Unit 5: Elements and Applications of calculus

5.1 APPLICATION OF CALCULUS IN BUSINESS DECISIONS

5.1.1 Revenue, Cost, and Profit Applications

5.1.1.1 Revenue Applications:
5.1.1.2 Marginal analysis
Examines Incremental Effects
C(X) = total cost function c
(X) = marginal Cost
R(X) = total Revenue function R
(X) = Marginal revenue
P(X) = R(X) – (C(X)) = Profit p
(X) = marginal Profit
p
(X) = R 
(X) - c 
(X)

Marginal Cost = is the additional cost incurred as a result of producing and selling one more unit of a product
or service. Linear cost functions assume that the variable cost per unit is constant for such functions the
marginal cost is the same at any level of output.
 A non-linear cost function is characterized by variable marginal costs.
 For the total cost function C(X), the derivative C’(X) represents
i) The instantaneous rate of change in TC given a change in the number of units produced.
ii) A general expression for the slope of the graph of the TC function
iii) The marginal cost, MC = c 
(X)
 c
(X) Can be used to approximate the marginal cost associated with producing the next unit.
I t is the rate of change in total cost per unit change in production at an output level of X
unit. It is also an optimization to the actual cost of making one more unit at any production
level X (non-linear functions).
Example: Suppose the total cost C(X) in thousands of dollars for manufacturing X unit is given by the
function
X2
C(X) = 575 + 25x ; 0 < X  50
4
[0 50]
Required:
1) Find the MC at a production level of X units
2) Find the MC at a production level of 40 unit and interpret the result

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 3) Find the actual cost of producing the 41st unit and compare this cost with the result found in
question number 2
Solution
1) c 
(X) = 25 – x/2
2) c 
(40) = 25 – 40/2
= 5 Br. = 5, 000Br.  m a r g inal cost of 41st unit.
3) C(41) – C(40) = ?
C(41) = 575 + 25(41) – (41)2/4
= 1179.75
C(40) = 575 + 25(40) – (40) – (40) 2/4
= 1175
C(41) – C(40) = 4750Br.  1 1 7 9 .75 – 1175 = 4.75 x 1000
At a production level of 40 units the rate of change of TC relative to production is Br. 5,000. In Other
words, the cost of producing 1 more unit at this level of production (40) is approximately 5, 000Br.

Marginal revenue (MR) is the additional revenue derived from selling one more unit of a product or
service. If each unit of a product sells at the same price, the MR is always equal to the price. Eg. R = 10x
MR= 10Br.
Marginal revenue for non-linear total revenue function is not constant.
For a total revenue function R (X), the derivative R 
(X) represents the instantaneous rate of change in
total revenue given a change in the number of units sold. For the purpose of marginal analysis, the
derivative is used to represent the
Marginal revenue or MR = R 
(X) P

Max

Q
It represent / approximately the marginal revenue from selling the next unit

Eg. R(X) = 500x – 0.005x2 X = number of units

R
(X) = 500 – 0.005X
Marginal Profit= Marginal revenue –Marginal cost
P
(X) = R 
(X) - C 
(X)

 Marginal revenue (Profit) analysis is concerned with the effect on profit if one-additional unit of a

product is produced and sold. As long as the additional revenue brought in by the next unit exceeds

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 the cost of producing and selling that unit, there is a net profit from producing and selling that unit

and total profit increases.

I. If MR > MC, produce the next unit

II. If MR < MC, do not produce the next unit.

5.2.2 Profit maximization criterion

If MR = MC, for the last unit produced and sold, total profit will be maximized.
P(X) = R(X) – C(X) = 0

P
(X) = R 
(X) - C 
(X) = 0

P
(X) = 0

R
(X) = C 
(X)
Example: The market research department of a Company recommends that the Company to manufacture and

market a new transistor radio after suitable test. The marketing department also presents the following

demand equation.

X=10,000-1000P i.e. P=10-X/1000

Furthermore, the financial department provides the following cost equation:

C(X) = 7, 000 + 2x

Conduct a marginal analysis for the company.

