x, and evaluate it as follows.
i. If f "(x) < 0 a local maximum occurs at x.
ii. If f " (x) >0 a local minimum occurs at x.
iii. If f " (x) = 0, the test fails to determine what happens at x. In this case use the first
derivative test.

Example

Find the local maxima and minima of each function.

A. f(x) = 2x2-8x+6
B. f(x) = 2x3-3x2-12x-5
C. f(x) = x4+5

Solution:
A. f(x)= 2x2-8x+6 f'(x) = 4x-8 4x-8 = 0

227
 4x= 8

x= 8_= 2 4
x = 2 = critical point f "(x) = 4 >0
Therefore; At x=2, the function attains a local minimum. f min = f(2)= 2(2 2) -8(2)+6
= 8 -16+6= -2 ^ the minimum value.
B. f(x) = 2x3-3x2-12x-5 f'(x) = 6x2-6x-12 x2-x-2=0
(x-2) (x+1) = 0 x =2 or x= -1 f "(x)= 12x-6
At x =2, f "(x) = (12(2)-6) =18>0 ^ the function attains local minimum at x= -1.
C. f(x) = x4+5 f'(x) = 4x3 = 0
x3 = 0 ~ x = 0. f "(x) =12x2
At x = 0; f "(x) =12(02) = 0 ^ the test fails to identify what happened at the critical value.

IApply the 1st derivative test;

Test _ _test value of f'(x) = 4x3
points -1 1 -4 ~ f'(x) < 0 local minimum is attained
4 ~ f'(x) >0
At x = 0, local minimum is
attained.
Exercise 6-2

228
1. Given f(x) = 4+10x-x2, [3, 8] find the local extrema.
2. Find the absolute maximum and minimum value of
f(x) = x3+3x2 -9x-7 in the interval [-6, 4].
Application of Differential Calculus to Marginal Analysis

The word marginal refers to rate o f change^- that is a derivative.

Let x be the number of units of a product produced Total cost function ^ C(x)
Total revenue function^- R(x)
Total profit function^- P(x) = R(x) -C(x)
Marginal cost function ^ C'(x)
S Marginal cost is the rate of change in total cost per unit change in production at an
output level of x-units.
S Marginal revenue function^- R'(x)
S Marginal profit function^- P'(x) = R'(x) - C'(x)
S Average cost^ c(x) = C(x)
x
S Marginal average cost^ c' (x)
S Average revenue ^ R(x) = R(x)
x
S Marginal average revenue^ R'(x
S Average profit ^ P_ (x) =P(x)
x
S Marginal average profit ^ P '(x)

Example-1
A company manufactures and sells x transistor radios per week. Its weekly cost and
demand
equations are:
C(x) = 5000 +2x
P = 10 - x find 1000
a) Production level that maximizes revenue and the maximum revenue.
b) The production level that maximizes profit and the maximum profit.
c) The MR and MC at the profit maximizing output level.
d) The average cost per unit if 1000 radios are produced.

229
 e) The marginal average cost at a production level of 1000 radios and interpret the
result.
Solution:

a) R(x) = P.X = (10-x) (x)

1000

R(x) 10x- x2 1000

R(x) = 10 -x = 0
5000

10= x_ ^ x = 5000 units

500

R'(x) = -1/5000; R'(x) <0 x= 5000 units is the revenue maximizing output level.

Maximum revenue is at x = 5000 units

R(x) = 10x - x2 1000

R(5000) =10(5000)- (5000)2 1000

= Birr 25000
b) P(x) = R(x) - C(x)
[10x- x2 1- [5000+2x]
1000

= 10x -x2 - 5000-2x 1000

P(x) = 8x-x2_- 5000
1000
P'(x) 8-2x= 8-x
1000 500
8-x= 0 500 8= x 500
x = 4000 units

230
P''(x) = -1 P''(x)<0 x = 4000 units is the profit maximizing output level
500

At x = 4000 units P(x) = 8x-x2 - 5000

1000
= 8(4000) - (4000)2-5000 1000
= Birr 11,000
c) C'(x) = 2 production cost increases by birr 2 at each level of
out put
R'(x) = 10- 2x = 10-x
1000 500
At x = 4000 units

R'(x) = 10 -4000 = 10-8 =2 birr

500
-I- At each level of output TR increases by birr 2
4- At the profit maximization; MR = MC, i.e. 2 Birr
d)
x =1000 radios;
S Average cost c(x) = C(x)
x
= 5000 +2x
x
At x 1000 radios; c(x) = 5000 +2(1000)
1000 = 7 Birr

e) Marginal average cost = c'(x)

MAC - 5000
x
c'(x) - 5000 -0.005 Birr
(1000)2

Interpretation: At a production level of 1000 units a unit increase in production will decrease
average cost by approximately 0.5 cents or by 0.005 Birr.

