Applied Economics

MODULE 3: Demand and Supply Function,

and Break-even Analysis

Subject Objectives

At the end of this module, learners are expected to:

1. understand and explain the demand function
2. understand and explain the supply function
3. compute for price equilibrium using the demand and supply functions
4. compute for break-even in production sales and sales per unit
5. create a target profit analysis per sales and sales per unit

Start-up Activity

Laws of Demand and Supply Review

1. Define the law of demand. Define the law of supply. Describe these
terms in your own words and make sure to include an explanation of
the relationship between price and quantity
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Applied Economics
Year Revised: 2020 Page 1 of 13
 Subject Content

THE DEMAND FUNCTION

An equation that lets us know how a variable like demand is determined
is called a linear function, if it produces a straight line when it is graphed.
The demand function takes the form Qd = a – bP, and this states how the
price (P) of a good or service determines the quantity demanded (Qd).

Qd = quantity demanded
a = the quantity demanded when the price = 0 (because b x 0 = 0)
P = price
b = Tells us how steep the demand curve will be. It is the
coefficient that determines the slope of the demand curve (from
steep to flat), and measures how responsive the change in
quantity demanded is to changes in the price. Sometimes a small
price change can produce a large change in quantity demanded
because, perhaps, there are a large number of substitute goods
the consumer can switch to. Sometimes a large price change will
only result in a small change in Qd because, perhaps, the good
is a necessity such as petrol. b is always negative because, as we
have seen, there is an inverse relationship between price and the
quantity demanded – the law of demand (i.e., as P increases, Qd
decreases, and as P decreases, Qd increases)

Example:
A = 100 units of goods
b = 10 (expected response of the demand curve)
P = Php 5.00

Qd = 100 – 10(5)
= 100 – 50
Qd = 50

50 units would be the quantity demanded by the consumers if the Price

of the good is Php 5.00.

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Year Revised: 2020 Page 2 of 13
USING THE DEMAND FUNCTION TO CONSTRUCT A DEMAND SCHEDULE

Using the given above, we could conclude the following:

At price Php 0, consumers would demand 100 units and at price Php
10.00, consumers would demand zero. In graphing this, we can now identify
the demand schedule for this good.

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Year Revised: 2020 Page 3 of 13
THE SUPPLY FUNCTION
The supply function takes the form Qs = c + dP, and this states how
the price (P) of a good or service determines the quantity supplied (Qs).

Qs = quantity supplied
c = the level of supply independent of price
P = the market price of the product
d = is the coefficient of price
Example:
Supply for Product X = 10 + 2(P)
If the market price of the product is Php 20.00, therefore:

Qs = 10 + 2(20)
= 10 + 40
Qs = 50

50 units are needed to be supplied of product X at Php 20.00 per unit.

USING THE SUPPLY FUNCTION TO CONSTRUCT A SUPPLY SCHEDULE

c d P Qs
10 2 ₱ - 10
10 2 ₱ 10.00 30
10 2 ₱ 20.00 50
10 2 ₱ 30.00 70
10 2 ₱ 40.00 90
10 2 ₱ 50.00 110
10 2 ₱ 60.00 130

70

60

50

40

30

20

10

0
₱10.00 ₱30.00 ₱50.00 ₱70.00 ₱90.00 ₱110.00 ₱130.00

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Year Revised: 2020 Page 4 of 13
MARKET PRICE EQUILIBRIUM
When the supply and demand curves intersect, the market is in
equilibrium. This is where the quantity demanded and quantity supplied are
equal. The corresponding price is the equilibrium price or market-clearing
price, the quantity is the equilibrium quantity.

Example:
These two curves intersect at Price = 6, and Quantity = 20.
In this market, the equilibrium price is Php 6 per unit, and equilibrium
quantity is 20 units. At this price level, market is in equilibrium. Quantity
supplied is equal to quantity demanded (Qs = Qd).

QUANTITY PRICE
DEMAND SUPPLY

0 10 2
10 8 4
20 6 6
30 4 8
40 2 10

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Year Revised: 2020 Page 5 of 13
Price Equilibrium could be computed at any point by doing this equation:
Qd = Qs.

Example 1:
Qd = 10000 – 80P
Qs = 0 + 20P
P = ? *Price Equilibrium
Q =? *Quantity Equilibrium

10000 – 80P = 0 + 20P

10000 – 0 = 80P + 20P
10000 = 100P
100
100 = P
P = 100

Qd = 10000 – 80(100) Qs = 0 + 20(100)

= 10000 – 8000 = 0 + 2000
Qd = 2000 Qs = 2000

Example 2:

Qd = 500 – 50P P=?

Qs = 50 + 25P Q=?

500 – 50P = 50 + 25P

500 – 50 = 50P + 25P
450 = 75P
75
6 = P
P = 6

Qd = 500 – 50(6) Qs = 50 + 25(6)

= 500 – 300 = 50 + 150
Qd = 200 Qs = 200

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Year Revised: 2020 Page 6 of 13
BREAK-EVEN ANALYSIS
Break Even Analysis in economics, business, and cost accounting
refers to the point in which total cost and total revenue are equal. A break
even point analysis is used to determine the number of units or amount of
revenue needed to cover total costs (fixed and variable costs).

Formula for Break Even Analysis

The formula for break even analysis is as follows:

Break even quantity = Fixed costs

(Sales price per unit – Variable cost per unit)

Where:

Fixed costs are costs that do not change with varying output (e.g., salary,
rent, building machinery).
Sales price per unit is the selling price (unit selling price) per unit.
Variable cost per unit is the variable costs incurred to create a unit.

