Chapter One

Linear Equations and their Interpretative Applications

Overview
Dear learners, well come to study the basic concept of linear equations and its applications
in business, in this chapter we will learn about the overall concepts of linear equations.
Before we proceed directly to the concept of linear equations there are some basic terms
you have to understand. These terms are: algebraic expression, algebraic sum, constant
coefficients, and equations.
Objectives of the chapter:
At the end of this chapter students will be able to:
 Define different terms such as algebraic expression, algebraic sum, terms, constant
coefficients, and equations.
 Develop equations of a line by using two point form, a slope point form and the
slope intercept form.
 Understand the application of linear equation.
 Determine breakeven point (BEP).
1.1 Definitions of Terminologies

☼Define the terms, algebraic expression, algebraic sum, constant coefficient and
equations
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 An algebraic expression is an expression formed only from combination of
numbers and variables by using the operations addition, subtraction multiplication
division, exponentiation (rising to powers) or extracting the roots.
2 x+3
3 x , x +2 , 5 x 2 y , √ 2 x +5 ,
Example: 1−5 x 2 etc, are algebraic expressions.
 An algebraic expression consisting of parts connected by plus or minus signs is
called algebraic sum and each of the parts together with the sign preceding it is
called a term.
term.

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 2 2
Example: 2 xy+6 x −3 y is an algebraic sum, whereas2 xy , 6 x , and −3 y are terms.
2
Observe 2 is the numerical coefficient of xy , 6 is the numerical coefficient of x , –3 is the
numerical coefficient of y and comely the numerical coefficients are called coefficients.
coefficients.
 An equation is a mathematical expression, which indicates two algebraic
expressions that are equal.

Example: y=2 x +3 , 3 x +2=−5 y+7 etc. are equations.

 A linear equation with two variables is equation of the form ax +by =c , where
a,b, and c are fixed real numbers,
numbers, with x and y being variables (or unknowns.
NB.1. In the above form of equation of a line both a and b cannot be zero at the same time.
NB.1.

Ifa=0 and b=0 ,then the linear equation will become 0=c , which is either a
true or false statement.
2. The powers of the variables are one and the variable can only be multiplied with a
constant.

Example: From the linear equation2 x−3 y=7 , you can observe that:
 The degree (the power) of the variables is 1.
 The constant term or the fixed value is 7.

 The terms of the equation are2 x and 3 y separated by – sign. However,

2 x−3 xy=7 is not a linear equation, because 3 xy is a constant times the product
of two variables.
 Linear equations in two variables are equations whose slope (that is; the rate of
change of one variable with respect to the other) is constant throughout the line. If

the general notion of a linear equation is expressed in the form y=mx+b where
y= dependent variable and x= independent variable, then m=slope , b= the y-
intercept..
Δy rise ( fall ) y − y1
= = 2
Slope (m ) = Δx run x 2 − x 1 , if( x 1 , y 1 ) and ( x 2 , y 2 ) are two distinct points on

the line with x 1≠x 2 .

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Slope measures the steepness of a line. If the slope is larger positive, the more steep
(steeper) the line is. If the slope is smaller negative, the more shallow (shallower) the line
is.
y y
+ ive slope m= undefined

x x

y y m=0

-ve slope
x x
 A line that is parallel to the x -axis is the gentlest of all lines i.e.m=0 .
 A line that is parallel to the y -axis is the steepest of all lines i.e. m is
undefined.
The slope of a line is defined as the change-taking place along the vertical axis relative to
the corresponding change taking place along the horizontal axis, or in business analysis the
slope is the change in the value of the dependent variable y relative to a one-unit change
in the value of the independent variable x .
1.2. Developing equation of a line
Dear learners now we will learn how we can obtain equation of a line depending on the
information we have. We will start with your geometric knowledge of similarity of triangle
and two distinct points uniquely determine the equation of the line that passes through
them. The other forms of equation of a line are the consequence of this as will observe
after a while.
There are at least three ways of developing the equation of a line depending on information
at hand, these are:
I. Two-point form
II. The slope-point form

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 III. The slope-intercept form
I. Two-Point Form
From geometry, it is known that two distinct points on a line completely determine a

unique straight line. Let P1 ( x 1 , y 1 ) and P2 (x 2 , y 2 ) be two distinct fixed points on a line

with x 1≠x 2 . Let P( x , y ) be any movable point on the line, then

y
From similarity of triangles P ΔP 1 AP≃ ΔP1 BP2 P2
P
AP BP 2
=
P
Which implies, 1 A P1 B P1 A B
x
y− y 1 y 2 − y 1
=
x−x 1 x 2 −x 1
y 2− y 1
y− y 1= ( x−x 1 )
x 2 −x1 ……… (1.1)
Equation (1.1) is the two-point form of equation of a line.

