Derivatives Part 1

Optimization in Economic Theory
PD Dr. Johannes Paha
University of Hohenheim
winter term 2021/22
johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 1 / 37

Chapter 2 – Derivatives and Differentials
Chapter 2
Derivatives and Differentials
Nov 9, 2021
Optimization in Economic Theory

PD Dr. Johannes Paha
winter term 2021/22

Chapter 2 – Derivatives and Differentials Double click here for audio contents
Overview – Derivatives and differentials
Motivation: Tangency condition of the consumer choice problem

Functions
Differentiation of univariate functions
Differentials of univariate functions
Differentiation of multivariate functions
Total differential
Application: Indifference curve
Concluding remarks
Background reading: Simon and Blume (1994, Ch. 2+14)

Overview – Learning goals
Students
Know common specifications of utility and production functions
Can take derivatives and differentiate univariate functions
Can take partial and total differentials of multivariate functions
Can apply total differentials to solve economic problems, e.g., the
two-dimensional consumer choice problem

Tangency condition of the consumer choice problem

O ptirni zati o rt in E conorn i c Tht:oru
choicc
Fig. 1.1 The consumerrs optimum choicc

Tangency condition of the consumer choice problem
Recall the two-dimensional optimal choice problem

Tangency condition says that in optimum, slope of the budget line equals
marginal elasticity of substitution (slope of the indifference curve)
How can we compute the slopes of the budget line and the indifference curve?

Motivation
Budget line
I p1
p1 x1 + p2 x2 = I ⇔ x2 = − x1
p2 p2
Consumption of good 2, x2 , is an explicit function of the exogenous variables (note
that in this context, consumption of good 1 is treated as an exogenous variable)
Slope of the budget line is
∂x2 p1
=−
∂x1 p2
In order to increase consumption of good 1 by 1 unit (which costs p1 ), we have to
give up pp12 units of good 2 (which frees up pp21 · p2 units of income)

Motivation
Indifference curve
Indifference curve is characterized by u(x1 , x2 ) = c, where c is a constant
Here, the endogenous variable x2 is defined as an implicit function of the
exogenous variable x1
Typically, it is not possible to separate the exogenous variable on one side and the
endogenous variable on the other side
However, we still want to ask: How does a small change in consumption of good 1
affect consumption of good 2?
In order to answer the question, we look at derivatives, differentials, and total
differentials

Functions
In Economics, we explore relationships between economic variables

Between consumption levels and utility: utility function
Between inputs and output: production function
These relationships are described mathematically by functions

Cobb-Douglas: f (x , y ) = ax α y β
Linear function: f (x , y ) = ax + by
Quasi-linear function: f (x , y ) = x + ag(y )
Leontief function: f (x , y ) = min{ax , by }
Constant Elasticity of Substitution (CES) function: f (x , y ) = (ax ρ + by ρ )1/ρ

For a univariate fn f : R → R, we ask how y changes if x changes. This question

can be answered by using the difference quotient.
Denote ∆x = x − x0 , then
∆y change in y f (x0 + ∆x ) − f (x0 )

= =
∆x change in x ∆x
Taking the limit of the above expression provides the definition of the derivative of
f
f (x0 + ∆x ) − f (x0 )
f ′ (x0 ) = lim
x →x0 ∆x
If the limit exists, f is called differentiable at x0 .

Geographically, the derivative of a function depicts the slope of a tangent line on f

through x0 .
Simon and Blume (1994, Figure 2.8): The graph of a nonlinear function


A tangent (here: the x-axis) can even cross a function (here: y = x 3 ).
Simon and Blume (1994, Figure 2.9): A tangent line (x-axis) and a nontangent line to the graph of x 3


Approximating the tangent line by letting ∆x converge towards 0.
f (x)
secant
derivative of f at x0
xo x2 x1 x
| {z }
∆x1
| {z }
∆x2
∆x → 0

Alternative notations are:

df df (x )
f ′ (x ) = y ′ = = = fx (x )
dx dx
Some derivatives
The derivative of x k is kx k−1 .
The derivative of ln x is 1/x .

Simon and Blume (1994, Theorem 2.4): c = product rule, d = quotient rule, e = power rule

A nondifferentiable function at x = 0:
The limits converge to different values if evaluated from the left (f ′ (x ) = −1 for x < 0)
or the right side (f ′ (x ) = 1 for x > 0).
Simon and Blume (1994, Figure 2.12): The graph of f (x ) = |x |

For a function to be differentiable, it must be continuous.

Definition: A function f : D → R1 is continuous at x0 ∈ D if for any sequence
{xn } which converges to x0 in D, f (xn ) converges to f (x0 ). A function is
continuous on a set U ⊂ D if it is continuous at every x ∈ U. Finally, we say that
a function is continuous is continuous if it is continuous at every point in its
domain.
Simon and Blume (1994, Figure 2.14): A discontinuous function with a discontinuity at x = 0

The second derivative of f at x0 is written

d df d 2f

f ′′ (x0 ) or (x0 ) = (x0 )
dx dx dx 2
′′
If f has a second derivative everywhere, then f is a well-defined function of x .
If f ′′ is itself a continuous function of x , then we say that f is twice continuously
differentiable.

