LECTURE FIVE: CONSTRAINED OPTIMISATION PROBLEM

5.1 INTRODUCTION

In this lecture we shall learn how we can maximize or

minimize economic functions when we are faced with a constraint.

5.2 LECTURE OBJECTIVES

By the end of this lecture the learner should be able to:

1. Write down augmented Langragian functions.

2. Determine the first order partial derivatives of a langragian
function.
3. Determine the optimal consumption bundles in utility
maximization problems.
4. Determine the optimal input values in cost minimization
 5.3 Constrained optimisation

So far we have looked at how we can get the optimal values in cases where optimization is not subject

to any constraints.

In a constrained optimization problem, the decision maker would want to optimize but is faced with a

constraint. The problem is composed of two parts:-

a) Objective function – what is to be maximized or minimized.

b) Constraints or constraining equation – defines the limiting conditions.

Example

Maximize utility = ( , )

Subject to = ( )

A consumer would want to maximize the utility (U) derived from consuming two goods but this will be

subject to the available income (m).

Minimise = ( , )

; = ( , )

A firm would want to minimize the cost of production but this will be subject to the output level that is to

be produced.

At times we can have more than two or more constraints or limitations. (This will be handled at another

level).

Langragian Multiplier
The purpose of this multiplier is to convert the objective function and the constraints into one augmented

function.

For example

max = ( , )

= ( , )

The two functions can be combined into one using a langragian multiplier and in our case we will use the

constant . The augmented function is known as the langragian function. It will be given as:

= ( , )+ ( − ( , )

The new function (Z) is a function of 3 variables. i.e.

= ( , , ).

To get the optimal values of x, y and λ, we need to get the first order derivatives of the augmented

function Z with respect to each of the variables x, y and λ. The first order derivatives will be equated to

zero, just like in the case of the normal maximization or minimization.

First order derivatives

= − =0

= − =0

= − ( , )=0
If the equations are solved for λ, we get that = =

The first order derivatives are then solved simultaneously to get the optimal values of X, Y and λ.

Example

Maximise

= + +

Subject to

+ 3 = 13

Solution

Form the augmented function

= + + + (13 − −3 )

Get the first order derivatives

=2 + − = 0−−−−−−−−−−−−−−−−−

=2 + −3 = 0−−−−−−−−−−−−−−−−

= (13 − −3 )= 0−−−−−−−−−−−−−−−

From equation (i) and (ii),

= (2 + )
 2 +
3 =2 + → =
3

Equating λ in the 2 equations, we get:

2 +
= = (2 + )
3

=2 + = (6 + 3 )

2 −3 =6 −

1
− = 5 =−
5

If we substitute this expression in the third first order condition, we get:

+ 3 = 13

1
− + 3 = 13
5

− + 15
= 13
5

14 = 65

65
=
14

−1 65 13
= =−
5 14 14

13
= −
14

=2 +
 26 65
=− +
14 14

39
=
14

Second order conditions

2 − ( ) + ( ) > 0 – Maximize

2 − ( ) + ( ) < 0 - Minimize

→ ℎ ℎ

→ ℎ ℎ

=Cross partial derivative of augmented function Z with respect to then with respect to .

= Second order partial derivative of the augmented function Z with respect to x.

= Second order partial derivative of the augmented function Z with respect to y.

5.4 Economic Applications

1. Utility Optimization

Maximise

= ( , )

= +

>0

Where

M is the level of income, q1 and q2 are the amounts of goods 1 and 2 respectively, and P1 and P2 are

the prices of good 1 and 2 respectively.

 = ( )+ ( − − )

= − . =0

= − . = 00

= − − =0

From the first equation,

= . → =

and from the second equation

= =

= =

= =

→ = This is the condition for utility maximization.

Ratio of to price of = Ratio of to price of

If this is rearranged, it can be written as:

→ =

slope of Budget line=slope of indifference curve for utility to be maximised.

Alternatively

If we get the total differential of the utility function

= ( )

= . + .

Along an indifference curve the utility does not change, hence du=0

= −
 = −

Slope of B.L

− +

= −

−
=

− =−

→ =

S.O.C

2 − + >0

Example one

Given a utility function U=5xy, and a budget constraint given as 5x+y=30, determine the levels of x and y

that will maximize the utility of the consumer/

Solution

=5 + (30 − 5 − )

= 5 −5 =0→ =

= 5 − =0→ =5

= 30 − 5 − =0

From the first equation and second equations,

= =5
 If we replace in the third equation we get:

= 30 − 5 − =0

5 + = 30

5 + 5 = 30

10 = 30

=3

= 5 = 15

= = 15

Maximum utility will be given as:

=5 = 5 ∗ 3 ∗ 15 = 225

Cost minimization

If the firm wants to minimize the cost subject to a given output level, the problem can be written as:

Minimise = +

= ( , )

Where r and w are input prices of capital and labour respectively while K and L are the units of capital

and labour used respectively.

If we form the langragian function:

= + + − ( , )

= − ( , )=0

= − ( , )=0
 = − ( , )=0

= ( , ) = ( , )

= ( )
= =

= →

Proof

Slope of Isocost

= −

= −

−
=

Slope of Isoquant

= ( )

Total differential

= ( , ). + ( , )

Along an isoquant, the output does not change, hence =0

= . + .

. =−
 +
=+ =

Second order condition

2 . . − . + . < 0 - Minimise

Example three

. .
The production function for a firm is given as = 12 . If the firm wants to produce an output of

240 units, find the optimal values of labour and capital that will minimize the total cost of production

given that labour cost per unit is 25 dollars and capital cost per unit is 50 dollars

Solution

. .
= 25 + 50 + (240 − 12 )

. .
= 25 − 0.5.12 =0

. .
= 50 − 0.5.12 =0

. .
= 240 − 12 =0

If we solve for the first order conditions:

. .
0.5.12 = 25

. .
0.5.12 = 50

. .
25 0.5.12
= . .
=
50 0.5.12

1
→ =
2

If we substitute this in the 3 equation, we get:

 . .
= 240 − 12 =0

. .
12 = 240

. . . .
240
12 (0.5 ) = 240 (0.5 ) = = 20
12

(0.5) .
= 20

20
= = 28.28
0.5 .

1
= = 14.14
2

= 25 + 50 = 1414

Example Three

The production function for garages which services cars and trucks is given as:

/ /
= 15

If each unit of labour used costs $5 while each unit of capital cost $3, find the units of labour and capital

to be used so as to maximize the production given that the garage has only $450 dollars at its disposal.

Solution

Set up the constraint function

We will represent labour as L and capital as K. The equation of the iso-cost line will be given as:

5 + 3 = 450

Augmented function will be given as:

 / /
= 15 + (450 − 5 − 3 )

/ /
2 /
2 15
= 15 ∗ 15 −5 = − 5 =0
3 3
/ /
1 1 15
= 15 ∗ 15 −3 = − 3 =0
3 3

= 450 − 5 − 3 = 0

If we solve the three first order conditions we get:

2 15
− 5 =0
3
2
=5
3
2
=
15

and from the second equation

1 15
− 3 =0
3
1
=3
3
1
=
9

From the expressions of in the first and second equations we get:

2 1
= → 18 = 15
15 9
15
=
18

We then substitute this in the third equation:

= 450 − 5 − 3 = 0

5 + 3 = 450

15
5 +3 = 450
18
= 5 + 2.5 = 450

7.5 = 450

450
= = 60 ℎ ℎ
7.5
15 15
= ∗ = ∗ 60 = 50 ℎ ℎ
18 18

Q = 15L K = 15(60) (50)