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    Mathematics for Economics second edition The MIT Press Michaet Hoy John Livernois Chris McKenna Ray Rees Thanasis Stengos Cambridge, Massachusetts London, England (© 2001 Massachusetts Institute of Technology All rights reserved. No part ofthis book may be reproduced in any form by any lectronic or mechanical means (inching photocopying. recording. oF information storage and retrieval) without permission in writing from the publisher. ‘This hook was set in Helvetica and Times Roman by Int Corporation. tive Composition Printed and bound in the United States of America. Library of Congress Cataloging-in-Publication Data Mathentaties for economics/Michael Hy .. [et al.}—2nd ed. pcm. Includes inde. ISBN 0-262-08254-2 (he. : alk. paper)—ISBN 0-262-58207-4 (pbk. : alk. paper) 1, Economies, Mathematical. I. Hoy, Michael, 1953 Sept. 22- H1B135 M3698 2001 St. 8—ae21 100-068385, sO Preface xiii Part! Introduction and Fundamentals Chapter 1 Introduction 3 1. What Is an Economic Model? 1.2 Howto Use This Book 8 13° Conclusion 9 Chapter 2 Review of Fundamentals 11 2A. Sets and Subsets 11 22 Numbers 23 2.3 Some Properties of Point Sets in" 33 24 Functions 43 28 Proaf, Necessary and Sufficient Consitions* 60) Chapter 3 Sequences, Series, and Limits 67 Bd Definition of a Sequence 67 2 LimitofaSequence 70 3.3 Present-Value Calculations 75 34 Properties of Sequences 84 3S Series 89 Part il Univariate Calculus and Optimization Chapter 4 Continuity of Functions 118 441 Continuity of a Function of One Variable 115 4.2 Economic Applications of Continuous and Discontinuous Functions 1 43° Intermediate-Value Theorem 143 viii CONTENTS Chapter 5 ‘The Derivative ana Differential for Functions of One Variable 155 $A Definition of a Tangent Line 155 5.2. Definition of the Derivative and the Differential 262 5.3 Conditions for Differentiability 169 34° Rules of Differentiation 175 3 Higher-Onder Derivatives: Concavity and Convexity of a Function 208, .6 Taylor Series Formula and the Mean-Value Theorem — 218 Chapter 6 Optimization of Functions of One Variable 227 6.1 Necessary Conditions for Unconstrained Maxima and Minima — 227 6.2 Second-Order Conditions 253 6.3 Optimization over an Interval 265 Part Ill Linear Algebra Chapter 7 Systems of Linear Equations 279. 7. Solving Systems of Linear Equations 279 712 Linear Systems in n-Variables 293 Chapter 8 Matrices 317 84 General Notation 317 8.2. Basic Matrix Operations 324 3 Maitix Transposiion 340 84 Some Special Matrices 345 Chapter 9 Determinants and the Inverse Matrix 353, YA Defining the Inverse 353 9.2 Obtaining the Determinant and Inverse of a 3% 3 Matrix 370 9.3 The Inverse of an nm Matrix and Its Properties 376 94 Cramer's Rule 386 Chapter 10 ‘Some Advanced Topics in Linear Algebra” 405 WL Vector Spaces 408 102 The Eigenvalue Problem — 421 10.3 Quadratic Forms 436 CONTENTS bx Part iV. Multivariate Calculus Chapter 11 Calculus for Functions of n-Variabies 455 ALI Panial Differentiation 485 112. Second-Onder Partial Derivatives 469 U3 The First-Order Total Differential 477 324. Curvature Properties: Concavity and Convexity 498 11.5 More Properties of Functions with Economic Applications $13 11.6 Taylor Series Expansion* 534 Chapter 12 Optimization of Functions of n-Variables 845 12.1 First-Order Conditions $43 12.2 Second-Order Conditions 360 12.3 Direct Restrictions on Variables 569 Chapter 13 Constrained Optimization 585 13 Constrained Problems and Approaches io Solutions 585 13.2 Second-Order Covaltions for Constrained Optimization 616 13.3. Existence, Uniqueness, and Characterization of Solutions 622 Chapter 14 Comparative Statics 631 14.1 Introduction to Comparative Statics 631 14.2. General Comparative-Statics Analysis 643 143° The Envelope Theorem — 660 Chapter 15 Concave Programming and the Kuhn-Tucker Conditions 677 18.1 ‘The Concave-Programming Problem 677 18.2. Many Variables and Constraints. 686 Part V_ Integration and Dynamic Methods Chapter 16 Integration 701 16.2 The Indefinite Integral 704 16.2 The Riemann (Definite) Integral 709 16.3 Properties of Integrals 721 x CONTENTS 16.4 Improper Integrals 733 16.5 Techniques of Integration 742 Chapter 17 ‘An Introduction to Mathematics for Economic Dynamics 753 171 Modeling Time 784 Chapter 18 Linear, First-Order Difference Equations 763 18.1 Linear, First-Order, Autonomous Difference Equations 763 182 The General, Linear. First-Order Difference Equation 780 Chapter 19 Nonlinear, First-Order Difference Equations 789 19.1 ‘The Phase Diagram and Qualitative Analysis 789 192 Cycles and Chaos 799 Chapter 20 Linear, Second-Order Difference Equations 811 20.1 The Linear, Autonomous, Second-Order Difference Equation 811 20.2. TheLinear,Second-Onder Difference Equation witha VariableTerm — 838 Chapter 21 Linear, First-Order Differential Equations 849 21.1 Autonomous Equations 849 21.2 Nonautonomous Equations 870 Chapter 22 Nonlinear, First-Order Differential Equations 879 22.1 Autonomous Equations and Qualitative Analysis 879 22.2 ‘Two Special Forms of Nonlinear, First-Order Differential Equations 888 Chapter 23 Linear, Second-Order Differential Equations 897 23.1 ‘The Linear, Autonomous, Second-Order Differential Equation 897 232. TheLinear Second-Order Differential Equation witha VariableTerm 919 Chapter 24 ‘Simultaneous Systems of Differential and Difference Equations 929 24.1 Linear Differential Equation Systems 929 24.2 Stability Analysis and Linear Phase Diagrams 981 24.3 Systems of Linear Difference Equations 976 CONTENTS xt Chapter 25 Optimal Control Theory 999 25.1 25.2 283 284 255 236 ‘The Maximum Principle 1002 Optnnization Problems Involving Discounting 1014 AAltenative Boundary Conditions on «(7 1026 Tnfinite—Time Horizon Problems 1040 Constraints on the Control Variable 1083 FreeTerminai-Time Problems (7 Free) 1063 ‘Appendix: Complex Numbers and Circular Functions 1081 Answers 1091 Index 1123 Lele} A major challenge in writing a book om mathematics for economists is to select the appropriate mathematical topics and present them with the necessary clarity Another challenge is 10 motivate students of economics to study these fopics by convincingly demonstrating their power to deal with economic problems. All this must be done without sacrificing anything in terms of the rigor and correctness of the mathematics itself, ‘A problem lies in the difference hetween the logic of the development of the mathematics