Chapter!

2
Mathematics!for!
Mi
Microeconomics
i
The!Mathematics!of!Optimization
• Economic!theories!assume!that!an!economic!
agent!is!seeking!to!find!the!optimal!value!of!
some!function
– consumers!seek!to!maximize!utility
– firms!seek!to!maximize!profit
firms seek to maximize profit
• This!chapter!reviews!the!mathematics!that!go!
into!these!problems
 Functions!with!One!Variable
• Simple!example:!Manager!of!a!firm!wants!to!
p p g
maximize!profits
" ! f (q)
"
Maximum profits of
"* "* occur at q*
" = f(q)

Quantity
q*
 Functions!with!One!Variable
• Vary!q to!see!where!maximum!profit!occurs
– an!increase!from!q1 to!q2 leads!to!a!rise!in!"

"
#"
$0
"*

#q
"2 " = f(q)

"1

Quantity
q1 q2 q*
 Functions!with!One!Variable
• If!output!is!increased!beyond!q*,!profit!will!
decline
– an!increase!from!q*!to!q
q p "
q3 leads!to!a!drop!in!"
"

#"
%0
"*

" = f(q)
#q
"3

Quantity
q* q3
 Derivatives

• The!derivative!of!" =!f(q) is!the!limit!of!

#"/#q!for!very!small!changes!in q
d" df f (q1 ' h) & f (q1 )
! ! lim
dq dq h ( 0 h

• The value depends on the value of q1

 Value!of!a!Derivative!at!a!Point
• The!evaluation!of!the!derivative!at!the!
point!q
i =!q1 can!be!denoted
b d d
"
d"
d" "**

dq q ! q1
" = f(q)

"3

• In our previous example,

q* q3 Quantityy
Q

d" d" d"

$0 %0 !0
dq q !q
1
dq q !q
3
dq q ! q *
First!Order!Condition!for!a!Maximum
• For!a!function!of!one!variable!to!attain!its!
maximum!value!at!some!point,!the!
derivative at that point must be zero
derivative!at!that!point!must!be!zero

df
!0
dq q ! q *
 Second Order Conditions
Second!Order!Conditions
• The!first!order!condition!(d"/dq)!is!a!
necessary condition!for!a!maximum,!but!it!
condition for a maximum, but it
is!not!a!sufficient condition
"
If the profit function was u-shaped,
the first order condition would result
in q* being chosen and " would
be minimized

"*

Quantity
q*
 Second!Order!Conditions
• This!must!mean!that,!in!order!for!q*!to!be!
the!optimum,!
d"
d" d"
d"
$ 0 for q % q * and % 0 for q $ q *
dq dq

• At q*, d"/dq must be "

decreasing
"*
– the derivative of
" = f(q)
d"/dq must be
"3
negative at q*

q* q3 Quantity
 Second Derivatives
Second!Derivatives

• The!derivative!of!a!derivative!is!called!a!
second!derivative
• The!second!derivative!can!be!denoted!by
The second derivative can be denoted by

d 2" d 2f
2
or 2
or f " (q )
dq
q q
dq
 Second Order Condition
Second!Order!Condition

• The!second!order!condition!to!represent!a!
(local)!maximum!is

d "
2

2
! f " (q ) q !q * % 0
dq q !q *
 Rules!for!Finding!Derivatives
db
1. If b is a constant, then !0
dx
d [bf ( x )]
2 If b is a constant,
2. constant then ! bf ' ( x )
dx

dx b b &1
3. If b is constant, then ! bx
dx
d ln x 1
4
4. !
dx x
 Rules!for!Finding!Derivatives
x
da
5
5. ! a x ln
l a for
f any constant
t ta
dx
– a!special!case!of!this!rule!is!de
i l f hi l i d x/dx /d =!ex
 Rules!for!Finding!Derivatives
• Suppose!that!f(x)!and!g(x)!are!two!functions!
of x and!f
of!x and f’(x)
(x)!and!g
and g’(x)
(x)!exist
exist
• Then
d [f ( x ) ' g ( x )]
6. ! f '(x) ' g'(x)
dx

d [f ( x ) ) g ( x )]
7. ! f ( x )g ' ( x ) ' f ' ( x )g ( x )
dx
Rules!for!Finding!Derivatives
/& # ,

""
!!
' -- **
. % # + & $ # % # & & # %$ #

"
!
"
" !
! "
!
"
!
)*( ! (
'# +
0% # 1
01234'5' ( -./- ( % # 2,
"

!
 Rules!for!Finding!Derivatives
• If!y =!f(x)!and!x =!g(z)![so!y =!f(g(z))] and!if!
both f’(x)
both!f (x)!and!g
and g’(x)
(x)!exist,!then:
exist then:
dy dy dx df dg
9.
9 ! ) ! )
dz dx dz dx dz
– this
thi is
i called
ll d the
th chain
h i rulel
– allows us to study how one variable (z)
affects another variable (y) through its
influence on some intermediate variable (x)
 Rules!for!Finding!Derivatives
• Some!examples!of!the!chain!rule!include

de ax de ax d (ax )
10.
10 ! ) ! e ) a ! ae
ax ax

dx d (ax ) dx

' 068
6 /# 1 ! ' 068
6/# 1 ' /# 7 7
"

"

!
"

!
77*(( ) ! )/ !
'# ' /# '# /# #
"

!
2 2 2
d [ln( x )] d [ln( x )] d ( x ) 1 2
12. ! 2
) ! 2 ) 2x !
dx d(x ) dx x x
 Example!of!Profit!Maximization
• Suppose!that!the!relationship!between!profit!
and output is
and!output!is
" =!1,000q " 5q2
• The!first!order!condition!for!a!maximum!is
d"/dq
/ q =!1,000!"
, 10q
q =!0
q*!=!100
• Since!the!second!derivative!is!always!! "10,!
q!=!100!is!a!global!maximum
 Functions!of!Several!Variables
• Most!goals!of!economic!agents!depend!on!
several variables
several!variables
– trade"offs!must!be!made
• The!dependence!of!one!variable!(y)!on!a!
series of other variables (x1,xx2,…,xxn)!is!
series!of!other!variables!(x ) is
denoted!by

y ! f ( x1, x 2 ,..., xn )
 Partial Derivatives
Partial!Derivatives

• The!partial!derivative!of!y with!respect!to!x1
is denoted by
is!denoted!by
3y 3f
or or fx or f1
3x1 3x1 1

– in calculating the partial derivative, all of

the other xx’ss are held constant
 Partial Derivatives
Partial!Derivatives

• A!more!formal!definition!of!the!partial!
derivative is
derivative!is

3& & #7 ' . 9 # +9***9 # 8 & & #79 # +9***9 # 8

"

!
"

!
"

!
"

!
! 64:
3# 7 # +9***9# 8 . (, .
 Calculating!Partial!Derivatives
1. If y ! f ( x1, x 2 ) ! ax ' bx1 x 2 ' cx , then
2
1
2
2

3f
! f1 ! 2ax1 ' bx 2 and
3x1
3f
! f2 ! bx1 ' 2cx 2
3x 2
ax1 ' bx 2
2. If y ! f (x1, x 2 ) ! e , tthen
e
3f ax ' bx 3f ax ' bx
! f1 ! ae 1 2
and ! f2 ! be 1 2

3x1 3x 2
 Calculating!Partial!Derivatives
3. If y ! f (x1, x 2 ) ! a ln x1 ' b ln x 2 , then
3f a 3f b
! f1 ! and ! f2 !
3x1 x1 3x 2 x2
 Partial Derivatives
Partial!Derivatives

• Partial!derivatives!are!the!mathematical!
expression of the ceteris paribus
expression!of!the!ceteris!paribus
assumption
– show!how!changes!in!one!variable!affect!some!
outcome!when!other!influences!are!held!
constant
Second"Order!Partial!Derivatives
• The!partial!derivative!of!a!partial!derivative!
is!called!a!second"order!partial!derivative

3 (3f / 3xi ) 32 f
! ! f ij
3x j 3x j 3xi
 Young’ss!Theorem
Young Theorem

• Under!general!conditions,!the!order!in!
which!partial!differentiation!is!conducted!to!
p
evaluate!second"order!partial!derivatives!
does!not!matter

fij ! f ji
 Functions of Several Variables
Functions!of!Several!Variables

• Suppose!an!agent!wishes!to!maximize
y!=!f (x1,x2,…,xn)
• The!change!in!y
The change in y from!a!change!in!x
from a change in x1
(holding!all!other!x’s constant)!is
3&
'; ! '# 7 ! &7'# 7
3# 7
– the change in y is equal to the change in x1
times the slope (measured in the x1
direction)
Party!time!!Let’s!make!the!change!bigger
y g gg
3&
'; ! '# 7 ! &7'# 7
3# 7

