MATECO2: Mathematical Economics 2

I. INTRODUCTION

Calculus Review

Economic Equilibrium a state in which selected interrelated variables
of a model are in a position for which there is no inherent tendency for
change, i.e. variables are in a state of rest.

Optimization quest for the best; process of finding the relative
maximum or minimum of a function.

A Dash of Logic: Necessary versus Sufficient Conditions

Necessary condition a prerequisite; a requirement
p q p only if q; p implies q
q is a necessary condition of p
e.g. p: DLSU student
q: goes to the DLSU campus

Sufficient but not necessary condition
p q p if q; if q, then p
q is a sufficient condition of p
e.g. p: one can get to Bora
q: one takes a plane to Bora

Necessary-and-sufficient condition
p q p if and only if q
e.g. p: in the economics program
q: would have to take MATECO2


II. FUNDAMENTALS OF LINEAR ALGEBRA

a. Systems of Linear Equations

i. Parameters, Variables and Constants ingredients of a
mathematical model

2
Equations describe the structure of a model
Variables value or magnitude than can change; e.g. price, profit,
revenue, cost, national income, consumption, investment,
imports, exports, etc.
Constants fixed values, represented simply by numbers
Parameter (or parametric constant) a constant that is variable,
assumed to be given

ii. Linear Equations in Economics

Examples of Economic Models

1. Partial equilibrium analysis: supply and demand

The equation system

Demand equation:
Q
d
= a bP + eY
(1)
Supply equation:
Q
s
= c + dP
(2)
Equilibrium cond.:
Q
s
= Q
d (3)

3 equations and unknowns
(Q
d
,Q
s
, P)

exogenous variable: Y
parameters/coefficients:
a,b,c, d,e


Algebraic Solution:

P
*
=
a + eY + c
b + d

Q
d
*
= Q
s
*
=
ad + deY bc
b + d


2. Determination of national income

The equation system

Equilibrium cond.:
0 0
Y C I G = + + = + + = + + = + + (4)
Consumption fnc.:
C = C
0
+ cY
(5)

2 equations and unknowns
(C
and
Y)

exogenous variables:
I
0
,C
0
,G
0

Algebraic Solution:
3

Y
*
= C
0
+ I
0
+ G
0
( )
1
1c
|
\

|
.
|

C
*
= C
0
+ c I
0
+ c G
0
( )
1
1c
|
\

|
.
|


3. Partial equilibrium analysis: 2 goods

The equation system

Demand good 1:
Q
d1
= a
1
b
1
P
1
+ e
1
P
2 (6)
Supply good 1:
Q
s1
= c
1
+ d
1
P
1 (7)
Equi cond good 1:
Q
d1
= Q
s1 (8)

Demand good 2:
Q
d 2
= a
2
b
2
P
2
+ e
2
P
1 (9)
Supply good 2:
Q
s2
= c
2
+ d
2
P
2 (10)
Equi cond good 2:
Q
d 2
= Q
s2 (11)

6 equations and 6 unknowns
(2Q
d
,2Q
s
,2P)


Solution procedure:

Eliminate
Q
d s by subst. Eqns 11 and 8 into 9 and 6, respectively

Q
s1
= a
1
b
1
P
1
+ e
1
P
2 (6a)
Q
s2
= a
2
b
2
P
2
+ e
2
P
1 (9a)

Eliminate
Q
ss by equating Eqn 6a with 7 and Eqn 9a with 10

a
1
b
1
P
1
+ e
1
P
2
= c
1
+ d
1
P
1
(7a)
a
2
b
2
P
2
+ e
2
P
1
= c
2
+ d
2
P
2
(10a)

Solutions:

Eqns 7a and 10a represent a two-equation system with
P
1 and
P
2
as unknowns and the solutions to the problem are:

P
1
*
=
a
1
+ c
1
( )
b
2
+ d
2
( )
+ e
1
a
2
+ c
2
( )
b
1
+ d
1
( )
b
2
+ d
2
( )
e
1
e
2


4
( ) ( ) ( )
( ) ( )
2 2 1 1 2 1 1 *
2
1 1 2 2 1 2
a c b d e a c
P
b d b d e e
+ + + +
=
+ +


Subst eqns 12 and 13 to 6a and 9a to derive the solutions for the
Q
s1 and
Q
s2. Subst the results to eqns 8 and 11 to derive the
solutions for
Q
d1 and
Q
d 2.


b. Matrices

i. Matrix a rectangular array of parameters, variables or numbers

Let A be a matrix

A = a
ij
[ ]
=
a
11
a
12
a
13
a
21
a
22
a
23
a
31
a
32
a
33












3 rows (i subscript), 3 columns (j subscript)

Elements of a matrix the numbers that appear inside the matrix
o
a
ij
- states that a is an element that appears in
i
th
row
and
j
th
column of matrix A

Dimension of a matrix matrix A is a 3 X 3 matrix; sometimes
denoted as
A
33

o first value number of rows
o second value number of columns

Below is an m x n matrix

A
mn
= A
ij
[ ]
=
a
11
a
1n

a
m1
a
mn













5
ii. Basic Special Forms

1. Square matrix a matrix that has the same number of rows
and columns, i.e., m = n

2. Diagonal matrix a square matrix where non-zero elements
appear only in the principal diagonal, e.g.

a
11
0 0
0 a
22
0
0 0 a
33












3. Identity matrix a diagonal matrix that has values of 1 in
its principal diagonal, e.g.

I
33
=
1 0 0
0 1 0
0 0 1












Special feature: A matrix pre- or post-multiplied by a
(conformable) identity matrix is equal to itself, i.e.,
plays the same role as 1 in scalar algebra.