and the way in which economies progresses from models of in- dividual consumer and firm, through market models and general equilibrium, to macroeconomic models. The primary building blocks, the models of consumer and firm behavior, are based on methods of constrained optimization that, mathe- matically speaking, are already relatively advanced. In this book we have chosen instead to follow the logic of the mathematics. After a review of fundamentals, concemed primarily with sets, numbers, and functions, we pay careful attention tothe development ofthe ideas of limits and continuity, moving then tothe ealcue lus of fumetions of one variable, linear algebra, multivariate calculus, and finally dynamics. Inthe treatment of the mathematics our goal has always been 1 give the student an understanding of the mathematical concepts themselves, since we believe this understanding is required if he or she is to develop the ability and confidence {0 tackle prublems in economic analysis, We have very consciously sought to avoid a “cookbook” approach. ‘We have tried to develop the student's problem-solving skills and motivation by working through « large number of examples and economic applications. far ‘more than is usual inthis type of book, Although the selection ofthese, and the order in which they are presemted, was determined by the logic ofthe development of the ‘mathematies rather than that of an economies course. in the end the student will hhave covered virtually all of the standard undergraduate mathematical economics syllabus, Many people helped us in the preparation of this book and itis a pleasure to ucknowledge our deb to them here, The following individuals read early versions of the manuscript and offered helpful suggestions large number of which were Ireely used: xiv PRERACE Richard Anderson Paul Anglin Walter Bossert Zhigi Chen Peter Coughlin ‘Swapan DasGupta Erie Davis ‘Allun DeSerpa Richard Fowles Jan Irvine Roger Latham Chenghu Ma Paul Segersirom James A. Stephenson Rugu Wang. Steven Williams ‘Texas A&M University University of Windsor University of Waterloo Carleton University University of Muryland at College Park Dalhousie University Carleton University Arizona State University University of Utatt Concordia University York University MeGill University Michigan State University Lowa State University ‘Queen's University University of Ulinois Drafts of the book, at various stages, have been used in classes at the Uni- versity of Guelph. We thank the many students involved for their cooperation in finding their way around incomplete manuscripts, ancl we thank Louise Grenier {for helping them do just that. For assistance in preparing answers to the exercises and for helpful comments on the text, we would like to thank Matias Polborn, Mathias Kifmann, Markus Wagoer, Erich Kolger, Tina Farber, Ursula Bachmann and Andreas Wildermuth. ‘A number of individuals who used the first edition suggested many useful changes and we thank them for that. We especially thank Naney Bower for her ‘numerous contributions. introduction and Fundamentals Chapter 4 Introduction Chapter 2 Review of Fundamentals Chapter 3 ‘Sequences, Series, and Limits Chapter 1 Introduction Aimast for as long as economics has existed as a subject of study, mathematies ‘has played a part in both the exploration and the exposition of economic ideas,! Its not simply that many economic concepts are quantifiable (examples include prices, quantities of goods, volume of money but also that mathematics enables us to explore relationships among these quantities, These relationships are explored in the context of economic models, and haw such models are developed is one of the key themes of this book. Mathematics possesses the accuracy, the rigor, and the capacity to deal clearly with complex systems, which makes it highly valuable as a method for analyzing economic issues. This book covers a wide range of mathematical techniques and outlines a large number of economic problems to which these techniques may be applied. However, mathematical modeling in economics has some unifying features and Conventions that we will summarize here at the outsct. Although model details ure problem-specific, here are rome basic principles in the modeling process that are ‘worth spelling out, 1.1. What Is an Economic Model? Av its most general, a model of anything is a representation. As sech, a model differs from the original in some way such as scale, amount of detail, or degree of complexity, while atthe samme time preserving what is important in the original in its broader or most salient aspects. The same is tre of an economic model, though unlike model airplanes, our models do not take a physical fon, Instead, we think of an economie model as a set of mathematical relationships between economic ‘magnitudes. Knowing iow to distill the important aspectsof an economic problem inte an abstract simplification is part of the formal training of an economist. The ‘model must be convincing and must be Capable of addressing the questions that the researcher has set, We now set out the central features af an economic model "The mre famous early works in economics witha aematical exposition include A. Coun, ‘Récherchessurlesprncie mathémaignerde la theriedesichesses{ 1838). WS .ev0ns, The Theory of Paliuen! Economy (1814), L. Walas, Etniens dScrmomie pric pure (4874, A. Marshal Princes of Ecos (1890), an V. Past, Cou economic prtigu | 196). 4 CHAPTER 1 INTRODUCTION Quantities, Magnitudes, and Relationships We can start by thinking of how we measure things in economies. Numbers repre- Sent quantities and ultimately itis this circumstance that makes it possible to use ‘mathematics as an instrument for economic modeling. When we discuss market activity, for example, we are concerned with the quantity traded and the price at which the trade occurs. This is so whether the “quantity” is automobiles, bread, hrairwuts, shares. or treasury bills. These items possess cardinality, which means that we ean place @ definite number on the quantity we observe. Cardinaliy i absolute but isnot always necessary for comparisons. Ondinality is also-a property ‘of numbers but refers only to the ordering of items. The difference between these ‘two number concepts may be illustrated by the following {wo statements LL Last year, the economy's growth rate was 3%. 