8890 Economic Theory , Applications and Issues

Reviews linear break-even analysis as typically outlined in textbooks on managerial economics. It is claimed that a major shortcoming of these expositions is their failure to demonstrate in what circumstances linear break-even analysis is relevant for a business and in what circumstances it is inapplicable. This article helps rectify this situation. It points out that such analysis can not be applied to perfectly competitive firms. However, in special circumstances, it might apply to a purely competitive firm. It is highly relevant for businesses operating in oligopolistic conditions where the kinked demand curve applies. Furthermore, it is applicable if imperfectly competitive firms follow fixed price rules. On the other hand, if imperfectly competitive firms, such as monopolists, adopt flexible pricing (for example, prices to clear whatever quantity of product they have supplied to the market) the linearity assumption involved in this type of break-even analysis will, as a rule, be violated. This is so because the firm’s total revenue will be a non-linear function of the quantity of the product supplied by the firm to the market. Nevertheless, because fixed price behaviour by businesses may be common, as well as constant average variable costs of production over a considerable range of output, linear break-even analyses has a considerable range of application to business. LINEAR BREAK-EVEN ANALYSIS: WHEN IS IT APPLICABLE TO A BUSINESS?