For f (x ) = y with dx as a change in x , the differential of y

(change in y , dy ) is defined as
dy = f (x0 + dx ) − f (x0 )
(1)
≈ f ′ (x )dx
This differential is only useful for marginal changes of x .
The bigger dx the less precise the approximation.
Later in this course, we will improve the precision of the approximation (see:
Taylor series approximation)
We sometimes write the differential df in place of the differential dy .


f (x1 ) − f (x0 ) ≈ f ′ (x0 )(x1 − x0 ) ⇔ f (x1 ) ≈ f (x0 ) + f ′ (x0 )(x1 − x0 )
f (x)
secant
derivative of f at x0
xo x2 x1 x
| {z }
∆x1
| {z }
∆x2
∆x → 0

In the case of multivariate functions y = f (x1 , . . . , xn )

with n variables, we have to specify the direction of movement
∂f
A partial derivative ∂xi
considers the derivative of f along one
of the axes, i.e., xi
Definition: Let f : Rn → R. Then for each variable xi at each point
x0 = (x10 , . . . , xn0 ) in the domain of f , the partial derivative of f with respect to xi
is given by
∂f (x10 , x20 , ..., xi0 , ..., xn0 ) f (x10 , x20 , ..., xi0 + h, ..., xn0 ) − f (x0 )
= lim
∂xi h→0 h
if this limit exists.
Only the ith variable changes; the others are treated as constants.

Consider a multivariate function y = f (x1 , x2 , . . . xn ). The partial derivative with

respect to xi is denoted by ∂f (x1 , x2 , . . . xn )
.
∂f
∂xi
Other common ways of referring to ∂x i
include f i , fxi , and Di f .
It is a scalar that refers to the change in y if only xi changes and all the other xn
for n ̸= i stay constant.
Conceptually, there is no difference between a derivative of a univariate function
and a partial derivative of a multivariate function.
Standard differentiation rules apply.

Example: Cobb-Douglas production function
f : R2 → R, f = x1α x21−α
First partial derivatives are
∂f x1 α−1

= αx1α−1 x21−α = α
∂x1 x2
α
∂f α −α x1
= (1 − α)x1 x2 = (1 − α)
∂x2 x2
Those first partial derivatives could, for example, be

the marginal product of labor or the marginal product of capital.


We can represent a function z = f (x , y ) geometrically either by drawing its graph

in R3 or its level curves in R2 .
For example, hold y constant at b,
and study variations in x around x = a.
We are looking at f only on the two-dimensional slice {y = b} in R3 .
On this slice, the graph of f is a curve, i.e.,
a function of variable x only.
The partial derivative ∂f ∂x(a,b)
is the slope of the tangent line to this graph on this
slice, line ℓ in the figure on the next slide.

Simon and Blume (1994, Figure 14.1): The graph of x → f (x , b) on the slice {y = b}

We can also “slice horizontally” by holding the value of f constant

at different values.
Then hold x constant at x = a.
The closer the level curves are to each other, the more f changes as y increases by
one unit, the larger is ∂y
∂y
.
∂f (a,b)
Simon and Blume (1994, Figure 14.3): ∂y
measures the change in f on {x = a}

Total differential: Definition
The total differential is the multivariate equivalent of the differential and is defined
as
∂f (x1 , x2 , . . . xn ) ∂f (x1 , x2 , . . . xn )
dy = dx1 + . . . dxn
∂x1 ∂xn
n
X ∂f (x1 , x2 , . . . xn )
= dxi .
∂xi
i=1
The effect of a simultaneous change of all n variables can be approximated by the

sum of the effects of one-variable changes.
For a function y = f (x1 , x2 ) of two variables, the graph is a two-dimensional
surface in R3 . And the analogue to a tangent line is the tangent plane (see next
slide for this bivariate case).

Total differential: Bivariate case

Total differential: Bivariate case
The total change in f is approximately the sum of the effects of one-variable

changes
∂f ∂f
∆f ≈ ∆x1 + ∆x2
∂x1 ∂x2
The change ∆f on the surface of f is approximately the same as the change on
the target plane at the considered position (x10 , x20 )
For ∆x1 → 0 and ∆x2 → 0, the total differential of a function is
df = fx1 dx1 + fx2 dx2 .
It is natural to form a matrix/vector whose entries are all the partial derivatives of
f and call it the derivative of f .

The total differential: Multivariate case
Recall function f (x1 , . . . , xn ) whose graph is in Rn+1 .

The tangent to this graph is an n-dimensional hyperplane H in Rn .
The linear mapping
∂f (x0 ) ∂f (x0 )
(dx1 , . . . , dxn ) →
dx1 + · · · + dxn
∂x1 ∂xn
is a good approximation to the actual change in f .
We call the matrix
∂f (x0 ) ∂f (x0 )

DFx0 = ...
∂x1 ∂xn
the (Jacobian) derivative of f at x0 .

