# Break-even Analysis Form

BREAK-EVEN ANALYSIS - 5

DOL

Q

Q

=

Π

Π

∂

∂

§ Example 4 Given TR and TC, a firm is currently operating at 50% of its capacity at

some profit target

A

0

. How much of a price drop would cause the firm to operate at 75%

capacity at the same level of profit?

Answer: the vertical dotted line on the right marks the firm’s capacity. Current output is

half of that. Draw the line through A and parallel to TC, this is the “isoprofit” line. From

75% capacity output point, draw the vertical line. B is the intersection. Draw the line TR

2

through B. The slope of TR

2

gives the required output price.

III. OPERATING LEVERAGE

We have seen several types of elasticities: of demand, supply, etc. There is another kind that

is quite popular among financial economists: the elasticity of total profit with respect to

output level, also known as the degree of operating leverage.

!

Definition: The Degree of Operating Leverage (DOL) at a given output level Q is the

percentage change in total profit that results from a one-percent change in units sold:

Change in Profit (in percentage)

__________________________

Degree of Operating Leverage =

Change in Output (in percentage)

For example if, as a result of a 1% increase in output, profit increases by 3% then the DOL

is 3%/1% = 3.

! Algebraically, this may be expressed as:

O Under the special assumptions adopted by break-even analysis (that is, if price and AVC

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