2. The economy’s output last year was greater than the year before. Both of these statements convey quantitative information. The fist of these is wcardinal property of the change in output, We are able to measure the change and put a definite value on it. The second is an onal statement about economic activity in the past year. Last year's output is higher than the year before, ‘This of course isan implication of the frst staernent, but the first statement cannot be inferred from the second statement. However, there isa greater difference between cardinality and ordinality, be- cause we cam also decide ona ranking of items hased on their gualizarive properties rather than on their quantifiable ones. Most statements about preferences are ordi hal in this sense, 50 to says “I prefer brand A to brand B, and brand B to brand C” i an ordinal statement about how one person subjectively evaluates three brands of a good. If we let larger oumbers denote more preferred brands, then we could associate brand A with the number 3, brand B with the number 2, and brand C with the number 1. However, the numbers 10, 8, and O would serve equally well inthe absence of any other information. This statement may provide useful information, and certain logical and mathematical consequences may follow from it, but itis ‘ota statement about quantities. Variables and Parameters Wren we start to build an economic model, We know thal we are not going to be able to explain everything. Some things must be treated as given or as data for our problem. These are the exogencits variables and the parameters of the model. The endogenous variables, then. are those tna are going fo be explained by the model A simple example will illustrate. Suppose that we are trying to determine the equilibrium price and quantity in market fora homogeneous good, We hypothesize that the quantity demanded of 1:1 WHATISANECONOMIC MODEL? 5 some good may be represented as ° —bp toy oy ‘which is a simple tinear demand function. Each time price, p. inereases by one dollar, the quantity demanded, q”, falls by b times one dollar. rise in income, y, ‘of one dollar increases quantity demanded fy © units, This demand curve may be chosen purely for simplicity, or it may be known, by looking at market data, that the demand curve for this gbod does take this simple forin. Now suppose that the supply of this good is fixed ar some amount which we will eall q°, and suppose hat we believe that the prevailing price in this market isthe price that equates demand with supply. Then implies. p= “4 a2) So bere, p is the endogenous variable, a and i> ate the exogenously given parame- ters, and and_y are exogenous Variables, For instance, demand is determined by tastes, weather, and many other environmental and social factors, all of which are ‘captured hereby a, b,c. All supply-side considerations ae, in this particularly simple case, surnmarized by the quantity 7°. Parameters may also incorporate the effects of exogenous variables, which we do nat wish to specify explicitly. For example, « may incorporate the effects of prices of others goods on the demand for this one. Finally, in this example, there is one furthe: endogenous variable, Since quantity demanded, 4”, depends partly on p (which is endogenous) it too is endogenous: therefore 4” is only known when the price is known, Substituting ‘egjuation (1.2) into equation (1.1) gives simply q” = g° as the value of demand In general, as in this simple example, we can use relationships between eco nomic variables and fckground parameters to reach conclusions or predictions ‘based upon the mattematical solutions of those relationships Behavior and Equilibrium ‘As we have just seen, further step in building an economic model isto identity the ‘ehavioral equations, or the equations that describe the economic environnient. and to identify the equilibrium conditions. tthe simple supply-and-demand ex:um- ple above, the behavioral equations are the demand and supply functions describing the relationships between the endogenous variables nd exogenous variables. The equilibrium condition determines what the values of the endogenous variables ‘will be, In this ease the condition is that supply equals demand. The specification of the equilibrium condition is based on our understanding of how the part of the economy in question Works, and embodies the crucial hypothesis of how the ‘endogenous variables are determined, 6 CHAPTER INTRODUCTION Behavioral equations contain hypotheses about the way the individusl, market, ‘oreconomy works. Oneof the key strengths of mathematical analysis in economics is that it forces us tobe precise about our assumptions. I the implications of those behavioral equations prove (o be unsubstantiated or ridiculous, then the natural course of aetion isto lock more closely at the assumptions and o atteapt to idemify those esponsible for throwing us offcourse. Single-Equation Models and Multiple-Equation Models Although sometimes the problem we are trying to analyze may be captured in 8 single-equation model, there are many instances where two or more equations are necessary, Interactions among a number of economic agents or among different sectors of the economy typically cannot be captured in a single equation, and & system of equations must be specified and solved simultaneously. We can extend ‘our earlier example to illustrate this ‘Consider frst the demand and supply of two goods. We denote the demands by g? and g? and the supplies by 9° and gS, where the subscrips | and 2 identify which good weare referring 1, Now, as before, we may specify how demands and supplies are related to the prices of the two goods, bat this lime recognizing that the demand for and supply of good 1 may depend on both its own price und on the price of good 2. Recognition ofthis fact gives rise to an inverdependence between the two markets. For simplicity, suppose that the demand for each good depends ‘on both prices, while the supply of each good depends only on the good's own price. The question we are asking is: Ifthe interdependence between two goods takes this form, what are the consequences for the equilibrium price and quantity traded in each market in equilibrium? Again, as before, we will restrict ourselves to finear celationships only. We may write qP =a—bypy +b: dy be > 0 (ay and af = 0 Bip + Papi, aay ‘Notice that in addition to incorporating the usual negative relationship between the demand fora good and its own price, we bave included « specific assumption about tne cross-price effects, namely that these goods are yubstitufes. Ifthe price of ‘good | increases, the demand for goo! 2 inereases. and vice versa. Setting supply ‘equal 0 an exogenous amount in each market gives us (sy at Bap - a a (6) and solving gives Bila G) + (aH 1 See 7 Bala ai) + n(o ia) BiB — bapa Notice thatthe solutions hece express the two prices in terms only of the exogenous variables and the parameters—these are the reduced-form solutions. We are now set to consider the implications of our imitial model. Statics and Dynamics Inintroductory treatments of economics the time dimension ofthe problem soften ignored, or supressed for simplicity In eality, the time dimension salway’ present, In the examples of market equilibrium already discussed, we should think of the ‘quantities as flows per period of time, so that g° is the quantity demanded of a ss00d per period, however short o long that period may be in terms of calendar time. Models where we explicitly or implicitly considera situation within a single period of time we refer to as staric models. The economic activities studied in static models do not take into account the history of these activities and do not ‘consider the future consequences of these activities. Static problems are solved in- dependently of the possege of time. Put this way, it seems that the static framework for economic analysis is extremely restrictive. However, many useful models of ‘economic behavior have been developed in the static framework, and we will be studying several such examples in the book. Many problems, though, are neces- sarily dynamic in nature. The theories of economic growih, inflation, and resource depletion, for example, are impossible to model without explicit consideration of the time dimension Explicit consideration of time opens up new challenges as well as new oppor tunities for the modeler, and in the later chapters of the book we will develop the ‘more important techniques for studying dynamic models. Its useful at this point, however, to highlight some important concepts that emerge when. we explicitly account forthe passage of ime. ‘Quantities and values that recur each peried in a dynamic moxle! continue to be referred to as flows. Income, investment, saving, production, worker hires, and 8 CHAPTER INTRODUCTION purchase and consumption of goods are examples. Some of these flows may be stored or accumulated into stocks. Flows of investment in machinery become the -cumulated capital stock. Accumulated savings are assets. Accumulated hires are the Workforce. Unsold production aécumlates into inventovies. Accumulated deficits are total debt, and so on. Mathematically we must specify the telationships between the flows and the stocks as part of any dynamic model, The relationship between investment andthe ‘capital sock is « useful example, Denote by J; the amount of investment during period and denote the capital stock atthe hegining of period by K;,. Then we can define the flow of investment in terms of the change in the capital stock between periods (ignoring the depreciation of capital) h Kin — Ky The flow of investment is simply the change inthe stock of capital. Nove that we use time subscripts to date the stocks and the flows dat we are interested in From the modeling point of view, we have certain choices whien we are decid- ing onthe appropriate mathematica structure fora dynamic model, One a these is the modeling of time itself, So far we have thought of time as being divided up into intervals or “periods.” Ia these models of discrete time, al zelevant economic fac torsare allowed to change between periods but aot within periods, OF eourse, since the leagth of a period is arbitrary, this condition is not very restrictive, Different mathematical techniques are required if we wish to think of time as evolving ex tinvously. In continuous time models, we date the stocks and flows by instants in time, and we can invoke calculus io define the relationships between flows and suc- ‘cessive instantaneous yalues of stocks. We show how this is dove later in the book 1.2 How to Use This Book ‘The book is intended to be comprehensive ints coverage of mathematical methods for undergraduate economics programs. The arrangement of the material follows the logic of the development af the mathematical ideas rather than those of eco- nomics. Examples and exercises relate both to purely mathematical techniques and {o their applications in economics. The book also contains extended discussions of some economic applications. Chapters, sections, exercises, examples, and eco- nomic applications that we regard as advanced or that might otherwise be onytted are indicated by an asterisk. Important concepts are highlighted. Key theorems and definitions are dis- played, while keywords are set im bold (ype. Each section ends with exercise land each chapter ends with a chapter review, consisting of a list of key concepts, {questions for discussion o¢ review, and review exercises: Answers 0 the oxd- ‘numbered questions ure given at the end of the book. 4a PONCISION 9 To the Instructor... There is clearly mone material here than can be covered in a one-semester course. {A fist course is unlikely 1o progress beyond chapter 13 or possibly chapter 14 ‘Chapter 16, on integration is positioned here as a preparation for the chapters on ‘dynamic methods, though it could be brought forward if integration techniques are 10 be given a higher priority in the single-semester course, A second-semester ‘course vould be built around ehapter 15 onward To the Student... In any course, you will need to attempt exercises, and other material, that have not ‘been coveted in class. The only way to learn mathematics ancl economics isto do ‘mathematics and economics. We have provided many examples and exercises in ‘order to encourage independent study. 