UNIT ONE

LINEAR EQUATIONS AND THEIR INTERPRETATIVE

APPLICATIONS
1.1 Introduction
Dear students! Mathematics, old and newly created, coupled with innovative applications of the rapidly
evolving electronic computer and directed toward management problems, resulted in a new field of study
called quantitative methods, which has become part of the curriculum of colleges of business. The
importance of quantitative approaches to management problems is now widely accepted and a course in
mathematics, with management applications is included in the core of subjects studied by almost all
business students. This manual develops mathematics in the applied context required for an understanding
of the quantitative approach to management problems.

1.2 Linear Equations

Equation:
Equation: - is a mathematical statement that indicates two algebraic expressions are equal
Example: y = 3x + 5

Algebraic expressions:
expressions: - A mathematical statement indicating that numerical quantities are linked by
mathematical operations (+, -, = signs).
Example: 3x + 5
2x – 1/2
Linear equations with one variable: -
- are equations with a variable of degree one & a constant.
-are equations whose terms are separated by the signs +, -, =.
-are constants, or constants times one variable with 1st degree.
Example:
Linear Constant Variable Degree Terms/parts
equations with
one variable
3x – 5 = 8 8 X 1 3x ,5 and 8
2y = 11 11 Y 1 2y and 11

Note that: - * 3x + 5xy = 9 isn’t a linear equation, because 5xy is a constant times the product of 2
variables, x and y.
* 3x2 + 6x = 9 isn’t a linear equation, because 3x2 is not a first degree term
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 In this unit we will work with linear equation of two variables.
Linear equation of two variables is given in the form y= mx + b where
 m is called slope,
 b is called the y- intercept,
 y is called dependent variable, and
 x is called independent variable.
Example:- Let us take two quantities Consumption and income
Let C stands for supply and I stands for price
Now the relation b/n C and I can be given by C= 0.5I + 200
Here the slope is 0.5. This means, for each value of the income I the Consumption increases by 0.5.
Graphically this linear equation can be displayed as follows.

Given a linear equation Y = mx + b

changeinY Y rise  fall y Y Y
   2 1
Slope (m) = changeinX X runx X 2  X 1 where X  X
1 2

Slope measures the steepness of a line. The larger the slope the more steep (steeper) the line is, both in
value and in absolute value.

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 L1 has negative slope, as the value of x increases the value of y decreases.
L2 has positive slope, as the value of x increases the value of y also increases.
L3 has 0 slope, as the value of x increases the value of y doesn’t change.
L4 has undefined slope.

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. the slope m is undefined or infinite.
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 the change in the value of Y relative to a
one-unit change in the value of X.

1.2.1 Developing equation of a line

There are at least three ways of developing the equation of a line. These are:
1. The slope-intercept form
2. The slope-point form
3. Two-point form

1. The slope-intercept form:

form: Y = mx + b
This way of developing the equation of a line involves the use of the slope “m”
“m” & the intercept “b”
“b” to
formulate the equation.
Often the slope & the Y-intercept for a specific linear function are obtained directly from the description
of the situation we wish to model.

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Example - 1
Given Slope = 10
Y-intercept = 20, then the equation of a line with slope = 10 and Y-intercept 20 is given by Y =
10x + 20
Interpretative Exercises
Example - 2
Suppose the Fixed cost (setup cost) for producing product X be br. 2000. After setup it costs br. 10 per
X unit of products. If the total cost is represented by Y:
1. Write the equation of this relationship in slope-intercept form.
2. State the slope of the line
3. State the Y-intercept of the line
Answer:
1. y = 10x + 200
2. For each units of x the value of y (production cost) increases by 10 birr.
3. Even, when there is no production there is a cost of birr 200 that is paid for some sort of expenses,
example house rent.
Example - 3
A sales man has a fixed salary of br. 200 a week. In addition; he receives a sales commission that is 20%
of his total volume of sales. State the relationship between the sales man’s total weekly salary & his sales
for the week.
Answer: Y = 0.20X + 200

2. The slope point form

The equation of a non-vertical line, L, of slope m, that passes through the point (X 1, Y1) is defined by the
formula Y – Y1 = m (X – X1)
Example -1 If slope is 3, Y1 = 4 and X1=5, then the equation becomes Y – 4 = 3 (X – 5)
Example -2
A sales man earns a weekly basic salary plus a sales commission of 20% of his total sales. When his
total weekly sales are br. 1000, his total salary for the week is 400. Derive the formula describing the
relationship between total salary and sales.
Answer m=20% and (X1, Y1) = (1000, 400)
Y – Y1 = m (X – X1)

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 Y – 400 = 20% (X – 1000)
Y = 20% (X – 1000) + 400
Y = 20% .X – 20%x1000 + 400
Y = 0.2X –200 + 400
Y = 0.2X +200
Example -3
If the relationship between Total Cost and the number of units made is linear, & if costs increases by br.
7.00 for each additional unit made, and if the Total Cost of 10 units is br. 180.00. Find the equation of the
relationship between Total Cost (Y) & number of units made (X)
Answer: m=7 and (X1, Y1) = (10,180)
y = 7x + 110

3. Two-point form
Two points completely determine a straight line &, of course, they determine the slope of the line.
Hence we can first compute the slope, then use this value of m together with either point in the point-slope
form Y – Y1 = m (X – X1) to generate the equation of a line.

Two point form of linear equation:

 Y2  Y1 
  X  X 1 
 X 2  X 1 
(Y – Y1) =

Example -1
Let (x1, y1) = (2, 20) & (x2, y2) = (12, 0)
0  20  20
  2
slope = 12  2 10 , then
Y – Y1 = m (X – X1)  Y – 10 = -2 (X – 1)
Y – 10 = -2X + 2
Y = -2X + 12
Example -2

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 A salesman has a basic salary &, in addition, he receives a commission which is a fixed percentage of his
sales volume. When his weekly sales are Br. 1000, his total salary is br. 400. When his weekly sales are
500.00, his total salary is br. 300. Determine his basic salary & his commission percentage & express the
relationship between sales & salary in equation form.
Answer:
Answer: (x1, y1) = (1000, 400) & (x2, y2) = (500, 300)
Y = 0.2X + 200
Example -3 A printer costs a price of birr 1,400 for printing 100 copies of a report & br. 3000 for
printing 500 copies. Assuming a linear relationship what would be the price for printing 300 copies?
Answer: (x1, y1) = (100, 1400) & (x2, y2) = (500, 3000)
Cost = 4(# of coppies) + 1000
y = 4x + 1000
Cost = 4.0 (300) + 1000 = br. 2200

1.2.2 Special Formats

a) Horizontal & vertical lines
When the equation of a line is to be determined from two given points, it is a good idea to compare
corresponding coordinates because if the Y values are the same the line is horizontal & if the X values are
the same the line is vertical

Example: 1 Given the points (3, 6) & (8, 6) the line through them is horizontal because
both Y-coordinates are the same i.e. 6
The equation of the line becomes Y = 6, which is different from the form Y = mx + b

If the X-coordinates of two different points are equal, then the line that passes through these points is a
vertical line.
line.

Example (5, 10) & (5, 12) the line through them is vertical, & its equations is X = 5 i.e. X is equal to a
constant. If we proceed to apply the point slope procedure, we would obtain.
12  10 2
 
Slope (m) = 5  5 0 & if m is  infinite, the line is vertical & the form of the equation is x =
constant
b) Parallel & perpendicular lines ( and )
i) Two straight lines are parallel if they have the same slope.

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 Example: y=2x-3 and y=2x+3 are parallel lines.
ii) Two straight lines are perpendicular if the slope of the one is a negative reciprocal of the other or if the
product of their slope is equal to –1
1
Example: y=2x-3 and y= 2 x-6 are perpendicular lines.
*The rule doesn’t work for two perpendicular lines of which one is Vertical and the other is Horizontal.

c) Lines through the origin

Any equation in the variables X & Y that has no constant term other than zero will have a graph that
passes through the origin. Or, a line which passes through the origin has an X-intercept of (0, 0) i.e. both
X and Y intercepts are zero.
Example : y=2x
Y=-3x

1.3 Application of Linear Equations

1.3.1 Linear cost output relationships
Generally speaking productions, either goods or services, are unthinkable with out cost.
These cost are of two types, fixed cost and variable cost.
Total Fixed cost=TFC, Total Variable cost=TVC and Total Cost=TC
From its name Total Variable Cost which is denoted by TVC is dependent on the amount of product, X,
produced. TVC=mX, where m is the slope

i) Total Fixed Cost which is denoted by TFC doesn’t dependent on the amount of product
produced. Note that TFC=b in the y=mx + b equation.

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 ii) Total Variable Cost which is denoted by TVC depends up on the amount of product produced,
X.
Note that TVC=mX in the Y=mX + b equation.

We have seen the graphs of TFC=b and TVC=mX above independently.

Now the graph of TC=TFC + TVC is nothing but the sum of the graphs of TFC=b and TVC=mX as
follows.

As you can see below adding up TFC and TVC we get TC.

It is obvious that Total Revenue minus Total Cost equals Total profit.
profit.
Usually Total Revenue is denoted by.
Usually

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=TR-TC
Total Revenue directly changes as production changes.
TR=aX
=TR-(TFC + TVC)
=aX-(TFC + bX)
=X(a _ b)-TFC
= cX – TFC , where c=a-b
See that Total profit depends on quantity X.
We can also write the equation of total profit, = cX – TFC, in the Y=mX + b form
where m=c, Y= and b= -TFC

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Observe that:
 TR=PQ, where p is the unit price of the product and Q is the product
 TC is a straight line that starts from A and moves on ward above TFC.
 TFC is a straight line that is parallel to the production axes and meets TR at point F.
Interpretation of the graph:
1. TFC remains constant regardless of the number of units produced. Given that there is no any
difference in scale of production.
The vertical distances AB, FC, GD are the same because Fixed Cost is the same at any levels of output.
2. TR=PQ, there is no revenue without sales, when there is no production ie when Q=0, TR=P0=0.
That is why the line of Total Revenue function passes through the origin.
3. There is cost even when there is no production TFC= AB
4. Up to point T:
 Total Cost is greater than Total Revenue
 TR – TC<0 results in loss.
5. At point T , at breakeven
 Total Revenue = Total Cost
 TR – TC=0
 There is no loss or gain.
6. Above point T:
 TR - TC >0
 There is profit

7. TVC=mQ, Total Variable Cost increases at the same rate, m, as production increases. The rate m is
called Marginal cost, MC.
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 TC  (TFC  TVC ) TVC TVC 2  TVC1 TVC 2
MC       AVC
Q Q Q Q 2 _ Q1 Q2
Where TVC1=0 and Q1=0.
Note that this is true when the equation of total cost is linear.

8. As production increases TC increases by the rate equal to the AVC = MC (average cost equal to
marginal cost)

9. AFC decreases continuously when Q increases because

10. As Quantity increases TR increases at a rate of P. and average revenue remains constant.
TR P. Q

AR = Q Q = P  AR = P in linear functions

1.3.2 Break-even Analysis

Break-even point is the point at which there is no loss or profit to the company. It can be expressed as
either in terms of production quantity or revenue level depending on how the company states its cost
equation.

Manufacturing companies usually state their cost equation in terms of quantity (because they produce and
sell) where as retail business state their cost equation in terms of revenue (because they purchase and sell)

Case 1: Manufacturing Companies

Consider a Company with equation
TC = VC + FC / Total cost = Variable cost + Fixed cost
TR = PQ/ Total Revenue = Price x Quantity
At Break-even point, TR = TC i.e TR – TC = 0
PQ = TVC + TFC where Qe = Breakeven Quantity
PQ – AVC.Q = FC TFC = Total Fixed Cost
Q (P – VC) = FC P = unit selling price
FC
P  VC
Qe = AVC = unit variable cost

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Example #1 A manufacturing Company has a Total Fixed Cost of Br. 5,000 & a Unit Variable Cost of Br.
5. If the Company can sell what it produces at a price of Br. 10 then:-
a) Write the Revenue, cost & 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

Answer
a) TC = TVC + TFC TR = PQ Profit () = TR – TC
TC = 5Q + 5,000 TR = 10Q = 10Q – (5Q + 5,000)
= 5Q – 5,000
b) At break even point TR = TC
10Q = 5Q + 5,000
5Q – 5,000 = 0
5,000
Qe = 5
Qe = 1000 units
i.e. Breakeven Quantity is 1000 units
Sales volume = 1000 X 10 = 10,000 br.

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 Number 1stands for TFC
Number 2stands for TVC
Number 3stands for Total profit,[ 1 + 2 +3 –(1+2)=3]
Number 1 + 2 represents TC

Interpretation:
When the company produces & sells 1000 units of output, there is no loss or gain (no profit, nor loss)
The effect of changing one variable keeping others constant
Case 1 - Fixed cost
We know that that =TR – TC
At equilibrium =0 ie TR – TC=0
TR – (TFC +TVC)=0
TR =TFC +TVC
PQe= TFC +bQ
PQe-bQ= TFC

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Qe (P-b)= TFC
TFC
Qe= P  b
Qe=kTFC, where k=1/(P-b).See that Qe depends up on Q.
Assume for the above problem TFC is decreased by Br. 2500, Citrus Paribus (other things being constant)
TC = 5Q + 2500 & TR = 10Q
2500
 Qe = 5 = 500 units
Where FC  then Qe 
Where FC  then Qe 
* Qe and TFC are directly related ( by the equation of the form Y=mX)
Case 2-Unit variable cost
Assume for the above problem TVC decreased by 1 br. Citrus Paribus (keeping other thing constant)
Now TC = 4Q + 5000 and TR = 10Q
5000
 1,667 units
 Qe = 6

See that where VC  then Qe  and VC   Qe 

TVC & Qe are directly related

Case 3- Selling price

Assume for the above problem selling price is decreased by br. 1, Citrus Paribus,
Now TC = 5Q + 10,000 and TR = 9Q
5000
 1250 units
 Qe = 4
We see that when P  then Qe  and when P  then Qe Price
Observe that Qe and P are inversely related

Now from =TR – TC

=PQe – (b + mQe) ,where m is unit Variable cost and b is TFC
=PQe – b -mQe
=(P – m)Qe –b
From this equation observe that the company can maximize its profit, , by taking one of the following
measurements:
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  by decreasing b, ie TFC or ( by TFC)
 by decreasing m, ie unit VC or( by VC)
 by increasing P,the unit selling price( by P)
Note: For the purpose maximizing profit it is not recommended to increase price because number of
customers can be affected.
Finding the quantity level which involves profit or loss
We know that  = TR – TC
=TR – (TVC + TFC),
 = TR – TVC – TFC
 = PQ – mQ – TFC, where m is a unit cost ie m=TVC/Q
 = Q (P – m) – TFC
 +TFC= Q (P – m)
FC  
Q
Pm
FC  0
Remember that Qe = P  m , where Qe is equilibrium quantity
Example #1 If the above company wants to make a profit of 20,000 br. What must be the quantity Q?

FC  
TR = 10Q and Q = P  m for >0 the quantity Q must be greater than Qe

5,000  20,000
TC = 5Q + 5,000 and Q = 10  5
= 5,000 units

At quantity Q will the profit be -5000?

FC   5,000  2500

Q = P  VC 10  5 =500
* Observe that the break even quantity Qe=5000 >Q=2500

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Case 2 Merchandising /Retail Business
Breakeven Revenue = Qe ×P
Suppose that a Firm with product X has the following cost & revenue items.
Unit Variable cost m = 120 br and selling price P= 180 br.
Markup = Selling price – Unit Variable cost
Markup = P-m
Markup = 180 – 120 = 60
i. as a function of cost, the markup is 60/120 = 50%
ii. as a function of retail price, the markup is 60/180 = 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 i.e. 0.01X
So, the TC equation becomes:
Y = 0.68X + FC
Where: X is sales revenue
Y is total cost
Out of 100% selling price 68% is the variable cost of goods purchased & sold
Example Suppose a retail business sale its commodities at a margin of 25% on all items purchased &
sold. Moreover the company uses 5% commission as selling expense & br. 12000 as a Fixed Cost.

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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%
Y = 0.8X + 12000
Break even revenue is obtained by making sales revenue & cost equals
At breakeven point TC = TR Y = mx + b
i.e. Y = X then, unit variable cost
FC FC   VC TVC
or where m  
0.8X + 12000 = X  1  m 1  m P TR

-0.2X = -12000
X = 60,000 br.  When the co. receives br. 60,000 as sales revenue,
there will be no loss or profit.
FC  
The Breakeven 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 for all goods. However, in
FC  
Breakeven quantity method or BEQ = P  V it is not possible and hence we have to use different
formula for different items.
Example #1 It is estimated that sales in the coming period will be br. 6000 & that FC will be br. 1000 &
variable costs br. 3600, develop the total cost equation & the breakeven revenue.
3600
Answer: Y = 6000 X + 1000 = 0.6X + 1000
Where Y = Total Cost
X = Total revenue
1000 1000
  2500 br.
BER = Xe = 1  0.6 0.4

At the sales volume of br. 2500, the company breaks even.

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* 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 = Break even revenue
P = selling price
Qe = Breakeven quantity
To change the breakeven revenue equation in to breakeven quantity we have to multiply price by the
coefficient of X. likewise, to change in to breakeven revenue from Break even quantity, we have to divide
the unit VC by price.

1.4 Model Examination Questions

1. XYZ company’s cost function for the next four months is
C = 500,000 + 5Q
a) Find the BE dollar volume of sales if the selling price is br. 6 / unit
b) What would be the company’s cost if it decides to shutdown operations for the next four
months
c) If, because of strike, the most the company can produce is br. 100,000 units, should it
shutdown? Why or why not?

2. In its first year, “Abol Buna Co” had the following experience
Sales = 25,000 units Selling price = br. 100
TVC = br. 1,500,000 TFC = br. 350,000

Required:
1. Develop Revenue, cost & profit functions for the co. in terms of quantity.
2. Find the Breakeven point in terms of quantity
3. Convert the cost equation in terms of quantity in to a cost equation in terms of revenue
4. Find the Breakeven revenue
5. If profit had been br. 500,000 what would have been the sales volume (revenue) & the quantity of
sales
6. What would have been the profit if sales are br. 2,000,000.

3. A small home business set up with an investment of $ 10,000 for equipment. The business
manufactures a product at a cost of br. 0.64 per unit. If the product sales for Br. 1.20 per unit how
many units must be sold before the business breaks even?

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4. A retail co. plans to work on a margin of 44% of retail price & to incur other Variable Cost of 4%.
If is expected Fixed cost of Br. 20,000.
i. Find the equation relating Total Cost to sales
ii. Find the profit if sales are Br. 60,000
iii. Find the breakeven revenue
iv. If profit is Br. 15,000 what should be the revenue level?
v. If you have any one item at a price of Br. 15/unit how do you convert the cost equation
in terms of revenue in to a cost equation in terms of quantity?
Problems which is accounted from 10%
1. A manufacturer has a fixed cost of birr 60,000 and a variable cost of birr 2 per unit made
and sold. Selling price is 5 per unit.
a ) Write the revenue and cost equations using C for cost and q for number of units.
b ) Compute profit if 25,000 units are made and sold.
c ) Compute profit if 10,000 units are made and sold.
d ) Find the break-even quantity.
e ) Find the break-even birr volume of sales(Revenue)
f ) Construct the break –even chart . Label the cost and revenue lines, the fixed
cost line and the break even point.
2. A company’s cost function for the next three month is C=200,000 + 100q. Find the break-
even quantity if the selling price is birr180 per unit.
3. A company’s cost function for the next three month is C=500,000 + 5q. Find the break-
even birr volume of sales if the selling price is birr 5.5 per unit.
4. if total cost ,y, is related to sales volume ,x , by the equation y=0,47x + 29,786,find
a ) Variable cost per birr of sales
b ) Fixed cost
c ) Total cost on sales of birr 72,000.
d ) The break-even point.
e ) Net profit on before taxes on sales of birr 80, 000.

UNIT TWO
MATRIX ALGEBRA AND ITS APPLICATION

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Contents
2.0 Aims and Objectives
2.1 Introduction
2.2 Matrix algebra
2.2.1 Types of matrices
2.2.2 Matrix operation
2.2.3 The multiplicative inverse of a matrix
2.3 Matrix Application
2.3.1 Solving systems of linear equations
2.3.2 Word problems
2.3.3 Markov Chains

2.0 Aims and Objectives

At the end of this unit, the students will be able to:
 explain what a matrix is
 define the different types of matrices
 perform matrix operations
 find inverse of a square matrix
 explain how to solve a systems of linear equations
 solve word problems applying matrices
 understand the concept of Markov chain

2.1 Introduction
Dear students! Brevity in mathematical statements is achieved through the use of symbols. The price paid
for brevity, of course, is the effort spent in learning the meaning of the symbol.