Example-2
A certain manufacturing company has the following information;

Average total cost is given by the equation:

c(q) = 0.5q -500+ 5000 and,
q
The demand function is:

231
 P = 2500-0.5q

A. Find the firm’s:

i. Total profit function
ii. Marginal cost function
iii. Marginal average cost function

B. Find the quantity level that:

i. maximizes total revenue
ii. Maximizes total profit
iii. Minimizes total cost

C. Find the firm’s:

i. Maximum revenue
ii. Maximum profit

D. Find the price level that leads to

maximum:
i. Revenue
ii. Profit

SECTION TWO: BASIC CONCEPTS OF INTEGRAL

CALCULUS

Section Objectives

Up on completing this section, you will be able to:

• Rules of definite and indefinite integration

• Ways of undertaking marginal analysis

232
 • Ways of finding total functions
• Handling area problems using definite integration

6.2 Integral Calculus

Dear student, so far we have seen differential calculus. In this section, however, we will see
integral calculus. Can you guess what it is taking about?

There are two types of integrals:

a) Indefinite integral
b) Definite Integral

6.2.1 Indefinite Integral

Definition: Given F(x) which is the anti-derivative of f(x), the indefinite integral of f(x) is defined
to be:

Jf(x) dx = F(x) +C,

Where;
J = the integral symbol
f(x) = the integrand (the function to be integrated)
F(x) = the integral (the outcome of integration)
C = the constant of integration
dx = indicates the variable to be integrated
Example-1
f(x) =x3 ; c = 0
f'(x) = 3x2

Jf(x)dx = J(3x2)dx = 3(x2+1) = 3x3= x3 2+1 3

F(x) = x3 + 4, and C = 4 F'(x) =3x2
Jf(x)dx = ^2+1 = 3x3 = x3+c ; C = 4

233
 2+1 3 x3+4

Example-2

Find the equation of the curve that passes through [2, 6], if the slope of the curve at any point
x is given by 3x2.

Solution:

f(x) = 3x2
Jf(x)dx = F(x) + C
Jf(x)dx = J(3x2)dx = 3x2+1 2+1
= ^3+ C = x3+C 3
F(x) = x3+C 6 = (2)3+C 6 =
8+C C = -2
Therefore; F(x) = x3-2

The rules of integration

1. A constant function rule;

If f(x) = k
Jf(x)dx = J(k)dx = kx0+1 + C =
kx+C 0+1

E.g. If f(x) = 5
Jf(x) dx = J(5)dx = 5x0+1 + C =
5x+C
234
 0+1

2. The power rule;

If f(x) = xn
jf(x) dx=l(xn)dx=xn+1+C
n+1

E.g. If f(x) = x5;

Jf(x)dx = J(x5)dx = x5+1 + C = x6 + C 5+1
6

3. A constant times a function rule;

If f(x) = axn
J(x)dx = J(axn)dx = aj(xn)dx = a(xn+1) + C
n+1

E.g. If f(x) = 3x3

Jf(x)dx = J(3x3)dx = 3j(x3)dx = 3(x3+1)+
C
3+1 = 3/4x4+C

4. The sum and difference rule;

If f(x) =g(x) ± h(x)

Jf(x)dx = J[g(x) ± h(x)]

=jg(x)dx ± J(h(x)dx E.g. If f(x) = 5x+9

Jf(x)dx = J(5x+9)dx = J(5x)dx+ J(9)dx

= 5x1+1 + 9x0+1 1+1

0+1 = 5/2 x2 + 9x +
C

5. The product rule;

235
If f(x) = (ax+b)n

Jf(x)dx = J(ax+b)n = (ax+b)n+1 +

C a(n+1)

E.g. If f(x) =(x+2)2= Jf(x)dx = J(x+2)2dx

= (x+2)2+1 + C = (x+2)3+ C (2+1) 3

6. The quotient
rule;
If f(x) = g(x) + h(x)
k(x)
Jf(x)dx = J(g(x)dx +
l(h(x))dx k(x) k(x)

E.g. If f(x) = 8+x3

x
Jf(x)dx =J(8 )dx + J(x!)d
2 2
x
x x
J(8x-2)dx + J(x)dx
= 8x-2+1 = x1+1 +
C -2+1 1+1 = 8x1
+x2+ C -1 2
= -8x-1 +1/2x2 + C