3f
#y ! #x1 ! f1 #x1
3x1
 Total Differential
Total!Differential

• Suppose!that!y =!f(x1,x2,…,xn)
• If!all!x’s!are!varied!by!a!small!amount,!the!
f ll ’ db ll h
total!effect!on!y will!be
3f 3f 3f
y !
dy dx1 ' dx 2 ' ... ' dx n
3x1 3x 2 3xn

dy ! f1dx1 ' f2dx 2 ' ... ' fn dx n

#y ! f1 #x1 ' f 2 #x2 ' ... ' f n #xn

 #x2

#x1

#y ! f1 #x1 ' f 2 #x2

 #y ! f1 #x1 ' f 2 #x2 ' ... ' f n #xn

First"Order!Condition!for!a!Maximum
• A!necessary!condition!for!a!maximum!of!the!
function f(x1,xx2,…,xxn)!is!that!dy
function!f(x ) is that dy =!0!for!any
= 0 for any
combination!of!small!changes!in!the!x’s
– this!can!only!be!true!if

f1 ! f2 ! ... ! fn ! 0

• A point where this condition holds is

called
ll d a critical
iti l point
i t
 Second"Order!Conditions
• This!condition!is!not!sufficient to!ensure!a!
maximum
– we!need!to!examine!the!second"order!partial!
d i ti
derivatives!of!the!function!f
f th f ti f
– conditions!that!will!make!f concave!would!be!
sufficient!for!a!maximum
 Finding!a!Maximum
• Suppose!that!y is!a!function!of!x1 and!x2
= " (x1 " 1)2 " (x2 " 2)2 +!10
y =! + 10
y =!" x12 +!2x1 " x22 +!4x2 +!5
• First"order!conditions!imply!that
3y
! &2 x1 ' 2 ! 0 x !1
*
3x1 OR
1

3y x !2
*
! &2 x 2 ' 4 ! 0 2
3x 2
 Implicit!Functions
• An!“explicit”!function!which!is!shown!with!
a dependent variable (y) as a function of
a!dependent!variable!(y)!as!a!function!of!
one!or!more!independent!variables!(x)!such!
as
y =!mx +!b
can!be!written!as!an!“implicit”!function
y!– mx – b =!00
f( ,y, , )
f(x,y,m,b)!=!0
Derivatives!from!Implicit!Functions
• It!will!sometimes!be!helpful!to!compute!
derivatives directly from implicit functions
derivatives!directly!from!implicit!functions!
without!solving!for!one!of!the!variables!
directly
– the!total!differential!of!!g(x,y)!=!0 is
0!=!gxdx +!gydy
– this!means!that
dy gx
!&
dx gy
 Implicit!Function!Theorem
• It!may!not!always!be!possible!to!locally!solve!
implicit functions of the form g(x y)=0 for
implicit!functions!of!the!form!g(x,y)=0!for!
unique!explicit!functions!of!the!form!y!=!f(x)

Sufficient condition for y ! f ( x) to exist :

gy 2 0
10 & ( x & 1) 2 & ( y & 2) 2 ! 0
10 & ( x & 1) 2 & ( y & 2) 2 ! 0
 Implicit!Function!Theorem
• It!may!not!always!be!possible!to!locally!solve!
implicit functions of the form g(x y)=0 for
implicit!functions!of!the!form!g(x,y)=0!for!
unique!explicit!functions!of!the!form!y!=!f(x)

Sufficient condition for y ! f ( x) to exist :

gy 2 0
 The Envelope Theorem
The!Envelope!Theorem

• The!envelope!theorem!concerns!how!the!
optimal!value!for!a!function!changes!when!a!
p
parameter!of!the!function!changes
g
– this!is!easiest!to!see!by!using!an!example
 The Envelope Theorem
The!Envelope!Theorem

