REVIEW OF MATHEMATICAL CONCEPTS
Variables, functions and slopes:
A Variable is any entity that can take different values such as: price, output, revenue, cost, etc. In economics we try to 1. Identify the variables 2. Measure them 3. Study their behavior in relation to other variables to understand how and why these variables change 4. Find the conditions that will lead to the optimal values of the variable. We express the change in the variable in response to a change in another variable in term of a function A function refers to the relationship between one (dependent) variable’s value and the value of one or more (independent) variable(s). Functions are expressed in functional forms The functional relationship can be expressed in schedules (tables), graphs, or equations The general form of an equation looks as the following Y = ƒ(X) Where, Y is the dependent variable, and X is the independent variable. Independent variable is the variable whose value is determined independently of any other variable under consideration Dependent variable is the variable whose value depends on some other variable.
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Example: TR = P x Q Assume P is known so TR = f (Q) If P = 5. “a” is the intercept. which measures the slope of the line. The slope of the line measures the rate of change of the dependent variable with respect to a change in some independent variable.
Tabular form of the function TR 0 5 10 15 20 Q 0 1 2 3 4
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. and “b” is the coefficient of X. since much of economic analysis is based on the incremental or marginal analysis of variables. Slope =
∆Y Y 2 − Y1 = ∆X X2 − X1
Slope is very important in economics. X is the independent variable. Y is the dependent variable.To explain the components of the linear function equation Y = a + bX Where.
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. and the coefficient = slope = b = TR / Q = (15-10) / (3-2) = 5/1 = 5 o Slope of the function is critical to economic analysis.Graphical representation of the function
Slope = b =
TR / Q
0 0 1 2 Q 3 4 5
Equation form of the function Y = a + bX TR = a + bQ TR = 0 + 5Q TR = 5Q o From the above table. the intercept = a =0. It tells us what would be the change in the dependent variable as a result of change in the dependent variable. graph.
In the above example. So the change in price ultimately results in change in profit. TR is expected to change by $5 for every one unit change in Q. P Q Q Q Q (demand function) R (TR function) C (TC function) π (π function)
Many other economic decisions rely on managerial analysis. purchasing additional machines. Most of economic analyses attempt to study how a change in one or several variables affects the change in another variable and in what direction. For example. the change is represented by the slope. P Q R and C π. However. If the relationship between dependent and independent variables is linear. which may be positive or negative depending on other factors. Incremental analysis is used when total change is considered For example if P and as a result Q by 10 and TR by 20 then Marginal Revenue= TR/ Q = 20/10 =2 Incremental Revenue = 20
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. such as hiring additional worker.Marginal Analysis Marginal analysis refers to o The change in dependent variable as a result of a one unit change in an independent variable (discrete change definition) o The consideration of a small change around some given point (continuous change definition). etc. many other decisions are also taken in incremental way.
Q = f (P) Q=a+bP Intercept: when P = 0. but there are many instances when a linear function is not the proper representation for changes between variables. this demand function could be written as
. Q by 100 ( Q= 100). b=( Q/ P) = (100) / (-1) = -100
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Therefore. a = Q = 700 Coefficient: when P by one ( P= -1).Functional Forms For the purpose of illustration and simplicity we will often use a linear function. most common cost functions are non-linear functions. Most famous non-linear functions in economics are quadratic functions and cubic functions o Linear (or straight line) function: Y = a + bX o Quadratic function: Y = a + bX + cX2 o Cubic Function: Y = a + bX + cX2 + dX3 Example: Consider the following demand schedule and demand curve Demand Schedule P Qd 7 0 6 100 5 200 4 300 3 400 2 500 1 600
8 7 6 5 P 4 3 2 1 0 0 200 400 Q 600 800
Both the demand schedule and demand curve show a linear relationship between P and Q. For example. and nonlinear TR functions are also common. So we use non-linear functions.
As we can see.
TR equation …………….01 (200)2 =1000 2100 .0.01Q) Q = 7Q – 0.01 (300)2 =1200 2800 .01Q2 Q 100 200 300 400 500 600 700 TR 700 . a linear demand function results in a nonlinear TR function (quadratic equation If the independent variable is raised to a third power we will have a cubic function such as TC = 1500 + 300Q -25Q2 +1. (1)
But TR = P x Q and it is a function of Q So we have to express P in terms of Q in order to eliminate P From equation (1) 100 P = 700 – Q P = 7 – 0.0.Q = 700 – 100P TR = f (Q)
demand function ……………. .0. cubic) the curves will not be a straight line.01 (600)2 =600 4900 .01Q TR = P x Q = (7-0.0.01 (400)2 =1200 3500 .01 (100) = 600 1400 ..5Q3 In both cases (quadratic.….0.01 (500)2 =1000 4200 .0.0.
Q Page 6 of 17
.01 (700)2 =0
0 700 Q TR
inverse demand function………… (2)
Substituting 2 in TR equation.
Exponential: Y = Xa
b. Reciprocal: Y = 1/X
Continuous vs. and machines.
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.There are other forms used in economics such as a. Logarithm: Y = log X
c. output. Discreet We will assume for the purpose of the analysis that all economic variables are related to each other in a continuous fashion although many of these variables are discrete such as people.
That is. X). It is written as: dY/dX = lim∆x→0. It can be applied only if the function is continuous Calculus is actually a slope-finding technique. ∆Y/∆X d means ∆Y relative to very small ∆X. Calculus (slope-finding) is important if the function is nonlinear because slope is different at every point. It is equal to the coefficient “b”.USING CALCULUS
We know that a marginal is the change ( ) in a dependent variable associated with a one-unit change in an independent variable. Using calculus. If: Y = ƒ(X). then: ∆Y = ∆Y/ ∆X = (Y2 – Y1) / (X2 – X1) Calculus: is a mathematical technique that enables one to find instantaneous rate of change of a continuous function. instead of finding the rate of change between two points ( Y/ can find it at any given point on the function. Derivative turns out to be the slope of a line that is tangent to some given point on a curve. no need for calculus. we
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. Finding the slope for linear function is easy because the slope is the same at any point and between any two points. To know how very small. we need to use the concept of derivative The derivative (the slope) measure of ∆Y relative to a very small ∆X. it is possible to measure the slope exactly at one point. The slope here is a measure of the change in Y relative to a very small change in X. So. Calculus helps obtaining optimum values of function (maximum or minimum).
dY/dX = 3(10)X(3-1) = 30X2 o If Y = 20 X-4 = -80X-5
3. which has zero slope.
2. V = 4X3. then dY/dX = 0 o If Y = 10. Derivatives involve rates of changes. U and V are functions of X.e. and dY/dX = 6X + 12X2 o If Y = 15X2 +7X. dY/dX = dU/dX + dV/dX o The derivative of the sum is the sum of the derivatives. then dY/dX = 1X1-1 = 1X0 = 1 o If Y = 10X3. and “C” is a constant. Sum and Difference Rule Sum: o U = g(X) and V = h(x). o A constant by definition never change in value o The graph of a constant function is a horizontal line. o U = 3X2. There are 6 main rules to find a derivative: 1. Constant Rule o If Y = f (X) = C. then Y = U + V = 3X2 + 4X3. Power function Rule o If Y = aXn where “a” is constant and “n” is the exponent (power).Rules of differentiation
Differentiation is the process of determining the derivative of a function. then dY/dX = (n)(a) X(n-1) o If Y = X. then dY/dX = 30X +7
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. i. then: o If Y = U + V. then dY/dX = 0 o The derivative of a constant is zero. finding dY/dX (ory’) when Y = ƒ(X).
Chain Function Rule o If Y = ƒ(U) and U = ƒ(X). and then
dY/dU = 3 (2X2)2. so. o U = 5X2. where U = g(X) and V = h(X).Difference: o If Y = U – V.2X) = X2 – 4 + 2X. then
dY (10 X 2 )(5) − (5 X − 9)(20 X) 50 X 2 − 100 X 2 + 180 X 180 X − 50 X 2 18 − 5 X = = = = dX (10 X 2 )2 100 X 4 100 X 4 10 X 3
V(dU / dX) − U( dV / dX) V2
6. Quotient Rule: o If Y = U / V. then Y = U – V = X2 – (4 .15 X2
5. Y = (2X2)3 + 10. then dY/dX = 5 -20X
4. and dY/dX = 5X2 (-1) + (7 – X) (10X) = . V = 7 – X. then Y = 5X2 (7 – X). U = 2X2. then dY/dX = U (dV/dX) + V (dU/dX) o The first times the derivative of the second plus the second times the derivative of the first.5X2 + 70X -10 X2 dY/dX = 70X . then dY/dX = dY/dU * dU/dX o Y = U3 + 10. and dU/dX = 4X dY/dX = 3 (2X2)2 * 4X = 3 (4X4) * 4X = 12 X4 * 4X = 48 X5
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. then dY/dX = dU/dX . V= 4 – 2X. Product Rule o Y = UV where U and V are functions of X. and dY/dX = 2X + 2 o If Y = 5X – 10X2.dV/dX o The derivatives of the difference is the difference of the derivatives o U = X2. then dY/dX = o Y = (5X -9) / 10X2.