In this unit we shall learn the symbols for matrices, and apply them in the statement and solution of input-
output problems and other problem involving linear systems.

2.2 Matrix Algebra

Algebra is a part of mathematics, which deals with operations (+, -, x, ).

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A matrix is a rectangular array of real numbers arranged in m rows & n columns. It is symbolized by a
bold face capital letter enclosed by a bracket or parentheses.

a11 a12      a1n 

A  a 21 a 22      a 2 n 
a m1 a m 2       a mn 
eg. in which ajj are real numbers

Each number appearing in the array is said to be an element or component of the matrix. Element of a
matrix are designated using a lower case form of the same letter used to symbolize the matrix itself. These
letters are subscripted as aij, to give the row & column location of the element with in the array. The first
subscript always refers to the raw location of the element; the second subscript always refers to its column
location. Thus, component aij is the component located at the intersection of the ith raw and jth column.

The number of rows (m) & the number of columns (n) of the array give its order or its dimension; M x n
(reads “M” by “n”)

Eg. The following are examples of matrices

1 7 element a12 = 7
A= 5 3 this is 3 x 2 matrix a21 = 5
4 2 a32 = 2

X= 1 5 9 15 This is a 4 x 4 matrix
2 6 10 20 Element X44 = 45
3 7 11 30 X34 = 30
4 8 12 45 X42 = 8
X32 = 7
2.2.1 Types of Matrices
There are deferent types of matrices. These are
1. Vector matrix – is a matrix, which consists of just one row or just one column. It is an
m x 1 or 1 x n matrix.

1.1 Row vector is a 1 x n matrix i.e. a matrix with 1 row

e.g. W = -1 0 6 1x3
1.2. Column vector:
vector: is an m x 1 matrix i.e. a matrix with one column only

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 eg. 0
Z= 20
5 3x1
2. Square matrix:
matrix: - a matrix that has the same number of rows & columns. It is also called n-th order
matrix
e.g. 2 x 2 , 3 x 3, nxn X= 1 2
3 4 2x2

3. Null or zero matrix:

matrix: - is a matrix that has zero for every entry.
It’s generally denoted by Om x n e.g. Y = 0 0
0 0

4. Identity (unit) matrix: - a square matrix in which all of the primary diagonal entries are
ones & all of the off diagonal entries are zeros. Its denoted by I.

e.g. I2 = 1 0 1 0 0 0
0 1 2x2 I2 = 0 1 0 0
0 0 1 0
0 0 0 1 4x4

N.B.
N.B. Each identity matrix is a square matrix
* Primary diagonal represents: a11, a22, a33, a44---------ann entries element
A x I = A & I x A = A that is, the product of any given matrix & the identity matrix is the
given matrix itself. Thus, the identity matrix behaves in a matrix multiplication like number 1 in an
ordinary arithmetic.

5. Scalar matrix: - is a square matrix where elements on the primary diagonal are the
same.
“ An identity matrix is a scalar matrix but a scalar matrix may not be an identity
matrix”.

2.2.2 Matrix operations (Addition, Subtraction, Multiplication)

Matrix Addition/ Subtraction

22
Two matrices of the same dimension are said to be CONFORMABLE FOR ADDITION. Adding
corresponding elements from the two matrices & entering the result in the same raw-column position of a
new matrix perform the addition.

If A & B are two matrices, each of site m x n, then the sum of A & B is the m x n matrix C whose
elements are:

Cij = aij +bij for i = 1, 2 --------m C11 = a11 + b11

j = 1, 2 ---------n C22 = a22 + b22
C12 = a12 + b12 etc

eg. 1 3 7 9 8 12
2 4 + 8 -10 = 10 –6

eg. –2 7 2 8 7 These two matrices aren’t

4 6 9 + 6 4 = conformable for addition
because they aren’t of the
same dimension.

Laws of matrix addition

The operation of adding two matrices that are conformable for addition has these two basic properties.
1. A + B = B + A  The commutative law of matrix addition

2. (A + B) + C = A + (B + C)  the associative law of matrix addition

 The laws of matrix addition are applicable to laws of matrix subtraction, given
that the two matrices are conformable for subtraction A – B = A + (-B)

e.g. A= 1 2 B= 0 1
3 4 2 5

A–B= 1 1

1 -1
Matrix Multiplication

a) By a constant (scalar multiplication)

23
 A matrix can be multiplied by a constant by multiplying each component in the
matrix by a constant. The result is a new matrix of the same dimension as the
original matrix.

If K is any real number & A is an M x n matrix, then the product KA is defined to

be the matrix whose components are given by K times the corresponding
component of A; i.e.

KA = Kaij (m x n)

e.g. If X = 6 5 7 , then 2X = (2 x 6) (2 x 5) (2 x 7)

2X = 12 10 14

Laws of scalar multiplication

The operation of multiplying a matrix by a constant (a scalar) has the following basic properties. If X & Y
are real numbers & A & B are m x n matrices, conformable for addition, then

1. XA = AX 3. X (A + B) = XA + XB
2. (X + Y) A = XA + YA 4. X (YA) = XY (A)

Laws of scalar multiplication

e.g. Given matrices A & B and two real numbers X & Y

A= 1 2 3 B= 4 2 1
4 5 6 3 0 5

X=2 Y=4

1) XA = AX
Proof: XA = 2 1 2 3 AX = 1 2 3 2
4 5 6 4 5 6

24
 XA = 2 4 6 AX = 2 4 6
8 10 12 8 10 6

Therefore XA = AX

2) (X + Y) A = (XA + YA)
Proof:
 (X + Y) A means first add X with Y and then multiply the result by matrix A.
The result of X + y is (2 + 4) = 6 then 6 will be multiplied by matrix A

6 1 2 3 becomes 6 12 18
4 5 6 24 30 36

Therefore (X + Y) A = 6 12 18
24 30 36

 XA + YA means multiply the constant numbers X and Y with matrix A independently, then add the
two results together

XA = 2 1 2 3 YA = 4 1 2 3
4 5 6 4 5 6

XA = 2 4 6 YA= 4 8 12
8 10 12 16 20 24

Then add the result XA with YA

XA + YA = 2 4 6 + 4 8 12
8 10 12 16 20 24

= 6 12 18
24 30 36
25
Therefore it is true that (X + Y) A is equal with XA + YA

3) X (A + B) = XA + XB
Proof:
 X (A + B) means add matrix A and B first and then multiply the result by a constant X

Given constant number X = 2 matrices A and B then the result of X (A + B) will be

A= 1 2 3 B= 4 2 1 A+B= 5 4 4
4 5 6 3 0 5 7 5 11

X (A + B) = 2 5 4 4
7 5 11

= 10 8 8
14 10 22

 XA + XB means multiply matrices A and B by a constant number X independently

then add the results

XA = 2 1 2 3 XB = 2 4 2 1
4 5 6 3 0 5
XA = 2 4 6 XB= 8 4 2
8 10 12 6 0 10

Then Add XA with XB

i.e. XA + XB = 2 4 6 + 8 4 2
8 10 12 6 0 10

= 10 8 8
14 10 22

26
Therefore it is true that X (A + B) is equivalent with XA + XB
4) X (YA) = XY (A)
Proof:
 X (YA) means multiply the second constant number Y with matrix A first and then
multiply the first constant number X with the result.

YA = 4 1 2 3 X(YA) = 2 4 8 12
4 5 6 16 20 24

= 4 8 12 = 8 16 24
16 20 24 32 40 48

 XY (A) means multiply the two constant real numbers X and Y first and multiply
the result by matrix A.

XY = 2 X 4 XY (A) = 8 1 2 3
= 8 4 5 6

, 8 16 24
32 40 48

Therefore it is also true that X (YA) = XY (A) of columns in B

b ) Matrix by matrix multiplication

If A & B are two matrices, the product AB is defined if and only if the number of
Columns in A is equal to the number of rows in B, i.e. if A is an m x n matrix, B
should be an n x b.

If this requirement is met., A is said to be conformable to B for multiplication. The

matrix resulting from the multiplication has dimension equivalent to the number of
rows in A & the number columns in B

If A is a matrix of dimension n x m (which has m columns) & B is a matrix of dimension p x q (which has
p rows) and if m and p aren’t the same product A.B is not defined.

27
That is, multiplication of matrices is possible only if the number of columns of the first equals the
number of rows of the second.

If A is of dimension n x m & if B is of dimension m x p, then the product A.B is of dimension n x p

A B
Dimension Dimension
n x m m x p

Must be the same

Dimension of A.B
nxp

eg. A= 2 3 4 B= -1 7
6 9 7 2x3 0 8
5 1 3x2

AB = (2x – 1) + (3 x 0) + (4 x 5) (2 x 7) + (3 x 8) + (4 x 1)
= 18 = 42
(6x – 1) + (9 x 0) + (7 x 5) (6 x 7) + (9 x 8) + (7 x 1)
= 29 = 121

 AB = 18 42
29 121

Find BA =
B= -1 7 A= 2 3 4
0 8 6 9 7 2x3
5 1
3x2

B A

28
 3 x 2 2 x 3 result 3 x 3 matrix

Conformable
BA = (-1 x 2) + (7 x 6) (-1 x 3) + (7 x 9) (-1 x 4) + (7 x 7)
=40 60 45

(0 x 2) + (8 x 6) (0 x 3) + (8 + 9) (0 x 4) + (8 x 7)
= 48 72 56

(5 x 2) + (1 x 6) (5 x 3) + (1 x 9) (5 x 4) + (1 x 7)
16 24 27

BA = 40 60 45
48 72 56
16 24 27

Special properties of matrix application

# 1 The associative & distributive laws of ordinary algebra apply to matrix multiplication.
Given three matrices A, B & C which are conformable for multiplication,

i. A (BC) = AB (C)  Associative law,

ii. A (B+C) = AB + AC  Distributive property
iii. (A + B) C = AC + BC  Distributive property

# 2 on the other hand, the commutative law of multiplication doesn’t apply to matrix multiplication. For
any two real numbers X & Y, the product XY is always identical to the product YX. But for two matrices
A & B, it is not generally true that AB equals BA. (in the product AB, we say that B is pre multiplied by A
& that A is post multiplied by B.)

# 3 In many instances for two matrices, A & B, the product AB may be defined while the
product BA is not defined or vice versa.

In some special cases, AB does equal BA. In such special cases A & B are said to be Commute.
A= 1 1 B = 2 2 AB = 4 4 BA = 4 4
1 1 2 2 4 4 4 4

29
 2x2 2x2 2X2 2x2

# 4. Another unusual property of matrix multiplication is that the product of two matrices can be zero
even though neither of the two matrices themselves is zero: we can’t conclude from the result AB = 0 that
at least one of the matrices A or B is a zero matrix

A= 3 0 0 B= 0 0 0 AB = 0 0 0
2 0 0 7 –10 4 0 0 0
1 0 0 8 3 2 0 0 0

# 5 Also we can’t, in matrix algebra, necessarily conclude from the result aB = AC that B= C even if A 
0. Thus the cancellation law doesn’t hold, in general, in matrix multiplication

e.g. A= 1 3 B= 4 3 C= 1 2
-2 –6 2 5 3 4

AB = AC = 10 14 but B  C
-20 –28

2.2.3 The Multiplicative Inverse of a Matrix

If A is a square matrix of order n, then a square matrix of its inverse (A -1) of the same order n is said to be
the inverse of A, if and only if A x A-1 = I = A-1 x A

Two square matrices are inverse of each other, if their product is the identity matrix.
AA-1 = A-1 A = I

Not all matrices have an inverse. In order for a matrix to have an inverse, the matrix must, first of all, be a
square matrix.
matrix.

Still not all square matrices have inverse. If a matrix has an inverse, it is said to be INVERTIBLE OR
NON-SINGULAR. A matrix that doesn’t have an inverse is said to be singular. An invertible matrix will
have only one inverse; that is, if a matrix does have an inverse, that inverse will be unique.

Note: i. Inverse of a matrix is defined only for square matrices

ii. If B is an inverse of A, then A is also an inverse of B
iii. Inverse of a matrix is unique

30
 iv. If matrix A has an inverse, A is said to be invertible.
invertible.
v. Not all. Square matrices are invertible.

Finding the inverse of a matrix

Lets begin by considering a tabular format where the square matrix A is AUGMENTED with an identity
matrix of the same order as A / I i.e. the two matrices separated by a vertical line

Now if the inverse matrix A-1 were known, we could multiply the matrices on each side of the vertical line
by A-1 as
AA-1 / A-1 I

Then because AA-1 = I & A-1I = A-1, we would have I / A-1. We don’t follow this procedure, because the
inverse is not known at this juncture, we are trying to determine the inverse. We instead employ a set of
permissible row operations on the augmented matrix A / I to transform A on the left of the vertical line
in to an identity matrix (I). As the identity matrix is formed on the left of the vertical line, the inverse of A
is formed on the right side. The allowable manipulations are called Elementary row operations.
ELEMENTARY ROW OPERATIONS: are operations permitted on the rows of a matrix.
In a matrix Algebra there are three types of row operations

Type 1: Any pair of rows in a matrix may be interchanged / Exchange operations

Type 2:
2: a row can be multiplied by any non-zero real number / multiple operations
Type 3:
3: a multiple of any row can be added to any other row.
row. / Add A-multiple operation
In short the operation can be expressed as

1. Interchanging rows
2. The multiplication of any row by a non-zero number.
3. The addition / subtraction of (a multiple of) one row to /from another row

eg.1. A= 4 3 2 B= -2 6 7 interchanging
-2 6 7 4 3 2 rows

2. A=
4 3 2 B= 8 6 4 Multiplying the first
-2 6 7 –2 6 7 rows by 2

31
 4.
A= 4 3 2 B= 4 3 2 multiplying the 1st row
-2 6 7 6 12 11 by 2 & add to the 2nd
row. This case there
is no change to the
first row.
Theorem on row operations
A row operation performed on product of two matrices is equivalent to row operation performed on the
pre factor matrix.

AB = C
Pre factor post factor product
Matrix matrix matrix

eg. A= 1 2 3 B= 1 2 C= 9 13
2 3 4 2x3 1 1 13 19 2 x 2
2 3 3x2

Interchange row-1 (R1) with row- 2 (R2)

A= 2 3 4 B= 1 1 C= 13 19
1 2 3 2x3 1 2 9 13 2 x 2
2 3 3x2

Basic procedures to find the inverse of a square matrix

1. To set ones first in a column & next zeros (with in a given column)
2. To set zeros first in a matrix & next ones.

Ones first method

Find the inverse of the following matrix
A= 3 2
1 1
Augment A 3 2 1 0

32
With the same dimension identity matrix first 1 1 0 1
Interchange rows (row 1 with row 2)
1 1 0 1
3 2 1 0

Multiply R1 by –3 & add to R2

(-3R1 + R2) i.e. No change to R1
1 1 0 1
0 -1 1 -3
Multiply R2 by –1 = (-R2)
1 1 0 1
0 1 -1 3

Add R2 by –1 & add to R1 Ones first:

first: try to set ones first in a column and then
1 0 1 -2 zeros of the same column. Goes from left to right
0 1 -1 3
Therefore inverse of A is
A-1 = 1 –2
-1 3

Zeros first method

A= 3 2
1 1

Find inverse of A
Augmentation  3 2 1 0
1 1 0 1

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

-1R1 + R2 Therefore, inverse of A

1 0 1 -2 i.e. A-1 = 1 -2

33
 0 1 -1 +3 -1 3
Exercise: Find the inverse for the following matrices (if exist)
1. A= -2 2 3 A-1 = 1/3 –4 –5 3
1 -1 0 -4 –8 3
0 1 4 1 2 0

2. B= 2 -17 11 B-1 = 1 1 2
-1 11 -7 2 4 -3
0 3 -2 3 6 -5

3. 1 1 2 4. What do you conclude from question 2 and 3?

C= 2 4 -3
3 6 -5

5. D = 2 7 1
-3 -9 2

Answers for exercises

1) Finding inverse of matrix A:-
 Use ones first method
 Next change the remaining number With in the same column into zero.
 First augment the matrix with the same dimension identity matrix.
 The appropriate operation is multiplying row 2 by 1 and adding the result to row number 1.
i.e. 1R2 + R1
i.e. –2 2 3 1 0 0 1 0 4 0 1 1
1 –1 0 0 1 0 0 1 4 0 0 1
0 1 4 0 0 1 0 0 3 1 2 0
Our objective is to change
the given matrix into identity format
by applying elementary row operations now proceed to the third column and
exchange row –1 with row –2 change the column into its required

34
 1 –1 0 0 1 0 form. First change the primary
-2 2 3 1 0 0 diagonal entries into one. By
0 1 4 0 0 1 multiplying the third row by 1/3

Next multiply Row 1 by 2 and add the i.e. 1/3 R3

result to Row –2 i.e.2R1 + R2 1 0 4 0 1 1
1 –1 0 0 1 0 0 1 4 0 0 1
0 0 3 1 2 0 0 0 1 1/3 2/3 0
0 1 4 0 0 1 then change the remaining numbers
Now proceed to the 2nd column and into zero.
change the primary diagonal entry multiply Row 3 by –4 and add
into positive one by applying elementary the result to raw 2
row operation. The best operation is 1 0 4 0 1 1
is exchanging row 2 with row 3 0 1 0 –4/3 –8/3 1
1 –1 0 0 1 0 0 0 1 1/3 2/3 0
0 1 4 0 0 1 now multiply the third row by –4 add
0 0 3 1 2 0 the result to row 1 i.e. –4R3 + R1
1 0 0 –4/3 –5/3 1
0 1 0 –4/3 –8/3 1
0 0 1 1/3 2/3 0
Therefore the resulting matrix that is a matrix consisting of the elements at the right side is assumed to be
inverse of matrix A i.e. A-1

A-1 = -4/3 –5/3 1

-4/3 –8/3 1
1/3 2/3 0

2) Inverse of matrix B is
1 1 2
B-1 = 2 4 -3
3 6 -5
3) Inverse of matrix C is
2 –17 11

35
 C-1 = -1 11 –7
0 3 -2
4) We can conclude (observe) that matrix B and C are inverse to each other.
5) Matrix d doesn’t have an inverse because it is not a square matrix.

2.3 Matrix Applications

2.3.1 Solving Systems of Linear Equations

I. n by n systems
Systems of linear equations can be solved using different methods. Some are:
i. Estimation method – for two (2) variable problems (equation)
ii. Matrix method
- Inverse method
- Gaussian method

Inverse method:
Steps 1. Change the system of linear equation into matrix form. The result will be three
different matrices constructed using coefficient of the variables, unknown values
and right hand side (constant) values

2. Find the inverse of the coefficient matrix

3. Multiply the inverse of coefficient matrix with the vector of constant, and the
resulting values are the values of the unknown matrix.

e.g. 2X + 3Y = 4 Given this system of linear equation

X + 2Y = 2 Applying inverse method we can find the unknown values.

Step 1. Change it into matrix form

- Using coefficient construct one matrix i.e. coefficient matrix

1 3 = Coefficient matrix
1 2

36
 - Using the unknown variables construct unknown matrix & it is a column vector (a matrix which
has one column)
X = vector of unknown
Y

-Using the constant values again construct vector of constant

4 = vector of constant
2

Step 2. Find inverse of the coefficient matrix

Now we are familiar how to find an inverse for any square matrix. Assuming once first method find the
inverse for matrix 2 3
1 2

Its inverse become 2 -3

-1 2

Step 3. Multiply the coefficient inverse with the vector of constant

2 -3 4 = 2
-1 2 2 0

Therefore the resulting matrix that is 2 is

0

the value for the unknown variables i.e. X = 2

Y 0

Then X = 2 and Y = 0 that is unique solution

* The logic is this. Given three matrices, coefficient matrix, unknown matrix and vector of constant in the
following order.

37
 AX = B A = coefficient matrix
Given this we can apply different X = vector of unknown
operations, say multiply both sides B = vector of constant
of the expression by A-1
A-1AX = A-1B
IX = A-1B
X = A-1B this implies that multiplying inverse of the coefficient matrix will give us the value of
the unknown matrix

Limitations of inverse method

- It is only used whenever the coefficient matrix is square matrix
- In addition to applying the method the coefficient matrix needs to have an inverse
- It doesn’t differentiate between no solution and infinite solution cases.

