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nt 3
On
Assumptions
and
Limitations of
Break-even
Analysis
By
Jomon Jacob
1021904
One of the assumptions to study break-even analysis is that the total revenue and total
cost is a linear curve.
TR = 15Q
When this is plotted as shown is graph above, the TR and TC curve intersects at a
point. At any output below this point, the firm is producing under a loss and at any
point above this point, it is running on profit. Thus this intersecting point is called as
the Beak-even point and the output corresponding to this is called as the break-even
output.
But the assumption of linearity is not valid in the real world. As shown above, the TR
and TC curve intersect only at a single point, which gives the impression that all
output above break-even is a profit. This is not true.
In real world, the cost and revenue functions are non linear. This non linearity arises
because AVC and price vary with variation in output. As a result TC may increase at
an increasing rate and TC revenue increases at
a decreasing rate.
In this graph the vertical distance between TFC and TC is the TVC. Also the vertical
distance between TR and TC is the profit or loss at various levels of output.
Thus for the whole range of output between points B1 and B2, the firm runs with a
profit. If the output is less than B1 or greater than B2, firm has to incur a loss.
a) The break-even analysis can be applied only to a single product system. Under
the condition of multiple products and joint operations, the break-even
analysis can be applied only if product wise cost is ascertained, which is very
difficult.
b) Break-even analysis cannot be applied usefully where cost and price data
cannot be ascertained beforehand and where historical data are not relevant for
estimating future cost and price.