Example:
Olin is the managerial accountant in charge of Company A, which sells water
bottles. He previously determined that the fixed costs of Company A consist
of property taxes, a lease, and executive salaries, which add up to Php
100,000.00. The variable cost associated with producing one water bottle is
Php 2.00 per unit. The water bottle is sold at a premium price of Php 12.00.
To determine the break even point of Company A’s premium water bottle:

Break even quantity = Php 100,000 / (Php 12.00 – Php 2.00) = 10,000 units

Therefore, given the fixed costs, variable costs, and selling price of the
water bottles, Company A would need to sell 10,000 units of water bottles to
break even.

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 Graphically Representing the Break Even Point
Price

1. The number of units is on the X-axis (horizontal) and the dollar amount
is on the Y-axis (vertical).
2. The red line represents the total fixed costs of Php 100,000.00
3. The blue line represents revenue per unit sold. For example, selling
10,000 units would generate 10,000 x Php 12 = Php 120,000 in revenue.
4. The yellow line represents total costs (fixed and variable costs). For
example, if the company sells 0 units, then the company would incur Php
0 in variable costs but Php 100,000 in fixed costs for total costs of Php
100,000. If the company sells 10,000 units, the company would incur
10,000 x Php 2 = Php 20,000 in variable costs and Php 100,000 in fixed
costs for total costs of Php 120,000.
5. The break even point is at 10,000 units. At this point, revenue would be
10,000 x Php 12 = Php 120,000 and costs would be 10,000 x 2 = Php
20,000 in variable costs and Php 100,000 in fixed costs.
6. When the number of units exceeds 10,000, the company would be making
a profit on the units sold. Note that the blue revenue line is greater than
the yellow total costs line after 10,000 units are produced. Likewise, if the
number of units is below 10,000, the company would be incurring a loss.
From 0-9,999 units, the total costs line is above the revenue line.

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Year Revised: 2020 Page 8 of 13
 As illustrated in the graph above, the point at which total fixed and
variable costs are equal to total revenues is known as the break even point.
At the break even point, a business does not make a profit or loss. Therefore,
the break even point is often referred to as the “no-profit” or “no-loss point.”

The break even analysis is important to business owners and managers

in determining how many units (or revenues) are needed to cover fixed and
variable expenses of the business.

Therefore, the concept of break even point is as follows:

 Profit when Revenue > Total Variable cost + Total Fixed cost
 Break-even point when Revenue = Total Variable cost + Total Fixed cost
 Loss when Revenue < Total Variable cost + Total Fixed cost

Cost-Volume Profit Table

Using the Break-even given which is 10000 units.

Total Per Unit

Sales (10000 x 12) ₱ 120,000.00 ₱ 12.00
Less: Variable Cost ₱ 20,000.00 ₱ 2.00
Contribution Margin ₱ 100,000.00 ₱ 10.00
Less: Fixed Cost ₱ 100,000.00 ₱ 10.00
Net Operating Income ₱ - ₱ -

10,000 units must be sold in order for the company to break even. The
contribution margin is the amount to cover the fixed costs for the production
of goods. It is the foundation for break-even analysis used in the overall cost
and sales price planning for products. The contribution margin helps to
separate out the fixed cost and profit components coming from product sales
and can be used to determine the selling price range of a product, the profit
levels that can be expected from the sales, and structure sales commissions
paid to sales team members, distributors or commission agents.

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Year Revised: 2020 Page 9 of 13
 Continuing from the previous example, if the company sold higher than
10000 units, it would earn operating income. Supposed the company sold
15,000 units:

Total Per Unit

Sales (15000 x 12) ₱ 180,000.00 ₱ 12.00
Less: Variable Cost ₱ 20,000.00 ₱ 2.00
Contribution Margin ₱ 160,000.00 ₱ 10.00
Less: Fixed Cost ₱ 100,000.00 ₱ 6.67
Net Operating Income ₱ 60,000.00 ₱ 3.33
The company would then earn Php 60,000.00 or Php 3.33 per unit sold.
Supposed the company sold less than 7500 units:

Total Per Unit

Sales (6000 x 12) ₱ 72,000.00 ₱ 12.00
Less: Variable Cost ₱ 20,000.00 ₱ 2.00
Contribution Margin ₱ 52,000.00 ₱ 10.00
Less: Fixed Cost ₱ 100,000.00 ₱ 16.67
Net Operating Income -₱ 48,000.00 -₱ 6.67

The company would incur net loss of Php 48,000.00. If the contribution
margin is less than the fixed cost, then the company would be at a loss.

Applied Economics
Year Revised: 2020 Page 10 of 13
 Self-Assessment

Activity 1: Demand and Supply Function

Compute for Qd and Qs. Show your solutions.
1. a = 18 b=3 P = Php 5.00

2. a = 80 b=1 P = Php 12.00

3. c = 32 d=6 P = Php 3.50

4. c = 14 d=4 P = Php 200.00

Activity 2: Market Equilibrium

Compute for Equilibrium Price for the following Qd and Qs. Write your
solution for each number.

1. a = 30 c=0 2. a = 60 c = 20
b = 56 d = 44 b = 75 d = 25

3. a = 20 c=6 4. a = 10 c=9
b = 15 d=9 b=7 d = 16

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Activity 3: Cost Volume Profit Analysis
Compute for what is ask in the following income statements.

1. TOTAL Per Unit

Sales (400000) Php 2.35
Variable Expenses 700,000.00
Contribution Margin
Fixed Expenses ---
Net Operating Income Php 100,000.00 ---

TOTAL Per Unit

2.
Sales ( ) Php 7.35
Variable Expenses 5.95
Contribution Margin
Fixed Expenses 280,000.00 ---
Net Operating Income Php 0.00 ---

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Year Revised: 2020 Page 12 of 13
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Applied Economics
Year Revised: 2020 Page 13 of 13