1.3. Conclusion ‘The aim of this book is to present the key mathematical concepts that most fre- 4uenily prove helpful in analyzing economic problems. However, the approach We take is not simply 10 provide a recipe book of results and procedures. Our imis to take students through the model-building process by working out a lange number of economic examples. BY the end of the book, in addition to acquiring particular mathematical skills, we hope that the student will have some knowledge of the ‘main economic models ant their properties. Review of Fundamentals In this chapter we give a concise overview of some funnlamental concepts that underlic everything we do in the rest of the book. In section 2.1 we present the basic clements of set theory. We then goon to discuss the various kinds of numbers, ending with a concise treatment of the properties of real oumbers. and the dimensions of economic variables. We then introduce the idea of point sets, beginning with the simplest case of intervals of the real line, and define their most important properties from the point of view of economics: closedness, boundedness, and convexity. Next we give the general definition of a function, and set out the main properties of the types of functions ‘most frequently encountered in economics, We also define the important properties ‘of concavity, convexity, and quasiconeavity and convexity. Finally. there isa short discussion of the meaning of necessary conditions and su ‘of how proofs are formulated, inthe context of an economic example, iclent conditions, and 2.1 Sets and Subsets A set is any collection of items thought of as a whole, The collection is treated ‘asa single cbject, to which mathematical operations may be applied. One way of defining a particalar set is by enumeration: we simply list the items included in the set—the elements of the set. Alternatively, we can state a specific property. If.an item possesses that property, itis an element of the set, but if it does not, it is excluded from the set, This fatter method is far more generally used because defining a set by enumeration is often very cumbersome and sometimes impossible. For example, consider the set of even numbers between 1 and 17, In the standard notation for deseribing seis, we could write (x: isuo even number between 4 and 11) (2d) or, equivalently. 2.4.6.8, 10) The first way of writing S corresponds to definition by property (the "should be 42° CHAPTER? [REVIEW OF FUNDAMENTALS Example 2.1 read as "given that”); the second to definition by enumeration. The key aspects of this notation are as follows + A capital leter denoting the set, here S. ‘© A lowercase letter denoting a typical element ofthe set, here x ‘* Braves, |...) that enclose the elements ofthe set and emphasize that we treat them as a single entity In general, a lowercase letter such as x denotes items that may or may not be clements of some particular set. For example, here x can represent any number ‘whatsoever. Then, if takes on a Value that is inthe set, we write xes and if it takes on a value that is notin the set, we write res Also, in general, the definition of a set by property may be written X= |r: Poy) where P is a property that x may or may not have, so P(x) is equivalent t0 the statement “x possesses the property P.” Consider now three further sets of numbers: Zy = (x sx isa positive imeger) (23) Aa (re Zoe SU) =(,2,3,4,5,6,7.89, 1011] 24) Ba{reAsx/leZ, (2.4.6.8, LO} es) Note that in the case of A and B we have extended the notation slightly by writing, the set to which must belong fa property of A and B) to the left ofthe colon, Deline the set Z,, in equation (2.3) by enumeration Solution ‘The difficulty here fs thatthe set of positive integers is very large. The way around this istohave anotation to stand for “and so on” once a pattern has been established so that there i litle ambiguity about what follows, One suggestion inthis example right be Z= 1234.0) 24 SETSAND SUBSETS 13 Where"... stands for “and so on.” Notice. however, that this notation only suggests the nature of Wy infinitely long sequence of integers could follow 4, . We observe also that all the elements of A are also elements of Zand that all the elements of B are also elements of A, This observation leads 10 the following important definition: If all the elements of a set X are also elements of a set ¥. then X is a subset of ¥. and we write xey Where C is the set-inelusion relation. In our cxamples we have B © A and A Z,. Note also that these two facts feud BC Z,, Since A contains B and Z, contains A, then Z4 must contain B. Is Z, subset of A? Clearly not, because there exist numbers x > 12 that are in Z,. bul oot in A. This observation leads 10 PERRIER 2 tic ctemens in a set © are ova sr ¥, hur nov alle elements of ¥ ae in X then X is a proper subset of ¥, and we write cY So, for our examples, we certainly have AC Z,. Itmust ther also be true that BC Zz, Since B < A, Now consider the relationship between A and B. Is Ba proper subset of A? Clearly. B CA because the ad integers 1, 3,..., 1] ate in A bat not in B, The equality between two sets is defined by PEST 0 set: ¥ and ¥ ave equal if they contain exactly the same elements. and we write 14 CHAPTER 2 _ REVIEW OF FUNDAMENTALS [Note thatthe equality of two sets means cha they are identical. as is the ease with S and B defined earlier, Formally, we demonstrate that two sats are equal by showing that they are both subsets of each other. That is, XCY and YOX & x implies and is implied by So far we have considered examples that are sets of numbers. Itis important to emphasize, though, that we cun tlk of w huge variety of things that we ean eollect into sets. Some economic examples are as Follows: 4 ‘The set of all the firms in an economy, ‘# The setof firms producing a particular good, usually referred to asthe industry for that good. “© The set of buyers and sellers of good, usually ferred 16 as the market for that good, + The set of quantities of goods and servicesthat consumers physically capable of consuming, usually called the consumption se for the consume: © The set of bundles of goods and services that consumer ean afford to buy, usuilly called the budget ser of the consumer. + The set of output quantities » frm is technologically capable of producing and the input quantities required to produce these, usually called the production ser forthe firm. * The set of output quan ‘economy given the ay day set for an economy es technologically capable of being produced in an ble resources, usually called the production possibit Set Operations We are now going to define operations on sets that can be thought of as roughly analogous to the basie operations of addition, subtraction, multiplication, and di- vision that we earry oveon numbers. To avoid some logical problems that can arise {f we continue to asstine that we are dealing With any kinds of sets whatsoever, we take i that we have some given set of items of some specific kind, called