4. Idempotent matrix matrix a is idempotent if A A = A, e.g.,
identity matrix

5. Null matrix a matrix that has 0s for its elements; plays a
role similar to 0 in scalar algebra

6. Triangular matrix

Upper-triangular matrix a matrix for which every
diagonal entry in the northeast including the principal
diagonal is non-zero, e.g.
a
11
a
12
a
13
0 a
22
a
23
0 0 a
33











6

Lower-triangular matrix a matrix for which every
diagonal entry in the southwest including the
principal diagonal is non-zero
a
11
0 0
a
21
a
22
0
a
31
a
32
a
33













7. Symmetric matrix a matrix for which the off-diagonal
elements in the northeast are a mirror image of the off-
diagonal elements in the southwest, e.g.
D
22
=
d
11
b
b d
22









8. Equal matrices matrices with the same dimensions and
same elements in corresponding positions, e.g.

1 2
3 4






=
1 2
3 4








Application: If
x
y






=
5
10






, then x =5 and y =10.


9. Vectors
Column matrix a matrix that only has one column,
i.e., n=1
Row matrix a matrix that only has one row, i.e.,
m = 1


10. Scalar a constant; a matrix that has one row and one
column, i.e.,
m = n = 1
7
iii. Systems of Equations in Matrix Form

Matrices allow us to write equations in a compact format. The
process involves identifying the endogenous variables, coefficients
and constants (along with exogenous variables), and organizing
these into separate matrices.

Equation system in expanded form

a
11
X
1
+ a
12
X
2
+a
1m
X
m
= d
1
a
21
X
1
+ a
22
X
2
+a
2m
X
m
= d
2

a
m1
X
1
+ a
m2
X
2
+a
mm
X
m
= d
m


m equations and endogenous variables
(X
1
X
m
)


a
ij
s are coefficients on the LHS m x m coefficients
m x 1 constants on the RHS
ds exogenous variables and/or constant terms


Coefficient matrix

The coefficients of the equation system can be written as

A
mn
=
a
11
a
1m

a
m1
a
mm












A is m x m because the system has m equations and unknowns
coefficients of an equation appear in a row
coefficients associated with a particular X appear in a column





8
(Column) vector of endogenous variables

x
m1
=
X
1

X
m











The order in which the variables appear in the vector matters


(Column) vector of constants or exogenous variables

d
m1
=
d
1

d
m













Equation system in matrix notation

o Compact presentation
A
mm
x
m1
= d
m1


o Expanded presentation

a
11
a
1m
a
21
a
2m

a
m1
a
mm

X
1
X
2

X
m












=
d
1
d
2

d
m















c. Matrix Algebra

- a compact way of writing an equation system
- provides a mechanism for testing the existence of a solution to
an equation system
- an alternative procedure for finding the solution to an equation
system

Note: Matrix algebra applies to linear equations only!
9

i. Matrix Addition and Subtraction

^ Requirement: 2 matrices (A and B) are conformable for
addition/subtraction if and only if they have the same dimensions.
Conformable:
A
23
+ B
23

Not conformable:
A
23
+ B
53


^ If A and B are conformable, then matrix C (=A + B) will have the same
dimension as A and B.

^ Illustration:
a b
c d






+
e f
g h






=
a + e b + f
c + g d + h








Note: the same applies to subtraction

ii. Scalar Multiplication

^ Scalar multiplication involves taking the product of a matrix and a
scalar.

^ Procedure: Multiply each element of the matrix by the scalar.

If q is a scalar, then
q
a b
c d






=
aq bq
cq dq








Example:
10
1 2
3 4






=
10 20
30 40








iii. Matrix Multiplication

^ Matrix multiplication is not as simple as scalar multiplication since it

10
requires conformity between 2 matrices and

involves calculation of the inner product

^ Some concepts: For
A B = C
,

lead matrix A

lag matrix B

pre-multiply matrix B by matrix A

post-multiply matrix A by matrix B

^ Condition for Conformity: number of columns in the lead matrix equals
number of rows in the lag matrix

Let
A
mn
and
B
nk
.
Possible:
A
mn
B
nk

Not possible:
B
nk
A
mn


^ Dimension of the product of two matrices


A
mn
B
nk
= C
mk


C has the same number of rows as the lead matrix

C has the same number of columns as the lag matrix

^ Elements of C

Each element in C is an inner product of two vectors in matrices
A and B

To illustrate the concept of inner product, consider vectors u and
v.
11

u
1n
= u
1
u
n
[ ]

v
n1
=
v
1

v
n












Noting that uv satisfies the conformity requirement for matrix
multiplication, the inner product will be given by the scalar:

uv = u
1
v
1
++ u
n
v
n


Example:

u v = 1 2 3
[ ]

