SECOND ORDER CONDITIONS: ECONOMIC

APPLICATION
 THE LAGRANGE MULTIPLIER METHOD

Differentiate with respect to x and y, equate the partials to 0

λ =(marginal benefit of x)/(marginal cost of x)

 Economic Interpretation of the Lagrange Multiplier
• Consider the problem:

Max XY subject to 2X+Y=M, obtain X*, Y* and λ*

X*= M/4, Y*(M)=M/2 and λ*=M/4

f*(M)=

λ*=M/4

ℒ= f(x1,x2,x3,…,xn)+ λ (g1,g2,……,gn)

λ=
Sufficiency Conditions
Envelope Results

If and is the value of x that maximizes f(x,r), then

,
•
Maximizing/Minimizing a function

Let f(x)= f(x1, x2, …..,xn) be defined over a set S in and let F be a
function of one variable defined over range of f. Define g over S
by

g(x1,x2,……,xn)= F(f(x1,x2,…..,xn)) then:

If F is increasing and c=(c1,c2,…..cn) maximizes (minimizes) f

over S, then c also maximizes (minimizes) g over S
 
Maximizing a function is equivalent to maximize a (strictly)
increasing transformation of that function.
Then we can just as well try to find those (x,y) that maximize over
S any one of the following alternative objective function:
af(x,y)+b (a>0)
 
 ln f(x,y)

 
Mathematical Application:
1) maximize (x,y) ɛ S
2)maximize subject to (x,y) ɛ S
Hessian Matrix
Let f(x,y) be a function with partial derivatives of the first and
second order in a convex domain S, and let (be an interior point
of S at which f is stationary

If, for all (x,y) in S, one has , and

then (is a maximum point for f(x,y) in S

Hessian Matrix

The following function has stationary points (-2,-2,-2) and (0,0,0)

f(x,y,z)=

Classify the stationary points

 
• Suppose that f(x) has continuous partial derivative in a convex
set S in and let be an interior point in S. Now,

a) If f is concave, then is a global maximum point of f in S iff

is a stationary point of f

b) If f is convex, then is a global minimum point of f in S iff is a

stationary point of f
• Let z=f(x) be a function in an open convex set S in . If H(x)
denotes the Hessian matrix of f, then:

• f is concave <=> H(x) is negative semidefinite for all x ɛ S

• f is convex <=> H(x) is positive semidefinite for all x ɛ S

• Let f(x,y)= for all (x,y). Is f concave/convex?

• Show that the Cobb- Douglas function Y= A, defined for all K>0
and L>0, is concave if A>0 , a0, b0 and a+b1, and is strictly
concave if a and b are positive with a+b<1.
Show that the CES function f defined for K>0, L>0 by
F(K,L)= ( A>0, 0)
Is concave for and convex for
BORDERED HESSIAN & QUASI-CONVEX/CONCAVE

• Show that f(x,y)= (x,y>0, 0<α,β<1) is strictly quasi-concave

= - <0

• =