Stochastic CVP Analysis with Economic Demand and Cost Functions

James A Yunker

Review of Quantitative Finance and Accounting, 2001, vol. 17, issue 2, 127-49

Abstract: The analysis focuses on key concepts associated with the extensive CVP under uncertainty literature which has developed since the seminal contribution by Jaedicke and Robichek (1964). For the most part the previous literature has not incorporated economic functions relating production quantity to price and/or average cost. This model developed herein incorporates a linear demand function and a quadratic average cost function. Explicit solutions are found for five "special quantities": (1) the lowest quantity which sets break even probability equal to the minimum acceptable level, (2) the quantity which maximizes break even probability, (3) the quantity which maximizes a Cobb-Douglas utility function defined on expected profits and break even probability, (4) the quantity which maximizes expected profits, and (5) the highest quantity which sets break even probability equal to the minimum acceptable level. Comparative statics effects are determined of the various model parameters on the five special quantities. A "CVP possibilities graph" is developed showing attainable combinations of expected profits and break even probability. Possible applications of the model are discussed. Copyright 2001 by Kluwer Academic Publishers

Date: 2001
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