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FIXED COST are costs that do not vary in proportion to the quantity of
output.
p
r
i
c
e
Supply
LAW OF DEMAND
The demand for a commodity varies inversely as the
price of the commodity, though not proportionately
p
r
i
c
e
Demand
LAW OF DEMAND AND SUPPLY
Under conditions of perfect competition, the price at
which any given product will be supplied and purchased
is the price that will result in the supply and the demand
being equal.
p
r
i
c
e
Quantity
The relationship between price and demand can be
expressed as a line
p
r p = a - bD
i
c
e
Demand (D)
Where a is the intercept on the price (p)axis and b is
the slope.
TOTAL REVENUE VOLUME
RELATIONSHIP
R Peak point represents the
T e Maximum revenue
O v
T e
A n
L u
e Demand that maximizes
Total Revenue
TR pD
TR (a bD) D D'
Volume (D)
or
TR aD bD 2
COST - VOLUME RELATIONSHIP
TC TVC TFC
Total Cost
TC vcD TFC
C Variable Cost
o
s
t Fixed Cost
Volume (D)
COMBINATION OF COST - VOLUME &
REVENUE VOLUME RELATIONSHIP
R
e Represents the
C v Maximum Profit
o e
s or Total Cost
n
t u
e
Demand that maximizes
Total Profit
D*
Volume (D) * a vc
D
2b
Formulas:
Price: p a bD
Total Revenue: TR pD
TR (a bD) D
or
TR aD bD 2
Total Cost : TC TVC TFC
TC vcD TFC
Profit: P TR TC
P pD (vcD TFC )
P (a bD) D vcD TFC
P bD 2 (a vc) D TFC
( a vc) ( a vc) 2
4(b)( TFC)
D
'
2(b)
I. COST CONCEPTS
TFC
Break even point: D '
p vc
R D'
TFC
C p vc
e
O or v
S
e
T Break Even Point
n
u where TR=TC
e
Volume (D)
Examples:
1. A company produces circuit boards to update the
outdated computer equipment. The fixed cost is $42,000
per month and the variable cost is $53 per circuit board.
The selling price per unit is p = $150 0.02D. Maximum
output of the plant is 4000 units per month.
(a) Determine the optimum value for this product.
(b) What is the maximum profit per month?
(c) At what volumes does break-even occur?
(d) What is the companys range of profitable demand?
Examples
2. A large semiconductor plant has approximately 95% of sales
due to a single circuit design. The plant can therefore be
considered to produce 3,000,000 printed circuit boards (PCBs)
per year. Presently, the plant is operating at 60% of capacity.
The selling price of the PCB is p = $19.25 (10- 6 )D, and the
variable cost per PCB is $15.75. At zero output, the plants
annual fixed costs are $1,000,000 and are approximately
constant up to the maximum production quantity per year.
a. What is the present expected annual profit or loss (60%
capacity)?
b. What the percentage of production capacity that will result in
optimal operation? What is the maximum profit or minimum loss
at this optimal volume?
b.Determine at what demand(s) breakeven occurs in the
operation
Examples:
3.A manufacturing company leases for $100,000 per year a
building that houses its manufacturing facilities. In
addition, the machinery in the building is being paid for
installments of $20,000 per year. Each unit of product
produced costs $15 in labor and $10 in materials and can
be sold for $40.
a.How many units per year must be sold for the company
to break even?
b. If 10,000 units per year are sold, what is the annual
profit?
c. If the selling price is lowered to $35 per unit, how many
units must be sold each year for the company to earn a
profit of $60,000 per year?
4.A company produces and sells a consumer product and
thus far has been able to control the volume of the product
by varying the selling price. The company is seeking to
maximize its net prot. It has been concluded that the
relationship between price and demand, per month, is
approximately D = 500 5 p, where p is the price per unit in
dollars. The xed cost is $1,000 per month, and the
variable cost is $20 per unit. Obtain the answer
mathematically to the following questions:
a. What is demand that will maximize revenue per month
and the maximum revenue
b. What is the optimal number of units that should be
produced and sold per month?
c. What is the maximum prot per month?
d. What are the breakeven sales quantities and the
range of protable demand (volume)?