Example: Given two points P1 (1 , 10 ) and P2 (6 , 0 ) on a line with

x 1=1 , y 1 =10 , x 2=6 , and y 2 =0 , then from (1.1)

y 2− y 1
y− y 1= ( x−x 1 )
x 2 −x1
0−10
y−10= ( x−1 )
6−1
y−10=−2( x−1 )
Therefore, y=−2 x +12 is the equation of the line

Ø Activity: 1.1.
A salesman has a basic salary and, in addition, receives a commission which is a fixed
percentage of his sales volume. When his weekly sales equal is Birr 1000, his total salary is
Birr 400. When his weekly sales equal Birr 500, his total salary is Birr 300. Determine his
basic salary and his commission percentage and express the relationship between sales
and salary in the form of an equation.

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II. The slope-point form

This way of developing the equation of a line involves the use of the slope (m) and the

point P1 ( x 1 , y 1 ) on the line to formulate the equation.

From equation (1.1) the expression on the right hand side will give us the slope ( m ) of the
line to be:
Δy y 2 − y 1
m= =
Δx x 2 −x 1
Therefore, the equation of the line will be:
y− y 1=m( x−x 1 ) ……… (1.2)

Example: Given the slope of a line to be m=4 and the line passes through the point
P1 (1 , 2 ) , then find the equation of the line.

Solution From point-slope form of equation of a line

y− y 1=m ( x− x 1 )
y− 2=4 ( x−1)

Therefore, y=4 x−2 is the equation of the line

Ø Activity: 1.2.
A salesman earns a weekly basic salary plus a sales commission which is 20% of his total
sales. When his total weekly sales total Birr 1000, his total salary for the week is 400.
Derive the formula describing the relationship between total salary and sales.
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III. The slope-intercept form

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

y− y 1=m( x−x 1 )
y−b=m( x−0)
Therefore, the equation of the line will be:

y=mx+b …………... (1.3)

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

Ø Activity: 1.3.
1. Suppose the fixed cost (setup cost) for producing x units of a product is Birr 2000. After
setup it costs Birr 10 per unit product produced. If the total cost is represented by y and x
units are produced:
a) Write the equation of this relationship in slope-intercept form.
b) state the slope of the line and interpret the number
c) state the y -intercept of the line and interpret the number
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2. A printer costs a price of Birr 1,400 for printing 100 copies of a report and Birr 3000 for
printing 500 copies. Assuming a linear relationship, what would be the price for printing
300 copies?

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3. If the relationship between total cost and the number of units made is linear, and if cost
increases by Birr 7.00 for each additional unit made, and if the total cost of 10 units is

Birr 180.00. Find the equation of the relationship between total cost ( y ) and number of

units made( x ) .
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4. A sales man has a fixed salary of Birr 200 a week In addition; he receives a sales
commission that is 20% of his total volume of sales. State the relationship between the
salesman’s total weekly salary and his sales for the week.
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5. Determine whether the following pairs of lines are parallel or perpendicular to each
other.

a) 3 x+4 y =1 and 6 x +8 y=11 .

b) 5 x−2 y=4 and 2 x+5 y =15 .

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1.3. Application of Linear Equations

Application of linear equations is common in the fields of Business, Economics,
Management, as well as in the social and natural sciences. The nature of linear equations in
two variables will make it simple to understand the relationship between the variables
algebraically and geometrically, as it is simple to draw the graph of linear equations on the
coordinate plane.
In this section we will learn the applications of linear equations in cost-output
relationship,
relationship, and Break-even analysis.
analysis.

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1.3.1. Linear Cost Output Relationships
Suppose the total cost (TC) of production of a product is linearly related to the number of
units of products (Q) produced and sold. Let’s denote the variable cost per unit (VC), fixed
costs (FC), total variable costs (TVC), average cost (AC), marginal cost (MC), total

revenue (TR), and profit( Π ) . You can observe the break-even chart (that is graphical
representation of cost out put analysis) shown below:
TC = TFC + TVC
TR = unit price ¿ quantity = P.Q
π = TR - TC

= P.Q – (VC + FC)

=PQ – [Link] - FC
π = Q. (P – VC) – FC

 TR

TVCCD
Profit region
TC

T
BEP
E TC
VC
A Loss region
F FC
G
FC
B D Q
C

Interpretation of the graph:

1. The vertical distance between AB, FC, GD is the same because Fixed Cost is the
same at all levels of output.
2. If there is no sale, then there is no revenue (hence the graph of the total revenue
function passes through the origin). However, without production there is cost (for

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 the land, machine, etc.) called the fixed cost and the total cost function starts from
A and doesn’t pass through the origin.