1) C 
(X) = 2
X2
2) TR = P.X = 10x -
1,000
X
R
(X) = 10 -
500
3) P(X) = R(X) – C(X)
X2
= (10x - ) – (7, 000 + 2x)
1,000
X2
= 8x - - 7, 000
1,000
X
P
(X ) = 8 - or
500
P
(X ) = R  (X) - C  (X)
X
= 10 - -2
500
X
=8-
500

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Average cost, Average revenue, Average profit
C( X )
A verage Cost = C (X) = C o s t per unit
X

Marginal Average cost = C (X) t h e rate of change of average cost

R( X )
A verage revenue = R (X) =  R e venue/unit
X

Marginal Average revenue = R (X)  R ’ ( X)\X

p( X )
A verage Profit = P (X) =
X
Marginal Average profit = P ' (X)
X2
Suppose: C(X) = 1, 000 + 25x -
10
X
C
(X) = 25 -
5
1,000 X
C (X) = + 25 -
X 10
 1,000
C ' (X) = - 1/10
X2
1,000 1
C (10) = 
100 10
= Br. –10.10  S h o ws that a unit increases in production will decrease the average cost
by approximately Br. 10.10 at a production level of 10 units. If f  set equal to zero
1000  X
C (X) = + 25 - =0
X 10
X = represents the minimum value of f, If f 
(X) > 0 i.e.-Cost

f
(X) < 0 i.e. –Profit

5.3.4 Optimization Problems

Ex. 1. A company manufactures and sales X units of transistor radios per week. If the weekly cost and
demand equations are:
C(X) = 5, 000 + 2x

X
P = 10 - [0, 8000]
1,000

Finding for each week

a) The production level that leads to maximum revenue and the maximum revenue.

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 b) The production levels that leads to maximum profit and the maximum profit.

c) The production level that leads to minimum cost and the minimum cost.

Solution
X2 X
1) R(X) = 10x - = (10 - ) . (X)
1,000 1,000

X
R
(X) = 10 - R
(X) = 0
500
X
= 10 - =0
500
X = 5, 000 units

 1
R
(X) = = -0.02, so X = 5, 000 units leads to maximum revenue
500
TR = XP = 5, 000 x 5 (5, 000 25, 000)

(5,000) 2
= 25, 000 Br R(5, 000) = 10 x 5, 000 -
1,000
= 25, 000

X2
2) P(X) = 10x - - 5, 000 – 2x
1,000
(X) =
X2
= 8x - - 500
1,000 Negative, so it is an optimal solution
X
P
(X) = 8 - (4, 000 unit Br. 21, 000)
500
P
(X) = 0 P(4, 000) = 4, 000 x 8 -
X
8- =0 = 21, 000
500
4, 000 = X

3) Cost is minimum at zero production level. If there is non-linear function, we can use the 2nd derivative

test.

C(X) = 5, 000 + 2x

C
(X) = 2

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 C (X) = 0  2
Ex. 2. When X gallons of alcohol are produced, the average cost per gallons is given by the
following function.
200
C(X) =  0.05 X , X > 0
0.1x  5
Required:
1) Find the gallon of alcohol production level that leads to minimum cost.
2) Prove that this value (1) of X occurs at a local minimum of C(X)
3) Compute the minimum average cost per gallon.
Solution
1. We can rewrite C(X) as
C(X) = 200 (0.1x + 5)-1 + 0.05X
C (X) = -200 (0.1x + 5)-2(0.1) + 0.05
= -20 (0.1x + 5)-2 + 0.05
C (X) = 0
-20 (0.1x + 5)-2 + 0.05 = 0
 20
+ 0.05 = 0
(0.1X  5) 2
  0.1x 
5 
  400
2 1/ 2 1/ 2

0.1x + 5 =  200
X = 150 or X = -250
We discard X = -250 since it is negative.

2. To show X = 150 yields a minimum cost, we start with,

A (X) = -20 (0.1x + 5)-2 + 0.05
Find A (X)
A
(X) = -20 (-2) (0.1x + 5)-3 (0.1)
=
4
 X   0 Minimum point.
A

 0.1x  5 3
A
(150) = Positive
3. Minimum average cost / gallon
200
C(X) = + 0.05x
0.1x  5

 0.05  150
200
C(150) =
0.1  150  5
= 17.5 Br/ gallon

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