the universal set, U/, and we define the set-theoretic operations i terms of subsets of UA Venn diagram, shown in figure 2.1, is useful device for ilustrating the relationships between sets and subsets. The rectangle represents the universal set, UW, so that any point in U7 is an item x, The sets we are interested in are shown by collections of points such as A and # o¢ X and ¥. Note that this isa purely schematic representation, and #/ should be thought of as-a set of items in xen eral, not necessarily as points in a plane, When we think about the relationship between the sets, we notice a difference between the cases shown in (a) and (b) of figure 2.1. l(b). X and ¥ overlap, whereas in (a) A and B do not 21 SETSAND SUBSETS 15 @ om) Figure 2.1 Venn diagrams ‘The intersection, W, of two sets X and ¥ is the set of elements that are in borh X and ¥, We write W=xXOY=(xixeXandxe¥) ‘Thus the intersection is the set of common elements. The expression Xr ¥ is read “Whe intersection of X and Y.” What about the intersection of the sets A and & in figure 2.4 (a)? Clearly, it does not exist, since there are no com: ‘mon clements shared by A snd B. This leads to the idea of a set that has no elements “The empty set or the mull set is the set with no elements. The empty setts always written Since there are no common elements shared by A and B, we can write ANB=6 2.6) land these two sets are said to be disjoint. Sinc® all the sets under discussion sire in U, we have @ © U. We can also think about the total of elements in a number of sets 16 CHAPTER? REVIEW OF FUNDAMENTALS Cam PERE Te union of wo sets A and # is the set of elements We write ‘one or other ofthe set C=AUB= (vse AorB) The expression AU B is read "the union of A and B.” In Sgure 2.1 (a), C simply consists of the points in A and the points in B thought of now as a single set. Ifwe let R = X UY, then, in figure 2.1 (b), is the set shaped something like 00" Note that we must have XOYCR, where R= XUY and if we now define (10 be a proper subset of any nonempty subset of U,, we can also write where C = AUB ‘So we see that intersections of sets are always contained in theie unions, Example 2.2 Take as our univer set the set of postive integers, Zand let N= (ee Z.x 2) 18 CHAPTER2 REVIEW OF FUNDAMENTALS 1,2, 25259) 11, 1B, 25 25, 26,002) eZ, ox <= 10, orx > 24, orl0 20, or 24) Since XZ, =X, wehave XZ, =¥. Since XUZ,=Z,,wehave UZ, = Z.=0. . ‘These examples show that if we have a set X © U or X = (x € U : Pla} so that elemenis x in have the property P. then the complement of X is the set of values that do not possess property P or X= [x © U : not PCs) ‘We can think of the complement of a set X © Uas the difference between the sets X and U. This can be generalized to indicate the difference between any two sets Poe EEE) the relative difference of X and Y, denoted X that are not also in ¥ is the set of elements of X XaV=(xeU sre Xande? Y) ‘As the Venn diagram in figure 2.1 (b) shows, we can think of X — Yas the part of X remaining when we take out the intersection of X and ¥, so we may write Example 25 If X =Y.showtha X-¥=¥—X Solution WX = Yatben ¥ —¥ =X —X=XOX=GWX =VabenY—X=¥—-Y= Y 1) ¥ = 8, since no element of a set ean be an element of its complement, and vice versa, . Example 26 IF X 1 ¥ =), show that X 2) SETSAND SUBSETS 19 Solution First note that if XP) ¥ = @, shen X 0 Y = X. Itshen follows immediately that x- =xny We have considered only individual subsets of the universal set U. We now consider ‘wo important collections of subsets A partition ofthe universal set 1 is acallection of disjoint subsets of U, the union ‘of which is Thus, if we have n subsets X).i «7, such that xn and. X/UXUXL nau them these 7 subsets form a partition of (. This result is Mlustrated in figure 2.3, ‘The key point is that each element of U fies in one and only one of the subsets. Let ‘S denote this collection of subsets, and let the union of the m subsets be denoted “oh Figure 2.3 partition of U 20 CHAPTER? REVIEW OF FUNDAMENTALS Example 2.7 Example 2.8 Example 2.9 by Uy Xi. Then we have isa partition of U. ‘Show that (X, X), for X © U. is a panttion of U. Solution By the definition of acomplement, we know that XUX = U. Buralso, XX = ‘Thus (X, X) is panition of U. . Do the sets X and ¥ of example 2.2 form a partition of 2,7 Solution No, sitee VF # Band XUV CZy. . Consider the collection of subsets of Z., defined as follows: X= (we ZIM i (and j > i+ ).1fx € Xi,then-x < IF = 101) — 1), and sox ¢ X).Ifx © Xj, then x > 10(/— 4) > 10¥ and so x ¢ Xy. Thus the subsets are disjoint. To prove that any element of Z, is in one of these sets, take any « € Z. and note that either x is a multiple of 10 or itis not, IF it is, then let, Example 2.10 Example 2.11 21 SETSAND SUBSETS 21 i = x/10. Then we have x € X). If itis not, then x/10 can be written a + (b/10), where a € Z, and (b/10) < 1. Then setz = a + 1, and it is straightforward to show that x © X; . “The power set of a set X isthe set of all subsets of X, and is written P(X). That is, PIX) = (AZ AC Xi}, Find the power set of X = (1,2. 3} Solution Note first that @ is a subset of every set X CU and by convention, we take X itself to be a subset of X. We also have {1}, (2}, {3}, and the sets of pairs o give PEK) = (1). (2). (Ys (1.29. (1, 3}, 2.3}. X.) . ‘Note that P(X) in this example has exactly 2° = 8 elements, For any set X with a finite number of elements, it can be shown that its power set has exactly 2° elements, In other words, a set with n elements has 2° subsets, Find the power sets of the following sets: wo Gi) X = fa) Gi) 2, = (1,2.3...4 Solution Gi) The only possible subset of is itself and so P(@) = (4). Note that using the formula for finding the number of subsets of a set, we have n = () and Pal i) A set with only one element is usoally called a singleton, and it has (wo subsets, so P(X) = (fal, i] = (X, 4) (iii) We cannot construct the power set of Z., by enumeratior itby 1, but we can define P(Z4) =X 2X SZ.) the set of all possible sets of positive integers. . eae Explain the difference between the statements X, where A = (x) Define the relationships (C: if any, among the following sets: O O and x < 0} equals the empty set. 7. A.consumer’s consumption set is given by Clann): and her budget set ven by B= (025,22): piss + pa O are prices, and M > 0 Ilustrate in a diagram the sets @) B.C 22 NUMBERS 23 (bh) Buc w anc and interpret each of these 8. Given twa subsets X and ¥ of a universal set U, prove that (a ¥AV=xuy ) FUV=koP () X-y=xnF (a) X CV implies PX (©) XS ¥ implies ¥ UO’ — x) ) x-vexuy (@) XP Y =Himplies YX = Ilusteate each case on a Venn diagram, 9. A firm's production st is given by PalaOsysvi0srsr) where y is output and x is labor input. Sketch and interpret P in economic terms. How would you interpret 52 10, Prove that for subsets X.Y, and Z of a given universal set @ X-Y¥=x-(xnyy=ukUy-¥ ) (X=) -Z=N-UZ) @ X=(¥-Z)=(-YUUKNZ) @ (xUY)-Z=(x-ZuUY-2) @ x-(WuZ=-NA(X-2) Mustrate each case on a Venn diagram, 2.2 Numbers ‘The most basic and familiarkinds of sumbers are natural numbers, of the set ‘They arise naturall counting objects of all kinds. What does it mean to count a 24 CHAPTER? =a aot Figure 2.4 The set Z 234 REVIEW OF FUNDAMENTALS. set of objects, say a pile of dollar bills? When we count dollar bills, we take each element in the set of dollar bills and pair it with an element of 2. starting with I and moving successively through the set. When we have exhausted the elements of the first set (of dollar bills) the clement of Z,. that we have reached in this process gives us the number of dollar bills. This number is called the cardinality Of the set of dollar bills the cardinality of a set isthe number of objects it contains, As we saw in section 2.1, Z.. has an infinite number of elements, Given any positive integer, we can always find a larger one. We now define some properties (of natural numbers and show that ather types of nutmbers arise Irom the operations cf addition, multiplication, subtraction, and division. Consider the addition or multiplication of any two elements, a and b. of Z,. These two operations are closely related, since multiplying a and b is simply adding a to itself b times or b to itself «times. The first thing we note is thatthe result of this is itself always an element of Z. UtbeZ., ubeZ, This is formally expressed by saying that the set Zs 18 closed under the operations ‘of addition and multiplication. Is Z;, closed under the operations of subtraction and division? Clearly not, i a b> 0), Itis also clear that ZC Z. 22 NUMBERS 25 The set of integers is closed under addition, subtraction, and multiplication. However, neither Z nor Z,. is closed under division, since, for example, a/b ¢ Z if@ = ~2 and 6 = 3, though both a and b are in Z. This means, for example, that ‘we could not in all cases find x © Z such that be=a, abez This leads to the definition ofthe set Q of rational numbers @ fraezvez~(o}] Note that ZC Q, since we could clearly choose a = kb for k € Z. Note also that we rule out division by zero, We say that any expression involving zer0 inthe ‘denominators undefined. The reason forthiscan be een from the equation bx = a. fb = 0, then no.x exists such that bx =a for any a % 0,and so ruling out division by zero recognizes tis fact. (The term “rational number” comes fromthe facrthese rumbers are ratios of integers.) Figure 2.5 shows the set of rational numbers and indicates that these include points between the integers. Take any two points om the line that give distinct rational nurnbers. There is an infinity of other rational numbers between those points. To see this, consider the two rational numbers L and 2, and note that 1 +2 ~1)/e with € Z... must be rational number between 1 and 2. Each value of ¢ gives a different rational number, and since Z, has an infinite number of elements there must be an infinite number of rational numbers between | and2, Replacing t by a and2 by b > a, where a and/ are any elements in Q, shows that is must be true in genera. = 3 0 t 7 Figure 2.5 The set 0 An important observation i that the segment hetween the numbers | snd 2 (or between any two rational numbers) is not entirely composed of rational numbers. Other numbers exist, In figure 2.6 we have constructed a right-angle triangle with sides A and 8 of length 1 and hypotenuse of length L lying along the line. From the Pythagorean theorem we know that the square ofthe distance L along the line is given by +0 so L.= VE. The following theorem, the proof of which was well known o the 26 CHAPTER? REVIEW OF FUNDAMENTALS ancieot Greeks, shows that V3 is nota rational number. This tells us that Q is not closed under the operation of taking square routs Alternatively, it ells us that there must be numbers other than rational numbers. These ate irrational numbers, ‘which eannot be expressed a the ratio of two integers 4 2b = ofr im: « G Figure 26 Vis ination os = 0 = Figure 27 The sct of real numbers. Proof ‘The proof is by contradiction, Suppose that /3 e Q. Then there exist integers p and q such that p/q = V2, where we choose the smallest such p and g. Now P'[q? = 2, or p? =24°, so p must be an even number. Since the square of an (00d number is always odd, pis even, and we may write p = 2r, where ris also an iteger, We then have and so g® = 2r?, Clearly, 2, and hence q, must be even. This result contradicts the assumption teat p and.q sere the smallest numbers to give p/q = +/7. Thus ‘the statement /2 © @ must be false. . ‘This result establistes the fact thatthe line in figure 2.6 must contain at feast one number that is not rational. Altematively, it shows that if we wish to solve a simple ‘equation such as v-2=0 then we need a set of mumbers larger than Q. since x cannot belong to Q. In fact there are « farge number of irrational numbers. The Real Numbers and Their Properties ‘The union ofthe sets of rational and irrational numbers isthe set of real numbers, We think of the set of real numbers, R, as extending along 2 line to infinity in each direction having no breaks or gaps, as in figure 2.7, We refer to 2his as the real line. ‘The properties of B define the basic operations that we can carry out on the elements of R. Consider three (not necessarily distinct) elements of Ra, b. and c. ‘We can postulate the following properties: 1, Closure Ifa,b © B, then a+b € Rand ab ¢ BR, So R is closed under addition and maltiplication 22 NUMBERS 27 Example 242 Commutativetaws Forall a,b €B a+b a and ab=ba ‘which simply says that the order in which we ada or multiply two veal numbers does not affect the outcome. 