= -8/x+x2 + C
2

Indefinite integral for finding total functions

Example-1

The function describing the marginal cost of producing a product is given by f(x) = x+100,
where x is the number of units produced, determine the total cost function if the total
cost of producing 100 units is birr 40 000.
Solution:
C(x) = Jf(x)dx= f(x) = x+100
J(x+100)dx = +100x0+1 + C

236
 1+1 0+1
x2 +100x+ C 2
C(x) =1/2x2 + 100 x +c_^ (fixed cost)
40.000 = 1/2(100)2+100(100) + C
40.000 = 5000+ 10,000+ C 40,000=15000+ C
40.000 -15000 = C C = 25000 Birr
Therefore; C(x) = /x2+100x+25,000 Example-2
The marginal revenue function for a company’s product is
given by f(x) = 50,000-x, where x is the number of units
produced. Develop the total revenue function if revenue is
zero when no units are produced and sold.
Solution:
Marginal revenue ^ R'(x) = 50,000-x
R(x) = 0 when x = 0 ^ (0, 0) ^ (x, f(x))
R(x) = Jf(x)dx = 1(50,000 -x)dx
R(x) = 50,000x -x1+1+ C 1+1
= 50,000x- x2 + C 2

0 = 50,000(0) -1/2(0)2+ C
0 = 0+ C ^ C = 0

Therefore, R(x) = 50,000x -1/2x2

Definite integral

Definition: If f(x) is a continuous function on the interval [a, b], the definite integral of f(x)
rb

is defined as f f (x)dx = F(b) -F(a)

Where F(x) = the anti-derivative for f(x)

F(b) = the upper limit F(a) = the lower limit

237
F'(x) = f(x)

A definite integral has a single numerical value associated with it and can be obtained through
the indefinite integral by using the following steps.

Step-1: get the indefinite integral of the function Step-2: substitute the value x = a in the
indefinite integral Step-3: substitute x = b in the indefinite integral
Step-4: subtract the numerical value obtained in Step 2 from step 3 and the result gives the
definite integral value of the function between the limits x = a x = b.

Example
If marginal revenue is given by:

F(q) = 200-6q , what extra total revenue is obtained by increasing sales (q) from 15 to 20?

Solution:
<•20 f20
Extra revenue = J f(q)dq = J (200-6q)dq

= 200q - 6q1+1 + C 1+1

= [200(20) -3(20)2+ C] - [200(15) -3(15)2+C]

= 2800+C- 2325 - C = Birr475

Area Problems

S Area between a curve and the x- axis S The area between two curves

Example-1
Compute the area below the graph of f(x) =x2; above the x axis and bounded on the sides by x
= 1 and x= 3 as shown in the following figure.

238
 f(x) =x2

-* *•
x

Solution:

3 3

A = J f(x)dx = J f(x2)dx = x2+1 +

C
1 i

2+1
= x3
3

= 1/3 (33)-1/3(13) = 9-1/3 =26/3 A = 26/3 square units

Example-2
Sketch the function f(x) = 10x-x2 and find the area bounded by the function and the x-axis.

Solution:

Step-1; find the x and y intercepts

X-intercept^ (set f(x) = 0) f(x)
=10x-x2 = 0 0= x(10-x)

239
X= 0 or x =10 y -intercept (set x = 0)
f(x) = 10x-x2 f(x) = 10(0) -(02)
f(x) = 0

Step-2; find the critical values f'(x) =

10-2x = 0 10 = 2x^ x = 5
f"(x) = -2^ x = 5 is a local maximum
At x = 5; f(x) = 10x-x2 = 10(5)-52 f(x)
= 50-25=25
(5, 25) = coordinate for local maxima

Step-3; plot the graph

f(x) ■

x
<■ *•

f(x) =10x-x2
A= J10 f(x)dx= of10 (10x-x2)dx
= 10x1+1 - x2+1 +C 1+1 2+1

= 5x2-1/3x3 10 0
= [5(10 ) - 1/3 (10 )] -[(5(02)-2/3(03)]
2 3

= 500 -1000-0 3
= 500 square units 3
Exercise 6-3

The function describing the marginal profit from producing and selling a product is f(x) = -
6x+750, where x is the number of units produced and sold. Total profit is birr 25000 when
100 units are produced and sold. Develop the total profit function.