5. A plant operation has fixed cost of $2,000,000 per
year, and its output capacity is 100,000 electrical
appliances per year. The variable cost is $40 per
unit, and the product sells for $90 per unit.
a) What is the annual break even volume of this
product?
b) Compare annual profit when the plant is operating
at 90% capacity with the plant operation at 100%
capacity. Assume that the first 90% of capacity
output is sold at $90 per unit and that the remaining
10% of production is sold at $70 per unit.
Examples
6. A company has established that the relationship
between the sales price for one of its products and
the quantity sold per month is approximately D = 780
10p units. The fixed cost is $800 per month, and
the variable cost is $30 per unit produced. What
number of units should be produced per month and
sold to maximize net profit? What is the maximum
profit per month? Determine the range of profitable
demand.
Examples:
7. The annual fixed costs for a plant are P100,000
and the variable costs are P140,000 at
70%utilization of available capacity with net
sales of P280,000. What is the break even point
in units of production if the selling price per unit
is P40.
8. Suppose we know that p=1,000 D/5, where p =
price in dollars and D = annual demand. The total
cost per year can be approximated by $1,000 + 2D2 .
a. Determine the value of D that maximizes profit.
b. Show that in part(a) profit has been maximized
rather than minimized.
Answer:
(a) p = 1,000 - 0.2D
TC = 1,000 + 2D2
(b) d 2 (Profit)
2
= - 4.4 < 0
dD
Since the second derivative is negative, profit has been maximized at
D*.
6. The fixed cost for a steam line per meter of pipe is
$450X + $50 per year. The cost for loss of heat from
the pipe per meter is $4.8/X1/2 per year. Here X
represents the thickness of insulation in meters and
X is a continuous design variable.
a. What is the optimum thickness of the insulation?
b. How do you know that your answer in (a)
minimizes total cost per year?
Answer:
(a) Total Annual Cost (TAC) = Fixed cost + Cost of Heat Loss
4.80
= 450X + 50 +
X1/ 2
d (TAC) 2.40
= 0 = 450 - 3/2
dX X
3/2 2.40
X = = 0.00533
450
X* = 0.0305 meters
(b) for X > 0.
d 2 (TAC) 3.6
= > 0
dX2 X5/ 2
Since the second derivative is positive, X* = 0.0305 meters is a minimum
cost thickness.
(c) The cost of the extra insulation (a directly varying cost) is being traded-off against the
value of reduction in lost heat (an indirectly varying cost).
7. A local defense contractor is considering the
production of fireworks as a way to reduce
dependence on the military. The variable cost per unit
is $40D. The fixed cost that can be allocated to the
production of fireworks is negligible. The price
changed per unit will be determined by the equation
p=$180-(5)D, where D represents demand in units
sold per week.
a. What is the optimum number of units the defense
contractor should produce in order to maximize
profit per week?
b. What is the profit if the optimum number of units are
produced?
(a) Total Revenue = p D
= (180 5D)D = 180D 5D2
Total Cost = (40D)D = 40D2
Total Profit = -5D2 + 180D 40D2
dD = 88.5 0.08(1.75)D0.75
88.5
D0.75 =
(0.08)(1.7 5)
D Volume (D)
TCA = TCB
Examples
1. Two manufacturing methods are being
considered. Method A has a fixed cost of
P5,000 and a variable cost of P50. Method B
has a fixed cost of P2500 and a variable cost of
150. For what production volume would one
prefer (a) Method A, and (b) Method B?
2. Two companies are engaged in the manufacture of shirts.
Company A, using mostly handwork, has a fixed cost monthly
expense of P45,000 and a variable cost of P15.00 per shirt.
Company B has been able to mechanize most of its
operations, and it finds its fixed monthly expenses are
P80,000 and the variable cost per shirt is P12.50.
a. How many shirts should be manufactured by each
month so that the total cost will be the same for the two
companies?
b. If each shirt sells for P32.00 to the retailers,
determine the monthly gross profit for each company.