• Suppose!that!y (ice!cream!seller’s!profit)!is!a!
function of x (ice!cream!output)
function!of!x (ice cream output)
y =!"x2 +!ax
• If!a (temperature)!is!assigned!a!specific!value,!
then y becomes!a!function!of!x
then!y becomes a function of x only!and!the!
only and the
value!of!x that!maximizes!y can!be!calculated
 How!does!the!profit!depend!on!temperature?!
Use!the!Envelope!Theorem

Optimal Values of x and y for Alternative Values of a

Value of a Value of xx* Value of yy*(Profit)
(Profit)
0 0 0
1 1/2 1/4
2 1 1
3 3/2 9/4
4 2 4
5 5/2
/2 2 /4
25/4
6 3 9
 The!Envelope!Theorem
y* y = -x2 + ax
10

9 As a increases,,
8
the maximal value
7
for y increases
6

4 The relationship
p
3
between a and y
2

1
is q
quadratic
0 a
dy *
0 1 2 3 4 5 6 7
!?
da
 The!Envelope!Theorem
• Suppose!we!are!interested!in!how!y*!changes!
as a changes
as!a
dy *
!?
d
da
• There!are!two!ways!we!can!do!this
Th t d thi
– calculate!the!slope!of!y* directly
– apply!envelope!theorem
 The!Direct!Approach
• To!calculate!the!slope!of!the!function,!we!
must solve for the optimal value of x for!any!
must!solve!for!the!optimal!value!of!x for any
value!of!a
dy/dx =!"2x +!a =!0
xx*!=!a/2
a/2
• Substituting,!we!get
y*!=!"(x*)2 +!a(x*)!=!"(a/2)2 +!a(a/2)
= a2/4!+!a
yy*!=!"a /4 + a2/2!=!a
/2 = a2/4
 The!Direct!Approach
• Therefore,
dy*/da =!2a/4!=!a/2
2a/4 a/2

• We!can!save!time!by!using!the!envelope!
theorem (x*!may!not!also!be!explicit)
theorem!(x may not also be explicit)
– for!small!changes!in!a,!dy*/da can!be!computed!by!
h ldi
holding!x t * d l l ti 3 /3 directly!from!
at!x*!and!calculating!3y/3a di tl f
y
 The Envelope Theorem Way
The!Envelope!Theorem!Way

3y/!3a =!x
• Holding!x =!x*
3y/!3a =!x*!=!a/2

• This!is!the!same!result!found!earlier
 The!Envelope!Theorem
• The!change!in!the!optimal!value!of!a!function!
with respect to a parameter of that function
with!respect!to!a!parameter!of!that!function!
can!be!found!by!partially!differentiating!the!
objective!function!while!holding!x
bj ti f ti hil h ldi (
(or!several!
l
x’s)!at!its!optimal!value

dy * 3y
!
da 3a x ! x*(a )
 The Math of Envelope Theorem
The!Math!of!Envelope!Theorem
• How!did!the!formula!come!about?!We!have!
g y =!f![x
from!maximizing! f 1,x2,a]!with!respect!to
p x1
and x2
yy*!=!f!(x
= f (x1*(a)
(a),!xx2*(a)
(a),a)
a)
• Taking!derivative!w.r.t.!a

dy * 3f dx1 3f dx2 3f
! ) ' ) '
da 3x1 da 3x2 da 3a
 The!Envelope!Theorem:!Extention
• This!can!be!extended!to!the!case!where!y!is!a!
function of several variables
function!of!several!variables
y =!f(x1,…xn,a)

• Finding!an!optimal!value!for!y
g p y would!consist!of!
solving!n first"order!equations!
3 /3 i =!0!!!!(i
3y/3x 0 (i =!1,…,n)
1 n)
 The Envelope Theorem
The!Envelope!Theorem

• Optimal!values!for!these!x’s!would!be!a!function!
of a
of!a

x1*!=!xx1*(a)
(a)
x2*!=!x2*(a)
.
.
.
xn*= xn*(a)
 The Envelope Theorem
The!Envelope!Theorem

• Substituting!into!the!original!objective!function!
gives us the optimal value of y (y*)
gives!us!the!optimal!value!of!y
y*!=!f![x1*(a),!x2*(a),…,xn*(a),a]
• Differentiating!yields

dy * 3f dx1 3f dx 2 3f dx n 3f
! ) ' ) ' ... ' ) '
da 3x1 da 3x 2 da 3xn da 3a
 The Envelope Theorem
The!Envelope!Theorem