N.5Q3. find the MC function. Ps..Economic Application:
If demand function is Q = 700 – 100P find the slope Slope = b = dQ/dP = -100 So.004) – (1/0. W. ∆Q with respect to ∆P is always the slope = b = -100 That is why there is no need for calculus in linear equations.
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. MC = dTC/dQ = 300 -50Q + 4. Y = f (X. no matter what is the value of P. Y. find MR function.004)Q = 2500 – 250 Q TR = P x Q = (2500 – 250 Q) Q = 2500Q – 250 Q2 MR = dTR/dQ = 2500 -500Q
If TC = 1500 + 300Q – 25Q2 + 1.004P = 10 – Q P = (10/0. Take partial derivative of each unknown variable. so the maximization procedure is different than for single variable equations Most economic variables depend on more than one economic variable.004P.) For example. I..) Maximization Procedure 1. Z.
If demand function is Q = 10 – 0. demand equation Qd = f (P.5Q2
Partial Derivatives and Multivariate Functions
Multivariate functions have more than one unknown variable.…. We have to find TR function but since TR is a function of Q we should first find the inverse demand function P = f (Q) 0.
I = Customers’ income. if Q = -100P + 50I +2Ps + 4N Where.913 Substituting into X equation. take the partial derivative of Q with the independent variable and held all other variables constant (the derivative of a constant is zero) ∂Q/∂P = -100P1-1 = -100. P = Price of the good. Find X* and Y* that maximize TR. Y = 80 – 4 (100 – 6Y) Y = 80 – 400 + 24Y -23Y = -320 Y* = 320 / 23 = 13. Second. set partial derivatives equal to zero and solve for X* and Y*: 80 – 4X – Y = 0 100 – X – 6Y = 0 Y = 80 – 4X X = 100 – 6Y ∂Q/∂N = 4
Thus. ∂TR/∂Y = -X – 6Y + 100 (treat X as constant). N = Number of Customers To know the change in Q as a result of a change in one of the independent variables.2.522
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. and given: TR = 80X – 2X2 . find partial derivatives: ∂TR/∂X = 80 – 4X – Y (treat Y as a constant). Set each partial derivative equal to zero. 3. Suppose TR = f(X. The partial derivative. Y) where X = sales of X and Y = sales of Y. For example. Ps = Price of substitute goods.XY – 3Y2 + 100Y. holding constant all other factors. Another example. X* = 100 – 6(13.913) = 16. Solve the resulting system of simultaneous equations for all unknown variables. measures the marginal change in Y associated with a very small change in X. and find the maximum TR First. ∂Y/∂X. Q = Quantity demanded.
the maximum TR (TR*) is: TR* = 80(16. dY/dX = 0 To determine whether the optimal value is at maximum or minimum. This means finding “the best” value under certain conditions.Therefore.522)2 – 16.913) = 1356. then set dY/dX equal to zero and solve for the optimal value of the independent variable (Q*) that maximizes or minimizes the objective function
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.take first derivative of the equation. In economic analysis.
Y A 0 + Y
0 B X
At both pints of A and B. but it is important in many economic applications to find the second derivative (second-order condition) Y = 2X4 dY/dX = 8X3 dY2/d2X = 24 x2 First-order Condition Second-order Condition
Maximum and Minimum Values of a Function
The main objective of managerial economics is to find the optimal values of key variables.522) – 2(16.913)2 + 100(13.522(13. finding the optimum means finding either the maximum or minimum value of a variable.52
So far we have discussed only the first derivative (first-order condition) (dY/dX or y’).913) – 3(13.