Gaussian method
It is developed by a mathematician Karl F. Gauss (1777-1855). It helps to solve systems of linear
equations with different solution approaches i.e. unique solution, No solution and infinite solution cases.
“n” by “n” systems
Step: 1. Change the system of linear equation into a matrix form
2. Augment the coefficient matrix with the vector of constant.
3. Change the coefficient matrix into identity form by applying elementary row operation and apply
the same on the vector of constant.
4. The resulting values of the vector of constant will be the solution or the value of
the unknown

Example: 2X + 3Y = 4
X + 2Y = 2

Step 1. Change it into matrix form

2 3 X = 4
1 2 Y 2

Coefficient unknown vector of

Matrix matrix constant

38
Step: 2. Augmentation
2 3 4
1 2 2

Step: 3. Change the coefficient matrix into identity form by applying elementary row operation (use ones
first method)
2 3 4
1 2 2

Change first the primary diagonal entry from the first row into positive one. Possible operation is
exchange row one with row two.
1 2 2
2 3 4

Next change the remaining numbers in the first column into zero, this case number 2

Now multiply the 1st row by –2 & add the result to row –2
1 2 2
0 -1 0

Then proceed to column 2 and change the primary diagonal entry i.e. –1 into 1
Multiply the 2nd row by –1 (-1R2)
1 2 2
0 1 0
Now change the remaining number with in the same column (column –2) into zero i.e. number 2

Multiply 2nd row by –2 and add the result to the 1st row
1 0 2
0 1 0

Therefore X = 2 and Y = 0

Example 2. X+Y=2

39
 2X + 2Y = 4

Step-1
1 1 X = 2
2 2 Y 4

Step-2 1 1 2
2 2 4

Multiply Row-1 by –2 & add the result to raw-1 (-2R1 + R2)

1 1 2
0 0 0

The next step is changing the primary diagonal entry in the 2nd row to 1. But there is no possible operation
that can enable you to change it in to number 1

Therefore the implication is that you can’t go further but we can observe something from the result. And it
is implying an infinite solution case

Example 3. X+Y=5
X+Y=9

Step 1. 1 1 X = 5
1 1 Y 9

Step 2 1 1 5
1 1 9

Change the encircled number above in to zero

Multiply the first row by –1 & add the result to the 2nd row.
1 1 5
0 0 4
0 = 4 no solution

40
There is no possible operation that we can apply in order to change the primary diagonal entry in the 2nd
column without affecting the first column structure. Therefore stop there, but here we can observe
something i.e. it is not solution case.

Therefore, Gaussian method makes a distinction between No solution & infinite solution unlike the
inverse method.

* Summarizing our results for solving an “n” by “n” system, we start with the matrix.
(A/B), & attempt to transform it into the matrix (I/C) one of the three things will result.
1. an “n” by “n” matrix with the unique solution.
e.g.
1 0 0 10
0 1 0 -5
0 0 1 3

2. A row that is all zeros except in the constant column, indicating that there are no solutions,

e.g. 1 0 0 3
0 1 0 -5
0 0 0 7

3. A matrix in a form different from (1) & (2), indicating that there are an unlimited number of solutions.
Note that for an n by n system, this case occurs when there is a row with all zeros, including the constant
column.

Eg. 1 0 2 5
0 1 3 -3
0 0 0 0

Reference Exercise
1. X + 2Y – 3Z = 11 2. X + Y + Z = 4 3. X + Y + Z = 4
3X + 2Y + Z = 1 5X – Y + 7Z = 25 5X – Y + 7Z =20
2X + Y - 5Z = 11 2X – Y + 3Z = 8 X – Y + 3Z = 8
Unique solution case * No solution case * Many solution case
i.e X = -1
Y=3

41
 Z=2

4. 2X + 6Y – Z = 18
Y + 3Z = 9
3X – 5Y + 8Z = 4 X = 1, Y = 3, Z = 2

II m by n linear systems Reading assignment

The m x n linear systems are those systems where the number of rows (m) and number of columns (n) are
unequal or it is the case where the number of equations (m) & the number of variables (n) are unequal.
And it may appear as m > n or m < n.
Linear equation where m > n
To solve an m by n system of equations with m > n, we start with the matrix (A/B) and attempt to
transform it into the matrix (I/C).

One of the three things will result:

1. An m by n identifying matrix above m – n bottom rows that are all zeros, giving the
unique solution:
1 0 0 3 3X1 + 2X2 + X3 = 23
0 1 0 -5 X1 + 3X2 + 2X3 = 26
0 0 1 4 2X1 + X2 + 2X3 = 10 3, 5, 4
0 0 0 0 4X1 + 5X2 + 3X3 = 49

2. A row that is m – n bottom raw is all zeros except in the constant column, indicating that there are no
solutions

e.g. 1 0 0 3 2X1 + X2 = 30
0 1 0 -5 X1 + 2X2 = 24
0 0 1 7 4X1 + 5X2 = 72
0 0 0 1

3. A matrix in a form different from (1) & (2), indicating that there are an unlimited

42
 number of solutions

e.g. 1 0 2 -4 3X1 + 2X2 + X3 = 6

0 1 3 8 6X1 + 4X2 + 3X3 = 12
0 0 0 0 9X1 + 6X2 + 3X3 = 18
0 0 0 0 15X1 + 10X2 + 5X3 = 30

Linear Equations where m < n

Our attempts to transform (A/B) into (I/C) in the case where m < n will result in:

1. A row which is all zeros except in the constant columns, indicating that there are no solutions, or

2. A matrix in a form different from number one above indicating that there are an unlimited number of
solutions.
“Every system of linear equations has either No solution, exactly one
solution or infinitely many solutions.”
solutions.”

Example Solve the following systems of linear equations

1) 4X1 + 6X2 – 3X3 = 12

6X1 + 9X2 – 9/2X3 = 20
No solution
X1 + 3X2 + X3 = 6
-X1 + X2 + X3 = 2

Unlimited solution
2X1 + 3X2 + 4X3 + X4 = 37
X1 + 2X2 + 3X3 + 2X4 = 24
3X1 + X2 + X3 + 3X3 = 33
Unlimited solution

Solution for an “n” by “n” system

1. 1 2 -3 11 2. 1 1 1 4

43
 3 2 1 1 5 -1 7 25
2 1 -5 11 2 -1 3 8
-3R1+R2 / -2R1+R3 –5R1 + R2 / -2R1 + R3
1 2 -3 11 1 1 1 4
0 -4 10 -32 0 -6 2 5
0 -5 4 -22 0 -3 1 0
-1/4 R2 / -2 R2 + R1 / 3 R2 + R3 -1/6 R2 / -R2+R1 / 3 R2 + R3

1 0 2 -5 1 0 4/3 13/2
0 1 -5/2 8 0 1 -1/3 –5/6
0 0 -13/2 13 0 0 0 -5/2
-2/13 R3 / 5/2 R3 + R2 / -2 R3 + R1 this implies No solution case
1 0 0 -1
0 1 0 3
0 0 1 -2
3) 1 1 1 4
1 0 0 X -1 5 -1 7 20
0 1 0 Y = 3 2 -1 3 8
0 0 1 Z -2 –5R1 + R2 / -2R1 + R2

X = -1
Y 3 1 1 1 4
Z –2 0 -6 2 0
X = -1 Y = 3 Z = -2 0 -3 1 0
-1/6 R2 / 3 R2 + R3 / -R2 + R1
1 0 4/3 4
0 1 -1/3 0
0 0 0 0
This implies that there are so many or infinite solution

“m” by “n” systems

1) 3 2 1 23 2) 2 1 30
1 3 2 26 1 2 24

44
 2 1 2 19 4 5 72
4 5 3 49 R1 R2 / -2R1 + R2 / -4R1 + R3
R1 R2 / -3R1 + R2 / -2R1+R3 / -4R1 + R4
1 2 24
1 3 2 26 0 -3 -18
0 -7 -5 -55 0 -3 -24
0 -5 -2 -33
0 -7 -5 -55
-1/7 R2 / -3R2+R1 / 5R2 + R3 / 7R2 + R4 -1/3 R2 / -2R2 + R1 / 3R2 + R3

1 0 -1/7 17/7 1 0 14
0 1 5/7 55/7 0 1 6
0 0 11/7 44/7 0 0 -6
7/11R3 / -5/7R3 + R2 / 1/7R3 + R1 this implies that there is no
solution which uniquely satisfy
the system
1 0 0 3
0 1 0 5 3) 3 2 1 6
0 0 1 4 6 4 3 12
0 0 0 0 9 6 3 18
15 10 5 30
Unique solution case 1/ 3R1 / -6R1 + R2 / -9R1+ R3 /
-15R1 + R4
 X1 = 3 X2 = 5 X3 = 4 1 2/3 1/3 2
0 0 1 0
0 0 0 0
0 0 0 0
This implies that there are unlimited numbers of solutions

m by n system where m <n

i.e. number of equations are less than # of variables
1) 4X1 + 6X2 – 3X3 = 12
6X1 + 9X2 – 9/2X3 = 20

45
 4 6 -3 X1 12
6 9 -9/2 X2 = 20
X3

4 6 -3 12
6 9 -9/2 20
1/4R1 / -6R1 + R2
1 3/2 –3/4 3
0 0 0 2 No solution

2) X1 + 3X2 + X3 = 6
-X + X2 + X3 = 2

1 3 1 X1 6
-1 1 1 X2 = 2
X3

1 3 1 6
-1 1 1 2
1xR1 + R2
1 3 1 6
0 4 2 8
1/4R2
1 3 1 6
0 1 ½ 1/2
Infinite solution

2.3.2 Word Problems

Steps
1. Represent one of the unknown quantities by a letter usually X & expresses other
unknown quantities if there is any in terms of the same letter like X1 X2 etc
2. Translate the quantities from the statement of the problem in to algebraic form & set

46
 up an equation
3. Solve the equation (s) for the unknown that is represented by the letter & find other
unknowns from the solution
4. Check the findings according to the statement in the problem
Example:
1) A Manufacturing firm which manufactures office furniture finds that it has the
following variable costs per unit in dollar/unit

Desks Chairs Tables Cabinet

Material 50 20 15 25
Labor 30 15 12 15
Overhead 30 15 8 20

Assume that an order of 5 desks, 6 chairs, 4 tables & 12 cabinets has just been received. What is the total
material, labor & overhead costs associated with the production of ordered items?
Answer:
Material cost = $ 750
Labor cost = $ 918
Overhead cost = $ 512

3. Gutema carpet co. has an inventory of 1,500 square yards of wool & 1,800 square yards of nylon
to manufacture carpeting.
Two grades of carpeting are produced. Each roll of superior grade carpeting requires 20 sq. yards of wool
& 40sq. yards of nylon. Each roll of quality-grade carpeting requires 30 square yards of wool & 30 square
yard of nylon. If Gutama would like to use all the material in inventory, how many rolls of superior &
how may rolls of quality carpeting should be manufactured?
15 & 40

3. Kubsa invested a total of br. 10000 in three different saving accounts. The accounts paid simple interest
at an annual rate of 8%, 9% & 7.5% respectively. Total interest earned for the year was br. 845. The
amount in the 9% account was twice the amount
invested in the 7.5% account. How much did Kubsa invest in each account?
1000, 6000, 3000

47
4. A certain manufacturer produces two product P & q. Each unit of product P requires (in its production)
20 units of row material A & 10 units of row material B. each unit of product of requires 30 units of raw
material A & 50 units of raw maternal B. there is a limited supply of 1200 units of raw material A & 950
units of raw material B. How many units of P & Q can be produced if we want to exhaust the supply of
raw materials?
Answer: 45 units of P and
10 units of Q

5. Attendance records indicate that 80,000 South Koreans attended the 2002 world cup at its opening
ceremony. Total ticket receipts were Birr 3,500,000. Admission prices were Birr 37.5 for the second-class
and Birr 62.50 for the first class. Determine the number of South Koreans who attended the football game
at first class and second class.
Solutions / word problems
1) D Ch T Cb
Mt 50 20 15 25 5 Desk
Lab. 30 15 12 15 6 Chair
FOH 30 15 8 20 4 Tables
12 Cabinet

Material cost = (50 x 5) + (20 x 6) + (5 x 4) + (25 x 12)

= 730 br.
Labor cost = (30 x 5) + (15 x 6) + (12 x 4) + (15 x 12)
= $ 468.00
FOH cost = (30 x 5) + (15 x 6 ) + (8 x 4) + (20 x 12)
= $ 1710.00
2) Given: wool inventory 1500 yards
nylon inventory 1800 yards
Grade one carpet The other grade carpet
Wool requirement
per roll 20 Sq. 30 Sq.
Nylon requirement
per roll 40 Sq. 30 Sq.
Let X be rolls of superior grade carpeting &
Y be rolls of quality grade carpeting

48
 20 30 X 1500 20 30 1500
40 30 Y 1800 40 30 1800

2 3 150
20X + 30Y = 1500 4 3 180
40X + 30Y = 1800 1/2 R1 / -4R1 + R2
-20X = -300
X = 15 1 3/2 75
0 -3 -120
20X + 30Y = 1500 –1/3 R2/ -3/2 R2 + R1
20 (15) + 30Y = 1500 1 0 15
30Y = 1500 – 300 0 1 40
Y = 1200
30
Y = 40 X = 15 & Y = 40

3) Total investment 10000.00

interest earned from the three accounts 8%, 9% and 7.5%
total interest earned for the year was 845.00
amount in 9% = 2 (amount in 7.5%)
Let amount invested in 8% account be X1
amount invested in 9% account be X2
amount invested in 7.5% account be X3

X1 + X2 + X3 = 10,000
0.08X1 + 0.09X2 + 0.075X3 = 845
X2 = 2(X3)
or

X1 + X2 + X3 = 10,000
0.08X1 + 0.09X2 + 0.075X3 = 845
X2 – 2X3 = 0

49
 1 1 1 10,000
80 90 75 845,000
0 1 -2 0
-80R1 + R2

1 1 1 10,000
0 10 -5 45,000
0 1 -2 0
1/10R2 -R2 + R1 -R2 + R3

1 0 3/2 5500
0 1 -1/2 4500
0 0 -3/2 -4500
-2/3 R3 ½ R3 ½ R3 + R2 -3/2 R3 + R1

1 0 0 1000
0 1 0 6000
0 0 1 3000
X1 = 1000,
1000, X2 = 6000,
6000, X3 = 3000

2.3.3 Markov Chains

This model is a forecasting model. It is probabilistic (stochastic) model. A Russian Mathematician called
Andrew Markov around 1907 develops this model.
Markov chains are models, which are useful in studying the evolution of certain systems over repeated
trials. These repeated trials are often successive time periods where the state (outcome condition) of the
systems in any particular time period can’t be determined with certainty. Therefore, a set of transition
probabilities is used to describe the manner in which the system makes transition from one period to the
next. Hence, we can predict the probabilities of the system being in a particular state at a given time
period. We can also talk about the long run or equilibrium or steady state.

The necessary assumptions of the chain:

1.The system condition (outcome) state in any given period depends on its state in the
Preceding period & on the transition probabilities

50
2. The transition probabilities are constant overtime
3. Change in the system will occur once & only once each period
e.g. If it’s a week, its only once in a week
4. The transition period occurs with regularities
* if we start with days, we use the day until we reach our end.

Information flow in the analysis

The Markov model is based on two sets of input data
 The set of transition probabilities
Set of transition
 The existing or initial or current conditions orSteady
states states
Probabilities
The Markov process, therefore, describes the movement Or of a system
long from a certain state in the current
run states
state/time period to one of n possible states in the next stage. The system makes in an uncertain
environment, all that is known is the probability associated with any possible move or transition. This
probability is known as transition probability, symbolized by P ij. It is the likelihood that the system which
Currently / initial
is currently The probability of
in state i will move to state j in the next period.
States The expressed
From these inputs the model makes two predictions usually system being in
as vectors.
Any sate at any give time
1. The probabilities of the system being in any state at any given future time period
2. The long run (equilibrium) or steady state probabilities.

The set of transition probabilities are necessary for both prediction (time period n, & steady state), but the
initial state is needed for only the first prediction.

Input data prediction (outcome)

about the past

about today

51
Example
Currently its known that 80% of customers shop at store 1 & 20% shop at store 2. In reviewing a past data
suppose we find that out of all customer who shopped at store 1 in a given week 90% remain loyal for the
next week (store one again), 10% switch to store 2. On the other hand, out of all customers who shopped
at store 2, in a given week 80% remains loyal for the next week (store 2 again), 20% switch to store 1.
What will be the proportion of customers shopping at store 1 & 2 in each of the next two weeks?
Solution
Let S1 be the proportion of store 1
S2 be the proportion of store 2
- Initial state/current state probability matrix for store one and two will be:
V12 = (0.8 0.2)

To the next weekly shopping period

from one S1 S2 Transition probability matrix

week S1 0.9 0.1 is a square matrix such that each
shopping S2 0.2 0.8 entry indicates the prob. Of the
period system moving from a given state to
another state.

- The sum of rows in the transition matrix should be 1

- We have to be consistent in writing the elements
Markov Chain Formula

a) Vij (n) = Vij (n – 1) x P where P = Transition matrix

Vij (n) = Vector for period n
Vij (n – 1) = Vector for period n – 1

V12 (0) = (0.8 0.2) current share

V12 (1) = V12 (1 –1 ) x P
= V12 (0) x P
(0.8 0.2) 0.9 0.1
0.2 0.8

52
 = (0.8 x 0.9) + (0.2 x 0.2) (0.8 x 0.1) + (0.2 x 0.8)
= 0.72 + 0.04 0.08 + 0.16
= 0.76 0.24

V12 (1) = (0.76 0.24)

V12 (2) = V12 (2 – 1) x P
= V12 (1) x P
(0.76 0.24) 0.9 0.1
0.2 0.8
(0.76x 0.9) + (0.24 x 0.2) 0.76 (0.1) + (0.24 x 0.8)
(0.732 0.268)
b) Long run market share

Assumption

In the log run the share of the systems is assumed to be constant.

Let - the share of store 1 in the long run be V1
- the share of store 2 in the long run be V2

n p n+1
(V1 V2) 0.9 0.1 = (V1 V2)
0.2 0.8

0.9V1 + 0.2V2 = V1
0.1V1 + 0.8V2 = V2
-V1 + 0.9V1 + 0.2V2 = 0
0.1V1 + 0.8V2 – V2 = 0
-0.1V1 + 0.2V2 = 0
0.1V1 + (0.2V2) = 0

0.9V1 + 0.2 (V2 – V1) = V1

0.9V1 + 0.2 – 0.2V1 = V1
0.7V1 + 0.2 = V1

53
 0.2 = 0.3V1
V1 = 2/3
V2 = 1 – V1
= 1 – 2/3
V2 = 1/3

In the long run 67% of the customers will shop in store 1 & 33% in shop 2.
Prediction:
Long run: only the transition matrix
= At specified time:-
time:- the transition matrix & state vector. Hence unless the transition matrix is affected,
the long run state will not be affected. Moreover, we can’t know the number of years, weeks to attain the
long run state / point but we can know the share
Exercises
1. A division of the ministry of public health has conducted a simple survey on the public
attitude to wards smoking . From the results of the survey the department concluded that currently
only 20% of the population smokes cigarette & every month 10% of non-smokers become smokers
where as 5% of smokers discontinue smoking.

Required:
Required:
1. Write the current & transition matrices
2. What will be the proportion of the non-users (non-smokers) & users (smokers) in the
long run?

Solution
1) Let U – stands for Smokers
N – stands for non-Smokers

Initial state VUN(0) = (0.2 0.8)

To the next month

Smokers Non smokers

From Smokers 0.95 0.05 P = .95 .05
one month Non-smokers 0.10 0.90 .10 .90

54
2. VUN(1) = VUN(0) x P VUN(2) = VUN(1) x P
= (0.2 0.8) .95 .05 = (.27 .73) . .95 .05
.10 .90 .10 .90

= ( 0.27 0.73) = (0.3295 0.6705)

2. A population of 100,000 consumers make the following purchases during a particular week: 20000
purchase Brand A, 35,000 Brand B & 45000 purchase neither Brand. From a market study, it is estimated
that of those who purchase Brand A, 80% will purchase it again next week, 15% will purchase brand B
next week, & 5% will purchase neither brand. Of those who purchase B, 85% will purchase it again next
week, 12% will purchase brand A next week, & 3% will purchase neither brand. Of those who purchase
neither brand, 20% will purchase A next week, 15% will purchase Brand B next week, & 65% will
purchase neither brand next week. If this purchasing pattern continues, will the market stabilize?? What
will the stable distribution be?
Yes. The share of A, B and C is = (0.4 0.5 0.1) respectively

3. A vigorous television advertising campaign is conducted during the football reason to promote a well-
known brand X shaving cream. For each of several weeks, a survey is made & it is found that each week
80% of those using brand X continue to use it & 20% switch. It is also found that those not using brand X,
20% switch to brand X while the other 80% continue using another brad.
a) Write the transition matrix, assuming the transition percentage continue to hold for
succeeding weeks.

b) If 20% of the people are using brand X at the start of the advertising campaign,
what percentage will be brand X 1week later? Two weeks later?