UNIT SUMMARY

Summary of the major formulas for application of concept of calculus in marginal analysis
and optimization problems include the following.
- Marginal cost is the rate of change in total cost per unit change in production at an output
level of x-units.
- Marginal revenue function^- R'(x)
- Marginal profit function^ P'(x) = R'(x) - C'(x)
- Average cost^ c(x) = C(x)

241
 - Marginal average cost^ c' (x)
- Average revenue ^ R(x) = R(x)

x
- Marginal average revenue^- R'(x
- Average profit ^ P_ (x) =P(x)
x
- Marginal average profit ^ P'(x)

-I- J f(x) dx = F(x) +C

b

4- J f (x)dx = F(b) -F(a)

a

Self-Check Review Problems VI

1. Suppose the total cost of producing x - electric guitars is given by the function:
C(x) = 1000 +100x-x2/4, find;

A. The marginal cost at a production level of x- units.

B. The marginal cost at a production level of 50 units and interpret the result.
C. The actual cost of producing the 51st unit.

2. The marginal cost curve for a product is; f(q) = 100 -4q+q 2;what is the total cost of
increasing from q = 20 to q =30?

242
3. Find the area bounded by the function f(x) 15- 2x-x2 and g(x) =9-x.

REFERNCES

1. Barnett Raymond A. and Ziegler Michael R, Essentials of College Mathematics for

business and Economics, life science and social science, 3rd ed., 1989
2. Bowen Earl K et. Al, Mathematics with applications in Business and Economics, 1987
3. Ann j. Hughes, Applied Mathematics: For Business, Economics, and the social
Science, 1983.
4. Ronald E. Larson and Bruce H. Edwards, Finite Mathematics with Calculus, 1991
5. Ronald J. Harshbager and James J. Reynolds, Mathematics Applications.
6. Ronald J. Harshbager and James J. Reynolds, Finite Mathematics, 3 rd Ed.

243
 7. Hole Poul G., Finite Mathematics and Calculus with Applications to Business, 1974.

8. Dexter j Booth and John K Turner, Business mathematics with Statistics, 1996, and other relevant Books

are recommended as reference.

9. Teresa Bradley and Paul Patton, “ Essential Mathematics for Economics and Business’, Jon Wiley and

Sons, December 1999.

ANSWER KEY TO EXERCISES

UNIT - ONE
Exercise 1.1
y = 65x + 150

Exercise 1.2
(6/4, 0) and (0, 6)

Exercise 1.3
a. V. S = 5 and H. S = 8

244
 b. V. S =4 and H. S=

16

c. V. S =6 and H. S=0

d. V. S =0 and H. S=6

Exercise 1.4
a. 6.33

b. 15

c. 5.099

d. 13.153

Exercise 1.5
a. y = 2x + 2500

b. It implies that every additional book printed and bound adds Birr 2 to the total cost. cost that

c. b = 2500 is the fixed cost for machinery set up and a book is printed and is incurred evenif no

bound.