3. Associativelaws For all a, b,c € at(btey=la+b)+e and athe) = (abe so thatthe order in which we add or multiply three real numbers does not mater 4, Distributive law Forall a,b ¢ © R, ab +0) =ab-+ac 5. Zero The element 0) € ® is defined as having the property that for all a € BR, a+0=a and ad=0 6. One The element | € Bis defined ay having she property that Masa 7. Negation For each a € R, there is a number ~a © K defined as having the property a+(-a)=0 8. Reciprocals For each element a R ~ (0), there is an element I/a =H efined as having the property For a = 0, the reciprocal is undefined. Forull a,b € Byifa +b = ) showy that 28 CHAPTER? REVIEW OF FUNDAMENTALS Solution Start with a + b =O and add —a to both sides to obtain -atat+b=-a (-atay+b O+b b= —a (from property 3) —a (from property 7) a (from property 5) ” The following are also the more obvious consequences of these properties: (a) Foralla eR, 1a (b) Forall a,b € B, (a +b) = (©) Foralla © R,(-a) =a. (4) Forall a,b © R, (—a)(—b Indeed all the standard rules of algebra follow from properties | through 8. The Order Properties of 8 First we define two important subsets of R. PEE 2c se: CR consists oF the strictly postive real numbers with the character: istics that (By. is closed under addition and multiplication. (ii; For any a © R, exactly one of the following is true: aeRy or or =a E Rey By 2 = (0) i the ser oF nonnegative real aumbers Dingrammatically, the set By. is the right half of the real line in figure 2.7, excluding zero, while Bt, is that half including zero, We may simmiarty identify the left half of the real line, excluding zero, as the complement R. (note that this isnot closed under multiplication) and including zero as B., = RU (0). ‘The inequality symbols “>" and “=” may be given formal meaning in terms of Ry, and B. 22 NUMBERS 29 WEEE Gites nyodew (i) a—beR,,,thena > b. Gi) I (@~b) © Ry, then b > a. Git) a —b € By, thena > b. (iv) If (ab) € Ry, then b > a. We referto“>"as the strict inequality and “>” as the weak inequality, since it per- ‘The properties of these inequalities are stated inthe following theorem. The Completeness Property of R We have already indicated that che set of real numbers has the property that there are no “gaps.” That is, between any two points (nurnbers) on the rea line, ‘every point is occupied by 2 number that is either a rational number or an irational ‘number. In other words, corresponding to each point on the real Hine there is a real ‘number, and vice verse This is known as the completeness property, and we can express this property formally by considering the concepts of the greatest lowest ‘bound and the least upper bound of a subset of I. We develop these ideas in the following definitions. ‘A set $C R is bounded above if there exists b € R such that forall x € S,.x = by bis then called an upper bound of S. A set T is bounded below if there exists ae R such that for all x € T, > a;a is then called a fower bound of T. For example, the set Z;= 1.2.3...) is bounded below but unbounded R—R,=[x ¢R=x <0) is unbounded below but bounded 30 CHAPTER? _ REVIEW OF FUNDAMENTALS fa subset of R has an upper (lower) bound, it has an infinity of upper (lower) ‘bounds, This follows from the transitivity property of the inequality relation (part (Gi) of theorem 2.2), since if x € Sand x < band b < y, then. < y and y is also an upper bound of 5, However, we are interested in just one upper bound of ‘S—the smallest upper bound, called the supremum—and just one lower bound of §—the largest lower bound, called the infimum, R88 se prernor oF a ser 5, writen sup 8, has the properties: (i) x < sup Sforallx eS. (Gi) If is an upper bound of S, then sup 5 < b. PY 18 itis oF 5e07, orten ink 7. has the properties: (x= inf 7 forall x = 7, Gi) TFa isa tower bound of T then a < inf T- Here we see that inf Z = I while sup Z, does not exist; inf %, does not exist while sup B., = 0. These show thatthe inf and sup ofa subset of R may or ‘may notexist, and when either of these does exist, it may or may not be an element of the set. (Look at the sup of B,.) ‘The completeness property of R may now be stated as sups SS Ss set of upper bounds of ‘See the application of this theorem, for sup S, in figure 2.8. ensions of Economic Variables Figure 2.8 Completeness property The variables in economic models are usually represented by real numbers corres- of ponding to quantities such as cost, profit, and price or to amounts of goods and services such as coal, bread, and haircuts. These variables are measured in 22 NUMBERS 31 particularkinds of units that we refer to as the dimensions of these variables, For ‘example, cost, revenue, and profit are measised in units of money (dollars): a price is measured in terms of units of money per physical unit of a good (dolurs/anit ‘quantity); coal, potatoes, wine will be measured by weight (pounds, kilograms) or ‘volume (liters, gallons), and so on. Economists, unlike engineers and physicists, are often rather careless about defining the way in which their variables are measured. The standard rules of arithmetic apply not only to the variables themselves bt also to the units in which they are measured—you cannot add apples and pears! Teke, as an example, total revenile measured in dollars. This is the product of the total sales of physical ‘output, whose units depend om the output concemed, s9y tons, and the price perton ‘Thus, corresponding to the identity Revenu Price x quantity \we have the identity in terms of dimensions a Dollars = soles > tons An equation involving economic variables that does not satisfy the arithmetic relationship among the dimensions ofthe variables earinot be s valid equation, For example, suppose that after a complicated bit of mathematical analysis we derive the solution Revenue = marginal cost Since revenue is meas proposing the equation +d in dollars amd marginal cost im dollars per unit_we are: dollars ton Dollars which cannos be trve. Maybe what we should have obtained was Marginal revenve = marginal cost ‘Dimeasionally, this equation is correct, with units of dollars per ton on each side. ‘A pure number is 1 aumber that does rot have « dimension. For example, consider profit expressed as a rate of return on sales revenue: profit Fevenue Rate of return = 32 CHAPTER2 REVIEW OF FUNDAMENTALS ince both profit and revenue are measured in dollars, the rate of return has dh ‘mension dollars/dollars and so is a pure number. se 1. Demonsicate the boundedness or unboundedness of the following sets @) Z.=11,2.3,.04 ib) Zz © @ (@) S=weR:0 a.we | deline * the closed interval: (a, b] = |x €R:a =x =) * the half-open interval: [a, b) ~ [x Ra ) = (x €R sa

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