Solutions for question number 2, 3 & 4

2) Given: 20,000 purchase brand A

35,000 purchase brand B
45,000 purchase neither brand
Total consumers = 100,000 (20,000 + 35,000 + 45,000)
Let VA represents the share of brand A purchasers
VB represents the share of Brand B purchasers
VN represent the share of neither brand purchasers

55
The system is arranged in a weekly basis
To the next week shopping period
From A B N
One week A 0.80 0.15 0.05
Shopping B 0.12 0.85 0.03 = P
Period N 0.20 0.15 0.65
The stable market means the long run or steady state market because it is noted that in the long run the
share will be stable.
And in the long run we have said that the share at n period is equal with the share at n + 1 period.
Therefore
(The share at n period) x (the transition probabilities) = (the share at n + 1 period)
Let the share of brand A purchasers be V1 in the long run
the share of brand B purchasers be V2 in the long run
the share of neither purchasers be V3 in the long run

Then (V1 V2 V3) 0.80 0.15 0.05

0.12 0.85 0.03 = (V1 V2 V3)
0.20 0.15 0.65

0.8V1 + 0.12V2 + 0.2V3 = V1

0.15V1+ 0.85V2 + 0.15V3 = V2
0.05V1 + 0.03V2 + 0.65V3 = V3
V1 + V2 + V3 = 1
Therefore V1 = 1 – V2 – V3
Substitute 1 – V2 – V3 in place of V1 to reduce your system in to two variable case
Take the first equation
0.8V1 + 0.12V2 + 0.2V3 = V1
0.8 (1- V2 – V3) + 0.12V2 + 0.2V3 = 1 – V2 – V3
0.8 – 0.8V2 – 0.8V3 + 0.12V2 + 0.2V3 + V2 + V3 = 1

add similar variables together

0.32V2 + 0.4V3 = 1- 0.8

56
 0.32V2 + 0.4V3 = 0.2 this is a summarized equation from the first equation. And do the same for
the second equation.
0.15V1 + 0.85V2 + 0.15V3 = V2
0.15 (1 – V2 – V3) + 0.8V2 + 0.15V3 = V2
0.15 – 0.15V2 – 0.15V3 + 0.85V2 + 0.15V3 = V2

add together similar variables and take the constant values to the right side.
-0.3V2 = -0.15
V2 = -0.15
-0.30
V2 = 0.5 this implies the long run share for the purchasers of brand B will be 50%. Then
using this value and the first summarized equation (0.32V2 + 0.4V3 = 0.2)

Find the value of V3 in the long run

That is, 0.32 (0.5) + 0.4V3 = 0.2
0.16 + 0.4V3 = 0.2
0.4V3 = 0.20 – 0.16
V3 = 0.04
0.04
V3 = 0.1
This implies the share of neither brand purchases in the long run will be 10%. Hence the share of Brand A
purchasers will be 0.4 (1 – 0.5 – 0.1)
Because we said above V1 = 1 – V2 – V3
Therefore V1 = 1 – 0.5 – 0.1
V1 = 0.4
That is the long run share of Brand A purchasers will be 40% of the total population
i.e. VA VB VN = (0.4 0.5 0.1)

3) A) let X be the proportion of brand X users

X1 be the proportion of other brand users
To the next week Shopping period
From this X X1
Week X 0.80 0.20 =P
Shopping X 1
0.20 0.80
period
B) Current users of brand X = 20% then, the users of other brand will be 80%
VXX1 (0) = (0.20 0.80)
VXX1 (1) = VXX1 (0) P
= (0.20 0.8) 0.80 0.20
57
 0.20 0.80
= (0.32 0.68)
The proportion of brand X and other brand users after one week period is expected to be 32% and 68%
respectively. Then the expected users in the 2nd week will be
VXX1 (2) = VXX1 (2 – 1) (P)

= VXX1 (1) P
= (0.32 0-.68) 0.80 0.20
1.20 0.80
= 0.392 0.608
The expected share of brand X and other brand users is 39.2% and 60.8% in the second week.
Problems to be accounted out of 10%
1. Consider the system
8x1 + 5x2 = 2
3x1 + 2x2 = 2
a) Relating the system to Ax=b What is A?, x?, b?
b) Solve the system using the Gauss-Jordan method
c) Compute A-1
d) Write x=A-1 in expanded matrix form.
e) Compute the solution from part (d).
f) What would be the solution vector if the elements in the vector of constants , 2
and 1, were changed to each of the following:
(1) 1, 0. (2) 0, 1. (3) 1, 1. (4) 3, 4. (5) -3, 1 . .
2. Given the system
x1 + x2 +x3 + x4 = b1
x1 + 2x2 +2x3 + 2x4 = b2
x1 + 2x2 +3x3 + 3x4 = b3
x1 + 2x2 +3x3 + 4x4 = b4
a) Verify by multiplication that the inverse of the coefficient matrix is
2 , -1 , 0 , 0
-1 , 2 , -1 , 0
0 , -1 , 2 , -1
0 , 0 , -1 , 1

58
3) The table shows that we plan to make x1 primers. Making each primers requires one hour on machine
M1 and one hour on M3. Other entries in the table have Corresponding interpretations. H1, H2 and H3 are the
total number of hours available on M1, M2 and M3 available, respectively.
a) set up the system of equations that must be solved if all available machine hours are to be used in
making ( x1 , x2 , x3 ) units of the product.
Machine hours per unit of machine

Product Units made M1 M2 M3

Primer X1 1 0 1
Middler X2 0 1 2
Laster X3 2 3 0
b) Set up the coefficient matrix and find its inverse. What number of units can be made if the number
available hours, ( H1 , H2 , H3 ) are: 160 80 200

UNIT THREE
INTRODUCTION TO LINEAR PROGRAMMING

Contents
3.0 Aims and Objectives
3.1 Introduction
3.2 Linear Programming Models
3.3 Formulating Linear programming Models
3.4 Solution Approaches to Linear Programming Problems

3.0 Aims and Objectives

At the end of this chapter students will be able to;
 apply the knowledge of linear programming to solve managerial problems;

59
  use linear programming models to solve managerial problems having quantitative application.

3.1 Introduction
Dear students! Linear programming- is an optimization method which shows how to allocate scarce
resources in the best possible way subject to more than one limiting condition expressed in the form of
inequalities and /or equations. It
- enables users to find optional solution to certain problems in which the solution must satisfy a
given set of requirements or constraints.
- optimization in linear programming implies either maximization of:
 Profit
 Revenue
 sales
 market share
or minimization of:
 Cost
 time
 distance
 or a certain objective function.
 *We can’t max/min two quantities in one model!
- involves linearly related multi-variety functions i.e. functions with more than one independent
variables.
- The goal in linear programming is to find the best solution given the constraints imposed by the
problem, hence the term constrained optimization.

3.2 Linear Programming Models

LP models are mathematical representation of LP problems. Some models have a specialized format
where as others have a more generalized format. Despite this, LPMs have certain characteristics in
common. Knowledge of these characteristics enables us recognize problems that are amenable to a
solution using LP models and to correctly formulate a LP model. The characteristics can be grouped into
two categories: Components and Assumptions. The components relate to the structure of a model, where
as the assumptions describe the conditions under which the model is valid.
Components Assumptions
1. Objective function 1. Linearity
2. Decision variables Model 2. Divisibility
Model
3. Constraints Structure 3. Certainty Validity
4. Parameters and Right. 4. Non-negativity

60
 Hand Side Values

3.2.1 Components of LP Model

a) The Objective function: is the mathematical/ quantitative expression of the objective of the
company/ model. The objective in problem solving is the criterion by which all decisions are
evaluated. In LPMs a single quantifiable objective must be specified by the decision maker. For
example, the objective might relate to profits, or costs or market share, best to only one of these.
Moreover, because we are dealing with optimization, the objective will be either maximization or
minimization, but not both at a time
b) The Decision Variables: represent unknown quantities to be resolved for. These decision variables
may represent such things as the:
- number of units of different products to be sold
- the # of birr to invest in various projects
- the # of ads to place with different media advertisement
Since the decision maker has freedom of choice among actions, these decision variables are controllable
variables.
c) The constraints: are restrictions which define or limit the attainability (achievability) feasibility of
a proposed course of action. They limit the degree to which the objective can be pursued.
A typical restriction embodies scarce resources (such as labor supply, production capacity, machine time,
storage space), legal or contractual requirements (Product standards, work standards), or they may reflect
other limits based on forecasts, customer orders, company policies etc.

d) Parameters- are fixed values that specify the impact that one unit of each decision variable will
have on the objective and on any constraint it pertains to as well as to the numerical value of each
constraint.
The components are the building blocks of a LP model. We can better understand their meaning by
examining a simple LP model as follows.

Example:
Maximize:
Maximize: 4X1 + 7X2 + 5X3 (profit)… objective function subject to
2X1 + 3X2 + 6X3  300 labor hrs
System
5X1 + 4X3  200 raw materials. Constraints

61
 3X1 + 5X2 + 2X3  360
X1 = 30 Individual
 40 Constraints
X1 – qty of product 1 X2
Decision
Variable

X2 qty of product 2 X1, X2, X3  0 Non negativity constructs

X3 qty of product 3
s

System constraints-
constraints- involve more than one decision variables
Individual constraint- involve only one decision variable.
None-negativity constrains-
constrains- specify that no variable will be allowed to take on a negative value. The non
negativity constraints typically apply in a LP model, whether they are explicitly stated or not.
3.2.2 Assumption of LP models
a) Linearity
The linearity requirement is that each decision variable has a linear impact on the objective function and in
each constraint in which it appears. Taking the above example, producing one more unit of products add
br 4 to the total profit. This is true over the entire range of possible values of x 1. The same applies (true) to
each of the constraints.

b) Divisibility: The divisibility requirement pertains to potential values of decision variables. It is

assumed that non-integer values are acceptable. For example: 3.5 TV sets/ hr would be acceptable 7TV
sets/ 2hr.

c) Certainty: The parameters are known and constant. The certainty requirement involves two aspects of
LP models. The constraint equations do not change.
(1) With respect to model parameters (i.e. the numerical values) –It is assumed that these values are
known and constant. Eg. In the above example each unit of product 1 requires 2 labor hours is
known and remain constant, and also the 300 labor available is deemed to be known and constant.
(2) All the relevant constraints identified and represented in the model are as they are.

e) Non-negativity-
Non-negativity- The non-negativity constraint is that negative values of variables are unrealistic
and, therefore, will not be considered in any potential solutions, only positive values and zero will
be allowed.
3.3 Formulating LP Models

62
Once a problem has been defined, the attention of the analyst shifts to formulating a model. Just as it is
important to carefully formulate the model that will be used to solve the problem. If the LP model is ill
formulated, ill-structured, it can easily lend to poor decisions.

Formulating linear programming models involves the following steps:

1) Define the problem/ problems definition:
definition: to determine the no. of type 1 and type 2 products to be
produced per month so as to maximize the monetary profit, given the restriction.
2) Identity the decision variables or represent unknown quantities.
quantities.
* Let X1 and X2 be the monthly quantities of type 1 and type 2 products.
3) Determine the objective function: Once the variables have been identified, the objective function
can be specified. It is necessary to decide if the problem is maximization or a minimization
problem and the coefficients of each decision variable.
4) Identify the constraints
- system constraints- more than one variable
- individual constraints- one variable
- non-negativity constraints.
Q(1) Check Your Progress- Question
1. A firm that assembles computers is about to start production of two new micro computers. Each
type of microcomputer will require assembly time, inspection time, and storage space. The amount
of each of there resources that can be devoted to the production of micro computers is limited.
The manager of the firm would like to determine the quantity of each micro computer to produce in order
to maximize the profit generated by sales of these micro computers.
Additional information
In order to develop a suitable model of the problem, the manager has met with the design and
manufacturing personnel. As a result of these meetings, the manager has obtained the following
information:
Type 1 Type 2
Profit per unit $ 60 $ 50
Assembly time per unit 4hrs 10hrs
Inspection time per unit 2hrs 1hr
Storage space per unit 3 cubic ft 3 cubic ft

63
The manager also has acquired information on the available company resources. These (weekly) amounts
are:
Resource Resource available
Assembly time 100hrs
Inspection time 22hrs
Storage space 39cubic feet

The manager has also met with the firms marketing manager and learned that demand for the micro
computers was such that what ever combination of these two types of micro computers is produced, all of
the out put can be sold.

Solution
Step 1:
1: Problem definition
- To determine the no. of two types of microcomputers to be produced (and sold) per week so as to
maximize the weekly profit,
profit, given the restrictions.

Step 2: Variable representation

- Let X1 and X2 be the weekly quantities of type 1 and type 2 microcomputers respectively.
Step 3: Develop the objective function
Maximize or Z max = 60X1 + 50X2

Step 4: Constraint identification

 System constraints: 4X1 + 10X2  100hrs Assembly
2X1 + X2  22hrs Inspection
3X1 + 3X2  39 cub Feet Storage
 Individual constraints ….No
 Non-negativity constraint ….X1, X2  0

In summary, the mathematical model for the microcomputer problem is:

Z max = 60X1 + 50X2 subject to 4X1 + 10X2  100
2X1 + X2  22
3X1 + 3X2  39
X1, X2  0
Q(2) Check your progress

64
2. An electronics firm produces three types of switching devices. Each type involves a two-step assembly
operation. The assembly times are shown in the following table:
Assembly time per unit (minutes)
Station 1 Station 2
Model A 2.5hr 3.0hr
Model B 1.8hr 1.6hr
Model C 2.0hr 2.2hr
7.5hr 7.5hr
Each workstation has a daily working time of 7.5 hrs. The manager wants to obtain the greatest possible
profit during the next five working days. Model A yields a profit of br. 8.25 per unit, Model B a profit of
br 7.5 per unit and model C a profit of Br 7.8 per unit. Assume that the firm can sell all it products. During
this time, it must fill outstanding orders for 20 units of each model type.

Required.
Required. Formulate the linear programming model of this problem.
Solution
Step 1: Problem definition: to determine the number of three types of searching devices
to be produced and sold for the next 5 days (working) so as to maximize the 5 days
profit.
Step 2. Variable representation
Let X1, X2, and X3 be the number of model A, B and C sketching devices to be
produced and sold.
Step 3. Develop objective function
Z max = 8.25X1 + 7.50X2 + 7.80X3

Step 4.Constraint identification

2.5X1 + 1.8X2 + 2.0X3  450 minutes…Assembly time station 1 System
Constraints
3.0X1 + 1.6X2 + 2.2X3  450minutes…. Assembly time station 2
X1  20 …. Model A Individual
Constraints
X2  20 ….Model B
X3  20….Model C
X1, X2, X3  0 ….no negativity
Summary
Z max = 8.25X1 + 7.50X2 + 7.8X3

65
 Subject to: 2.5X1 + 1.8X2 + 2X3  450
3X1 + 1.6X2 + 2.2X3  450
X1  20
X2  20
X3  20
X1 X2 X3  0

3.4 Solution Approaches to Linear Programming Problems

There are two approaches to solve linear programming problems.
1. The graphic solution method
2. The algebraic solution/ simplex algorithm

3.4.1 The Graphic solution Method

It’s a relatively straight forward method for determining the optional solution to certain linear
programming problems.
It gives us a clear picture.

This method can be used only to solve problems that involve two decision variables. However, most linear
programming applications involve situations that have more than two decision variables, so the graphic
approach is not used to solve these
Example 1. Solving the micro-computer problem with graphic approach.
Z max=60X1 + 50X2
4X1 + 10X2  100
2X1 + X2  22
3X1 + 3X2  39
X1 , X2  0
Steps
1. Plot each of the constraints and identify its region.
2. Identify the common region, which is all area that contains all of the points that satisfy the entire
set of constraints.
3. Determine the optional solution-identify the point which leads to maximum benefit or minimum
cost.

66
  Region EGHBO is the commonest region point
 Region EGHBO is called feasible region point
 Point E Contains (0, 10)
 Point G contains (5,8) the intersection of L1 and L3
 Point H contains (9,4) the intersection of L2 and L3
 Point B Contains (11, 0)
To identity the maximum (minimum) value we use the corner point approach or the extreme point
approach. The corner point/ extreme point approach has one theorem. It states that:

For problems that have optional solutions, a solution will occur at an extreme, or corner point. Thus if a
problem has a single optional solution, it will occur at a corner point.
If it has multiple optional solutions, at least one will occur at a corner point consequently, in searching for
an optional solution to a problem, we need to consider the extreme points because one of those must be
optional.
Further, determining the value of the objective function at each corner point, we could identify the
optional solution by selecting the corner point that has the best value (i.e. maximum or minimum,
depending on the optimization case) of the objective function. Extreme points represent interactions of
constraints.

67
Determine the values of the decision variables at each corner point. Some times, this can be done by
impaction (observation) and sometimes by simultaneous equation.
Substitute the value of the decision variables at each corner point into the objective function to obtain its
value at each corner point.
After all corner points have been so evaluated, select the one with the highest or lowest value depending
on the optimization case.

COORDINATES
VALUE OF THE OBJECT
CORNER X1 X2 DETERMINED
FUNCTION
POINTS BY Z=60X1 + 50X2
O 0 0 OBSERVATION 0BIRR
A 0 22 OBSERVATION 1100 BIRR
B 11 0 OBSERVATION 660 BIRR
C 13 0 OBSERVATION 780 BIRR
D 25 0 OBSERVATION 1500 BIRR
E 0 10 OBSERVATION 500 BIRR
F 0 13 OBSERVATION 650 BIRR
G 5 8 SIMULTANEOUS 700 BIRR
H 9 4 Simultaneous 740 BIRR
I 5 12 Simultaneous 900 BIRR

BASIC SOLUTION
X1 = 9 X2 = 4 Z = 740 Br.
After we have got the optimal solution, we have to substitute the value of the decision variables into the
constraints and check whether all the resources available are used or not. If there is any unused resource
we can use it for any other purpose. The amount of unused resource is known as slack- the amount of a
scarce resource that is unused by a given solution.
The slack can range from zero, for a case in which all of a particular resource is used; to the original
amount of the resource that was available (i.e. none of it is used.)
Computing the amount of slack

Constraints Originally Used time Unused time (slack)

Available Available to use
Time X1=9 X2=4
Assembly Time 100hr 4(9) + 10(4) = 76 100-76=24hr
68
Inspection Time 22hr 2(9) + 1(4) = 22 22-22=0hr
Storage 39sq.feet 3(9) + 3(4) = 39 39-39=0hr
 Coordinates
Value of object Function
Point X1 Determined by
X2 20X1 +15X2 = 145

O 0 0 Observation
A 0 9.67 Observation 77.3 birr
Constraints that
B 5 3 Simult. equation 49 birr
have no slack
C 14 0 Observation 70 birr
are sometimes
D 7.25 0 Observation 145 birr
referred to as
E 0 4.67 Observation 70.05 birr
binding
constraints since they limit or bind the solution. In the above cases, inspection time and storage space are
binding constraints, while assembly time has slack.

Knowledge of unused capacity can be useful for planning. A manager may be able to use the remaining
assembly time for other products, or, perhaps to schedule equipment maintenance, safety seminars,
training sermons or other activities

Interpretation: The Company is advised to produce 9 units of type 1 micro computer and 4 units of type 2
micro computers per week to maximize its early profit to Br. 740, and in doing so the company would be
left with unused resource of 24 assembly hrs which can be used for other purposes.

Example 2: Solving the diet problem with graphic approach.

C min = 5X1 + 8X2
L1: 10X1 + 30X2  140
L2: 20X1 + 15X2  145
X1, X2  0

69
Basic solution X1 = 5 pounds X2 = 3 pounds C = 49 br.
Interpretation to make the
diet the minimum cost of
br 49 we have to purchase
5 pounds of type 1 food
and 3 pounds type 2 food.