the value is a maximum.0625 MR = (450/16) – (1/8)(225)
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. what is the Q* and price P* that maximize TR? First find the inverse demand function: P = (450/16) – (1/16)Q So.0525 To check whether Q* and P* are in max or min conduct the second derivative d2Y/dX2 = . which means the last unit produced will not add any additional revenue dTR/dQ = (450/16) – (1/8)Q = 0 Q* = (450/16) x (8/1) = 225 P* = (450/16) – (1/16)(225) = 14.1/8 < 0 maximum Maximum TR = (450/16)(225) – (1/16)(225)2 = 3164.
o If d2Y/dX2 < 0 (if slope changes from positive to negative). Set dY/dX = 0 to determine the extreme of the function Taking the second derivative tells you whether the extreme is a maximum or a minimum.To distinguishing maximum from minimum. TR Maximization
If Q = 450 – 16P.
o If d2Y/dX2 > 0 (if slope changes from negative to positive). find the second derivative of the equation (d2Y/dX2).
the value is a minimum. dY/dX gives the slope of the function.
First Derivative Second Derivative
dY/dX = 0 d2Y/dX2 < 0
dY/dX = 0 d2Y/dX2 > 0
Examples 1. TR equation is: TR = PQ = (450/16)Q – (1/16)Q2 dTR/dQ = MR = (450/16)Q1-1 – 2(1/16)Q2-1 = (450/16) – (2/16)Q = (450/16) – (1/8)Q Set MR equation (dTR/dQ) equal to zero.
Inverse demand function: P = 172 – 10Q TR = PQ = (172 – 10Q)Q = 172Q – 10Q2 π = TR – TC = (172Q – 10Q2) – (100 + 65Q +Q2) = 172Q – 10Q2 .100 . Profit Maximization
Suppose Q = 17.Q2 = -100 +107Q -11Q2 dπ/dQ = 107 – 22Q = 0 Q* = 107/22 = 4. So. first find TR equation.10P. Since π = TR – TC.4 d2π/dQ2 = -22 < 0 maximum profit OR
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.2 -0.86 P* = 172 -10 (4.P 28
MR 0 TR 3164
D 450 Q
2. and TC = 100 + 65Q +Q2.86) = 123. find Q* and P* that will maximize profit.65Q .
10Q3.100 .60 − 0. then X = 2a
Suppose TR = 50Q.π = TR – TC dπ/dQ = (dTR/dQ) – (dTC/dQ) = 0 dTR/dQ = dTC/dQ MR = MC 172 -20Q = 65 + 2Q 22Q = 107 Q* = 107/22 = 4.86 To check second-order condition
o For TR: d2TR/dQ2 = -20 < 0 o For TC: d2TC/dQ2 = +2 > 0
maximum TR minimum TC
3.60 − 0.+3Q2 .30 ) − 0. What is the level of output that will maximize profit? π = TR – TC = 50Q .60
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.10Q3 = -100 -10Q . b = +6.30)( −10 ) − 6 ± 36 − 12 − 6 ± 24 − 6 ± 4.30Q2 + 6Q -10 = 0 The values of Q that set this quadratic function equal to zero can be found using the formula for the roots of a quadratic function
X= − b ± b 2 − 4ac 2a
In our example: a = -0.0. c = -10
Q= − 6 ± 6 2 − 4(0 − .10Q3 dπ/dQ = -10 +6Q – 0. and TC = 100 +60Q – 3Q2 + 0.60Q + 3Q2 .30Q2 Re-arrange to fit the general formula of a quadratic function Y = aX2 + bX + c So.9 = = = 2( −0. you can use the equation below to solve for the roots:
− b ± b 2 − 4ac If Y = aX + bX + c.30. dπ/dQ = – 0. Quadratic Equation
if you can’t find the roots.0.
6 .0.6 + 220.127.116.11.9) / .16) + 6 = .60 = 1. 60(18.84 Q2* = (.90 < 0 Thus. 60(1.16 Both quantities satisfy the first order conditions but only one satisfies the second order condition d2π/dQ2 = .4. only Q2* satisfies maximization conditions
Classical production function (Cobb-Douglus)
Q = ALαKβ Transfer into log log Q = log A + α log L + β log K
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.84) + 6 = 4. 60Q + 6 substitute Q1* and Q2* For Q1*: d2π/dQ2 = .0.4.90 > 0 For Q2*: d2π/dQ2 = .Q1* = ( .60 = 18.9) / .