The total differential: Contour lines
The total differential is useful to derive the slope of level curves or contour lines
along which the function value of y is constant such that dy = 0.
Suppose we have two variables x1 and x2 . Both change and we want to calculate
the slope of the level curve.
Then we have
∂f (x1 , x2 ) ∂f (x1 , x2 )
dy = dx1 + dx2 = 0
∂x1 ∂x2
∂f (x1 ,x2 )
dx2 ∂x
⇒ |dy =0 = − ∂f (x 1,x )
dx1 1 2
∂x2

Application: Indifference curve & Cobb-Douglas utility
Indifference curve
u(x1 , x2 ) = c
In totally differentiated form, we have
∂u(x1 , x2 ) ∂u(x1 , x2 )
dx1 + dx2 = dc
∂x1 ∂x2
As utility level doesn’t change along the indifference curve, dc = 0

Thus, we have
∂u(x1 ,x2 )
dx2 ∂x
|dc=0 = − ∂u(x 1,x )
dx1 1 2
∂x2

Recall that the partial derivatives w.r.t. x1 and x2 are given by

α−1 α
∂u x1 ∂u x1

=α and = (1 − α)
∂x1 x2 ∂x2 x2
Slope of indifference curve at point (x1 , x2 )

α−1
dx2 α xx12 α

x1
−1
|dc=0 = − x1
α = −
dx1 (1 − α) x2
1−α x2
Tangency condition
−1
α x1 p1 1 − α p1

!
= ⇔ x2 = x1
1−α x2 p2 α p2

Tangency condition implies

1 − α p1
x2 = x1
α p2
Interpretation
This is an income expansion path
p1
Ray from the origin with slope 1−α
α p2
Depicts consumption bundles consistent with utility maximization
For given income I and prices p1 and p2 , budget line and income expansion path
determine optimal consumption bundle
I = p1 x1 + p2 x2 (2)
1 − α p1
x2 = x1 (3)
α p2
αI
Using (2) to substitute out x2 from (1) and solving for x1 , we obtain x1 = p1

Instead of bringing the budget line in an explicit form, we can apply the total
differential to the budget line in its implicit form x1 p1 + x2 p2 = I
In totally differentiated form (for given goods prices), the budget line reads
p1 dx1 + p2 dx2 = dI
Moving along a given budget line implies dI = 0, such that the slope of the budget
line emerges as
dx2 p1
p1 dx1 + p2 dx2 = 0 ⇔ |dI=0 = −
dx1 p2

Summary
We generalized the concepts of differentiation and differentials to the multivariate

case.
We applied the total differential to the indifference curve and to the budget line.
We used the approach to solve the two-dimensional optimal consumer choice
problem analytically.

Derivatives Part 1

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Optimization in Economic Theory

PD Dr. Johannes Paha

winter term 2021/22

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 1 / 37

Optimization in Economic Theory

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 2 / 37

Overview – Derivatives and differentials

Motivation: Tangency condition of the consumer choice problem

Background reading: Simon and Blume (1994, Ch. 2+14)

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 3 / 37

Overview – Learning goals

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 4 / 37

Tangency condition of the consumer choice problem

Fig. 1.1 The consumerrs optimum choicc

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 5 / 37

Tangency condition of the consumer choice problem

Recall the two-dimensional optimal choice problem

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 6 / 37

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 7 / 37

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 8 / 37

In Economics, we explore relationships between economic variables

These relationships are described mathematically by functions

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 9 / 37

Differentiation of univariate functions

For a univariate fn f : R → R, we ask how y changes if x changes. This question

∆y change in y f (x0 + ∆x ) − f (x0 )

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 10 / 37

Differentiation of univariate functions

Geographically, the derivative of a function depicts the slope of a tangent line on f

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 11 / 37

Differentiation of univariate functions

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 12 / 37

Differentiation of univariate functions

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 13 / 37

Differentiation of univariate functions

Alternative notations are:

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 14 / 37

Differentiation of univariate functions

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 15 / 37

Differentiation of univariate functions

Simon and Blume (1994, Figure 2.12): The graph of f (x ) = |x |

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 16 / 37

Differentiation of univariate functions

For a function to be differentiable, it must be continuous.

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 17 / 37

Differentiation of univariate functions

The second derivative of f at x0 is written

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 18 / 37

Differentials of univariate functions

For f (x ) = y with dx as a change in x , the differential of y

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 19 / 37

Differentials of univariate functions

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 20 / 37

Differentiation of multivariate functions

In the case of multivariate functions y = f (x1 , . . . , xn )

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 21 / 37

Differentiation of multivariate functions

Consider a multivariate function y = f (x1 , x2 , . . . xn ). The partial derivative with

johannes.paha@uni-hohenheim.de Optimization in Economic Theory (winter term 2021/22) 22 / 37

Differentiation of multivariate functions

Example: Cobb-Douglas production function

First partial derivatives are

Those first partial derivatives could, for example, be