If there is a difference between

the minimum required amount
and the optimal solution, we call
the difference surplus; that is:
surplus is the amount by which the optimal solution causes a  constraint to exceed the required
minimum amount. It can be determined in the same way that slack can: substitute the optimum values of
the decision variables into the left side of the constraint and solve. The difference between the resulting
value and the original right-hand side amount is the amount of surplus.
Surplus can potentially occur in a  constraint.
3.4.2 The Simplex Algorithm/ Algebraic Solution Method
The simplex method is an iterative technique that begins with a feasible solution that is not optimal, but
serves as a starting point. Through algebraic manipulation, the solution is improved until no further
improvement is possible (i.e. until the optional solution has been identified.) Each iteration moves one
step closer to the optional solution.

The optimal solution to a linear programming model will occur at an extreme point of the feasible solution
space. This is true even if a model involves more than two variables; optimal solutions will occur at these
point of the feasible solution space; some will be outside of the feasible solution space. Hence, not every
solution will be a feasible solution. Solutions which represent in fasseetwim of constraints are called basic
solutions; those which also satisfy all of the constraints, including the non-negativity constraints, are
called basic feasible solutions. The simplex method is an algebraic procedure for systematically
examining basic feasible solutions. If an optimal solution exists, the simplex method will identify it. # of
basic solution n + mCm  not all basic solutions are feasible.

70
The simplex procedure for a maximization problem with all  constraints consists of the following steps.
1. Write the LPM in a Standard form: When all of the constraints are written as equalities, the LP
program is said to be in a standard form. We convert the LPM in to a standard form by applying the
slack variables, S, which carries a subscript that denotes which constraint it applies to. For example, S 1
refers to the amount of slack in the first constraint, S 2 to the amount of slack in the second constraint,
and so on. When slack variables are introduced to the constraints, they are no longer inequalities b/c
the slack variable accounts, they become equalities. Further more, every variable in a model must be
represented in the objective function. However, since slack does not provide any real contribution to
the objective, each slack variable is assigned a coefficient of zero in the objective function.
Slack = Requirement – Production,
Surplus = Production – Requirement
Taking the microcomputer problem, its standard form is as follows
Z max = 60X1 + 50X2 Z max = 60X1 + 50X2 + 0S1 + 0S2 + 0S3
4X1 + 10X2  100hr 4X1 + 10X2 + S1 = 100
2X1 + X2  22hr 2X1 + X2 + S2 = 22
3X1 + 3X2  39hr 3X1 + 3X2 + S3 = 39
X1, X2  0 All variables  0
(X1, X2, S1, S2, S3  0)
2. Develop the initial tableau
a. List the variables across the top of the table and write the objective function coefficient of each
variable just above it.
b. There should be one row in the body of the table for each constraint. List the slack variables in the
basis column, one per row.
c. In the Cj column, enter the objective function coefficient of zero for each slack variable.
d. Compute values for row Zj.
Cj = Coeff of variable J in the obj function.
e. Computer values for Cj – Zj.
bj = RHSV of constraint i.
Aij – coefficient of variable j in constraint i

Pivot column Pivot element

71
 Incoming Variable

Solution Cj 60 50 0 0 0 100/4 = 25
leaving
Basis X1 X2 S1 S2 S3 RHSV 22/2 = 11
39/3 = 13
S1 0 4 10 1 0 0 100
S2 0 2 1 0 1 0 22
S3 0 3 3 0 0 1 39
Zj 0 0 0 0 0 0
Cj - Zj 60 50 0 0 0
Initial feasible solution
S1 = 100 Obtained by
S2 = 22 equating tow
S3 =39 Variables to
X1 = 0 Zero
Entering variable X2 = 0 Decision
3. Develop subsequent tables Z = 0 Variable

3.1 Identify the entry variable –variable that has a largest positive value in the Cj – Zj row.
3.2 Identify the leaving variable –using the constraint coefficient or substitution rates in the entering
variable column divide each one into the corresponding quantity value. However do not divide by a
zero or negative value. The smalls non negative ratio that results indicate which variable will leave the
solution
4. Find unique vectors for the new basic variable using row operations on the pivot element.
-1/2 R21 –4R2new + R1old, -3R2new + R3old
Solution Cj 60 50 0 0 0
Cj = bi/xj (aij)
Basics X1 X2 S1 S2 S3 RHSV 56/8 = 7
11/1/2 = 22
S1 0 0 8 1 -2 0 56 6/3/2 = 4
X1 60 1 ½ 0 ½ 0 11
S3 0 0 3/2 0 -3/2 1 6
Zs 60 30 0 30 0 660
Cj – Zj 0 20 0 -30 0

Solution Cj 60 50 0 0 0 RHSV
Basis X1 X2 S1 S2 S3

72
 S1 0 0 0 1 6 -16/3 24
X1 60 1 0 0 1 -1/3 9
X2 50 0 1 0 -1 2/3 4
Zj 60 50 0 10 40/3 740
Opportunity cost
Cj – Zj 0 0 0 -10 -40/3

5. Compute Cj – Zj row
6. If all Cj – Zj Values are zeros and negatives, you have reached optimality
7. If this is not the case (step 6), repeat 2 to 5 until you get optional solution.
“A simplex solution in a maximization problem in optional if the Cj – Zj row consists entirely of zeros
and negative numbers (i.e. there are no positive values in the bottom row.)”
Note: The variables in solution all have unit vectors in their respective columns for the constraint
equations. Further, note that a zero appears in row C – Z in every column whose variable is in
solution, in row C – Z in every column whose variable is in solution, indicating that its maximum
contribution to the objective function has been realized.
Example 2
A manufacture of lawn and garden equipment makes two basic types of lawn mowers; a push type and a
self propelled model. The push type require 9 minutes to assemble and 2 minutes to package; the self-
propelled mover requires 12 minute to assemble and 6 minutes to package. Each type has an engine. The
company has 12hrs of assembly time available, 75 engines, and 5hrs of packing time profits are Birr 70
for the self propelled model and br 45 for the push type mower per unit.
Required:
1. a. To determine how many units of each type of mower to produce so as to maximize profit.
b. Let X1 be push type mower
X2 be self propelled mower
c. Determine the objective function
Z max = 45X1 + 70 X2
d. Identify constraints
9X1 + 12X2  720 minutes ……assembly time
2X1 + 6X2  300 minutes ……..packing time
X1 + X2  75 engine ………….Engines
X1, X2  0

73
 In summary,
Z max = 45X1 + 70X2
S.t. 9X1 + 12X2  720
2X1 + 6X2  300
X1 + 2  75
X1, X2  0
2. a. Write the Lpm in a standard form
Z max = 45X1 + 70X2 + 0S1 + 0S2 + 0S
S.T. 9X1 + 12X2 + S1 = 720
2X1 + 6X2 + S2 = 300
X1 + X2 + S3 = 75
X1 X2, S1, S2, S3  0
b. Develop the initial tableau
Solution C 45 70 0 0 0 RHSV
basis X1 X2 S1 S2 S3
Qij = Bi/aij
S1 0 9 12 1 0 0 720
720/12 = 60
S2 0 2 6 0 1 0 300
300/6 = 50 – Leaving
S3 0 1 1 0 0 1 75 75/1 = 75
Z 0 0 0 0 0 0
C-Z 45 70 0 0 0

Entering

c. Develop the subsequent tableaus

1/6R2, - 1R2new + R3, -12R2new + R1
C 45 70 0 0 0
Solution Basis X1 X2 S1 S2 S3 RHSV
S1 0 5 0 1 -2 0 120
X2 70 1/3 1 0 1/6 0 50
S3 0 2/3 0 0 -1/6 1 25
Z 70/30 70 0 70/6 0 3500
C-Z 65/3 0 0 -70/6 0

74
 Entering

1/5R1, -1/3 R1new + R2old, -2/3R, New + R3 old

C 45 70 0 0 0 Optimal solution
Solution Basis X1 X2 S1 S2 S3 RHSV X1 = 24units

X1 45 1 0 1/5 -2/5 0 24 X2 = 42units

S1 = 0
X2 70 0 1 -1/15 3/10 0 42
S2 = 0
S3 0 0 0 -2/15 1/10 1 9
S3 = 9 engine
Z 45 70 13/3 3 0 4020 Z = 4020
C-Z 0 0 -13/3 -3 0

9X1 + 12X2 = 720 2X1 + 6X2 = 300 X1 + X2 = 75

X1 0 80 X1 0 150 X1 0 75
X2 60 0 X2 50 0 X2 75 0
X2
120
9X1 + 12X2 = 720
100 2X1 + 6S2 = 300
9(150 – 3X2) + 12X2 = 720
80 1450 – 27X2 + 12X2 = 720
730 = 15X2
X2 = 730/15
60 9X1 = 720 – 4 (730/3)
9X1 + 12X2 = 720
E
40
D
20
C 2X1 + 6X2 = 300

0 20 40 60 B 80 100 120 140 X1

A

Coordinates How determinable? Profit

Points X1 X2 45X1 + 70X2

A 0 0 observation 45(0) + 70(0) = 0
B 75 0 observation 45(75) + 70(0) = 3375
C 60 15 simultaneous 45(60) + 70 (15) = 3750
D 24 42 simultaneous 45 (24) + 70 (42) = 4020

75
 E 0 50 observation 45(0) + 70 (50) = 3500

X1 = 24 b) 2 (24) + 6 (42) =300

X2 = 42
Z = br. 4020 c) 24 + 42 = 75
66
Constraints
a) (24) + 12(42) = 720 75 – 66 = 9
S3 = 9

Interpretation: The company is advised to produce 24 units of push type mower and 40 units of self-
propelled mowers so as to realize a profit of Br. 4020. in doing so, the company would be left with unused
resource of engine which can be used for other purposes.

Exercises
1. Firm manufactures three products which must be processed through some of or all four
departments. The table below indicates the number of hours a unit of each product requires in the
different departments and the number of pounds of raw materials required. Also listed are the cost
per unit, selling price, and weekly capacities of both work-hours and raw materials. If the objective
is to maximize total weekly profit, formulate the linear programming model. (Only the model)
Weekly
Product A Product B Product C Availability
Department 1 3 4 2 120 hours
Department 2 2 2 100 hours
Department 3 4 1 80 hours
Department 4 2 3 6 150 hours
Pounds of raw 5 4 3 250 pounds
Material per unit
Selling price $ 50 $ 60 $ 65
Cost / unit 41 40 43

76
 2. Solve the following linear programming problem
(a) (Use simplex method)
Z max. 40X1 + 32X2
Subject to
40X1 + 20X2  600
4X1 + 10X2  100
2X1 + 3X2  38
X1, X2 0
(b) C min. : 50X1 + 80X2
Subject to
20X1 + 30X2 1400
10X1 + 40X2 1200
X1 , X2  0
(Use the graphic method)
(c) Z max: X1 + 1.2X2 + 2X3
Subject to
X1 + 2X2  150
X1 + 2X3  150
2X1 + X2  80
2X1 + 3X2 + X3  225
X1X2X3  0
(Use the simplex method)

Solutions

(1) * Problem: Determine the number of three products (A, B, & C) that must be
produced and sold in order to maximize the total weekly profit of the firm,
given the different limiting factors.
77
 * Let, X1 = the number of product A, that must be produced & sold
X2 = the number of product B, that must be produced & sold
X3 = the number of product C, that must be produced & sold

* Objective function: profit maximization

Z max = 9X1 + 20X2 + 22X3

* Constraints:
 Production time constraints: 3X1 + 4X2 + 2X3  120
 Production time constraints 2X2 + 2X3  100
 Production time constraints 4X1 + X2  80
 Production time constraints 2X1 + 3X2 + 6X3  150
 Raw material constraints: 5X1 + 4X2 + 3X3  250

* Non-negative restrictions: X1, X2, X3 0

 Therefore, Z max: 9X1 + 20X2 + 22X3

Subject to:
3X1+ 4X2+2X3  120
2X2 + 2X3  100
4X1 + X2  80
2X1 + 3X2 + 6X3  150
5X1 + 4X3 +3X3  250
X1, X2, X3  0

(2) a. * Problem: determining the number of bentwood rocking chairs and bentwood
coffee tables that must be manufactured in order to maximize the total profit,
given the different limiting factors.

* Let, X1 = the number of bentwood rocking chairs that must be manufactured &
sold
X2 = the number of bentwood coffee tables that must be manufactured &
sold
78
 * Objective function: profit maximization
Z max = 40X1 + 32X2
* Constraints
 Raw material const. (Rosewood): 40X1 + 20X2  600
 Wood working hour const. 4X1 + 10X2  100
 Finishing hour constraint 2X1 + 3X2  38

* Non-negative restrictions: X1, X2  0

 Therefore, Z max = 40X1 + 32X2
Subject to:
40X1 + 20X2  600
4X1 + 10X2 100
2X1 + 3X2  38
X1 , X2  0

Standard form
Z max = 40X1 + 32X2 + OS1 + OS2 + OS3
Subject to:
40X1 + 20X2 + S1 = 600
4X1 + 10X2 + S2 = 100
2X1 + 3X2 + S3 = 38
X1 , X2 ,S1 , S2, S3, 0

Initial Table

Soln. Cj 40 32 0 0 0 Quantity
bases X1 X2 S1 S2 S3 (RHSV) Q/X1
S1 0 40 20 1 0 0 600 15
S2 0 4 10 0 1 0 100 25
S3 0 2 3 0 0 1 38 19
Zj 0 0 0 0 0 0
j = Cj – Zj 40 32 0 0 0
1/40 R1 / -4R1 new + R2 old / / -2R1 new + R3 old

79
 Soln. Cj 40 32 0 0 0 quantity
bases X1 X2 S1 S2 S3 (RHSV) Q/X2
X1 40 1 ½ 1/40 0 0 15 30
S2 0 0 8 –1/10 1 0 40 5
S3 0 0 2 –1/20 0 1 8 4
Zj 40 20 1 0 0 600
j =Cj- Zj 0 12 –1 0 0
1/2 R3 / -1/2R3 new + R1 old / -8R3 new + R3 old

Soln. Cj 40 32 0 0 0 (Quantity)
bases X1 X2 S1 S2 S3 (RHSV)
X1 40 1 0 3/80 0 –1/4 13
S2 0 0 0 1/10 1 –4 8
X2 32 0 1 –1/40 0 ½ 4
Zj 40 32 7/10 0 6 648
j = cj –zj 0 0 –7/10 0 –6
 Since, the numbers in j = cj – zj row are all 0 & Negative it shows that this solution
is optimal solution.
X1 = 13 , X2 = 4, S2 = 8 (unused) hours Z max = $ 648

 Proof for Question No. 2 by Graphic Method

* 40X1 + 20X2 = 600 X1 0 15
X2 30 0

* 4X1 + 10X2 = 100 X1 0 25

X2 10 0
* 2X1 + 3X2 = 38
X1 0 19

X2 12.7 0

T D V Remar

80
 Coordinate he Entries etermined by alue of k
points X1 X2 O.F
40X1 +
32X2
O 0 0 Intercept 0 Useful to compare b/s it is corner
A 0 30 Intercept 960 Not useful b/s it is not corner
B 0 12.7 Intercept 406.4 Not useful b/s it is not corner
C 0 10 Intercept 320 Useful to compare b/s it is corner
D 15 0 Intercept 600 Useful to compare b/s it is corner
E 19 0 Intercept 760 Not useful b/s it is not corner
F 25 0 Intercept 1000 Not useful b/s it is not corner
G 12. 5 Elimination 660 Not useful b/s it is not corner
5
H 10 6 Elimination 592 Useful to compare b/s it is corner
I 13 4 Elimination 648 Useful to compare b/s it is corner

Point H
4X1 + 10X2 = 100 4X1 + 10(6) = 100
-2 2X1 + 3X2 = 38 4X1 + 60 = 100
4X1 + 10X2 = 100 4X1 = 100 – 60
-4X1 – 6X2 = -76 4X1 = 40
4X2 = 24 4 4
4 4
X2 = 6 X1 = 10

Point I
40X1 + 20X2 = 600 40X1 + 20 (4) = 600
-20 2X1 + 3X2 = 38 40X1 + 80 = 600
40X1 + 20X2 = 600 40X1 = 600 - 80
-40X1 – 60X2 = -760 40X1 = 520
-40X2 = -160 40 40
-40 –40
X2 = 4 X1 = 13

Point G
40X1 + 20X2 = 600 40X1 + 20 (5) = 600
-10 4X1 + 10X2 = 100 40X1 + 100 = 600
40X1 + 20X2 = 600 40X1 = 600 - 100
-40X1 – 100X2 = -1000 40X1 = 500
-80X2 = -400 40 40
-80 –80
X2 = 5 X1 = 12.5

81
Interpretation
It is advisable for the company to produce 13 units of bentwood rocking chairs and 4 units coffee tables
and maximize its profit to birr 648, by doing so the company may be left with 8 unused wood working
hours, therefore, the company can use these unused hours for other purposes.
(b) * Problem: determine the number of two types of tiers that must be produced by the two machines
(M I & M II) in order to minimize costs of operating the machines.
* Let X1 = the number of tiers that must be produced by M I
X2 = the number of tiers that must be produced by M II
* Objective function: cost Minimization
Z min = 50X1 + 80X2
* Constraints:
 Grade A tiers constraints: 20X1 + 30X2  1,400
 Grade B tiers constraints: 10X1 + 40X2  1,200

* Non-negative restrictions X1 , X2  0
 Therefore, Z min = 50X1 + 80X2
Subject to:
20X1 + 30X2 1,400
10X1 + 40X2 1,200
X1, X2  0
 Solution for Question No. 3 Graphic Method
* 20X1 + 30X2 = 1,400
X1 0 70
X2 46.7 0

* 10X1 + 40X2 = 1,200

X1 0 120
X2 30 0

82
 The Entries
Coordinate Determined Value of
Remark
points X1 X2 by 50X1 + 80X2

O 0 0 Intercept 0 Useful to compare b/s it is corner

A 0 46.7 Intercept 3736 Not useful b/s it is not corner
B 120 0 Intercept 6000 Not useful b/s it is not corner
C 70 0 Intercept 3500 Useful to compare b/s it is corner
**D 40 20 Intercept 3600 Useful to compare b/s it is corner
E 0 30 Intercept 2400 Useful to compare b/s it is corner

* Point D
20X1 + 30X2 = 1400  in order to Minimize
-2 ( 10X1 + 40X2 = 1200) costs of operating the Machines
20X1 + 30X2 = 1400 M I  has to produce 40 tires
-20X1 + 80X2 = -2400 M II  has to produce 20 tires
-50X2 = -1000 Z min = 3600
50 50
X2 = 20
10X1 + 40 (20 = 1200
10X1 + 800 = 1200
10X1 = 1200 – 800
X1 = 40

10 ½ R2 / -R2new + R4 old

Soln Cj 1 1.2 2 0 0 0 0 Quantity Q/x2

83
bases X1 X2 X3 S1 S2 S3 S4
(RHSV)
S1 0 1 2 0 1 0 0 0 150  75
X3 2 ½ 0 1 0 ½ 0 0 75 75 
S3 0 2 1 0 0 0 1 0 80  80
S4 0 3/2 3 0 0 -1/2 0 1 150 225 50
Zj 1 0 2 0 1 0 0 150
 j = Cj - Zj 0 1.2 0 0 -1 0 0

1/3 R4 / -R4 New + R3 old / -2R4 new + R1 old

Soln Cj 1 1.2 2 0 0 0 0 Quantity
bases X1 X2 X3 S1 S2 S3 S4 (RHSV)
S1 0 0 0 0 1 1/3 0 -2/3 150
X3 2 ½ 0 1 0 ½ 0 0 75
S3 0 1 0 0 0 1/6 1 -1/3 30
X2 1.2 1/2 1 0 0 -1/6 0 1/3 50
Zj 1.6 1.2 2 0 0.8 0 0.4 210
 j = Cj - Zj -0.6 0 0 0 -0.8 0 -0.4

 since there is no positive number in Aj = Cj – Z raw we can suggest that we reach the optimum
solution therefore, X2 = 50
X3 = 75
S1 = 50
S3 = 30
and Zj = 210
Problems to be accounted out of 20%
Use the three steps graphical proceder to find the optimum , as required , assuming x ≥0 and y≥ 0 :
g) Subject to 4x + 3y ≤ 24.
x + 2y ≤ 11.
Find өmax if:
a) ө= x + y b) ө= x + 3y c) ө= 3x + y d) ө= 2x + 1.5y
h) Subject to x + y ≤ 30
x + 2y ≤ 22
2x + y ≤ 2
x ≤4

84
 Find өmax if:
a) ө= 5x + 8y b) ө= 4x -y c) ө= -2x + 7y d) ө= 5x + 10y

i) Subject to 4x + 5y ≥ 30
3x + 2y ≥ 19.
Find өmin if:
a) ө= 2x + 8y b) ө= 4x + 2y c) ө= 2x + 2y d) ө= 8x + 10y
4) Suppose that Steel Company manufactures two kinds of wrought-iron rails: Model E, the elegant, and
Model D the Distinctive. Model E rails sell for $ 59 and cost $50 to make, whereas Model D rails sell for
$ 48 and costs $41 to make. To make one Model E rails requires 2 hours on Machine A, 1 hour on
Machine B and 4 hours on Machine C.

