ECON104 Mathematics for Economics

Lecture Notes Chapter 1. Introduction and Basics

I. ECONOMIC MODELS

1. What is a mathematical model?

What is a mathematical model? It is simply a set of equations used to describe or explain certain aspects of the
world.

For example, we can hypothesize the following (simplified) model to predict a country's GDP:

𝑌 = 𝑎 + 𝑏𝐸 + 𝑐𝐿 + 𝑑𝑇 + 𝑒𝑊 + 𝑓𝐻

in which, 𝐸, 𝐿, 𝑇, 𝑊, and 𝐻 are the predictive variables, and 𝑎, 𝑏,…are the parameters to be determined
(through various econometric methods).

Question: should we use consumption to be one of the factors to predict GDP? Why or why not?

2. Economic models

An example of a simple economic model: the AD-AS model. Aggregate demand is given as

𝑌 = 𝑎 − 𝑏𝑃

while Aggregate Supply is

𝑌 = 𝑐 + 𝑑𝑃

Together they form a model that describes how output and price are determined.

2.1. Ingredients of an economic model

What does an economic model need? It needs first of all economic variables, unknown economic quantities
that we seek to explain in a model, such as consumption, output, inflation…In the AD-AS model, we have two
variables we seek to solve (explain), output and price level.

The model also needs parameters, numbers that are taken as given in order for the model to be solved. In the
AD-AS model, the parameters are 𝑎, 𝑏, 𝑐, 𝑑.

What counts as variables or parameters depends very much on the decision of the modelers, what he/she decides
are quantities that need explaining, and which quantities are taken as given.
II. FUNCTIONS

1. What is a function

1.1. Definition

A function describes a relationship between two quantities (variables). For example, the bus fare depends on the
distance travelled on the bus, thus the bus fare is a function of the travel distance. We usually call the bus fare
the dependent variable, and the distance travelled the independent variables. What kind of relationship? It
depends on how it is defined. For example, there is some formula used by the public transport company to
calculate fare based on distance.

The most important property of functions is that, continuing with the bus fare example, different travel distances
can yield the same fare, but the same travel distance cannot yield two or more different fares.

Basic definition of functions

A (real-valued) function of a real variable x with domain D is a rule that assigns a unique real
number to each real number x in D. As x varies over the whole domain, the set of all possible
resulting values f (x) is called the range of f.

1.2. Domain and range of a function

Let's look at the function 𝑓(𝑥) = √𝑥. Obviously, 𝑓 doesn't take values of 𝑥 that are < 0. The set of 𝑥 that make
𝑓 defined is called the domain of 𝑓.

Example: find the domain of the following functions

!
a. 𝑓(𝑥) =
"#$

b. 𝑔(𝑧) = √2𝑥 + 5

Again, let's look at 𝑓(𝑥) = √𝑥. If we use all the values of 𝑥 in the domain of 𝑓 to compute 𝑓(𝑥), we will find
that 𝑓(𝑥) can take all values ≥ 0. The set of all possible values of 𝑓(𝑥) is called the range of 𝑓.

Example: the cost of producing x units of a commodity is given by 𝐶(𝑥) = 1000 + 300𝑥 + 𝑥 % .

(a) Compute 𝐶(0). What does it mean?

b. Compute 𝐶(𝑥)/𝑥. What does it mean?

(b) Compute 𝐶(𝑥 + 1) − 𝐶(𝑥), and explain in words the meaning of the difference.

2. Graph of a function

Review textbook section 4.3.

3. Different types of functions

(You can read through textbook sections 4.4 to 4.10 for a quick review.)

3.1. Linear functions

Linear functions have a simple form

 𝑓(𝑥) = 𝑎𝑥 + 𝑏

which is a straight line if drawn using the x-y coordinates.

Many economic relationships are assumed to be linear. For example, demand functions

𝐷(𝑃) = 𝑎 − 𝑏𝑃

and supply functions

𝑆(𝑃) = 𝑐 + 𝑑𝑃

3.2. Quadratic functions

𝑓(𝑥) = 𝑎𝑥 % + 𝑏𝑥 + 𝑐

3.3. Polynomials

𝑓(𝑥) = 𝑎& 𝑥 & + 𝑎&'! 𝑥 &'! + ⋯ + 𝑎(

3.4. Power functions

𝑓(𝑥) = 𝑎𝑥 &

3.5. Exponential and logarithmic functions

𝑓(𝑥) = 𝑎𝑒 )"

𝑓(𝑥) = 𝑙𝑛𝑥

4. Changing function

4.1. Composite function

Given 𝑓(𝑥) and 𝑔(𝑥), we have

𝑓 ∘ 𝑔(𝑥) = 𝑓(𝑔(𝑥))

Example: given 𝑓(𝑥) = 2𝑥 and 𝑔(𝑥) = √𝑥, we have 𝑓 ∘ 𝑔(𝑥) = 𝑓(𝑔(𝑥)) = 𝑓H√𝑥I = 2√𝑥.

4.2. Inverse function

Consider the demand function

30
𝐷=
𝑃!/$
A producer would care about the price that would result if he/she sets production (output) at a certain level.
Thus what he/she would want to know is the inverse relationship

30$
𝑃=
𝐷$
In general, given 𝑦 = 𝑓(𝑥), by expressing 𝑥 in terms of 𝑦 we have

𝑥 = 𝑓 '! (𝑦)

This 𝑓 '! is the inverse of 𝑓.

Not every function has an inverse, though. Conditions for a function to have an inverse:

A (real-valued) function of a real variable f(x) has an inverse if and only if it is a one-to-one
function.

Example: find the inverse functions of the following functions

(a) 𝑦 = 4𝑥 − 3
!
(b) 𝑦 = √𝑥 + 1
$"'!
(c) 𝑦 =
"#+

5. Growth rate

5.1. Population growth

A town starts with 100 people. It grows by 10% a year. After 10 years, the town’s population has grown to

𝑁 = 100(1 + 0.10)!(

5.2. Interest compounding

Tom puts $A in a bank account. It grows by 𝑟% a year. After n years, Tom’s money has become

𝑀 = 𝐴(1 + 𝑟/100)&

These are examples of exponential growth. The opposite of exponential growth is exponential decay. For
instance, a car, with an initial value of 𝐴( , depreciates in its value by 20% per year. After 10 years of use, its
value has become

𝑉 = 𝐴( (1 − 0.2)!( = 𝐴( (0.8)!(
III. EQUATIONS

1. What is an equation

Earlier, when we learn about functions, we compute a value of a function, say 𝑓(𝑥), by putting a value of 𝑥 into
𝑓(𝑥). When we want to do the reverse, finding 𝑥 given a value of 𝑓(𝑥), we set up the following

𝑓(𝑥) = 𝑎

What we have is an equation.

For example, given 𝑓(𝑥) = 𝑥 % , find 𝑥 so that 𝑓(𝑥) = 4. We have the following equation

𝑥% = 4

Almost any equation can be thought of this way.

2. Rules concerning equations

The following things can be done with equations to help you solve them

If 𝐴 = 𝐵

-𝐴±𝑎 =𝐵±𝑎

- 𝐴/𝑎 = 𝐵/𝑎, only if 𝑎 ≠ 0.

- 𝐴𝑎 = 𝐵𝑎, again only if 𝑎 ≠ 0.

𝐴, 𝐵, 𝑎 stand for numbers, constants, functions, variables…

3. Solving equations

Review textbook chapter 3.