• Because!of!first"order!conditions,!all!terms!
except 3f/3a are equal to zero if the x’ss!are!at!
except!3f/3a!are!equal!to!zero!if!the!x are at
their!optimal!values

• Therefore,,
'; < 3&
!
'/ 3/
 Constrained!Maximization
• Suppose!that!we!wish!to!find!the!values!of!
x1,!xx2,…,!xxn that!maximize
that maximize
y =!f(x1,!x2,…,!xn)

subject!to!a!constraint!
subject to a constraint
g(x1,!x2,…,!xn)!=!0
 Lagrangian!Multiplier!Method
• The!Lagrangian multiplier!method!starts!
with setting up the expression
with!setting!up!the!expression
= =!f(x
f( 1,,!x2,,…,!x
, n ))!+!4g(x
g( 1,,!x2,,…,!x
, n)
– 4 is!called!a!Lagrangian multiplier
 = = f(x1, x2,…, xn ) + 4g(x1, x2,…, xn)

Lagrangian!Multiplier!Method
• First"Order!Conditions
3= /3x 4 1 =!0
/3 1 =!ff1 +!4g 0
3= /3 4g2 =!0
/3x2 =!ff2 +!4g 0
.
.
.
3= /3xn = fn + 4gn = 0
3= /34 = g(x1, x2,…, xn) = 0
 Interpretation!of!Lagrangian!Multiplier
• Rate!at!which!the!maximum!increases!as!the!
constraint is relaxed – shadow!price!for!the!
constraint!is!relaxed! shadow price for the
constraint
 Skip!the!discussion!of!Duality!from!
Skip the discussion of Duality from
the!textbook.
It!will!be!covered!little!later!(but!not!
from the textbook)
from!the!textbook)
 Constrained Maximization
Constrained!Maximization

• Suppose!a!farmer!had!a!certain!length!of!
fence (P) and wished to enclose the largest
fence!(P)!and!wished!to!enclose!the!largest!
possible!rectangular!area
– let!x and!y!be the!lengths!of!the!sides

• Problem:!choose!x and!y to!maximize!the!area!

(A =!x"y)!subject!to!the!constraint!that!the!
perimeter!is!fixed!at!P =!2x +!2y
 Constrained Maximization
Constrained!Maximization
• Setting!up!the!Lagrangian multiplier:
= =!x"y + 4(P " 2x " 2y)
= x y +!4(P

• The!first"order!conditions!for!a!maximum!are
h fi d di i f i
3= /3x!
/3x =!y!
y # 24 =!0
0
3= /3y!=!x!# 24 =!0
3= /34 =!P!# 2x!# 2y =!0
 Constrained Maximization
Constrained!Maximization

• Since!y/2!=!x/2!=!4,!x must!be!equal!to!y
– the!field!should!be!square
h fi ld h ld b

• Since!x =!y and!y =!24,!we!can!use!the!

constraint!to!show!that
x =!y =!P/4
4 =!P/8
/
 Constrained Maximization
Constrained!Maximization

• Interpretation!of!the!Lagrangian!multiplier
– 4 suggests!that!an!extra!yard!of!fencing!would!add!
h d ff i ld dd
P/8!to!the!area

– The!Lagrangian!multiplier!provides!information!
about the implicit value of the constraint
about!the!implicit!value!of!the!constraint
 Constrained!Maximization!&!
E l
Envelope!Theorem
Th
• Suppose!that!we!want!to!maximize
Suppose that we want to maximize
y =!f(x1,…,xn;a)
subject!to!the!constraint
g(x1,…,xxn;a)!=!0!
;a) 0
• Solve!by!setting!partial!derivatives!of!
y gp
Lagrangian equal!to!0
 Constrained!Maximization!&!
E l
Envelope!Theorem
Th
• It!can!be!shown!that
It can be shown that
dy*/da =!3= /3a!at (x1*,…,xn*;a)
– the!change!in!the!maximal value!of!y from!a!
change in a can!be!found!by!partially!
change!in!a can be found by partially
differentiating!= and!evaluating!the!partial!
derivative at the optimal point
derivative!at!the!optimal!point
Inequality Constraints (Not in the textbook)
Inequality!Constraints!(Not!in!the!textbook)