On the other hand, to make one Model D rails requires 1 hours on Machine A, 1 hour on Machine B and 4
hours on A , 2 hours on B, and 5 hour on C. Production scheduling indicates that during the coming week
Machine A will be available for at most 30 hours, Machine for at most 24 hours, and Machine C for at
most 72 hours.
Find the number of each kind of rail to be made in the coming week in order for the company to maximize
its profit. What is this maximum profit? At maximum which machine, if any, are not fully utilized?

UNIT FOUR
MATHEMATICS OF FINANCE

Contents
4.0 Aims and Objectives
4.1 Introduction
4.2 Interests
4.2.1 Simple Interest
4.2.2 Compound Interest
4.3 Effective Rate
4.4 Annuities
4.4.1 Ordinary Annuity
4.4.2 Sinking of Fund
4.4.3 Amortization
4.4.4 Mortgage

85
 4.5 Exercise/Problems
4.6 Solution to the Exercise / Problem

4.0 Aims and Objectives

After studying this unit, you should be able to:
 tell how simple interest differ from compound interest;
 use annuity formula to solve business and economics problems which involve finance;
 analyze and solve mortgage problems;
 analyze future and present value of money (sum of money and/or an annuity) and
 Solve sinking fund and amortization problems.
4.1 Introduction
Dear students! The basic concept of mathematics of finance is that money has time value which is
described either as present value or future value. Present value is the value of money today; future value
is the value of money at some point in the future. The difference between money now and the same money
in the future is called interest.

Interest have a wide spread influence over decisions made by businesses and every of us in our personal
lives. Therefore, the basic objective of this unit is to discuss interest rates and their effects on the value of
money. Specifically, it covers simple interest, compound interest, annuity and mortgage problems.

4.2 Interests
Interest is the price paid for the use of a sum of money over a period of time. It is a fee paid for the use of
another’s money, just rent is paid for the use of another’s house. A savings institution (Banks) pays
interest to depositors on the money in the savings account since the institutions have use of those funds
while they are on deposit. On the other hand, a borrower pays interest to a lending agent (bank or
individual) for use of the agent’s fund over the term of the loan.

Interest is usually computed as percentage of the principal over a given period of time. This is called
interest rate. Interest rate specifies the rate at which interest accumulates per year through out the term of
the loan. The original sum of money that is lent or invested/ borrowed is called the principal.

Interests are of two types: simple interest and compound interest. In the first part of this unit we shall
explore these two concepts

4.2.1 Simple Interest

86
If interest is paid on the initial amount of money invested or borrowed only and not on subsequently
accrued interest, it is called simple interest. The sum of the original amount (principal) and the total
interest is the future amount or maturity value or in short amount. Simple interest generally used only
on short-term loans or investments –often of duration less than one year. Simple interest is given by the
following formula.

I = prt ….. ---------------------------------- (1)

Where: I = Simple interest
P = principal amount
r = Annual simple interest rate
t = time in years, for which the interest is paid
If any three of the four variables are given, you can solve for the fourth (unknown variable) and their
relationship is as follows:

Amount (A) = P + I
= P + Prt.
= P (1 + rt) ……………………. (2)
A
P = 1  rt …………………..… (3)
r = I/pt………………………….. (4)
t = I/pr ……………………….… (5)

Example 1
Ato Megra Guluma wanted to buy TV which costs Br. 10, 000. He was short of cash and went to
Commercial Bank of Ethiopia (CBE) and borrowed the required sum of money for 9 months at an annual
interest rate of 6%. Find the total simple interest and the maturity value of the loan.

Solution:
p = Br. 10,000 A=P+I
t = 9 months = 9/12 = ¾ year = P (1 + rt)
r = 6% per year = 0.06 = 10, 000 (1 + 0.06 x ¾)
I=? A=? = 10, 000 x 1.045

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 Interest (I) = Prt = Br. 10, 450
= 10, 000 x 0.06 x ¾
= Br. 450
The total amount which will have to be repaid to CBE at the end of the 9 th month is Br. 10, 450
(the original borrowed amount plus Br. 450 Interest).
** Note: It is essential that the time period t and r be consistent with each other. That is if r is expressed as
a percentage per year, t also should be expressed in number of years (number of months divided by
12 if time is given as a number of months). If time is given as a number of days, then t =
No.ofdays
360 days . This approach is known as ordinary interest year method which uses a 360 day

years, whereas if we use 365 days years the approach is called exact time method.
Example 2
How long will it take if Br. 10, 000 is invested at 5% simple interest to double in value?
Solution
Given: p = Br.10, 000 I = prt Divide both sides of the
r = 10% = 0.10
equation by pr and solve
A = Br.20, 000 (2 x 10, 000) t = I/pr
10,000
t=? = 10,000 (0.10)
= 10 Years
I = Amount (A) – principal (p)
= 20, 000 – 10, 000

= 10,000
Therefore it will take 10 years for the principal (Br. 10, 000) to double itself in value if it is invested at
10% annual interest rate.

Example 3
How much money you have to deposit in an account today at 3% simple interest rate if you are to receive
Br. 5, 000 as an amount in 10 years?
Solution

88
 A
A = Br. 5, 000
P = 1  rt
t = 10 Years
5,000
r = 3% = 0.03
= 1  (0.03 x 10)
P=?
= Br. 3, 846.15
In order to have Br. 5, 000 at the end of the 10th year, you have to deposit Br. 3846.15 in an account that
pays 3% per year.
Example 4.
At what interest rates will Br. 5, 000 yield Br. 2, 000 in 8 years time.
Solution:
P = Br. 5, 000 r = I/pt
2, 000
I = Br. 2, 000 = 5, 000 x 8
t = 8 years = 0.05 = 5%
r=?
Example 5.
Find the Interest on Br. 5, 000 at 10% for 45 days.
Solution:
P = Br. 5, 000 I = Prt
t = 45 days = 45/360 years = 5, 000 x 0.1 x 45/360
r = 10% = 62.50 Br.
I=?

Try Your Self:

At what interest rate you should invest Br. 5000, if you want to receive an amount of Br. 7,000 in 8 years
time.
Answer = 5%
4.2.2 Compound Interest
If the interest, which is due, is added to the principal at the end of each interest period (such as a month,
quarter, and year), then this interest as well as the principal will earn interest during the next period. In
such a case, the interest is said to be compounded. The result of compounding interest is that starting with

89
the second compounding period; the account earns interest on interest in addition to earning interest on
principal during the next payment period. Interest paid on interest reinvested is called compound interest.

The sum of the original principal and all the interest earned is the compound amount. The difference
between the compound amount and the original principal is the compound interest.

The compound interest method is generally used in long-term borrowing unlike that of the simple interest
used only for short-term borrowings. The time interval between successive conversions of interest into
principal is called the interest period, or conversion period, or Compounding period, and may be any
convenient length of time. The interest rate is usually quoted as an annual rate and must be converted to
appropriate rate per conversion period for computational purposes. Hence, the rate per compound period i
is found by dividing the annual nominal rate r by the number of compounding periods per year m:
i = r/m

Example if r = 12%, i is calculated as follows:

Conversion period (m) Rate per compound period (i)
1. Annually (once a year) -------------------------------- i = r/1 = 0.12/1 = 0.12
2. Semi annually (every 6 months) --------------------- i = r/2 = 0.12/2 = 0.06
3. Quarterly (every 3 months) -------------------------- i = r/4 = 0.12/4 = 0.03
4. Monthly ------------------------------------------------- i = r/12 = 0.12/12 = 0.01

Example 1
Assume that Br. 10, 000 is deposited in an account that pays interest of 12% per year, compounded
quarterly. What are the compound amount and compound interest at the end of one year?

Solution
P = Br. 10, 000
r = 12%
t = 1 year
m = number of conversion periods = 4 times per quarter. This means interest will be computed
at the end of each three month period and added in to the principal.
i = r/m =12%/4 = 3%

In general, if p is the principal earning interest compounded m times a year at an annual rate of r, then (by
repeated use of the simple interest formula, using i = r/m, the rate per period, the amount A at the end of
each period is:

90
 (1) A = p (1 + i)………………compound amount at the end of first period.
If we are interested in determining the compound amount after two periods, it may be computed
using the equation:
(2) Compound amount = Compound amount + Interest earned during
after two periods after one period the 2nd period

A = p (1 + i) + [P (1 + i)]i
= P [1 + i +(1 + i)i]
= P (1 + i)2
(3) Compound amount = Compound amount + Interest earned
after three periods after two period during the 3rd period
A = P(1 + i)2 + [P (1 + i)2] (i)
A = P(1 + i)2 [ 1 + i]
A = P(1 + i)3
(4) Compound amount a fter nth period = P (1 + i)n
The compound amount formulas developed so far are summarized below:
1. Compound amount after one period = p (1 + i)1
2. Compound amount after two periods = p (1 + i)2
3. Compound amount after three periods = p (1 + i)3
4. Compound amount after nth periods = p (1 + i)n
* Compound amount formula.
A = P (1 + i)n Where: A = amount (future value) at the end of n periods.
P = Principal (present value)
i = r/m = Rate per compounding period.
n = mt = total number of conversion periods
t = total number of years
m = number of compounding/ conversion periods per
Year
r = annual nominal rate of interest
Now let us solve the above problem.
A = 10, 000 (1.03)1 = Br. 10, 300……..1st quarter
A = [10, 000 (1.03)] (1.03) = 10, 000 (1.03)2 = 10, 609 …….2nd quarter.
A = [10, 000 (1.03)2] (1.03) = 10, 000 (1.03)3 = 10, 927.27 …….3rd quarter.
A = [(10, 000) (1.03)3] (1.03) = 10, 000 (1.03)4 = 11, 255.088 ……..4th quarter.
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In general, the compound amount can be found by multiplying the principal by (1 + i) n. So for the above
problem the amount at the end of the year, using the general formula, is equal to:
A = P (1 + i)n n = mt = 4 x 1 = 4
= 10, 000 (1.03)4 i = r/m = 12%/4 = 3%
= Br. 11, 255.088

Compound Interest = Compound amount – original principal

= 11, 225.088 – 10, 000
= Br. 1, 255.088

We may evaluate “A” in several different ways. Among the possible alternatives are:
1. Use a hand-held calculator with a Yx function key. This is the procedure most often used.
2. Using Logarithms
Restate the equation by finding for log A (or In A) and then finding the antilog, using either a hand-

held calculator with logarithmic functions or a table of logarithms. Let us illustrate this alternative.

A = 10, 000 (1.03)4

log A = log 10, 000 + log (1.03)4
= log 10,000 + 4 log 1.03
= log 104 + 4 log 1.03
= 4 + 4(0.01284)
= 4(1 + 0.01284)
= 4(1.01284)
= 4.05135
A = Antilog 4.05135
= Br. 11255.117

Basic rules of logarithm

1. ax = b log ax = log b , Exa.. 2x = 5  log 2x = log 5
x log a = log b  x log 2 = log 5
x = log b/ log a x = log 5/ log2
x = 2.322
2. abx + c = d
abx = d – c
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 bx = (d – c)/a
d c
( )
log bx = log a
dc
x log b = log k , put: a = K
log k
X = log b ,dividing both side by log b.
Eg. If 4 (3x) + 10 = 18, the value of x.
4 (3x) = 18 – 10
4 (3x) = 8
3x = 2
log 3x = log 2
x log 3 = log 2
log 2
x = log 3
= 0.63093
3. x3 = a Eg. x3 = 1, 000
logx3 = log a log x3 = log 1, 000
3 log x = log a 3 log x = log 103
log a
log x = 3 log x = 3/3
log a
x = Antilog k Letting k= 3 ; log x = 1
x = Antilog 1
x = 10
4. If a = b (c + x)d , find the value of x.
(c + x)d = a/b
log (c + x)d = log a – log b
d log (c + x) = log a - log b
log a  log b
log (c + x) = d
log a  log b
log (c + x) = k ,Letting : d =k
c + x = Antilog k
x = Antilog k - C

Eg. 1, 000 = 250 (5 + x)5

93
 1,000
(5 + x) = 250 = 4
5

log (5 + x)5 = log 4

5 log (5 + x) = log 4
log 4
log (5 + x) = 5
log (5 + x) = 0.120412
x = antilog 0.120412 – 5
= 1.319508 – 5
= -3.6805

3. The third way of finding the compound amount is using specially prepared tables which provides
values of (1 + i)n for selected values of i and n.

Therefore, to calculate the value of “A” or other variables in the compound interest formula, you can use
any of these three approaches which ever convenient to you.

Example 2. Find the compound amount and compound interest after 10 years if Br. 15, 000 were invested
at 8% interest;
a) If compounded annually
Compounding annually means that there is one interest payment period per year. Thus
t = 10 years
m=1
n = mt = 1 x 10 = 10
i = r/m = 8 %/1 = 8% = 0.08
The compound amount will be:
A = 15, 000 (1.08)10
= 15, 000 (2.158925)
= Br. 32, 383.875
 Compound Interest = compound amount (A) – Principal (P)
= 32, 383.875 – 15, 000
= Br. 17, 383.875

b) If compounded semiannually

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 Compounding semiannually means that there are two times interest payments per year. Thus, the
number of payment periods in 10 years n = 2 x 10 = 20 and the interest rate per conversion period
will be i = r/m = 8%/2 = 4%.

The compound amount then will be:

A = P (1 + i)n
= 15, 000 (1.04)20
= 15, 000 (2.191123)
= Br. 32, 866.85
Compound Interest = A – P
= 32, 8666.85 – 15, 000
= Br. 17, 866.85
c) If Compounded quarterly
If compounding takes place quarterly (four times a year), then an 8% annual interest rate, the
interest rate per conversion period will be i = 0.08/4 = 0.02, there will be a total of n = 4 x 10 = 40
conversion periods over the 10 years. The compound amount will be:
A = 15, 000 (1.02)40
= 15, 000 (2.208039)
= Br. 33, 120.60

d) If compound monthly
p = 15, 000
t = 10 years
m = 12 (12 payment periods per year)
n = 12 x 10 = 120 payment periods over the 10 years
i = r/m = 8%/12 = 0.667% = 0.00667
Under these conditions:
A = 15, 000 (1. 00667)120
= 15, 000 (2.220522)
= Br. 33, 307.84
Interest = Br. 18, 307.84 =(33,307.84
=(33,307.84 – 15,000)
e) If compounded weekly
m = 52

95
 n = 10 x 52 = 520
i = 8%/52 = 0.154% = 0.00154, then
A = 15, 000 (1.00154)520
= Br. 33, 362.60
Interest = 33,362.60 – 15,000
= 18,362.60

f) Try your self: if Compounded daily, and hourly, what will be the compound amount respectively?
Answer = Br. 33,380.19 and Br. 33, 382.99 respectively.

g) If compounded continuously (Instantaneously),

(Instantaneously), what happens to the compound amount if interest
is compounded continuously? To derive a formula for continuous compound interest, we begin by
writing:
(1 + i)n = (1 + r/m) mt , where n=mt
Then, by inserting 1 = r/r in the exponent, we obtain
(1 + r/m)mt (r/r) = (1 + r/m) (m/r). (rt)
Then, letting m/r = x, we have
(1 + i)n =[(1 + 1/x)x] rt
As x increases indefinitely, the term (1 + 1/x)x approaches the value of the familiar mathematical
constant e = 2.7182818……. This means that the factor
(1 + i)n = [(1 + 1/x)x]rt approaches ert as n increases indefinitely.
The resulting formula for the amount under continuous compounding of interest is given by:
………………..**
Where: A= amount at the end of time t under continuous compounding
p = principal
r = annual rate, compounded continuously
t= time, in years
A = P ert
Note: the value of ert may be found using a calculator.
Example:- p = Br. 15, 000 A = P ert
t = 10 years = 15, 000 (e0.08 x 10)
A=? = 15, 000 x e 0.8
= 15, 000 x 2.22554
= Br. 33, 383.11

96
 Compound Interest = 33, 383.11 – 15, 000
= Br. 18, 383.11
What can you observe from the above discussion? When a number of conversion period within a year
increases, the interest earned also increases continuously towards an upper limit. The limiting case occurs
where interest is compounded continuously.

Example 3.
How long it takes to accumulate Br. 8, 000 if you invest Br. 6, 000 at 12% compounded monthly?

Solution:
P = Br. 6, 000 A = P (1 + i)n
A = Br. 8, 000 8000 = 6000 (1.01)n
r = 12% we can use logarithm to solve this problem
8000
i = r/m = 12%/12=1%= 0.01 6000 = (1.01)n
t =? and n?

log 1.3 3 = Log(1.01)n

log 1.3 3 = n log 1.01
log 1.33
n = log1.01 n = 28.92  29 months
It takes 29 months for Br. 6000 invested at 12% to grow to Br. 8000
The present value
Frequently it is necessary to determine the principal P which must be invested now at a given rate of
interest per conversion period in order that the compound amount A be accumulated at the end of n
conversion periods. Under these conditions, p is called the present value of A. This process is called
discounting and the principal is now a discounted value of future income A.
If A = P (1 + i)n then dividing both sides by (1 + i)n leads to
A
n
P = (1  i ) = A (1 + i)-n
P = A (1 + i) -n ……… …… Present value of compound amount.

Example 4:- How much should you invest now at 8% compounded semiannually to have
Br. 10, 000 toward your brother’s college education in 10 years?
Solution:-
Solution:-

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 A = Br. 10, 000 P = A (1 + i)-n
t = 10 years = 10, 000 (1.04)-20
m=2 = 10, 000 (0.456387)
n = mt = 20 = Br. 4,563.87
r = 8%
i = r/m = 4% = 0.04
p=?

4.3 Effective Rate

An effective rate is the simple interest rate that would produce the same return in one year had the same
principal been invested at simple interest without compounding. In other words, the effective rate r
converted m times a year is the simple interest rate that would produce an equivalent amount of interest in
one year. It is denoted by re.
If principal p is invested at an annual rate r, compounded m times a year, then in one year,
A = P (1 + r/m)m
What simple interest rate will produce the same amount A in one year? We call this simple interest rate
the effective rate. To find re we proceed as follows:

(Amount at simple interest after 1 year) = (Amount at compound interest after 1 year)
P 1 + Pre=P(1 + re) = p (1 + r/m)m
1 + re = (1 + r/m)m ………….. Dividing both sides by p.

re = (1 + r/m)m - 1
…………*isolating re on the left side gives you effective
interest rate formula.
Where: r = nominal annual rate of interest
m = number of conversion periods per year.
re = er - 1
……………………..putting (1 + r/m)m =er
This is effective interest rate in continuous compounding.
Example 5. An investor has an opportunity to invest in two investment alternatives A and B which pays
15% compounded monthly, and 15.2% compounded semi-annually respectively. Which
investment is better investment, assuming all else equal?
Solution

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Nominal rate with different compounding periods cannot be compared directly. We must find the effective
rate of each nominal rate and then compare the effective rates to determine which investment will yield
the larger return.
Effective rate for investment A Effective rate for Investment B
r = 15% r = 15.2%
m = 12 m=2
i = 1.25% = 0.0125 i = 7.6% = 0.076
reA = (1 + i)m – 1 reB = (1.076)2 - 1
= (1.0125)12 – 1
= 16.076% = 15.778%
Since the effective rate for investment A=16.076% is greater than the effective rate for investment B
=15.778%, A is the preferred investment alternative.
Example 6. What is the effective rate corresponding to a nominal rate of 16% compounded quarterly?
re = (1 + 0.16/4)4 -1
= (1.04)4 –1
= 1.169859 – 1 = 16.99%

4.4 Annuities
An annuity is any sequence of equal periodic payments. The payments may be made weekly, monthly,
quarterly, annually, semiannually or for any fixed period of time. The time between successive payments
is called payment period for the annuity. If payments are made at the end of each payment period, the
annuity is called an ordinary annuity.
annuity. If payment is made at the beginning of the payment period, it is
called annuity due.
due. In this course we will discuss only ordinary annuities. The amount, or future value, of
an annuity is the sum of all payments plus the interest earned during the term of the annuity.