3. Up to the point T, the total cost is greater than total revenue, which results in loss,
while at point T, the TR = TC and hence the profit is zero and this point is called
the break-even point. To the right of the point T, the TR > TC and hence there is a
profit or gain.
4. At any level of production the fixed cost remains the same. Notice that fixed cost at
B, C, and D is always the same.
5. As the number of products produced increases, total variable cost (TVC) increases
at the same rate (which is the slope of the TC function) and the unit variable cost is
called the marginal cost (MC). (Notice that MC = VC when the relationship is only
linear)
6. As production increases TC increases by the rate equal to the average variable cost
(AVC), which is equal to marginal cost (AVC= MC).
7. AVC is the same through, however Average Fixed out all levels of production Cost
(AFC) decreases when Quantity increases and ultimately ATC decreases when Q
increases As Quantity because of the effect of the decrease in AFC.
8. increases TR increases at a rate of unit sales price P and average revenue remains
constant.
TR P . Q
=
AR = Q Q = P  AR = P whenever the revenue function is linear.
1.3.2. Breakeven Analysis
In cost-output relationship company owners always need to observe the level of production
that leads them from loss to profit level. Specifically, they have to identify when this
transition is likely to take place.
Break-even point is the point at which there is neither loss nor profit to the company. It
can be expressed either in terms of production quantity or revenue level depending on how
the company states its cost equation.

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Manufacturing companies usually state their cost equation in terms of quantity (because
they produce and sell), whereas retail businesses state their cost equation in terms of
revenue (because they purchase and sell)
Manufacturing Companies
Consider a Company with the equation
Total cost = Fixed cost + total variable cost
TC = FC + TVC
Total Revenue = unit Price ¿ Quantity
TR = P.Q
At Break-even point, TR = TC i.e. TR – TC = 0
P.Q = VC + FC
P.Q – VC.Q = FC
Q. (P – VC) = FC
FC
Qe =
P −VC , where Q e is Breakeven Quantity.
The revenue obtained at the break-even quantity is called the break-even revenue (BER).
(BER).

TC/TR TR

Profit
TC

BER

Loss

B Q
FC
Qe 
P  VC
Example: A manufacturing company has a total fixed cost of Birr 10,000 and a unit
variable cost of Birr 5. If the company can sell its products at a unit price of Birr 10, then
a) write the cost, revenue, and profit functions
b) find the breakeven point in terms of quantity and sales volume
c) show diagrammatically the total revenue, total cost, total profit, fixed cost and
variable costs.
d) interpret the results

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Solution
a) TC = VC + FC.
Hence the total cost function is TC= 10,000+5Q.
TR = P.Q,
Hence, the total revenue function is TR=10Q.
Therefore, the total profit functions will be
π = TR – TC=10Q– (10,000+5Q)

π = 5Q – 10,000

b) At breakeven point TR = TC
10Q = 5Q + 10,000
5Q = 10,000
10 , 000
Qe = 5 = 2000 units
Therefore, the breakeven Quantity is 2,000 units and the sales volume = 2000(10) = 20,000
Birr.
Birr
TR=10Q TC=10,000 +5Q
Profit
250000 5Q + 10000
2000 TVC= 5q
20000 Q
2000
15000 TVC 
2000
Loss
10000
2000
5000 TFC
2000
0 Q
1000 3000 4000 5000
-5000 2000 2000 2000
2000
-10000
2000

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Interpretation:
When a company produces and sells 2000 units of output, there will not be any loss or gain
(no loss and no profit)
The effect of changing one variable, keeping others constant
Case i - Fixed cost
Assume for the above problem that FC decreased by Birr 5000, Citrus Paribus (other
things being constant)

{TC= 10,000+5Q¿¿¿¿ 5000

, implies that Qe = 5 = 1000 units.
Note that from the last relation, if the FC decreases, then Qe will decrease and if the FC
increases, then Qe will also increase. In short notation:

{FC ↓⇒Qe ↓¿¿¿¿ Where:  represent a decrease, and  represent an increase

Fixed costs (FC) and breakeven quantity (Qe) have direct relationship
Case ii-Unit variable cost (VC)
Assume for the above problem that decreased by Birr 1. Citrus Paribus (keeping other
thing constant)

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 {TC= 10,000+4Q¿¿¿¿ , would imply that Qe =
10 , 000
6 = 1,667 units.
Note that from the last relation, if the VC decreases, then Qe will decrease and if the VC
increases, then Qe will also increase. In short notation:

{ VC ↓⇒Qe ↓¿¿¿¿
Unit Variable cost (VC) and breakeven quantity (Qe) have direct relationship.

Case iii- Selling price

Assume for the above problem that selling price decreased by Birr 1, provided that all
other thing are kept constant,

{TC= 10,000+5Q¿¿¿¿ , would imply that Qe =

10 , 000
4
=2 ,500
units.
Note that from the last relation, if the unit price decreases, then Qe will increase and if the
unit price increases, then Qe will also decrease. In short notation:

{P ↓⇒Qe↑¿¿¿¿
Note that unit price (P) and break-even points (Qe) have indirect or inverse relationship

In the above examples, the company has the following options (to minimize its breakeven
point and maximize profit)
- decreasing its fixed cost
- decreasing its unit variable cost
- increasing the unit selling price
And if the organization is forced to choose between options (ii) and (iii), it is preferable to
decrease the unit variable cost. However, if we increase the selling price, the organization
may lose its customers and hence decreasing the FC is preferable.

TR
Birr
TC

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TFC
 Q
Finding the quantity level which involves profit or loss
FC +0
BEP = P − VC , any Q is related to the cost, profit, …
 = TR – TC
 = PQ – (VC.Q + FC)
 = (P.Q – VC.Q) – FC
 = Q (P – VC) – FC

Q= FC+ π
P-VC

that, if there is gain, then the profit π is positive and if there is a loss then the profit
Note that,
π is negative.

Example: If the above manufacturing company wants to make a profit of Birr 25,000,
what should be the quantity level?
Solution

Since TR = 10Q, TC = 5Q + 10,000 and the profit π=25 , 000 Birr, then the quantity level
will be::
FC ± Π 10 ,000 +25 , 000
= =7 ,000
Q = P − V 10−5 units.
* When there is profit, the quantities produced and sold have to be greater than the
breakeven quantity.
If it expects a loss of Birr 5,000 what will be the quantity level?

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 FC ±π 10,000 − 5000
= =1,000
Q = P − VC 10 − 5 units
*When there is loss, the quantity produced and sold should be less than the breakeven
quantity.

Ø Activity: 1.4.
1. A record company prepares a record album with fixed costs of Birr 18,000 and variable
cost of Birr 7 per album. If the album is sold for Birr 10 each:
a) Develop the total revenue and total cost functions in terms of quantity.
b) How many records must be sold for the company to breakeven?
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2. A manufacturer sells a certain product for Birr 110 per unit. Total costs consist of a
fixed overhead of Birr 7500 plus production costs of Birr 60 per unit. Based on this
data answer the following questions.
a) Write the total revenue (TR), total cost (TC), and total profit (TP) functions
b) Find the breakeven point in terms of quantity and sales volume
c) Show graphically the TR, TC, and TP.
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Merchandising (or Retail Business)

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

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 Selling price = Birr150
Markup = Selling price – Variable cost = 150 – 100 = 50
i. as a function of cost (that is in terms of cost), the markup is 50/100 = 50%.
ii. as a function of retail price, the markup is 50/150 = 33.3 % it is also called margin.
Margin Cost of goods sold (CGS)

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

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

Example:
Example: Suppose a retail business sale its commodities at a margin of 25% on all items
purchased and sold. Moreover the company uses 5% commission as selling expense and
Birr 12,000 as a Fixed Cost.
Find the Breakeven revenue for the retail business after developing the equation
Solution Selling price 100% Let X represents selling price
Margin 25% Y = total cost
CGS 75% FC = 12000
Comm. Exp. 5% Xe = Breakeven revenue
Total VC 80%
Therefore, the total cost is Y = 0.8X + 12000.
Generally the total cost for the retailer is given by
Y = mX + b, where m the variable cost per unit

Break-even revenue (BER) is obtained by making sales revenue and cost equal.
At breakeven point: TC = TR

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 That is: Y=X
0.8X + 12000 = X
-0.2X = -12000
Xe = 60,000 Birr
When the company receives, Birr 60,000 as sales revenue, there will be no loss or profit.
Generally, the break-even revenue will be given by:
FC FC ± Π VC TVC
Xe = or Xe = , where m= =
1−m 1−m P TR

FC ± Π
The Break-even revenue (BER = 1 − m ) method is useful, because we can use a single
formula for different goods so far as the company uses the same amount of profit margin
FC ± Π
for all goods. However, in Break-even quantity method or BEQ = P −V this is not
possible and hence we have to use different formula for different items.

