Topic 7 - Unconstrained

Optimisation

Chapter 5.4 in Jacques

BS1111 Mathematics for Economics

Topic 7 Plan

1. Unconstrained Optimisation
• Finding and classifying stationary points of a function
of two variables.
• Maximising profit of a firm that sells two goods or
operates in two markets.
Unconstrained
Optimisation
Optimisation of Functions of Several
Variables

• Finding maxima/minima of functions of several variables is an

important operation in economics.

• Optimisation problems can be subdivided into:

1. Unconstrained optimisation (this week)

• Example: find prices of an off-peak ticket and an
advance ticket which maximise a rail company’s profit.

2. Constrained optimisation (next week)

• Example: find optimal amounts of food and drink for a
limited budget of £30.
Unconstrained Optimisation

Reminder: optimising a function of one variable

Step 1: Solve the equation to find the stationary points.

Step 2: Check the second order conditions:

• , then has a minimum at ;
• , then has a maximum at .
• , then the point cannot be classified using the available information.
Unconstrained Optimisation cont’d

The algorithm (process) is similar for a function of two variables:

Step 1: Solve the system of equations…

or,

… to find the stationary points .

Unconstrained Optimisation cont’d

Step 2: Classify the stationary points you found using second-

order partial derivatives:

• If , and at , then has a minimum at

• If , and at , then has a maximum at

• If at , then has a saddle point at .

 Classification of stationary points

a) minimum: b) maximum: c) saddle point:

, ,

(rises in both x and y (falls away in both x

directions) and y directions)
Unconstrained
Maximisation
Profit from Two Goods Example
Profit Maximisation: A Firm Producing
Two Goods
Example: A firm is a monopolistic producer of two goods, Good 1
and Good 2. The prices are related to quantities and according
to the demand functions:

The total cost function is:

Q. Find the values of and which maximise profit and deduce the
corresponding prices.
A Firm Producing Two Goods cont’d

Solution: First, find the total revenue:

A Firm Producing Two Goods cont’d

Second, find profit as total revenue minus total cost:

A Firm Producing Two Goods cont’d

Third, follow the two-step optimisation method:

Step 1: find stationary points of the profit equation

A Firm Producing Two Goods cont’d

Step 1 cont: find stationary points of the profit equation by

equating partial derivatives to 0 and solving for ,

Multiply the first equation by 3, the second by 4 and subtract:

A Firm Producing Two Goods cont’d

Sub into one of the original equations to find

A Firm Producing Two Goods cont’d
Step 2: To confirm (5,10) is a maximum, find second-order partial
derivatives.
A Firm Producing Two Goods cont’d
Step 2: A stationary point is a maximum if:
, and

which holds here:

A Firm Producing Two Goods cont’d

We proved that and maximize profit.

Sub into the respective demand equations to find corresponding

prices:

In order to maximise profit, the firm should produce 5 units of

Good 1 and sell them at £45 each and produce 10 units of Good 2
and sell them at £65 each.
Practice Problem
A monopolist sells its products in two isolated markets with the
following demand functions

The total cost function is:

1. Deduce the profit function for this producer.

2. Find the values of and which maximise profit and calculate
the corresponding value of profit.