The term of an annuity refers to the time from the begging of the first payment period to the end of the
last payment period.

4.4.1 Ordinary Annuity

An ordinary annuity is a series of equal periodic payments in which each payment is made at the end of
the period. In an ordinary annuity the first payment is not considered in interest calculation for the first
period because it is paid at the end of the first period for which interest is calculated. Similarly, the last
payment does not qualify for interest at all since the value of the annuity is computed immediately after
the last payment is received.

99
Future value (Amount) of an ordinary annuity:
Example1.
Example1. What is the amount of an annuity if the size of each payment is Br. 100 payable at the end of
each quarter for one year at an interest rate of 4% compounded quarterly?

Solution
Periodic payment (R) = Br. 100
Payment interval (Conversion period) = quarter
Nominal (annual rate) r = 4%
Interest per conversion period (i) = r/m = 4%/4 = 1%
Future value of an annuity = ?

  Periods (quarter)
Now 1 2 3 4
Br. 0 Br.100 Br. 100 Br. 100 Br. 100 Amount
Br. 100
Br. 100 (1.01)1
Br. 100 (1.01)2
Br. 100 (1.01)3
Future value (sum) = 406.04 Br.
Compound interest = Amount – R(n)
= 406.04 – 100 (4)
= Br. 6.04
If R represents the amount of the periodic payment, i represents the interest rate per payment period, and n
represents the number of payment periods, then

R R R -------- R R
Periods
0 1 2 3 ------- n-1 n
The first payment of R accumulates interest for n-1 periods, the second payment R for n – 2 periods etc.
The last payment accumulates no interest, the next to last payment accumulates one period for interest. So
using the future value for compound interest we see the future value of the annuity:
A = R (1 + i) n-1 + R (1 + i)n-2 + ………..+ R (1 + i)1 + R….Equation 1
Multiplying each side of the equation by (1 + i), we obtain
A (1 + i) = R (1 + i)n + R (1 + i)n-1 + ……….+ R(1 + i)2 + R (1 + i) …… Eg. 2.
100
 Then subtracting the first equation (eq. 1) from the second equation (eq. 2), gives you:
A (1 + i) = R (1 + i)n + R (1 + i)n-1 + …….+ R (1 + i)2 + R (1 + i)
- A = R (1 + i)n-1 + ……..R (1 + i)2 + R(1 + i) + R
A (1 + i) – A = R (1 + i) n – R
A [(1 + i)-1] = R [(1 + i)n –1]
A (i) = R[(1 + i)n –1] Dividing both sides by i, we have

 R 1  i n 1
 
 i  ………………..* Amount of an ordinary annuity
A=

Where: A = Amount (future value) of an ordinary annuity at the end of its term
R = Amount of periodic payment
i = interest rate per payment period
n = (mt) total no. of payment periods
Solve the above problem (example 1) using the annuity formula:
100 1.04 4  1
 
 0.04 
A=
= Br. 406.04
Example 2. Mr X. Deposits Br. 100 in a special savings account at the end of each month. If the account
pays 12%, compounded monthly, how much money, will Mr. X have accumulated just after 15th deposit?
Solution:
 (1  i ) n 1
R = Br. 100  
 1 
n = 15 A=R

r = 12%  (1.01)15 1

 
 0.01 
m = 12 = 100
i = r/m = 12%/12 = 1% = 100 (16.096896)
A=? = Br. 1609. 69
Example 3. A person deposits Br. 200 a month for four years into an account that pays 7% compounded
monthly. After the four years, the person leaves the account untouched for an additional six
years. What is the balance after the 10 year period?
Solution:

101
 R = Br. 200 Amount after 4 years
t = 4 years
m = 12
n = mt = 4 x 12 = 48
r = 7%
i = 7%/12 = 0.07/12
After the end of the fourth year, we calculate compound interest rate taking Br. 11, 041.85 as principal
compounded monthly for the coming 6 years.
p = 11, 041.85 A10 = 11, 041.85 (1 + 0.07/12)72
t = 6 years = 11, 041.85 (1.5201
m = 12 = Br. 16, 784.77
n = 6 x 12 = 72
r = 7%
i = r/m = 7%/12 = 0.07/12
A10 = ?
Therefore, the balance after 10 years is Br. 16, 784.77.
4.4.2 Sinking Fund
A sinking fund is a fund into which equal periodic payments are made in order to accumulate a definite
amount of money up on a specific date. Sinking funds are generally established in order to satisfy some
financial obligations or to reach some financial goal.

If the payments are to be made in the form of an ordinary annuity, then the required periodic payment into
the sinking fund can be determined by reference to the formula for the amount of an ordinary annuity.
That is, if:
 (1  i ) n 1
 
i
A = R  then,
A
(1  i ) n  1
R= i

 i 
 n 
(1  i ) 1
=A 
 (1  0.07 / 12) 48  1
 
0.07 / 12
(A4)= 200  
= 200 (55.20924) 102

= Br. 11, 041.85

Example 4. How much will have to be deposited in a fund at the end of each year at 8% compounded
annually, to pay off a debt of Br. 50, 000 in five years?
Solution:
A = Br. 50, 000  i 
 n 
(1  i ) 1
t = 5 years R=A 
m = 1, n = 5 x 1=5  (0.08 
r = 8%  
 (1.08) 5 1
= 50, 000
i = r = 8%
= 50, 000 (0.174056)
R=?
= Br. 8, 522.80

The total amount of deposit over the 5 year period is equal to 5 x 8, 522.80 = Br.42, 614
Example 5: Ato Beka has a saving goal of Br. 100, 000 which he would like to reach 15 years from now.
During the first 5 years he is financially able to deposit only Br. 1000 each quarter into the
savings account. What must his quarterly deposit over the last 10 (ten) years be if he is to reach
his goal? The account pays 10% interest, compounded quarterly.

Solution:
For the first 5 years  (1.01) 20  1
 
0.01 
R = Br. 1,000 A5 = 1, 000 
t = 5 years = 1000 (22.019)
m=4 = Br. 22,019
n = 20
r = 10 %
i = 2.5%
A5 = ?

This sum (Br. 22,019) will continue to draw interest at the rate of 10%; compounded quarterly, over the
next 10 years; and the amount at the end of the 10th year will be:
t = 10 years A10 = 22019 (1.025)4
m=4 = 22019 (1.103813)
n = 40 = Br. 24,304.86
i = 2.5%

103
To determine the periodic payment for the remaining 10 years, we subtract Br. 24, 304.86 from Br. 100,
000 to obtain the amount of an ordinary annuity for the last 10 years which is equal to Br. 75,695.14 =100,
000 – 24, 304.86
 0.025 
 
(1.025) 40 1
R = 75695.14 
= 75, 695.14 (0.014836)
= Br. 1, 123.03

Thus, if Beka makes quarterly payments of Br. 1000 into a savings account over the first five years and
then quarterly payments of Br. 1, 123.03 over the next 10 years, he will reach his savings goal of Br. 100,
000 at the end of 15 years.
Present Value of an Ordinary Annuity
The present value of an ordinary annuity is the sum of the present values of all the payments, each
discounted to the beginning of the term of the annuity. It represents the amount that must be invested now
to purchase the payments due in the future.
The present value of an annuity can be computed in two ways:
 Discounting all periodic payments to the present (beginning of the term individually) or
 Discounting the future value (amount) of an annuity to the beginning of the term
Example 6. What is the present value of an annuity if the size of each payment is Br. 200 payable at the
end of each quarter for one year and the interest rate is 8% compounded quarterly?
Solution:
R = Br. 200
r = 8%,
m=4
n=4
i = 2%
p=?
Using the first approach (discounting each payment individually), the present value will be:

0 1 2 3 4 Periods (quarter)
Br. 200 200 200 200
Present value
196.1 = 200(1.02)1
192.23 = 200(1.02)2

104
188.46 = 200(1.02)3
184.77 = 200(1.02)4
1  (1  i )  n 
761.56 Br = Present value.  
 i
Equivalently we may find the future value of thePordinary
=R annuity using the formula and then discount it
1  (1.02) 4 
to the present taking it as a single future value.  
n = 200  0.02 
 (1  i ) 1
  = 200 (3.80773)
i
A=R  
= Br. 761.55
 (1.02) 4 1
 
= 200  0.02 

= Br. 824.32
P = A (1 + i)-n
= 824.32 (1.02)-4
Br = 761.56
If we multiply the future value of an ordinary annuity by the compounding discounting factor, we get the
present value of an annuity as follows:
 (1  i ) n  1
 
 i 
P=R ((1 + i)-n)
 (1  i ) n 1  i  n  (1  i)  n 
 
 i 
=R
 (1  i ) 0  (1  i )  n 
 
i
=  
…………………..* Present value of an ordinary annuity.
1  (1  i )  n 
Using the formula, the present value of the above example is computed as:
i
P=R  
R = Br. 200
r = 8%, i = 2%
m=4
t=4

Example 7. What is the present value of an annuity that pays Br. 400 a month for the next five years if
money worth 12% compounded monthly?
Solution:
1  (1  i )  n 
  105
 i 
P=R
1  (1.01) 60 
 
 R = Br. 400
t = 5 years
m = 12
n = 12 x 5 = 60
r = 12%
i = 12%/12 = 1% = 0.01
p=?
4.4.3 Amortization
Amortization means retiring a debt in a given length of time by equal periodic payments that include
compound interest. After the last payment, the obligation ceases to exist, it is dead and it is side to have
been amortized by the periodic payments. Prominent examples of amortization are loans taken to buy a car
or a home amortized over periods such as 5, 10, 20 or 30 years.

In amortization the interest is to determine the periodic payment, R, so as to amortize (retire) a debt at the
end of the last payment. Solving the present value of ordinary annuity formula for R in terms of the other
variable, we obtain the following amortization formula:

 i 
 n 
1  (1  i ) 
R=P  …………………………………** Amortization formula
Where: R = Periodic payment
P = Present value of a loan
i = Rate per period
n = Number of payment periods
Example:1
1. Ato Gemechu borrowed Br. 15, 000 from Commercial Band of Ethiopia and agrees to repay the
loan in 10 equal installments including all interests due. The banks interest charges are 6%
compounded Quarterly. How much should each annual payment be in order to retire the debt
including the interest in 10 years?
Solution
 0.015 
Pv = Br. 15, 000  40 
R = 15, 000 1  (1.015) 
n = 10 x 4 = 40
= 15, 000 (0.033427)
= Br. 501.4
106
Interest = [501.4 x 40] – 15, 000
= 20056 – 15,000
 t = 10 years
m=4
r = 6% i= 6%/4 = 15%
R=?
Check your progress:

If you have Br. 100,000 in an account that pays 6% compounded monthly and if you decide to withdraw
equal monthly payments for 10 years at the end of which time the account will have a zero balance, how
much should be withdrawn each month?

Answer: Br. 1,110.205

2. An employee has contributed with her employer to a retirement plan for 20 years a certain amount
twice a year. The contribution earns an interest rate of 10% compounded semiannually. At the date
of her retirement the total retirement benefit is Br. 300, 000. The retirement program provides for
investment of this amount at an interest rate of 10% compounded semiannually. Semiannual
payments will be made for 10 years to the employee of her family in the event of her death.
1. What semi annual payment should she made?
2. What semi annual payment should be made for her or her family?
3. How much interest will be earned on Br. 300, 000 over the 40 years?
Solution:
Retirement plan
Employment period Retirement period
0 Pay 20 Receive 40 yrs time
A20= 300, 000 Br. R2 = ?
t= 20yrs Pv = 300, 000
m= 2, n = 40 t = 20 yrs,
r= 10%, i = 5% m = 2, n = 40
R1 = ? r = 10%, I = 5%
 0.05   0.05 
 40   40 
R1 = 300, 000 1  (1.05)  R2 = 1  (1.05)  x 300, 000

107
 = Br. 2483.45 = 17483.45
4.4.4 Mortgage Payments
In a typical home purchase transaction, the home buyer pays part of the cost in cash and borrows the
remaining needed, usually from a bank or savings and loan associations. The buyer amortizes the
indebtedness by periodic payments over a period of time. Typically payments are monthly and the time
period is long such as 30 years, 25 years and 20 years. Mortgage payment and amortization are similar.
The only differences are:
 the time period in which the debt/ loan is amortized /repaid/
 the amount borrowed.
In mortgage payments m is equal to 12 because the loan is repaid from monthly salary or income, but in
amortization money takes other values. Similarly stated mortgage payments are of amortization in nature
involving the repayment of loan monthly over an extended period of time.
Therefore, in mortgage payments we are interested in the determination of monthly payments.
Taking:
A = total debt
R = monthly mortgage payments
r = stated nominal rate per annum
n = 12 x number of years (period of the loan)
R can be determined as follows:
 r / 12   i 
 n   n 
R=A 1  (1  r / 12)  or R=A 1  (1  i ) 

1  (1  r / 12) n 
 
r / 12
A=R  

Example: 1
W/ro Bontu purchased a house for Br. 115, 000. She made a 20% down payment with the balance
amortized by a 30 year mortgage at an annual interest of 12% compounded monthly so as to amortize/
retire the debt at the end of the 30th year.

Required:
1. Find the periodic payment
2. Find the interest charged.
Find the interest charged.

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Solution:
Selling price = Br. 115, 000 r = 12%, i = 0.01
Less: Down payment = 23, 000 (20% x 115,000) m = 12, n = 360
Mortgage (A) = Br. 92, 000 t = 30 years
R=?
 r / 12   0.01 
 n   360 
R=A 1  (1  r / 12)  = 92, 000 1  (1.01) 
= 92, 000 (0.010286125)
= Br. 946.32
W/ro Bontu should pay Br. 946.32 every month to retire the debt within 30 years or 360 monthly
payments.
Interest = Actual payment – mortgage (loan)

= (946.32 x 360) – 92, 000

= Br. 340, 675.20 – 92, 000
= Br. 248, 675.20
Throughout the 30 years period the loan earns an interest of Br, 284,675.20

Example: 2
W/ro Bedatu purchased a house for Br. 50, 000. She made an amount of down payment and pay monthly
Br. 600 to retire the mortgage for 20 years at an annual interest rate of 24% compounded monthly.

Required.
Find the mortgage, down payment, interest charged and percentage of the down payment to the
selling price.
Solution:
Selling price = Br. 50, 000
Down payment = ?
Mortgage (A) = ?
R = Br. 600
r = 24%, i = 2%
m = 12, n = 240
t = 20 years

109
 1  1 (1  i ) n 
 
 i 
* Mortgage (A) = R
1  (1.02) 240 
 
= 600  0.02 

= 600 (49.56855)
= Br. 29, 741.13
* Down payment = Selling price – mortgage.
= 50, 000 – 29741.13
= Br. 20, 288.87
* Interest charged = Actual payment – mortgage]
= 600 x 240 – 29, 741.13
= 144000 – 29741.13
= Br. 114, 258.87

Down payment
X 100%
* Percentage of down payment = Selling price

20258.87
X
= 50,000 100%
= 40.52 %

Self check Problems!

Ato Tolosa purchases a house for Br. 250, 000. He makes a 20% down payment, with a balance
amortized by a 30 year mortgage at an annual interest rate of 12% compounded monthly.
a) Determine the amount of the monthly mortgage payment.
b) What is the total amount of interest Ato Tolosa will pay over the life of the mortgage?
c) Determine the amount of the mortgage Ato Liku will have paid after 10 years?
Answer:
a) R = Br. 2,507.20
b) Interest = Br. 540,602.80

110
 c) Payment after 10 years = Br. 13,16357

4.5 Exercises/Problems
1. If you borrow Br. 1, 000 from Commercial Bank of Ethiopia for 1 year to pay at 6% interest rate
your tuition fee. Find the simple interest and the maturity value of the loan.

2. What is the present value of a loan that will amount to Br. 5, 000 in 5 years if money is worth 3%
compounded semi-annually?
3. How much should be deposited in an account paying 10% compounded quarterly in order to have
a balance of Br. 10, 000 ten (10) years from now? What would be the amount of compound
interest after 10 years?
4. A small boy at the age of 10 drops 0.25 cents into a Jar each day. At the end of each month (30
days months) he deposits this amount at Awash Bank that pays 5% interest compounded quarterly.
If he makes the deposit without interruption, how much will the boy have at the age of 20?
5. Bethi deposits Br. 1, 000 at the end of every 3 months period in to an account for 5 years which
earn 10% interest compounded quarterly and then her deposits are changed to Br. 500 monthly for
the next 5 years which earn 12% interest compounded monthly. How much is the account by the
end of the time period considered?
6. A Company purchased a delivery truck on credit from AMCE which requires a payment of Br.
400, 000 plus 5% interest compounded annually at the end of 5 years. The Company plans to set
up a sinking fund to accumulate the amount required to settle the debt.
Required:
A. Find the total debt at the end of the 5 year.
B. What should be the monthly deposit into the fund be if the account pays 15% interest,
compounded monthly?
7. If Br. 10, 000 is invested at 8% compounded:
A. Annually
B. Semi Annually
C. Quarterly
What can you observe from your answers in A, B and C, what is the amount after 5 years?
8. Assume you won a lottery and you want to deposit/ invest your money in the following investment
alternatives. Investment A which pays 15% compounded monthly and B that pays 14%
compounded semi annually, which is the better investment, assuming other factors remains
unchanged.

111
 4.6 Answer to the Exercise/Problems
1. Given: Solution
P = 1, 000 Br. I = PRT
T = 1year = 1, 000 x 0.06 x 1
R = 6% / year = Br. 60
I=? A=P+I or A = P (1 + rt)
A=? = 1, 000 + 60 = 1, 000 (1 + 0.06 x 1)
= Br. 1060 = 1, 000 (1.06)
= Br. 1, 060
2. Given: Solution:
A = Br. 5, 000 p = A (1 + i)-n
t = 5 years = 5, 000 (1.0015)-10
r = 3% / year = 5, 000 (0.985123)
m = 2 time = Br. 4925.62
n = mt = 2 x 5 = 10
i = r/m = 3%/2 = 1.5%
p=?
3. Given: Solution:
p = 10, 000 A = P(1 + i)n
t = 10 years = 10, 000 (1.0025)40
m = 4 times = 10, 000 (1.105033)
r = 10% = 11. 050.33 Br.
i = 10%/4 = 2.5% Compound Interest = A - P
n = mt = 10 x 4 = 11, 050.33 – 10, 000
= 40 = 1050.33 Br.
A=?

5) Solution
Amount of money at the end of every month the boy will have Br. 7.50 (0.25 x 30) to be deposited at
Awash Bank.
Therefore, R = 7.50
 1.0012540 1
t = 10 years  
 0.00125 
r = 5% A = 7.5
m = 4, n = 40 = 7.5 x 514.89557
= Br. 3861.72
i = 5%/4= 0.00125

112
If the small boy saves 0.25 cents every day and deposits if monthly in a bank account that pays 5%
compounded quarterly, he will have Br. 3,861.72 at after 10 years.

6. Solution
 1.02520 1
First 5 years  
 0.025 
R1 = 1000 A1 = 1,000
r = 10% = 1,000 (25.54466)
m=4 = Br. 25544.66
i = 2.5% This amount will be compounded quantity at a
t=5 12% interest rate. Therefore. The amount at the
n = 20 end of the next 5 years will be calculated as
A5 = ? follows.

7. a) A = ?
t = 5 years
p = 400, 000 Br.
m = 1,
r = 5%, n = 5
A = P (1 + i )n
= 400, 000 (1.05)5
= 510512.625 Br.

b) Given
A = 510512.625 Br.
t = 5 years
m = 12
n = 5 x 12 = 60
r = 12%
i= 1%
R=?
 i  0.01
 n 
(1  i ) 1 60
R=A  = 510512.625 X (1.01)  1

113
 0.01
= 510512.625 x 0.81669669
= 5150512.625 x 0.0122444
= Br. 6250.95

The company should deposit Br. 6250.95 every month for 5 years or 60 periods to a stinking fund in order
to settle its debt of 510512.625

8. Check your progress

Answer A) A =Br. 14693.28
B) A = Br. 14862.44
C) A = Br. 14859.47

9. Solution: Nominal rates with amount compounding periods in this case (quarterly and monthly) cannot
be compared directly. You have to find the effective rate of each nominal rate and then compare the
effective rates to determine which investment will yield the return
Effective rate for A =
Effective rate for Investment A: Effective rate for Investment B:
reA = (1 + i)M – 1 reB = (1 + 0.07)2 – 1
= (1 + 0.0125)12 – 1 = (1.07)2 – 1
= 0.16075 = 16.075% = 0.1449 = 14.5%
Therefore, investment A is a better alternative
P = 25,544.66 A10 = (25544.66 (1.01)60
r = 12% = Br. 46406.895
m = 12
i = 1%
t=5
n = 5 x 12 = 60

Since Bethi continues her payment for the second 5 years of Br. 500, the amount will be calculated using
an annuity formal as:

 1.0160 1
 
 0.01 
A2 = 500
= 500 (81.66966)

114
 = Br. 40834.845

At the end of the 10 years Bethi will have a total amount of Br. 87,241.73 (Br. 46,406.9 + Br. 40834.84).