Exercise 1.6
y = 3x + 10

Exercise 1.7
y = 3x + 50

Exercise 1.8
a. Birr 10,000

b. Birr 10,500

c. Birr 10

d. Birr 10

Exercise 1.9
a. y = 1.75q + 35,000 R =

2.7q

b. 36,842 units

c. Birr 810,000

245
Exercise
1.10
a. 13

b. 10.2%

c. 11.3%

Exercise 1.11
a. y = 0.55x + 23,400

b. $ 52,000

c. $10,500

Exercise
1.12
By $ 1500

Exercise 1.13
a.600 units

b.450 units
c.850 units

d.Birr 1800

UNIT - TWO

Exercise 2.1
1. a = 5, and b = 2

2. a) Identity matrix, b) Row c) Zero matrix d) Column matrix

3. A + B: -1 0

4 -1

9 9

J
4. 2A + 3B: r %
21 22 15

7 14 17
J
v

246
5. X = (1/3) r 28 16
10 34
v J

6. 1-1 1' 3 3 -1

A-B= 3-1 1 A+B= -1 -1 3

-1 0 1 125

r ~\
7. a) AB = -3 3 2 b) BA = 1 -7
1 -8
6 0 -3 v. j
9 3 -4
V J

c) 2A r 2 -4 ^
0 6

2 8
V J
8. AB ± BA

r 37 -6 5
i. A (B + C) = AB + AC = 117 0 -18

60 -171 138
J

ii. (A + B) C = AC + BC = r 30 -33 13

74 22 -11

-20 -131 76

J
r ^
9. (AB) C = A (BC) =
1299

357

1506

V J
10.
r *N

247
 a) At = 2 4 5 b) Bt = 4 c) C = 6

68

d) Dt = 3 9 6 e) Xt = r 12 34'
5 1 8 23 41
7 2 4 34 21
V J
4 1 12,

0 0 0^
12. X + Y = 0 0 0
0 0 0
Y. J

Exercise 2.2
1. Matrix A has no
inverse
2. a11 a12 a13
r ~\ a21 a22 a23
A. J

3. a) 2 by 1 b) r^
r ■\ x1
r ~\
an a12 v c) anx1 + a12x2 = b1
j b1
x2

r "X
4. A-1 = -3/20 4/5
3/10 -3/5
J

Exercise 2.3

248
v j
 -1/6 / -1/6
a) A-1 =
-7/6 / 5/6
5/6 -1/2 -1/6

c) D is not invertible
b) C-1 = r
5/13-2/13

V -1/33/13

Exercise 2.4

r
a) C-1 = 1/61/6 / b) x-1 = / /
2/3-1/3 0 -/ /
.
1/61/6 -1/2
J

Exercise 2.5
1. a) xi= 19/20; and X2=11/4 c) x1= b) x1= 1; x2= -1; and x3=1

-17/10; and x2=13/5

2. a) x= 2/6; y= -49/15; and z=7/3 b) x1= 24/21; x2= 9/7

c) x1= 1; x2= -1; and x3=1

3. a) x1= 7/13; x2= 5/13; and x3=9/13 b) x1= -1; x2= 2

Exercise 2.6

1. a) N ' b)r u N1
r u N
0.01099 0.98901 .1
v J 0.

r A
2. a) ~ 33% b)
U N 0.67 0.33
J
v

rEAF ~\
3. a) r EA F b) Long-run probabilities =

j
v

v J
249
 186 713 401 .10 .67 .23

r ~\
b) Long-run distributions 1
EAF
130 871 299
V. J

UNIT - THREE
Exercise 3.1

X1 =1 X2=3 and
Min Z= $3400

Exercise 3.2
a. No feasible
solution
b. Unbounded
solution
c. Unbounded
solution
d. Unbounded
solution
e. Infeasible
solution
f. Infeasible
solution

Exercise 3.3
1. X1=2, X2 =6,
si =0 , S2=0 and
MaxZ=$36
2. X1=50, X2 =0,
si =0 , S2=50 and
MaxZ=$1.ftftft

2503.4
Exercise
1. X1=450/13,
Exercise 4.1

1. log28 = 3
2. 1000 = 103
3. b = 3
4. y= 3
5. log864 = 2
6. 112 = 121
7. x = -2
8. b = 16

Exercise 4.2
1. 1/8
2. -0.00001
3. 1/(2x + 7)4
4. 7/x8
5. x = 32
6. y = 27
7. 9
8. 1/4

Exercise 4-3:
1. log 7x = log 7 + log x
2. log 4 = log 20 - log 5 = 0.60206
3. log x5 = 5 log x
4. a) 1 b) 1 c) 1 d) 1
5. a) 0 b) 0 c) 0 d) 0

UNIT FIVE

Exercise 5.1
b) Birr 7475
1. a) Birr 975
2. Birr 6841.25

251
Exercise 5.2
1. Birr 990

2. 2.5 years or 30 months

3. 4%

Exercise 5.3
Exact simple interest = Birr 8938.36 Ordinary simple interest = Birr 9062.50

The Ordinary simple interest provides Birr 124.14 higher amount than the exact one.

Exercise 5.4
a. F = Birr 418, i = 3%

b. F = Birr 660, n = 2.5 years

c. P = Birr 900, i = 4%

d. I = Birr 7.12, i = 6%

e. I = Birr 56.48, n = 0.5 years

Exercise 5.5
1. d = 15%

2. P = Birr 712.80, D = Birr 7.20 Exercise 5.6

1. a) Birr 11,505.925 b) Birr 11,640.68 c) Birr 11,711.47 d) Birr 11,760.01
3. n = 8.67 years or 17.34 semi-annuals

Exercise 5.7
1. One can save Birr 12.5 by discharging the debt paying Birr 600 after 18 months.

2. The buyer will save Birr 464.96 if she pays Birr 6000 cash now with additional payments specified.

3. Birr 142.9 .71

Exercise 5.8
1. Birr 2380.2

252
 2. a) Birr 7096.02 b) Birr 1096.02 c) Birr 446.17

Exercise 5.9
1. Birr 421. 68
2. Birr 3262. 15

Exercise 5.10

a) Birr 13,789.63 b) Birr 5410.37 Exercise

5.11
Mortgage payment = Birr 698. 87 Total
interest = Birr 97, 728.8
UNIT - SIX
Exercise 6.1
1. a) 5 b) 3 c) Doesn’t exist
2. a) 1 b) 3 c) 19
3. a) 1 b) 1/5

Exercise 6.2
1. Critical point is at x = 5, local maxima is 29.
2. The global minimum is -61 and global maximum is
69.

Exercise 6.3
P(x) = -3x2 + 750x - 20,000

253
254