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Economics – Dr. Sauer

Chapter 7: Functions of Several Variables 7.1 Partial Differentiation 7.1.1 Functions of two or more variables Because it’s hard to draw in three dimensions, in economics functions of two variables are frequently plotted by _________________________________________________. 7.1.2 Partial differentiation: first-order partial derivatives Partial differentiation is equivalent to differentiating along an ______________. A Partial Derivative is denoted with ________ instead of d. Suppose you have the function: z = x + 2y + 4 The notation to express that you are partially differentiating z with respect to x is: The notation to express that you are partially differentiating z with respect to y is: 7.1.3 Second-order partial derivatives A straight second-order partial derivative means:

A mixed second-order partial derivative means:

Abbreviations for second-order partial derivatives:

7.1.4 Differentials and small changes (incremental changes) Incremental Changes Incremental changes are small changes in the dependent variable which result from changes in the ________________________ variable(s). The differentials dy and dx are replaced with __________ and __________ which mean “small changes”, but not infinitesimally small changes. The formula for incremental changes is:

Differentials for functions of two variables The total differential of z = f(x,y) is:

7.2 Applications of Partial Derivatives 7.2.1 Production Functions A general production function takes the form: A Cobb-Douglas production function takes the form:

Marginal Functions in General The first derivatives of a production function are referred to as _________________________. The second derivatives of a production function indicate whether the marginal product is __________ or _______________. A Cobb-Douglas production function exhibits ___________________ returns to each factor. Relationship between marginal and average functions Review Table 7.5.

Production Conditions In practice, firms produce output over a certain range of the production function. Conditions for using labor: Conditions for using capital:

Graphical Representation of production functions: isoquants

The Slope of an Isoquant (MRTS) The slope of an isoquant is called the ___________________________________________. This is the amount of _____________ reduced for each one unit increase in _____________, while maintain output constant. A diminishing MRTS means: The slope of an isoquant is the ratio of the marginal products The slope of an isoquant may be expressed in terms of the MPL and MPK by means of the total differential: 2

The MRTS for a Cobb-Douglas production function

7.2.2 Returns to Scale Constant Returns to Scale means: Decreasing Returns to Scale means: Increasing Returns to Scale means: Homogeneous functions of degree r A Cobb-Douglas production function is described as homogeneous, order r if:

Incremental Changes

7.2.3 Utility Functions A Cobb-Douglas utility function takes the form:

Marginal Utility Marginal Utility for a function of one good is:

Marginal Utility for a function of multiple goods is:

Graphical Representations of Utility Functions A Utility function can be represented by a series of two-dimensional graphs known as ______________. To plot an indifference curve, ______________ is fixed at a constant value and then y is expressed in terms of x. Slope of an Indifference Curve The slope of an indifference curve is called the _______________________________________(MRS).

Incremental Changes

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7.2.4 Partial Elasticities Partial Elasticities of Demand Price Elasticity of Demand:

Income Elasticity of Demand:

Cross-Price Elasticity of Demand:

Partial Elasticities of Labor and Capital Partial Elasticity w.r.t. Labor:

Partial Elasticity w.r.t. Capital:

The Multipliers for the linear national income model The investment multiplier:

The government expenditure multiplier:

The income tax rate multiplier:

7.3 Unconstrained Optimization 7.3.1 Find the Optimum Points for functions of two variables Step1: Find the _____________ and _____________ derivatives. Step 2: Set the first derivative equal to __________ and solve for the variable. Step 3: Use the _____________________________ to determine the nature of the points found in step 2. Because we are working in more dimensions, we need a supplemental version of the test. Define Δ to be: The point is a maximum if: The point is a minimum if: 4

The point is an inflection point if: The point is a saddle point if: If you get zero then: 7.3.2 Total Revenue Maximization and Profit Maximization

7.3.3 Price Discrimination

7.4 Constrained Optimization and Lagrange Multipliers 7.4.1 What is a constrained maximum or minimum?

7.4.2 finding the constrained extrema with Lagrange multipliers A Lagrangian function takes the form: The Lagrange multiplier is ______. 7.4.3 Maximum Utility Subject to a Budget Constraint Graphical Analysis for locating maximum utility

Interpretation of the Lagrange Multiplier The value of λ gives the change in the maximum or minimum value of the function being optimized for each unit change in the _______________________.

7.4.4 Production Functions 7.4.5 Minimizing cost subject to a production constraint 5

7.5 Summary After we work through this chapter in class, review this section and write any notes here.

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