Problems to be accounted out of 20%

1).In each of the following f
a) the interest, an
b) the amount for each of the principals for the stated simple interest rate and
time period
I) Birr 500 ; 7 percent ; 1 year.
II) Birr 1000 ; 8% ; 1 y
III) Birr 4,000 ; 30 percent ; 2 year.
IV) Birr 5,000 ; 24 percent ; 3 year.
2). How many months will it take until the interest on birr 900 at 12% will be 135?

UNIT FIVE
ELEMENTS AND APPLICATIONS OF CALCULUS

Contents
5.0 Aims and Objectives
5.1 Introduction
5.2 The Derivative
5.2.1 The Rules of Differentiation
5.3 Application of Calculus in Business
5.3.1 Revenue, Cost and Profit Application
5.3.1.1 Revenue Applications
5.3.1.2 Marginal Analysis
Marginal Cost
Marginal Revenue
Marginal Profit

115
 5.3.2 Profit Maximization Criterion
5.3.3 Higher-Order Derivatives
The First Derivative Test
The Second Derivative Test
5.3.4 Optimization Problems

5.0 Aims and Objectives

After reading this unit students should be able to:
 explain the concepts of limits and continuity
 provide an understanding of average rate of change
 provide an understanding of derivative
 illustrate a wide variety of applications of optimization procedures
 understand skills in problem formulation
 reinforce skills of interpretation of mathematical skill
5.1 Introduction
Dear student! This unit examines the calculus and its application to business, economics and other areas of
problem solving. The major areas of study within the calculus are differential calculus and integral
calculus. Differential calculus focuses on rates of change in analyzing a situation.

Integral calculus involves summation of a special type. Graphically the concepts of area in two
dimensions or volume in three dimensions are important in integral calculus. The goal in this chapter is to
provide an appreciation for what the calculus is and where it can be applied. Though it would take several
semester of intensive study to understand most of -the Limits
finer points of the calculus, your coverage will
- at
enable you understand the tools for conducting analysis Continuity
an elementary level.
- Derivatives
Calculus is a mathematical tool used to solve problems in business, Economics and other areas.
- differential calculus and
- integral calculus

1) * Differential calculus focuses on rates of change in analyzing a situation. It broadens the concept
of slope.

116
 Application areas:
- Optimization problems i.e minimizing cost and /or maximizing profit, revenue---

2) Integral calculus involves summation of a special type, total change -------

It is the inverse of Differential calculus or vice versa like that of log and antilog.
Scope of this chapter = Differential calculus, derivative and its application in solving optimization
problems.

5.2 The Derivative

The process of finding a derivative is called differentiation. A set of rules of differentiation exists for
finding the derivatives of many common functions.

5.2.1 The Rules of Differentiation:

Differentiation:
The rules of differentiation have been developed using the limit approach. The mathematics involved in
providing these rules can be finally complicated. For our purposes it will suffice the rules without proof.

The rules of differentiation apply to functions, which have specific structural characteristics. A rule will
state that if a function has specific characteristics, then the derivative of the function will have resulting
form.
 Each function can be graphed and that the derivative is a general expression for the slope of the
function.
dy
Notation: dx  “which read the derivative of Y with respect to X”
: This notation can be used interchangeably with the notation f ’(x) –read f prime of x – which
represent the derivative of the function f at x. That is given f(x)
dy
f  (X)= dx

 Differentiation by direct application of the limit formula is time consuming and difficult, there
fore, functions should be classified into certain groups according to their behavior so that the
process of finding a derivative when applied to these groups follows a definite pattern (formula)

1. Derivative of a constant function.

function.
If f(x) = k Eg. F(x) = 10,
f  (x) = 0 f  (x) = 0, slope = 0

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 If you consider what the function (f(x) = 10) looks like graphically, this result seems
reasonable. The function f(x) = 10 is horizontal line intersecting the Y axis at y=10. The slope
at all points along such function equals 0.
Slope= y/x=(10-10)/(x1-x2)=0/(x1-x2)=0

2. Power functions

If f(x) = xn, where n is a real number f  (X) = nxn-1

Example
1) If (x) = x , where n = 1
f  (x) = nxn-1

= 1x1-1
= 1x0
=1
This implies that for the function f(x) = x, the slope equals 1 at all points.

You should remind that f(x) = x is a linear function with slope 1.

2) f(x) = x5 4) f(x) =
3
x2
f  (x) = 5x4 = x 2/3

1
3) f(x) = x
3 f  (x) = 2/3 x –1/3
1
2x 3
= x-3 = 3
f  (x) = -3X-4 2
1
3
= 3X
3
= X4
2
3
= 3. X
3. A constant times a function
If f (x) = k.g(x), where k is a constant and g is a differentiable function,

f  (x) = k. g  (X)

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 a) f(x) = 5X3 b) f(x) = x2 – 5x

f  (x) = 15x2 f(x) can be expressed as

f(x) = g(x) – h(x), where g(x) = x2 &

h(x) = 5x

f  (x) = g  (x) - h  (x)

= 2x – 5

4. Sum or differences of functions.

This implies that the derivative of function formed by the sum (difference) of two or more

component functions is the sum (difference) of the derivatives of the component functions.

If ƒ(x) = [g(x)  h(x)] g(X) = 6x4 g  (X) = 24x3

f  (x) = [ g  (x)  h (x)] h(x) = 5x2 h  (x) = 10x

f(x) = 6x4 – 5x2 g  (x) - h  (x) = 24x3 – 10x

f  (x) = 24x3 – 10x

ƒ(x) = 3x2 + 2x + 1

f  (x) = 6x + 2

5. Product of functions
If h(x) = f(x) . g(x) f(x) = 2x2 - 5

h  (x) = f(x). g  (x) + g(x). f  (x) g(x) = x + 3

h(x) = (2x2 – 5) (x + 3) f  (x) = 4x

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 = (2x2 – 5) x 1 + (X + 3) (4x) g  (x) = 1

= 6x2 + 12x – 5 h  (x) = f(x). g  (x) + g(x) . f  (x)

=(2x2 – 5) x 1 +(x + 3) (4x)

=2x2 – 5 +4x2 + 12x

=6x2 + 12x-5

Eg. 2. f(x) = (x2 – 5) (x – x3)

g(x) = x2 – 5  g  (x) = 2x

h(x) = x – x3 h  (x) = 1 – 3X2

f  (x) = g(x) . h  (x) + h(x) . g  (x)

= (x2 – 5) (1 – 3x2) + (X – X3) (2x)

= -5x4 + 18x2 – 5

6. Derivative of the Quotient of function

f (X )
h(X) = g ( X )

g ( X ) . f ( X )  f ( X ) . g ( X )
h  (X) = [ g ( X )] 2

1 X
2
Eg. 1. h(X) = X
(1) ( X 2 )  (1  X ) (2 X )
h  (X) = (X 2 )2

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  x 2  2x  2x 2 X 2  2x
= (X 2 )2 = X
4

1 3
Eg. 2. f(X) = X
3 f  (X) = X 4

3 x 4 15 x 2  6 x
3. F(X) = (3X2 – 5) /( 1 – X3) f  (X) = (1  x 3 ) 2

5.3 Application of Calculus in Business Decisions

5.3.1 Revenue, Cost, and Profit Applications
5.3.1.1 Revenue Applications:
5.3.1.2 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. That is TC=TFC + TVC

f(x)=b + mx, where m=TVC/Q and TFC=b

 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.

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  It is the rate of change in total cost per unit change in production at an out put 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- 4 ; 0 < X  50 , (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
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 = 5Br.  it costs 5 Br to produce one more of product x

3) C(41) – C(40) = ?

C(41) = 575 + 25(41) – (41)2 = 1179.75

4
C(40) = 575 + 25(40) – (40)2 =1175.00
4
Marginal cost of 41st unit is C (41) – C (40) = 1179.75 – 1175 = 4.75Br. nearly 5.
Marginal Revenue = 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. If TR = 10x, MR= 10Br.

Marginal revenue for non-linear total revenue function is not constant.

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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)

It represent / approximately the marginal revenue from selling the next unit
Eg. R(x) = 500x – 0.005x2 ,where x is number of units produced.
R  (x) = 500 – 0.01x
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 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, recommended to continue production.
II. If MR < MC, is not recommended to continue production.

5.3.2 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
= MR - MC
= 0, where MR=MC
P  (X) = 0 dTR=0 in the term P  (X)=dTR/dQ
Which again implies that Total Revenue is maximum.

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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 or P=10-x/1000, where P is price and X is production.
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
T R  (X) = 10 - 500
3) P(X) = R(X) – C(X), here P(X) is profit.
X2
= (10x - 1,000 ) – (7, 000 + 2x)
X2
= 8x - 1,000 - 7, 000
X
P (X ) = 8 - 500 or

P (X ) = R  (X) - C  (X)

X
= 10 - 500 - 2

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 X
= 8 - 500

Maximum profit is attained where P (X ) = 0

P (X ) = 0 where X=4000

Average cost, Average revenue, Average profit

C( X )
 Average Cost = C (X) = X  Cost per unit

Marginal Average cost = C (X)  the rate of change of average cost

R( X )
 Average revenue = R (X) = X  Revenue per unit.

Marginal Average revenue = R (X)  R’(X)\X

p( X )
 Average Profit = P (X) = X
Marginal Average profit = P' (X)
X2
Suppose: C(X) = 1, 000 + 25x - 10
X2 X
Let us draw the graph of C(X) = 1, 000 + 25x - 10 and C  (X) = 25 - 5 together.

See that:

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  for 0<X<125 cost increases with a decreasing rate , C’(x)>0 but decreasing
i.e. the slope of C’(x) =-1/5
 cost reaches maximum at x=125 i.e. C(125)max.=2562.5,wher C’(x)=0
 for X>125 cost decreases ,i.e. C’(x)<0

C(9) = 1, 000 + 25×9 - 92/10

= 1, 000 + 225 – 8.1
= 1, 225 – 8.1
= 1216.90
C (10) = 1240.00
C (11) = 1262.9

C (10) -C (9) = 1240.00-1216.90=23.10

C (11) -C (10) = 1262.9-1240.00=22.90

Look C(9) < C (10) < C (11)

1216.90 < 1240.001 < 1262.9
See that 1240.00>1216.90 by 23.10
and 1262.90>1240.90 by 22.90
C(9) < C(10) <C(11) but the rate of change is decreasing from 23.10 to 22.90!
C  (9) = 25 – 9/5
= (125 – 9)/5
= 116/5
=23.2

C (10) = 23.20
*C increases in the interval (0, 125) and decreases in x>125

5.3.3 Higher-order Derivatives

If a function ƒ has a derivative for each value of X in some specified interval, then the derivative function
f  is defined for that interval. If in turn the derivative function itself has a derivative for points in that

interval this new derivative function is called the second derivative of the original function f or the first

derivative of f  .
 The First Derivative Test

Locates all critical values of X, example where f  (X) = 0

Second derivative test
There is a rule that help us know the minimum and maximum values of a function.
Rule

1. Find f  (X)

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 2. Set f  (X)=0 and solve for X.
3. Evaluate ƒ’’(X) for each X of step number 2 above
 If ƒ’’(X) > then a local minimum occurs at X.
 If ƒ’’(X) <0 then a local maximum occurs at X.
 If ƒ’’(X) =0 then the test fails to determine what happens at X..

eg. Let f (X) = 3x3 + 5x2 + 2x + 3

Step1- Find the first derivative of f (X).

ƒ’(X)=9x2+10x +2

Step2- solve for f ’(X).

ƒ’(X)=0
9x2+10x +2=0x=-9 or x=-1

Step3- Evaluate f ’’(-9) and f ’’(-1)

f ’’(X) =18X + 10

f ’’(-9)= -162 + 10=-152<0there is local maximum of ƒ at x=-9

f ’’(-1)= -18 + 10=-8<0 there is local maximum of ƒ at x=-1

Given f :

If f  (X) > 0 f is increasing

If f  (X) < 0 f is decreasing

If f  (X) = 0 f is constant

If f  (X) > 0 f  is increasing f is increasing with increasing rate.

rate.
f  (X) < 0 f  is decreasing f is increasing with decreasing rate

f  (X) =0 f  is constant

For critical points, where f  (X) = 0, the most expedient test is the second –derivative test. Intuitively

the 2nd derivative test attempts to determine the concavity of the function at a critical point, f  (X) = 0
X 4 9x 2
f (X )  
Eg. 4 2
f  (X) = X3 – 9X

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 Critical point f  (X) = 0
X3 – 9X = 0
X (X2 – 9) = 0
X (X + 3) (X – 3) = 0
X = 0, X + 3 = 0 or X – 3 = 0
X = 0, X = -3, or X = 3
f (0)=0

81 81
f (-3)= f (3)= 4 - 2 = 81/2(1/2-1)=81/2×-1/2=-20.25

ƒ’’ (X) = 3X2 – 9

5.3.4 Optimization Problems
Ex. 1. A company manufactures and sales X units of radio transistor per week. If the weekly cost and
demand equations are:
C(X) = 5, 000 + 2x
X
P(X) = 10 - 1,000 P is price [0, 8000]
For each week find:-
1) The production level that leads to maximum revenue and the maximum revenue.
2) The production levels that leads to maximum profit and the maximum profit.
3) The production level that leads to minimum cost and the minimum cost.

Solution
1) R(x) =PX
X
R(x) =(10 - 1,000 )(x)
X2
=10x - 1,000
X2
R(x) =10X - 1,000
Now let us apply the Rule:-
X
 R  (X) = 10 - 500
 R  (X) = 0 at X=5000
 R’’(X) = - 0.002 for all X i.e. R’’(5000) = - 0.002<0, there is local maximum at x= 5000
 R’’ (5000) =-0.002< 0 ƒ, revenue, is increasing at decreasing rate.
128
  Revenue is maximum at X =5000 and R(5000)= 25,000

Observe that:-
 for x<5000 Revenue is increasing but with a decreasing rate; see that the graph of R  (X) is a
straight line with a negative slope = -1/500.
( R  (X) is above the horizontal line)
 for x=5000 Revenue attains its maximum at which R  (X) = 0
(the straight line crosses the horizontal axis)
 for x>5000 Revenue is decreasing
(see that the graph of R  (X) is below the horizontal axis)
2) Profit = Revenue- Cost
X2
R(X) = 10x - 1,000 and C(X)=5, 000 + 2x
Pro=R(X) - C(X)
X2
Pro= 10x - 1,000 - (5, 000 + 2x)
X2
= 8x - 1,000 - 500
X
P’ro(X) = 8 - 500
X
P’ro (X)= 0  8 - 500 = 0
 4, 000 = X

129
See that:-
 P’ro(x)=8 –x/500
 P’ro(x)=0=8 –x/500x=4000
 P’ro(4000)=-0.002 < 0  Pro(4000) is a local maximum.
 Pro(4000)=15500
 Profit increases, becomes zero, reaches its max. and then starts to decline.
 The rate of change of P(X) ie P’(X) is max., equals to 8, crosses the horizontal axis at X=4000 for
which profit is max and lastly lies under the production axis where profit decrease continuously.
3) Cost is minimum at zero production level.
 C(X) = 5, 000 + 2x
 C’(X) = 2
 C’’(X) = 0, does not suggest optimum.
Example 2. When X gallons of alcohol are produced, the average cost per gallons is given by the
200
 0.05 X
function C(X) = 0.1x  5 ,X>0

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. C(X) = 200 (0.1x + 5)-1 + 0.05X, why?
C  (X) = -200 (0.1x + 5)-2(0.1) + 0.05

= -20 (0.1x + 5)-2 + 0.05

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 Now C  (X) = 0-20 (0.1x + 5)-2 + 0.05 = 0
 20
(0.1X  5) 2 + 0.05 = 0

0.1x  5 
2 1/ 2
 400
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,

C’(X) = -20 (0.1x + 5)-2 + 0.05
Find C”(X)
C”(X) = -20 (-2) (0.1x + 5)-3 (0.1)
4
, C" X  0
= 0.1x  5
3
Minimum point.
C”(150) >0 which implies that C(150) is minimum, why?
3. Minimum average cost / gallon
200
C(X) = 0.1x  5 + 0.05x
200
 0.05 150 
C(150) = 0 . 1 150   5

= 17.5 Br/ gallon

Example: 3
A rectangular warehouse with a flat roof is to have a floor area of 9600 square feet. The interior is to be
divided into storeroom and office space by an interior wall parallel to one pair of the sides of the building
(as shown below). The roof and floor areas will be 9, 600 square feet for any building, but the total wall
length will vary for different dimensions.
For example a 96 foot building could have a 96-foot interior wall, two 100-foot exterior walls for a total
length of 3(96) + 2(100) =488 feet.

131
Required:
Find the dimensions that minimize the total amount of wall.
We know Area = XY = 9600 Sq.ft
9600
Y= X
W = 3X + 2Y i.e total length of the wall
9600
W(X) = 3X + 2( X )
19200
= 3X + X
19200
W ( X )  3 
X2
W  (X) =0
19200
2
3- X =0
3X2 – 19200 = 0
19200
 6400
X2 = 3
X =  6400 =  80

132
 X = -80 is discarded because X represents length.
9600
Hence we take X = 80 ie Y = 80 = 120
 Note that the second derivative W  ( X ) = -2 (-19200) X-3
38400
3
= X
* W  (80) > 0 ie W  (80) is positive. So we have a minimum value at x=80 and Y=120.
* The minimum length is
W = 3X + 2Y = 3(80) + 2 (120)
= 240 + 240
= 486 feet.
Ex2. Fence is required on three sides of a rectangular plot. Fence for the two ends costs Br. 1.25 per
running foot; fence for the third side costs Br. 2 per running foot. Find the maximum area that can be
enclosed with Br. 100 worth of fence.

2sides (1.25X) + 1side (2Y) = 100

2(1.25X) + 2Y = 50
2(1.25X) + 2Y = 50
Y = 50 -1.25X or X = 40 - 0.8Y
A=XY, where A is Area
A(X) = X (50
50 -1.25X) or A(Y) = Y (40
40 -0.8Y)
A(X) = 50X -1.25X2 or A(Y) = 40Y -0.8Y2
A’(X) = 50 -2(1.25)X or A’(Y) = 40 -1.6Y
A’(X) = 50 -2.50X
A (X) = 0 50 – 2.5X = 0 or A (Y) = 0 40 – 1.6Y = 0
50 = 2.5X or 40 – 1.6Y = 0
500= 25X or 400 = 16Y
20=X or 25 = Y
A(20) = 50.20 -1.25.202 or A(25) = 40.25 -0.8.252

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 A(20) = 1000 -500=500 or or A(25) = 1000 -500=500
500 sq.feet is the max. area that can be fenced by the 100 birr.
Note that A”(X) =-2.5 < which implies that A” (20) = A” (25) = 500sq. feet is the maximum area that can
be covered by the birr 100!

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, 3rd ed.
3. Bowen, K. Eral, Prichett, D. Gordon, and Saber, C. John 1987, Mathematics with
applications in management and economics, 6th ed., Richard Irwin Inc., USA
4. Teresa Bradley nad Patton, Paul 1999, Essential Mathematics for Economics and Business,
Jon Wiley and Sons.

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5. Anderson .D.R. and others 2003. An introduction to Management science Quantitative
Approaches at Decision making, Melissa Acuna, USA
6. Taha, H. 1999, Operations Research: An introduction. Prentice all, New Delhi
7. Uohra, N. 1998. Quantitative Techniques in Management. Tata McGraw Hill, New Delhi
8. Roland J. .Hershberger and James J. Reynolds Mathematics Applications
9. Dexter, J. Booth and John, K. Turner 1996. Business Mathematics with Statistics
10. Hole Poul G., Finite Mathematics and Calculus with Applications to Business, 1974
11. Roland E. Larson and Bruce H. Edwards, 1991. Finite Mathematics with Calculus

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