How Derivatives Help Us Make Business

Decisions
Natalie Rovetto
Kennesaw State University

Introduction
In this presentation, the applications of calculus in
business are considered. !
Examples of total revenue, marginal revenue,
average revenue, price elasticity of demand,
discrete future and present value, and optimization
are shown. !
In addition, optimization examples using calculus
within supply chain management are shown.

Total Revenue Defined

Total Revenue (TR) is the total amount received
by selling x items of the product at a price P per
unit. (Morey, 2002)
It is represented by the equation :

Total Revenue Example

Example 1.
Based on sales data from 2000 to 2009, the
relationship between the price per barrel of beer
(P) at the Boston Beer Company and the Number
of Barrels sold annually (Q) can be modeled by
the power function
! P=209.7204Q-0.0209
where Q is in the thousands of barrels.
! !
! Find the revenue function TR(Q).
4

Total Revenue Example Continued

Solution:!
Total Revenue= Price*Quantity!
!

TR(Q)=Q*209.7204Q-0.0209

TR(Q)=209.7204Q0.0791

thousands of dollars

Marginal Revenue Defined

Marginal Revenue (MR) is
the rate of change of total
revenue with respect to the
quantity demanded. (Morey,
2002)!
It is represented by the
equation:

Marginal Revenue Example

Example 1 (continued).
Using the first example, approximate the marginal
revenue when 1,500,000 barrels are sold.

Price Elasticity of Demand

Price Elasticity of Demand is a concept that helps see

what the responsiveness of a consumer would be for a
product if the price changed.
!
Example 2.
Using Data from Market years 2000 through 2010, the
relationship between the price per bushel of oats and
the number of bushels of oats sold is given by
Q=152.07P-0.543, where P is in dollars and Q is in
millions of bushels. Find the price elasticity of demand
when the price per bushel is $1.75 and determine if the
demand is elastic or inelastic.
8

Calculations Continued
! Example 2 (continued).
The Price Elasticity of Demand is
represented by the equation
!

!
!
!
First, find the derivative
and then insert it into the elasticity
function.

!
!
!
!
If the elasticity is less than -1, the
demand is elastic and if it is
greater than -1, but less than 0, it
is inelastic

Since the elasticity is between!

-1 and 0, it is inelastic.
9

Discrete Future and Present Value

Future Value (FV) of a payment (P) is the
amount that the payment would have grown
if deposited today in an interest bearing
account.!
Present Value (PV) of a future payment (P)
is the amount that would have to be
deposited in a bank account today to
produce exactly FV in the account at the
relevant time future.

10

Discrete Future and Present Value Cont.

!
The

relationship
between the values can
be illustrated after
interest is compounded
n times a year at an
annual rate for t years.
!

In the case of
continuous compound
interest:
!

11

Discrete Future and Present Value Examples

Example 3.

You need $10,000 in

your account 3 years
from now and the
interest rate is 8% per
year, compounded
continuously. How much
should you deposit
now?

Solution:!
!
!
!
FV= $10,000, r=0.08, t=3 !
PV=?!
!
!
!
!
PV is approximately
$7,866.28

Discrete Future and Present Value in Excel

13

Importance of Delivery Performance in

Supply Chain Management
Delivery performance is measurement of the
fulfillment of a customers demand to the wish date!
Delivery performance is a key customer service
initiative within a supply chain that must be
proactively managed (Min and Zhou, 2002).!
Delivery performance is a strategic level supply
chain performance measure (Gunasekaran et al.,
2007, 2001).!
Delivery performance is a key factor in supplier
selection decisions (Shin et al. 2009, Tracy, 2001).

14

Illustration of Delivery Time in a Two-Stage

Supply Chain
Let X = delivery time to the buyer in a serial supply
chain.

Supplier

Delivery
Time

Buyer

where f(x) is the probability density function of

delivery time X
15

Definition of Delivery Window

Legend:
!
X = random variable defining delivery time!
c , c +c = milestone times defining early, on-time
1
1
and late delivery !
c = the width of the on time delivery window
16

In the Presentation We Consider:

!

Model expected penalty cost for uniformly

distribution delivery time !
!

Assess the effect of delivery time

distribution parameters on the optimal
position of the delivery window and the
expected penalty cost

17

Expected Penalty Cost as a Function of the

Position of the Delivery Window
(based Guiffrida and Nagi, 2006)

Y = expected penalty cost!

c1 = beginning of on time delivery!

c = width of the delivery window!

Q = constant delivery lot size!
H = inventory holding cost per unit per unit time!
K = penalty cost per time unit late!
f(x) = pdf of delivery time X

18

Uniform Distribution
pdf!

Optimal position!

!
!

Expected cost!
!
!

or
19

Proposition 1. Increasing parameter a of

uniform distribution will increase the
optimal position of the delivery window and
reduce the expected penalty cost.!
Proposition 2. Increasing parameter b of
uniform distribution will increase the
optimal position of the delivery window and
increase the expected penalty cost.
20

The expected penalty cost is found for

uniformly distribution delivery time !
!

The results allow developing strategies for

improving delivery performance and answer
the question what supplier should do to
decrease the expected penalty cost

21

!
!

Increasing the optimal delivery window by increasing

parameter a will decrease the expected penalty cost.!
Because of this, proposition 1 is the best option!
Increasing the optimal delivery window by increasing
parameter b will increase the expected penalty cost.!
Because of this, proposition 2 in not in the best
interest of a company.!
Decreasing parameter b is a better

22

Conclusion
In conclusion, there is a wide array of
situations in which derivatives could assist
business people within the real world. From
finding the rate of change of total revenue to
finding optimal delivery time, derivatives will
always be useful in a business setting.

23

References
Finan, M. (2003). 52 Applications to economics. Reform calculus: part 2 (pp. 99-105). Arkansas:
Arkansas Tech University.

!
Tesler, G. (2012). Continuous distributions.
!

Guiffrida A.L. and Nagi R., 2006. Cost characterizations of supply chain delivery performance.
International Journal of Production Economics, 102(1), 22-36.

!
Morey, E. (2007). Economic Application of derivatives. Boulder: University of Colorado Boulder.
!
Shin H., Benton W.C., and Jun M., 2009. Quantifying suppliers product quality and delivery
performance: A sourcing policy decision model. Computers and Operations Research, 36,
2462-2471.
Tatiana Rudchenko Supply chain delivery performance improvement for uniformly distributed
delivery time.Conference Proceedings, of Southeast Decision Sciences Institute Wilmington
2014 Conference !

Vickers, J. (2004). The Uniform Distribution. In Work Book 38.

24