5
10
15










=1 5 + 2 10 + 3 15 = 70

For
A B = C
, we have

a
11
a
1n
a
21
a
2n

a
m1
a
mn

b
11
b
1k
b
21
b
2k

b
n1
b
nk












=
c
11
c
1k
c
21
c
2k

c
m1
c
mk















c
ij
= element of matrix C that appears in its ith row and jth column

c
ij
= inner product of the ith row of A and the jth column of B

^ Illustration

a
11
a
12
a
21
a
22

b
11
b
21






=
c
11
c
21






where
c
11
= a
11
b
11
+ a
12
b
21

and
c
21
= a
21
b
11
+ a
22
b
21


^ Example
1 2
3 4

10
20






=
c
11
c
21






=
50
110







12
iv. Digression: Summation Notation
The sum of
X
i
may be written as
X
i
i=1
n

= X
1
+ X
2
++ X
n


Since the inner product of two vectors may be written as

c
11
= a
11
b
11
+ a
12
b
21
+ a
13
b
31
++ a
1n
b
n1


then,
c
11
= a
1 j
b
j1
j=1
n

.

Implication for
A B = C
is

a
11
a
1n
a
21
a
2n

a
m1
a
mn

b
11
b
1k
b
21
b
2k

b
n1
b
nk












=
a
1i
b
i1
i=1
n

a
1i
b
ik
i=1
n

a
2i
b
i1
i=1
n

a
2i
b
ik
i=1
n

a
mi
b
i1
i=1
n

a
mi
b
ik
i=1
n

Note: Division of matrices is not possible but the procedure is
analogous to matrix inversion.

v. Laws of Matrix Algebra

1. Commutative

Matrix addition is commutative: A+B = B+A, if they A and B are
conformable for addition

e.g.,
A + B =
1 2
3 4






+
10 20
30 40






=
11 22
33 44








B + A =
10 20
30 40






+
1 2
3 4






=
11 22
33 44







13

Matrix multiplication is not commutative:
A B B A


Even if
A B
and
B A
are possible,
A B = B A
is not
necessarily true.

e.g.
AB =
1 2
3 4






10 10
30 40






=
10 + 60 10 + 80
30 +120 30 +160






=
70 90
150 190








BA =
10 10
30 40






1 2
3 4






=
10 + 30 20 + 40
30 +120 60 +160






=
40 60
150 220








Scalar multiplication is commutative:
k A = A k



2. Associative

Matrix addition is associative: (A+B)+C = A+(B+C)

Matrix multiplication is associative:
A B
( )
C = A B C
( )
,
assuming that the matrices are conformable for multiplication.

e.g., let
A =
1 2
3 4






,
B =
0 1
2 3






and
C =
1 3
5 7








then
A B
( )
C =
4 7
8 15

1 3
5 7






=
39 61
83 129








and
A B C
( )
=
1 2
3 4

5 7
17 27






=
39 61
83 129









3. Distributive

Matrix multiplication is distributive:
A B+ C
( )
= A B+ A C


14
vi. Transpose Matrices

The transpose of a matrix contains elements for which the rows
and columns of matrix A are interchanged.
The transpose of a matrix A = A or
A
T

E.g.,
A
32
=
1 4
2 5
3 6










A
23
=
1 2 3
4 5 6







Properties of transposes
o If A is an mxn matrix, then A is an nxm matrix.
o (A) = A
o (A+B) = A+B
o
A
mk
B
kn
( )
nm

= B
nk
A
km
nm
, where
A B
and
B A
satisfy
the conditions for conformity.
o Special property: If D is symmetric, then D = D.

Vector Operations

i. Geometric Interpretation of Vector Operations

Figure 1 shows the geometric counterpart of vector
3
2
u

=


either
as the point (3, 2) or the arrow emanating from the origin (0, 0) to
point (3, 2). It also shows the geometric representation of scalar
multiplication of a vector
6
2
4
u

=


and
3
2
u

=

Figure 2 shows vector addition of
2
3
v

=


and
3
2
u

=


with sum
5
5
v u

+ =




15
Figure 1

Figure 2
x
2


x
1



u
(3, 2)
-4 -3 -2 -1 1 2 3 4 5 6

6

5

4

3

2

1





-2

x
2


x
1


2u
(6, 4)
u
(3, 2)
-4 -3 -2 -1 1 2 3 4 5 6

6

5

4

3

2

1

-u
(-3, -2)



x
1
x
2


u
(3, 2)

5
4
3
2
1
1 2 3 4 5



x
1
x
2


u
(3, 2)

5
4
3
2
1
1 2 3 4 5



x
1
x
2


u


5
4
3
2
1
1 2 3 4 5
v
(2, 3)


v + u
(5, 5)
x
2


x
1



u
(3, 2)
-4 -3 -2 -1 1 2 3 4 5 6

6

5

4

3

2

1





-2

x
2


x
1



u
(3, 2)
-4 -3 -2 -1 1 2 3 4 5 6

6

5

4

3

2

1