Example: It is estimated that sales in the coming period will be Birr. 6000 and that FC will
be Birr 1000 and variable costs Birr 3600, develop the total cost equation and the
breakeven revenue.
Solution The total cost for the retailer will be:
3600
Y = 6000 X + 1000 = 0.6X + 1000, where Y = total cost and X = total revenue.
1000 1000
= = 2500
BER = Xe = 1 − 0.6 0.4 Birr
At the sales volume of Birr 2500, the company breaks even.
When the breakeven revenue equation is for more than one item it is impossible to find the
breakeven quantity. It is only possible for one item by Qe = Xe/P, where Xe = Breakeven
revenue, P = selling price and Qe = Breakeven quantity
To change the break-even revenue equation in to breakeven quantity, we have to multiple
price by the coefficient of X. Likewise, to change in to breakeven revenue from Break-
even quantity, we have to divide the unit variable cost (VC) by price.

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Summary
A Linear equation can be deals with different terminologies such as; algebraic
expressions, algebraic sum, constant coefficient and equations. There are at least three
ways of developing the equations of a line, these are i) Two point form ii) The slope point
form iii)The slope intercept form.
An application of linear equation is common in the field of business, economics and
management as well as in social and natural sciences. Basically application of linear
equation can be expressed in terms of cost-volume (output) relationship and break even
analysis both in manufacturing and merchandising (retail business). Breakeven point is the
point at which total revenues are equals to total costs, or the point at which there is no
profit or loss.

 Self-Examination questions 
1. In its first year, “XYZ Company” had the following experience
Sales = 25,000 units Selling price = Birr 100
TVC = Birr 1,500,000 TFC = Birr 350,000
Required:
a) Develop revenue, cost and profit functions for the company in terms of quantity.
b) Find the Breakeven point in terms of quantity
c) Convert the cost equation in terms of quantity into a cost equation in terms of
revenue
d) Find the Breakeven revenue
e) If profit had been Birr 500,000 what would have been the sales volume (revenue)
and the quantity of sales.
f) What would be the profit if sales were Birr 2,000,000?

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2. When the daily production of an item is 20 units, then the cost is 550 Birr. When the
daily production is 65 units the cost is 775 Birr. Assume that there is a linear
relationship between the number of product produced and its cost with the selling price
of 30 Birr per unit.
Required
a) Find the cost for producing 50 units per day?
b) Find the average cost for producing 50 units per day?
c) Draw the break-even chart? (The graph should show the fixed cost, the level
production of loss, break-even point and profit by drawing the cost and
revenue functions on the same coordinate plane)
3. XXX electronics business is an infant manufacturing company. Assume that currently,
you are employed as an assistant business analyst in the company. When you survey
the past few years’ data, you observe for a given year that the company has incurred a
total production cost of Birr 2,000,000 to produce 50,000 units of product. You find the
profit at this level to be zero. The production cost per unit is 60% of the selling.
Required
d) What is the fixed cost and unit variable cost of XXX Company?
e) What is the break-even revenue?
f) How many units should be produced to earn a profit of Birr 200,000?

4. A company uses a margin of 30% on all items it purchases for resale. The company
incurs selling expenses, which it budgets at 15% of the volume of sales. The company
budgets fixed expenses at 7500 Birr.
Required
g) Write the equation relating total cost and sales volume?
h) What is the break-even level of the sales volume?
5. A retail company plans to work on a margin of 44% of retail price and to incur other
variable cost of 4%. If the fixed cost of Birr 20,000, Find the
a) equation relating total cost to sales
b) profit if sales are Birr 60,000
c) the breakeven revenue

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d) If profit is Birr 15,000 what should be the revenue level?
e) If you have any one item at a price of Birr 15 per unit how do you convert the
cost equation in terms of revenue in to a cost equation in terms of quantity?

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