• In!some!economic!problems!the!constraints!
need!not!hold!exactly
• Suppose!we!seek!to!maximize
Suppose we seek to maximize y!
y =!f(x
f(x1,xx2)
subject!to
g1 (x1,x2)!5 0,
g2 ((x1,,x2))!5 0
 Lagrangian

• We!define
• = =!f(x1,!x2)!+!41 g1 (x1,x2)!+!42 g2 (x1,x2)!
• Now!we!write!down!the!first!order!
Now we write down the first order
conditions!for!this!Lagrangian
• In!this!case!the!multipliers!have!specific!
signs:!4
signs: 41,,!4
42!2 #!0
0
• Complementary!slackness:!at!least!one!of gi
) or 4i must!be!zero!at!solution
( 1,x2)!!
(x tb t l ti
 Kuhn Tucker Conditions
Kuhn"Tucker!Conditions
• Sometimes!we!have!a!standard!constrained!
p p
optimization!problem!with!the!additional!
constraints!that!the!variables!be!non"negative.
• In!that!case!we!bring!in!these!non"negativity!
In that case we bring in these non negativity
constraints!as!inequality!constraints!and!work!
with!the!Lagragian!the!standard!way
h h h
Second!Order!Conditions!" Functions!of!
One Variable
One!Variable
• Let!y
Let y =!f(x)
= f(x)
• A!necessary!condition!for!a!maximum!is!that
dy/dx =!f!’(x)!=!0
– to!ensure!that!the!point!is!a!maximum,!y
to ensure that the point is a maximum, y must!be!
must be
decreasing!for!movements!away!from!it
Second!Order!Conditions!– Sufficiency!
Condition
d2y
2
! f " ( x) % 0
dx

• This
This!means!that!the!function!f
means that the function f must!have!a!
must have a
concave!shape!at!the!critical!point
Second!Order!Conditions!" Functions!of!
Two Variables
Two!Variables
• Suppose!that!y
Suppose that y =!f(x
= f(x1,!xx2)
• First!order!conditions!for!a!maximum!are
3y/3x1 =!f1 =!0
3 /3 2 =!ff2 =!0
3y/3x 0
– to!ensure!that!the!point!is!a!maximum,!y must!
diminish!for!movements!in!any!direction!away!
from!the!critical!point
Second!Order!Conditions!" Functions!of!
Two Variables
Two!Variables
0 f11 f22 " f122 >!0
f11 <!0, 0

The!rest!of!the!sufficiency!conditions!will!be!on!a!need"
b i !
to"know!basis!!
k
 Quasi Concavity
Quasi"Concavity
• A!function!U is!quasi"concave!if!for!each!
g
number!c the!following!set!is!convex

0 ( x, y ) | U ( x, y ) 5 c 1
Example on Mathematica
Example!on!Mathematica
Example on Mathematica
Example!on!Mathematica
 Duality

• Any!constrained!maximization!problem!has!
a dual problem!in!constrained!minimization
a!dual problem in constrained minimization
– focuses!attention!on!the!constraints!in!the!
original!problem
 Integration
• Integration is!the!inverse!of!differentiation
– let!F(x)!be!the!integral!of!f(x)
– then!f(x)!is!the!derivative!of!F(x)
then f(x) is the derivative of F(x)

'> #
"
!
!>$ # !& #

"
!
"
!
'#
 Integration
• We!denote!an!integral!as
> # ! 6 & # '#

"
!
"
!
• If f(x) = x then
# 2
> # ! 6 & # '# ! 6 #'# ! '?
"
!
"
!
2
– C is an arbitrary constant of integration
 Definite Integrals
Definite!Integrals

• We!can!also!use!integration!to!sum!up!the!
area!under!a!function!over!some!defined!
interval
x !b
F' ( x) ! f ( x) 7
F 6 f ( x)dx ! F (b) & F (a)
x!a

x !b

6 f ( x)dx ! area under f ( x)

x! a
 Definite Integrals
Definite!Integrals

# !A
f(x)
/15/ @8'51 & # ! 6 & # '# ! > A & > /

"
!

"
!

"
!
"
!
# /
!

f(x)

a b x