EC 2104 Quantitative Methods for Economic Analysis

Problem Set 2 Suggested Solutions

Students will solve selected problems from the following questions during tutorial sessions the week
of February 4, 2019.

1. Determine where the following functions are increasing or decreasing, and convex or concave:

(a) 3x4 + 4x3 − 6x2 − 12x + 5

f 0 (x) = 12x3 + 12x2 − 12x − 12 and f 00 (x) = 36x2 + 24x − 12. f 0 (x) = 0 when
x3 + x2 − x − 1 = 0. Some factoring (combine the first and third terms, and com-
bine the second and fourth terms) reveals that this is the same as x(x2 − 1) + (x2 − 1) =
0 ⇒ (x + 1)(x2 − 1) = (x + 1)(x + 1)(x − 1) = 0. So, f 0 (x) = 0 when x = 1 or
x = −1. f 00 (x) = 0 when 3x2 + 2x − 1 = 0. Factoring this shows that this is the same as
(3x − 1)(x + 1) = 0, so x = −1 and x = 31 . Let’s test the various regions of the number
line to see where f 0 (x) and f 00 (x) are positive and negative:
′( ) − − − +

′′( ) + − + +

-1 1 1
3
Decreasing Decreasing Decreasing Increasing
Convex Concave Convex Convex

So, the function is decreasing and convex on the intervals (−∞, −1) and ( 31 , 1), decreasing
and concave on (−1, 13 ), and increasing and convex on (1, ∞).

(b) ln x

The domain of ln x is (0, ∞). f 0 (x) = 1/x and f 00 (x) = −1/x2 for all x > 0, and
neither of these functions are ever equal to 0. f 0 (x) is always positive f 00 (x) is always
negative (on their domains), so ln x is increasing and concave at all points of its domain.

1
 dy
2. Assume that F is a differentiable function with F 0 (2) = 5. Find at the point (x, y) = (1, 2)
dx
if y is defined implicitly by the equation
y
F = y2
x
Note that x, y and F are not related except through this equation. In particular, y 6= F (x).

Rewrite the equation replacing y with g(x) (so we don’t get this confused with F ), and
differentiate with respect to x. We then evaluate the expression at x = 1, g(x) = 2 and
dy
F 0 (2) = 5. Finally, we solve for g 0 (1), which gives us at (x, y) = (1, 2):
dx
 
g(x)
F = (g(x))2
x
   0 
0 g(x) xg (x) − g(x)
F · = 2g(x)g 0 (x)
x x2
F 0 (2) · (g 0 (1) − 2) = 4g 0 (1)
5(g 0 (1) − 2) = 4g 0 (1)
g 0 (1) = 10
dy
= 10
dx (x,y)=(1,2)

3. Sample Mid-Term Question: Let U(x) be the utility of Gary and V(x) be the utility of Ji
Hyo, when they consume good x. We note that Gary’s utility is affected by Ji Hyo’s utility
√
in the following manner: U (x) = x.V (x). Now, we know that for Ji Hyo, V (4) = 8 and
V 0 (4) = 7. Find U’(4), ie. Gary’s marginal utility of consuming 4 units of the good.

(A) 8
(B) 10
(C) 16
(D) 4
(E) None of the above

Solution: C

We first differentiate U with respect to x.

1 √ 1 √
We will get U 0 (x) = √ V (x) + xV 0 (x). Hence, U 0 (4) = √ V (4) + 4V 0 (4.)
2 x 2 4
0 1
Substituting V (4) = 8 and V (4) = 7, we will get (8) + 2(7) = 16
4

2
4. The inverse demand function for a good that a firm produces is given by p(q) = 1440000 −
300q 2 . This gives the price that each good will sell for on the market, given that the firm
produced q of the good. The firm’s total cost is given by c(q) = 337500q + 1000000.

(a) Find the production level q that minimizes total cost.

This is a global minimization problem. In this case, total cost is linear. So, there
are 2 possible solutions to the global minimization problem: 1) total cost is minimized
at the boundary point, q = 0, or 2) total cost will increase forever as q → ∞, giving us no
global minimum point. Clearly, q = 0 will minimize total cost at c(0) = 1000000. We can
also see this more systematically: we should check points where c0 (q) = 0, points where
c0 (q) does not exist, boundary points (q = 0), and points off to infinity (q → ∞). We
have already checked these last two. Taking the derivative of c(q) gives c0 (q) = 337500.
This is clearly never equal to 0. Also, since c(q) is a polynomial, it is differentiable at
all points, so we do not need to find points where c is not differentiable. Therefore, the
only possible q that could minimize costs occurs at q = 0.

(b) Find the production level q that maximizes total revenue.

First, we must find the function that describes total revenue. If we know the in-
verse demand function p(q), we know that the firm’s revenue will be r(q) ≡ q · p(q) =
1440000q − 300q 3 . This will be maximized either at a boundary, as q increases without
bound, or when r0 (q) = 0.
Since the coefficient on the q 3 term (highest order term) is negative, the function will
decrease without bound as q → ∞. Now, r0 (q) = 1440000 − 900q 2 . This is equal to
0 when q = −40 or q = 40. Obviously, the one that we care about is q = 40 since
q ≥ 0. It only remains to check whether this level of output provides more or less
revenue than producing nothing (q = 0, the boundary of the domain). r(0) = 0, and
r(40) = 38400000. Clearly, the production level that maximizes total revenue is q = 40.

(c) Find the profit-maximizing level of q. What is the firm’s profit at this level of output?

The profit equation is:

π(q) = r(q) − c(q)

= 1440000q − 300q 3 − 337500q − 1000000
= −300q 3 + 1102500q − 1000000

3
 To maximize this, we set the derivative equal to 0 and check that this gives us a profit
greater than -1000000 (otherwise the boundary solution of producing nothing is the
profit-maximizing level of production).

π(q) = −300q 3 + 1102500q − 1000000

π 0 (q) = −900q 2 + 1102500

This is equal to 0 when q = 35. Now, we should check that this is a maximum and
not a minimum. We do this by plugging in q = 35 into π 00 (q) = −1800q. Clearly,
π 00 (35) < 0, so this is a local maximum point for π(q). At this level of production,
π(q) = π(35) = 24725000. This is clearly greater than -1000000, so q = 35 is the (global)
profit-maximizing level of output, and the profit level at that output is π(35) = 24725000.

(d) Find the price elasticity of demand at the profit-maximizing q. Is demand elastic or
inelastic at this level of output? (Hint: use implicit differentiation)

dq p dq
The price elasticity of demand is defined as . To find , we can use implicit
dp q dp
differentiation on the demand
 function, treatingq as the dependent variable and p as
dp
the independent variable we currently have :
dq

p = 1440000 − 300q(p)2
1 = −600q(p)q 0 (p)
1
q 0 (p) = −
600q(p)

At the profit-maximizing q = 35, q 0 (35) = −1/21000. Also, p(35) = 1440000 − 300 ·

352 = 1072500. Therefore, the price elasticity of demand at this level of output is
1 1072500
εd = − 21000 35 ≈ −1.46. Since the absolute value of this is greater than 1, demand
is elastic at this level of output.