(X) Financial Theory Development
October16, 1977-2003

Themes and questions of Today's mind

  • "What-If" Analysis Versus Changing the Model
    For any given linear CVP analysis, we can ask a whole set of "what-if" questions about how increases and decreases in the sales price, unit variable costs, sales mix and fixed costs would affect the outcome. However, when we do that we are simply changing from one set of static assumptions to another set. This means that we are changing from one conventional linear problem to a somewhat different conventional linear problem. If the first two assumptions are relaxed to allow the sales price and unit variable costs to change continuously in response to the forces of supply and demand, we are not asking a "what if" question, we are changing the analysis from the practical linear approach to the theoretical nonlinear approach.
  • For the reason from summery, some critics of the conventional linear model argue that it represents a naive and dangerous view of a firm's economic environment. On the other hand, advocates of the linear model contend that short term planning does not require a theoretical model of the entire range of production possibilities. Although the concepts underlying the theoretical model are important, the model does not provide a practical approach for short term planning. However, the linear model is a practical and adequate alternative for planning within the normal relevant range of production and sales alternatives.

    • Consider the following curve:

    • © Definitions and assumptions of New Political Economic Theory.

    • Every consumer is a producer as will.
    • Energy as an INPUT, match the supply curve
    • Effort as an OUTPUT, match the demand curve
    • Value($) will be represented on Y axis.
    • Time will be represented on X axis.
    • Change(dx/dt) will be represented on X axis.
    • Rate of change will be represented on X axis.

    SUMMARY OF THE CONVENTIONAL LINEAR AND THEORETICAL MODELS

    Graphic summaries of the two models are presented in Figures 11-15 and 11-16. In the linear model there is one break-even point (BEP) where total revenue is equal to total cost. Since the total revenue and total cost functions are linear, the profit function is also linear.
    In the linear model illustrated in Figure 11-15, the area to the left of the break-even point represents a loss area and the area to the right of this point represents a profit area that continuously grows larger as additional units are produced and sold. In the linear model the company maximizes profit where production and sales are at maximum capacity.

    Consider the following curve:

    The theoretical model summarized in Figure 11-16 conveys a very different picture. There are two break-even points where total revenue and total cost are equal. The theoretical profit function intersects the horizonal axis at the two break-even points and reaches a maximum level at the point where the vertical distance between TR and TC is the greatest.
    However, in the theoretical model , there are two loss areas, one to the left of the first BEP and one to the right of the second BEP. The profit area is between the two break-even points, thus trying to achieve the maximum level of production and sales will produce losses rather than increased profits.

    Consider the following curve: