Humathematical Economics

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HUMathematical economics
economics (Debark University)
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Mathematical Economics(Econ2051) 2019/20
CHAPTER ONE
1. Introduction
In this unit we shall revise what you have studied in Quantitative method for economists I
and II such as basic concepts from calculus which incorporates differential calculus,
integral calculus, differential and difference equations. In addition to these, we will revise
matrix algebra which includes matrix representation, determinants, inverse of a matrix,
solutions of simultaneous linear equation systems, Leontief input - output model and
linear programming. Therefore, you should read your module of the above two courses to
understand this unit properly.
1.1 Basic Concepts from Calculus
1.1.1 Differential Calculus - Differentiation

Given a function y = ƒ(x), where x and y are independent and dependent variables
respectively, if x is an increment in the value of x and y is an increment in the value
of y, then y is referred to as the average rate of change or the rate of change of y
x
with respect to the given change in x. This limiting value is also known as derivative
which is the instantaneous rate of change of y resulted from a very small change in x
represented by dy .
dx
f ( x  x)  f ( x)
Lim y x
This means
= Lim = dy dx
x
x 0 x 0
Thus, differentiation is the process of finding the rate of change of the dependent variable
(y) with respect to a given change in the independent variable (x). In other words, it is a
process of determining the slope of the function y= ƒ(x) at any point of x in the domain of
dy
the function.  f (x)
dx
Rules OF Differentiation
.
Given the function y= ƒ(x) and other functions such as g(x) and h(x) which are
differentiable, the following are the rules of differentiation.
1.Constant function Rule

Given a function y = ƒ(x) = k, where k is constant
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dy dk
  0, That is the derivative of the constant function is zero.
dx dx
dy
Example If ƒ (x) = 4 = 4x 0 , = 0 (4x 01 ) = 0
dx
2.Linear function Rule

Given a function y = ax + b, where a and b are constants
dy
a
dx
Example If ƒ (x) = 3x + 5, then ƒ' (x) = 3

If f(x) = 5x, then ƒ' (x) = 5
3.Power function rule

Given a function ƒ(x) =x n where x  0 and n is any real number
ƒ '(x) = n x n 1
Example If ƒ(x) = 2x 5 , ƒ ' (x) = 5 (2x 51 ) = 10x 4
If ƒ(x) = 1 3  x 3 , ƒ' (x) = -3 (x 31 ) = -3x 4
x
ƒ '(x) =  3 4
x
1 1
1 1 1
If ƒ (x) = x  x ½, ƒ’ (x) = ½ x 2 = x 2 
2 2 x
4.Sum and Difference Rule
When y = g(x)  h(x), then ƒ' (x) = g' (x)  h' (x)
Example If g (x) = 2x+3 and h (x) = 5x 2 + 2x, then
ƒ ' (x) =g'(x)  h' (x)
= 2  (10x +2)
g' (x) + h' (x) = 10x +4
g' (x)- h' ( x) = 2 - (10x+2)
= -10x
5.Product rule
This rule enables us to differentiate two functions which are multiplied together.
If ƒ' (x) =g' (x) h(x) + h' (x) g(x)
(a) Example
dy
1. If ƒ(x) = ( 7.5+ 0.2 x 2 ) ( 4+8x 1 ) , What is ƒ' (x) = ?
dx
This function can be multiplied out and differentiated without using the product rule. But,
let us first use the product rule and then compare the answers obtained by the two
methods.
Let g (x) = 7.5 + 0.2x 2 and h(x) = 4+8x 1
Therefore, g' (x) = 0.4x and h' (x) = -1 (8x 2 ) = -8x 2
Using the product rule
ƒ' (x) = 0.4x ( 4+8x 1 ) + - 8x 2 ( 7.5 + 0.2x 2 )

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= 1.6x + 3.2 - 60x 2 - 1.6

f ( x)  60 x 2  1.6 x  1.6 --------------------------------- (1)
If we multiply the original function, we get

ƒ(x) = ( 7.5 + 0.2x 2 ) ( 4+8x 1 )
= 30+ 60x 1 + 0.8x 2 + 1.6 x
Therefore
f ( x)  60 x 2  1.6 x  1.6 ----------------------------------- (2)
These two derivatives, i.e. (1) and (2) are the same. But in some cases, it is not possible
to multiply out the different components of a function and then we must use the product
rule to differentiate.
Example
2.A firm faces a non - linear demand function P = ( 650 - 0.25q) 1.5
Determine the marginal revenue (MR) function of this firm. In this case first we should
determine the total revenue function and then differentiate it with respect to the level of
output using the product rule.
TR = p x q = q (650 - 0.25q) 1.5
To differentiate TR with respect to q using the product rule,
Let u = (650 - 0.25 q) 1.5 and v=q
du
Then = 1.5 (650 - 0.25q) 0.5
dq
dv
1
dq
dTR
Therefore, = 1 (650 - 0.25q) 1.5 + (q) (- 0.375) (650 - 0.25q) 0.5
dq
MR = (650 - 0.25q) 0.5 (650 - 0.625q)
6.Quotient rule
Dear colleague! This rule allows as differentiating two functions where one function is
divided by the other function.
If ƒ'(x) = h(x).g' (x) – g(x).h' (x)
( h (x) )2
1) Example
4x2
1.Determine ƒ' (x) if f ( x) =
8  0.2 x
2
Let g (x) = 4x and h(x) = 8+0.2x, g' (x) = 8x and h' ( x) = 0.2
According to the quotient rule,
ƒ'(x) = 8x(8+0.2x) – 0.2(4x2)
(8+0.2x) 2
= 64x + 1.6x2 – 0.8x2
(8+0.2x) 2

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64 x  0.8 x 2
ƒ' (x) =
(8  0.2 x) 2
2. If a monopoly faces a non- linear demand function

252
p=
(4  q)0.5
Derive the marginal revenue function (the rate of change of TR with respect to output).
As we know, TR = p x q,
252q
TR =
(4  q)0.5
If u = 252q and v = (4+q) 0.5 , then
du dv
 252 And  0.5 (4+q)-0.5
dq dq
Now we can find the marginal revenue function using the quotient rule as follows.
dTR 252(4  q) 0.5  252q(0.5)(4  q) 0.5
MR = =
dq [(4  q) 0.5 ]2
= 252(4+q) 0.5 – 252q (0.5) (4+q) -0.5
(4+q)
(4  q)252  126q
=
(4  q)1.5
1,008  252q  126q
=
(4  q)1.5
1,008  126q
MR =
(4  q)1.5
7. Chain Rule
The chain rule enables us to differentiate' functions within functions ', for instance, given
a function y = ƒ (z) and z = g(x), then y= ƒ [g (x)].
To differentiate y with respect to x, we use chain rule which states that

dy dy dz
 ( )( )
dx dz dx
Example
1. Given a non- linear demand function, p = (150 -0.2q) 0.5 , find its slope.
Let z = 150 - 0.2q as a result p = z 0.5
dz dp dz
= = (0.5z 0.5 ) (-0.2)
dq dz dq
= -0.1(150-0.2q) 0.5
= - 0.1
(150 – 0.2q) 0.5
2. If the present value of a one birr due in 8 years time is given by the formula

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1
PV =
(1  r )8
Where r is the given interest rate, find the rate of change of PV with respect to r.
Let (1+r) = z, then PV= 1 8 = z 8
z
dPV 8 dz
This means  8 z 9  9 and =1
dz z dr
i) Thus, using the chain rule
dPV dPV dz
 ( )  8(1  r ) 9 (1)  8(1  r ) 9
dr dz dr
dPV 8

dr (1  r ) 9
As you know in your microeconomics course the marginal revenge productivity theory of
demand for labor states that profit is maximized when MRP L = MC L .
Where MRP L = marginal revenue product of labor
MC L = Marginal cost of labor.
dTR dTC L
MRPL  and MC L 
dL dL
Where TR is total revenue and TC L is total cost of labor.
3. A firm is a monopoly seller of good q and faces the demand schedule P = 200 - 2q,
where p is price in birr and the short run production function is given as q = 4L0.5
Determine the marginal revenue productivity of labor (MRP L ) function.
dTR dq
MRP L = ,
dq dL
Thus, first we need TR, given P = 200 - 2q

TR = (200 - 2q) q = 200q - 2q 2
Therefore,
dTR dq
= 200 - 4 q, = 2L 0.5
dq dL
As a result, MRP L = (200 - 4q) (2L 0.5 )
= [200-4(4L0.5)] 2L 0.5
= (200- 16 L 0.5 ) 2 L 0.5

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MRPL = 400 – 32L 0.5

L 0.5
7.Implicit function Rule
Functions of the form y = ƒ(x) express the dependent variable y explicitly in terms of the
independent variable x and are called explicit functions. Where as functions of the form ƒ
(x, y) =0 do not express y in terms of x. These functions are referred to as implicit
functions. If the implicit function ƒ(x, y) = 0 exists, and the first order partial derivative
of the function with respect to y is different from zero (ƒ y  0), then the total differential
f x dx  f y dy  d 0
f x dx   f y dy
Rearranging these terms,
dy  fx  ( f ( x, y )
= , where ƒx =
dx fy x
f ( x, y )
ƒy =
y
Example
dy
1. Given the function ƒ (x, y) = x 2 + y 2 - 9 = 0, find .
dx
To do this we should partially differentiate the function with respect to x and with respect
dy
to y, and then determine .
dx
f x  2 x and f y  2 y
dy  2x x
Thus, = =
dx 2y y
dy
2. Given the implicit function ƒ (x, y) = x 3 - 2x 2 y + 3xy 2 - 22 = 0, find .
dx
ƒ x = 3x 2 - 4xy + 3y 2 and ƒ y = - 2x 2 +6xy
dy  (3x 2  4 xy  3 y 2 )
Therefore, 
dx  2 xy 2  6 xy
9. Inverse function rule
Given the function y= ƒ(x), it has an inverse if and only if each value of y corresponds
with one and only one value of x. According to the inverse function rule, the derivative of
the inverse function is the reciprocal of the derivative of the original function. The
dy
derivative of the given original function is . Thus, the derivative of the inverse
dx
1
dy dx
function x = ƒ 1 (y) which is =
dx dy
Example If Q = P 3 + 2P 2 +7p, find the derivative of P with respect to Q

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dQ dp 1
= 3 P 2 + 4P + 7, Thus, =
dp dQ 3 p 2  4 P  7
10. Logarithm and Exponential Function Rules

a. Logarithmic function rule
If we have two numbers 8 and 64 that can be related with each other by the equation 8 2 =
64 the exponent 2 can be expressed as the logarithm of 64 to the base 8. This means.
Log648 = 2. In general, if y = a x , then log y a = x where a >0 and a  1
In logarithmic application two numbers are mainly selected as abase. These numbers are
10 and e. If the base is 10, then the logarithmic is referred to as common logarithm. But
if we use e as abase, then the logarithm is known as natural logarithm.
Natural logarithmic function rule

Given the function ƒ(x) =  n 9( x ) = loge 9( x ) where ƒ(x) and g (x) are differentiable,
1
and g (x)  0, f (x) = [ g (x) ]
g ( x)
dy 6
Example If y =  n 6 x  7 , then =
dx 6x  7
Logarithmic function of base a

Given the function f(x) = log ag ( x ) , when f(x) and g (x) are differentiable, and g(x)  0,
dy 1 1
= ƒ' (x) = [g' (x)] a
dx g ( x) n
ii) Example
1 1 1
1. If f(x) = x 3 log6 x , then ƒ' (x) = 3x 2  og6 x + x 3 = x 2 ( 3 og 6 + 6 )
x
6
x ln ln
2
x
ƒ' (x)= 3x 2 og 6 + 6
x
ln
(3 x 2  2 x )
2. If ƒ(x) =, Log 3 then ƒ' (x) = 6x+2
(3x2+2x) ln3
b) Exponential Function Rule
The function y = a x where a is constant and a > 0, a  1 is known as exponential
function to base a. If the base is e, the function is referred to as natural exponential
function.
y = e x , where e= 2.71828
In economics, natural exponential functions are particularly useful for analyzing the
growth rates of different variables.
Natural exponential function rule

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If ƒ(x) = e g ( x ) where ƒ (x) and g(x) are differentiable, then ƒ' (x) = e g ( x ) g' (x).
dy
Given the function y =ex, then = ex.
dx
a. Example
1. If ƒ(x) = 5e 1 x , then ƒ' (x) = -10x e 1 x
2 2
b.
e5 x 5e 5 x (e 5 x  1)  5e 5 x (e 5 x  1)
2. If ƒ (x) = 5 x , then ƒ' (x) =
e 1 (e 5 x  1) 2
10e 5 x
ƒ' (x) =
(e 5 x  1) 2
Exponential Function Rule for Base a

Given the function f(x) = a g(x) Where g(x) and ƒ(x) are differentiable, a>0, a  1,
ƒ' (x) = a g(x) n a
Example.1. ƒ(x) = a 3 x , then ƒ' (x) = a 3 x 3 n a
ƒ' (x) = 3a 3 x n a
i.
ii. 1.1.3 Differentials
Given the function y = ƒ(x) if we know the rate at which x changes, we can find the
y y dy
change in y, y  ( )x . As x  0, 
x x dx
Denoting dy as small change in y and dx as small change in x,
dy dy
dy = ( )dx, where  f ( x)
dx dx
dy  f ( x)dx It is the differential.
Example
Given y = (5x3 + 2x2+ x) dy = (15x2 + 4x+1) dx
Suppose x changes from 2 to 2.01 (i.e. dx = 0.01), by what value does the dependent
variable y changes?
dy = (15 x2 + 4x +1) (0.01)
= [15 (2 2 ) + 4 (2) + 1] (0.01)
= (60+ 8+1) (0.01)
dy = (69)0.01 = 0.69
From the original function, the actual change in y is
y = ƒ (2.01) - ƒ (2)

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ƒ (2) = 5(2 3 ) + 2(2 2 ) +2

= 5 (8) + 2(4) +2
ƒ (2) = 40+8+2 = 50
ƒ(2.01) = 5(2.01) 3 + 2(2.01) 2 + 2.01
= 40.606020+8.0802+2.01
=50.696220
y  f (2.01)  f (20  50.696220  50  0.696220
y  dy  0.696220  0.69
= 0.006220
The value 0.006220 is the error term that is the error of calculation.
As x changes from 2 to 3, that is x = 1, what is the change in y?
dy = [15 (2) 2+ 4(2) + 1] 1
= 60+8 +1 = 69
y  ƒ (3) - ƒ(2)
But we have determined that
ƒ (2)  50
ƒ (3) = 5 ( 33 ) + 2(32) + 3
= 5 (27) + 2(9) +3
ƒ (3) = 135 + 18 + 3 = 156
Thus,  y = 156 - 50 = 116. The error term is 116-69 = 47
Note.
By now we have realized that the smaller the change in x the smaller error term and the
greater the change in x the larger will be the error term.
Total differentials
The concept of differential can be extended to a function of two or more independent
variables. Given the utility function U = U ( x1, x2)
Supposing U as continuous and differentiable
u
Ux1 = which is marginal utility of x1.
x1
u
Ux2 = which is marginal utility of x2.
x2
u
The change in total utility that results from small change in x 1 is given by dx1 and
x1
from small change in x2 is u dx 2

x 2
Then the total change in utility resulted from small change in x and small change in y is
represented by
u u
du  dx1  dx2
x1 x2

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Example Find the total differential, given

1. z  3x 2  xy  2 y 3
z z
dz = dx  dy
x y
dz = (6x + y) dx + (x- 6y2) dy
2. U = 2 x12  6 x1 x2  4 x22
dU  (4 x1  6 x2 )dx1  (6 x1  8x2 )dx2
By now you have completed the first section of this unit. Therefore, try to do the
following self - test questions in order to examine how you have understood this
section.

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CHAPTER TWO
DERIVATIVE IN USE
2.1 Elasticity: Definition and as Logarithmic Derivative
Elasticity is a measure of a proportionate change in the dependent variable which results
from a proportionate change in the independent variable. Thus elasticity of demand is a
measure of the percentage change is quantity demanded due to a percentage change in the
factors which determine demand.
If there is change in quantity demanded from Q to (Q+ Q) resulting from a given
change in price from P to (P + P ), the price elasticity of demand is
E p = Proportionate change in quantity demanded

Proportionate change in price
Q
Q
=
p
p
Q p Q p
= x = ( )
Q p p Q
It gives us the average price elasticity of demand over the price range of P to (P+ p) . It
is possible to use the method of derivative to get the price elasticity of demand at a
particular point P, i.e., as p approaches to zero.
p Q P Q
E p = lim ( ) = lim
Q p Q P
p  0 p  0
P dQ
= ( )
Q dp
dQ p
Thus price elasticity of demand E p= ( )
dp Q
Example
1.Find the price elasticity of demand if the demand function for a product is
Q = P 2 - 6P + 36, where Q is quantity and P is price of a product. Using the above
formula
dQ p dQ
E p= ( ), but  2p  6
dp Q dp

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p
Therefore, E p = (2 p - 6)
P  6 P  36
2
2p  6p
2
Ep = 2
p  6 p  36
2 p2  6 p
Ep =
p 2  6 p  36
What is the elasticity of demand at P = 4?
2(42 )  64) 
Ep =
42  6(4)  36
32  24 8
= = < 1
16  24  36 28
As E p < 1, then demand is said to be price inelastic at P = 4.
2. Find the price elasticity of demand in terms of quantity sold.

10
P= = 10 (Q+1) 2
(Q  1) 2
dQ P 1 dp Q
Ep = ( ), Therefore, = ( )
dp Q Ep dQ P
Differentiating the demand function with respect to Q gives us
dp  20
 -20 (Q+1) 3 =
dQ (Q  1)3
1  20 Q
Thus, =( )( )
Ep (Q  1) 3
10
(Q  1) 2
1  20 (Q  1) 2 (Q)
[ ][ ]
Ep (Q  1) 3 10
1  2Q
=
Ep (Q  1)
Q 1
This means Ep 
 2Q
3. If the demand function is given as Q= 10  p 2 , find the price elasticity of demand at

P = 2.

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dQ p dQ 1
Ep  = ½ (10 - p 2 ) 2 (-2p)
dp Q dp
 2p
= 1
2(10  P 2 ) 2
dQ p

dp 10  p 2
p p
Thus, E p = ( )( )
10  p 2 10  p 2
 p2  22 4 2
Ep = . Thus, at P = 2, E p = = 
10  p 2
10  2 2
6 3
This means, as the price of the product increases by one percent then the quantity
demanded for the product decreases by 2 percent at p = 2.
3
Elasticity as Logarithmic Derivative
In a function y = ƒ (t), when the dependent variable y is a function of time t, then the
instantaneous rate of growth is determined as
dy marg inalfuncti on
Rate of growth = dt =
y totalfunct ion
This ratio exactly represents the derivative of n ƒ (t). This means, the instantaneous rate
of growth of the function is the derivative of natural logarithm of the function with
respect to time. That is
d ln f (t )
Rate of growth =
dt
By now, given the function y = f(x), let us observe the result if we carry out
differentiation of ln y with respect to ( ln x). To start it, suppose u = ln y and v = ln x .
Then the chain of relationship relating u to y and v to x is that
u = n y , y = f(x), v = n x , x  ev
Finding the derivative of ln y with respect to ln x gives us
d (n y ) du du dy dx
  ( ) ( )( )
d (n x ) dv dy dx dv
Using the method of substitution

d (n y ) d (n y ) dy d (e v )
 [ ] [ ][ ]
d (n x ) dy dx dv
1 dy
= ( ) ( ) ev
y dx

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1 dy
= ( )( ) x as e v = x
y dx
d (n y ) dy x
 ( )
d (n x ) dx y
As you remember this expression is the point elasticity of the function. Hence, one can
generalize that for a function y = f(x), the point elasticity of y with respect to x is
d (n y )
E x y=
d (n x )
Example
1. Find the point elasticity of demand given Q = K/ P n where K and n are positive
constants
Q = K p n
ln Q  ln K  n ln P
d (ln Q )
Ep  =-n
d (ln p)
d ln Q
Ep = n
d ln P
2. Find the point elasticity of demand provided that x = a p b where a and b are
positive constants, and x and p are quantity demanded and price of a product
respectively.
ln x = ln a + b ln P
d (ln x)
Thus, E p = =b
d (ln p)
Relationship between Marginal Revenue, Average Revenue and Elasticity of

Demand
Given the total revenue function TR= PQ where P is the price at which the product is sold
and Q is the quantity sold. Then marginal revenue that is the rate of change of total
revenue with respect output is
d ( PxQ )
MR =
dQ
Using the product rule of differentiation
dQ dp
MR  p Q
dQ dQ
dp
MR = P + Q
dQ

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dQ p 1 dp Q
We know form the above analysis that E p  which implies that  ( )
dp Q Ep dQ p
p dp Q
multiplying both sides by p gives us  ( )( ) p
Ep dQ p
p dp
Q
Ep dQ
Substituting it in the above marginal revenue function , we get
P
MR  P 
Ep
However, we also know that p is equal to average revenue (AR), thus
AR
MR  AR 
Ep
1 1
MR = AR (1+ ) = AR ( 1  )
Ep Ep
1
MR  AR (1  )
Ep
From this equation we realize that
When demand is unitary elastic, i.e. E p = 1, MR = 0. This means, total revenue is

maximized.
When demand in elastic, i.e., E p > 1, MR > 0 which implies that total revenue is
increasing. However, as demand is inelastic, i.e., E p < 1, MR < 0 which implies that
total revenue in decreasing.
2.2 Higher Order Derivatives

Do you remember the concept of higher order derivatives from your earlier studies? So
far we have discussed the first order derivative f (x) of the function y = f(x). Now let us
turn our attention to the concept of second order derivative and higher order derivatives.
Having this knowledge enables us to have alternative criteria for determining the relative
maximum or minimum point of a function.
We know that the first order derivative f (x) of a function y = f (x) is a function of x. As
a result we can determine the rate of change of f (x) with respect to x if f (x) is
differentiable. The result of this differentiation is referred to as second order derivative of
the function y = f (x) . It is represented by f (x) where the double prime shows that the

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primitive function has been differentiated with respect to x twice. The expression (x) next
to the double prime indicates that the second order derivative in a function of x.
Alternatively this second order derivative can be represented by
d 2 y d dy
 ( )
dx 2 dx dx
The above expression indicates that the second derivative is a function of x . Thus, it is
possible to differentiate this function with respect to x in order to get the third order
derivative of the function f (x) or f 3 ( x) which in turn can be a source of fourth order
derivative and so on provided that the differentiable condition is satisfied.
Symbolically, these successive higher order derivatives are

f 3 (x), f 4 (x), f 5 (x) -----------, f n (x).
Or
d3y d4y d5y d n ( x)
, , , -----,
dx 3 dx 4 dx 5 dx n
Example
1. Find the first through the fourth derivative of the following function.
f (x) = 5x3 + 2x2 + 3x + 4
These derivatives are f (x) = 15x2 + 4x + 3

f (x) = 30x + 4
f (x) = 30
f 4 ( x) = 0
We have seen that each successive derivative gives us a simpler expression than it's
precedence until we get the fourth derivative. However, it is not always true. The fourth
order derivative is equal to zero does not imply that it does not exist.
2. Find the first four derivatives of the function given as

2x
f (x) = , x  1
1 x
2(1  x)  (1)(2 x)
f (x) = , using the quotient rule
(1  x) 2
2(1  x)  (1)(2 x) 2
f (x) = =
(1  x) 2
(1  x) 2
f (x) = 2(-2) (1-x)-3 (-1)
f (x) = - 4(-1) (1-x)-3 using the chain rule
= 4 (1-x) -3
f 3 ( x)  (3)(4)(1  x) 4 (1)
f 3 ( x) = 12 (1-x)-4

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f 4 ( x)  (4)(12)(1  x) 5 (1)
f 4 ( x)  48(1  x) 5
2.2.1 Convexity and Concavity of a Function
Given the function y = f(x), it is clear that the derivative of the function f (x) indicates
the rate of change of the primitive function with respect to x. Similarly, f (x) shows the
rate of change of f (x) with respect to x. Observing the sign of the first derivative of the
original function at any point of x, one can determine whether a function is increasing or
decreasing at that point. However, the sign of the second derivative indicates whether the
function is concave or convex at that particular point. In the original function is y = f(x),
 f (a) > 0 implies that the function is increasing at x = a and
 f (a) < 0 implies that the function is decreasing at x = a
 f (a) = 0, implies that the function is at its optimum point at x = a
Similarly
 If f (a) > 0, then the function is convex at x = a
 If f (a) < 0, then the function is concave at x = a
 If f (a) = 0, x = a is the point at which the curvature of the function is changed
In general, a positive first derivative coupled with a positive second derivative at x = a

shows that the function increases at an increasing rate at x = a . A positive first derivative
coupled with a negative second derivative at x = a , indicates that the original function is
increasing at a decreasing rate at this point. A negative first derivative with a positive
second derivative shows that the function is decreasing at an increasing rate where as a
negative first derivative with negative second derivative at x= a , implies that the function
decreases at a decreasing rate at x = a .
Example
If f (x) = x 3 - 12x 2 + 36x + 8,
a) Is it increasing or decreasing at x = 3?
b) Is it convex or concave at x = 3?
Solution
First we should find the first and second derivative of this function at x = 3 to answer
these questions.
f (x) = 3x2 - 24x + 36

f (x) = 6x - 24
Therefore, f (3) = 3(9) - 24(3) + 36
f (3) = 27 - 72+36 = 63- 72 = -9 <0
f (x) = 6(3) - 24 = 18 -24 = -6 <0

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This implies that the function is decreasing at decreasing rate at x= 3 and it is concave at
this point.
2.2.2. Linear Approximation

As we know there are complicated functions in economics. In order to avoid this
complexity, we sometimes try to find a simpler function which approximates the original
function. Given the function y = f(x), the equation of a straight line which passes through
point ( x1 , y1 ) and having a slope b is represented as
y  y1
b =
x  x1
b( x  x1 ) = ( y  y1 )
y  b( x  x1 )  y1
This means, the equation of the tangent line which passes through the graph of the
function y = f (x) at x = a provided that f(x) is continuous and smooth at x = a , is
expressed as
y  f (a)  f (a)( x  a)
y  f (a)( x  a)  f (a)
When we approximate the graph of f (x) by its tangent line at x = a . The resulting
approximation is referred to as linear approximation.
Example
1. Find the linear approximation of the function f ( x)  4 x , about x = 1.
First we should determine the value of f (x) and f (x) at x = 1 to answer this question.
Thus,
1 3
1 ( 4 1) = 1 (  4 )

f (x) = x x
4 4
3
 1
f (x) = 1 (1) 4 = 4
4
f (1) = 4 1  1
Therefore, the linear approximation of the function is

1
f (x)  (x-1) + 1
4
1
If x = 1.02, f (x)  (1.02 - 1) + 1
4
1
 (0.02) +1
4

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1
f (x)  +1 = 1.005
200
However, the actual value is f (1.02) = 4 1.02 =1.00496 which is very close to the
approximate value of the function, i.e., 1.005.
2. Determine the linear approximation of the function

1
3 1 2) 2
f (x) = (1+ x + x at x = 0
2 2
1 3 1 2 -½ 3
f (x) = (1+ x + x ) ( + x)
2 2 2 2
3
(1+ (0) + (0)]-½ ( 2  0)
1 3 1
This means f (0) =
2 2 2
1 1 3 1 3 3
f (0) = (1) 2 ( ) = ( ) =
2 2 2 2 4
1
3 1
And f (0) = [1+ (0) + (0)] 2
2 2
1
f (0) = (1) 2 = 1
Therefore, at x = 0 the linear approximation of the function is
f (x)  f (0) (x- 0) + f (0)
3
f (x)  (x - 0) + 1
4
3
f ( x)  x  1
4
2.2.3. Polynomial Approximation

Approximation using linear functions is not as such accurate. Therefore, it is necessary to
use quadrate approximation or higher order approximation so as to minimize this
problem.
a) Quadratic Approximation
Given a function y = f(x), how can it be approximated by the second degree polynomial
of the form P( x)  A  B( x  a)  C ( x  a) 2 as x is close to a ?
In this function we have seen three unknown coefficients such as A, B and C. Therefore,
we ought to put the following three conditions in order to determine these three
unknowns.
At x = a, it is assumed that
 f (a) = P (a)
 f  ( a ) = P ( a )
 f  ( a ) = P  ( a )
Given the polynomial function P( x)  A  B( x  a)  C ( x  a) 2

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P(x) = B+ 2 C (x - a )
P(x) = 2C
When x = a , P ( a ) = A + B ( a - a ) + C ( a - a ) 2
= A = f (a)
P  ( a ) = B+ 2C ( a - a )
P ( a ) = B = f  ( a )
1
P  ( a ) = 2C = f  ( a ), C = f  ( a )
2
Substituting these values in the given quadratic function gives us the quadratic
approximation of the function which is represented by
1
f (x)  f ( a ) + f  ( a ) (x- a ) + f  ( a ) (x- a ) 2 as x is close to a .
2
Example
1. Determine the quadratic approximation to a function f(x) = 4 x about x= 1. In this
case, first we should find the value of f (x) , f (x) and f (x) at x = 1 . Thus,
1 1
4 4
f (x) = x , f (1) = 1 =1
3 3 1
f (x) = 1 x 4 , f (1) = 1 (1) 4
=
4 4 4
 3 7 4 3
f (x) = 1 ( ) x , f (1) =
4 4 16
Thus,
1
f ( x)  f (1)  f (1)( x  1)  f (1)( x  1) 2
2
1 1 3
f ( x)  1  ( x  1)  ( )( x  1) 2
4 2 16
1 3
f ( x)  1  ( x  1)  ( x  1) 2
4 32
Compare the actual value and the approximate value of this function when x  1.02 .
2. Find the quadrate approximation to a function f (x) = (5x +3) 2 about x = 0.
Solution
1
f (0) =
9
f (x) = -2 (5x+3)-3 (5) = -10(5x + 3)-3
f (0) = -10 [5(0) +3]-3 = -10 (3)-3 =  10
27
f ( x)  30(5x  3) (5)  150(5x  3) 4
4
150
f (0) = 150 (5(0) +3) 4 = 150 (3) 4
=
81

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Therefore, the quadratic approximation of the function is
1
f ( x)  f (0)  f (0)( x  0) 
f (0)( x  0) 2
2
1 10 1 150
f ( x)   ( )( x  0)  ( )( x  0) 2
9 27 2 81
1 10 75 2
f ( x)   x x
9 27 81
B. Higher Order Approximation

As it is indicated above quadratic approximation is more accurate than linear
approximation of a function. However quadratic approximation is not as such accurate.
Therefore, functions with higher order derivatives can be better approximated near one
point by using polynomial function of higher degree.
Given a function y = f (x) , how can we approximate it around x = a by an n th degree

polynomial of the form
P( x)  A0  A1 ( x  a)  A2 ( x  a) 2  A3 ( x  a) 3      An x  a) n
As we have seen this function has (n+1) unknown coefficients. Therefore, we should
impose (n+1) conditions on the polynomial to determine the value of the unknown
coefficients. These are, at x = a, it is assumed that
f (a) = P (a)
f  ( a ) = P ( a )
f  ( a ) = P  ( a )
'
'
'
f ( a )= P n ( a )
n
Given the above polynomial function,

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P ( x)  A1  2 A2 ( x  a)  3 A3 ( x  a) 2  4 A4 ( x  a) 3       nAn ( x  a) n 1
P ( x)  2 A2  6 A3 ( x  a)  12 A4 ( x  a) 2  20 A5 ( x  a) 3      n(n  1) An ( x  a) n  2
P 3 ( x)  6 A3  24 A4 ( x  a)  60 A5 ( x  a) 2      n(n  1)(n  2) An ( x  a) n 3
.
.
.
P n ( x)  n(n  1)(n  2)(n  3)                    (3)(2)(1) An
Therefore, when x is close to a ,

f (a)
P(a )  0! A0  f (a )  A0 
0!
f (a )
P (a )  1! A1  f (a)  A1 
1!
f (a)
P (a )  2! A2  f (a)  A2 
2!
3
f (a)
P 3 (a )  3! A3  f 3 (a)  A3 
3!
.
.
f n (a)
P n (a )  n! An  f n (a )  An 
n!
Substituting these values of the unknown coefficients in the polynomial function gives us
the polynomial approximation of the function as x is close to a , which is represented by
f (a ) f (a)
f (x)  f ( a ) +
1!
(x- a ) +
2!
2
(x- a ) +---+
f n (a)
n!
x  a) n  
Example
Find the fourth order approximation of the function
f (x) = 1  x , about x = 0
f (0) f 3 (0) f 4 (0)
In this case f (x)  f (0) + f  (0) (x- 0) + 2
(x- 0) + 3
(x-0) + (x-0)4
2! 3! 4!
1
f (x) = 1 (1+x) 1 2 , f  (0) = 1 (1+0)  2 = 1
2 2 2
1 3
f (x) = (1+x) 2 , f  (0) =  1
4 4

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3 5 3
f 3 ( x) = 2
f 3 (0) 
8 (1+x) , 8
 15 7  15
f 4 (x) = (1+x) 2 , f 4 (0) =
16 16
Therefore,
1 1 1 3 1 15 1
1  x  1  ( x  0)  ( )( )( x  0) 2  ( )( x  0) 3  ( )( )( x  0) 4
2 4 2 8 3! 16 4!
1 1 3 3 15 4
1 x  1 x  x2  x  x
2 8 48 384
2.2.4 Estimation of Functions (Maclaurin and Taylor Series)
A. Maclaurin Series (Expansion of a function around x = 0)
It is an expansion of a function y = f(x) that is differentiable, around x = 0. In other

words, it represents the polynomial approximation of the function around x= 0.
Therefore, given the function
f ( x)  A0  A1 x  A2 x 2  A3 x 3  ....  An x n
Repeatedly differentiating this function gives us

f ( x)  A1  2 A2 x  3 A3 x 2  4 A4 x 3  5 A5 x 4  6 A6 x 5  ...  nAn x n 1
f ( x)  2 A2  6 A3 x  12 A4 x 2  20 A5 x 3  30 A6 x 4  ....  n(n  1) An x n  2
3
f 3 ( x)  6 A3  24 A4 x  60 A5 x 2  120 A6 x .  .......  n(n  1)(n  2) An x n 3
.
.
.
f n ( x)  (n)(n  1)(n  2)(n  3).............................................(3)(2)(1) An
(Where n is Positive integer)
We have understood that the number of constant terms is decreased by one until the nth
derivative is reached. We can determine the value of each rate of change at various values
of x. In this case, let us evaluate these derivatives at x = 0. When we determine the value
of the derivatives at x = 0, then all terms containing x will be eliminated.
f  (0) = A1, f  (0) = 2A2, f 3 (0) = 3(2) A3, f 4

(0) = (4) (3) (2) A4 ---------, f n (0) = n (n-1)
(n-2) (n-3) ... (3) (2) (1) An
Using the symbol (n!) which can be read as n – factorial, where n! = n (n-1) (n-2) (n-3)---
- (3) (2) (1).

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  f 3 (0) f n (0)
A1 = f (0) , A2 = f (0) , A3 = , ----------- An 
1! 2! 3! n!
Now the primitive function f(x) can be expressed as a new polynomial function by
substituting these terms in it as follows
f (0) f (0) f (0) 2 f 3 (0) 3 f 4 (0) 4 f n (0) n

f ( x)   x x  x  x  .......  x
0! 1! 2! 3! 4! n!
In this case, the unknown coefficients of the primitive function are replaced by the
derivatives evaluated at x = 0. Zero factorial represents one (i.e., 0! =1). This power
series representation is known as Maclaurin series of the primitive function
f (x) around x = 0.
Example
1. Determine the Maclaurin series of the function
f ( x)  5 x 3  2 x 2  3 x  1
This function has the following derivatives

f ( x)  15 x 2  4 x  3
f ( x)  30 x  4
f 3 ( x)  30
f (0)  1
f (0)  15(0) 2  4(0)  3  3
So that
f (0)  30(0)  4  4
f 3 (0)  30
Therefore, the Maclaurin series of this function is
f (0) f (0) f 3 (0)

f ( x)  f (0)  ( x  0)  ( x  0) 2  ( x  0) 3
1! 2! 3!
4 30
f ( x)  1  3( x  0)  ( x  0) 2  ( x  0) 3
2 6
f ( x)  1  3 x  2 x  5 x
2 3
This result shows that the Maclaurin series really represents the given function f (x).
2. Find the Maclaurin series of the function

f ( x)  3 x 2  2 x  4
The derivatives from this function are

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f ( x)  6 x  2
f ( x)  6
So that f (0) = 4, f  (0) = 2, f  (0) = 6
Thus, the Maclaurin series of the function is
f (0) f (0)
f ( x)  f (0)  ( x  0)  ( x  0) 2
1! 2!
6
f ( x)  4  2( x  0)  ( x  0) 2  4  2 x  3x 2
2
B. Taylor's Series
It deals about the expansion of the primitive function f (x) provided that the function is
continuous and smooth, around any point x  x0 . Thus given the function y = f(x), we
will explain it using a specific quadratic function for the sack of simplicity.
Let us consider the expansion of the function

f ( x)  A0  A1 x  A2 x 2  A3 x 3  A4 x 4  ....  An x n at some point x = x0
First let us write this function in terms of the power of (x-x0)

f ( x)  A0  A1 ( x  x0 )  A2 ( x  x0 ) 2  A3 ( x  x0 ) 3  A4 ( x  x0 ) 4  ....  An ( x  x0 ) n
This function has the following successive derivatives
f ( x)  A1  2 A2 ( x  x0 )  3 A3 ( x  x0 ) 2  4 A4 ( x  x0 ) 3  5 A5 ( x  x0 ) 4  ...  nAn ( x  x0 ) n 1
f ( x)  2(1) A2  3(2) A3 ( x  x0 )  4(3) A4 ( x  x0 ) 2  .5(4) A5 ( x  x0 ) 3  ....  n(n  1) An ( x  x0 ) n 2
f 3 ( x)  3(2)(1) A3  4(3)(2) A4 ( x  x0 )  5(4)(3) A5 ( x  x0 ) 2  ........  n(n  1)(n  2) An ( x  x0 ) n 3
.
.
.
f n ( x)  (n)(n  1)(n  2)(n  3)......................................................................(3)(2)(1) An
So that

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f ( x0 )
f ( x0 )  0! A0  A0 
0!
f ( x0 )
f ( x0 )  1! A1  A1 
1!
f ( x0 )
f ( x0 )  2! A2  A2 
2!
.
.
f n ( x0 )
f n ( x0 )  n! An  An 
n!
Therefore
f ( x0 ) f ( x0 ) f ( x0 ) f 3 ( x0 ) f n ( x0 )
f ( x)   ( x  x0 )  ( x  x0 ) 2  ( x  x0 ) 3  ...  ( x  x0 ) n
0! 1! 2! 3! n!
This power series representation is referred to as Taylor's series.
If we consider 3 as a point of expansion, then

f 2 (3) f n (3)
f ( x)  f (3)  f (3)( x  3)  ( x  3) 2  ..........  ( x  3) n
2! n!
Example
Find the Taylor's series of the function f ( x)  3x 2  2 x  5 , around x  x0
The successive derivatives of this function are
f (x) = 6x + 2
f (x) = 6
f ( x0 )  3x02  2 x0  5
So that f ( x0 )  6 x0  2
f ( x0 )  6
Therefore,
6
f ( x)  (3x02  2 x0  5)  (6 x0  2)( x  x0 )  ( x  x0 ) 2
2
f ( x)  (3x0  2 x0  5)  (6 x0 x  6 x0  2 x  2 x0 )  3( x 2  2 xx 0  x02 )
2 2
f ( x)  3x02  2 x0  5  6 x0 x  6 x02  2 x  2 x0  3x 2  6 x0 x  3x02

f ( x)  6 x02  5  6 x02  2 x  3x 2
f ( x)  5  2 x  3x 2  3x 2  2 x  5
This realizes that the Taylor's series correctly represents the given function.
2.2.5 Intermediate Value Theorem and Newton Method


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A. Intermediate Value Theorem

Suppose that there is a function f(x) that is continuous for all values of x in the close
interval [a, b], and assume that the values of the function at x = a and at x = b are not
equal to each other and each value has opposite sign, i.e., f (a) and f (b) have different
signs. The intermediate value theorem states that there is at least one value of x say c in
the interval [a, b] such that f (c)  0 .
Example
1. Prove that the equation x 6  3x 2  2 x  1  0 has at least one solution in between 0
and 1, i.e. [0, 1]
You ought to follow the steps below to solve this Problem.
 First put the equation in a polynomial form of f ( x)  x 6  3x 2  2 x  1

 Second check whether the function is continuous in between 0 and 1 or not.
 Third determine the value of the function at x = 0 and x = 1.
As we know the function f(x) is referred to as continuous in the interval (a, b) iff
i) f (x) is continuous at x = a [i.e., lim f(x) = f( a) ]
x a 
ii) f(x) is continuous at x = b [ i.e. lim f(x) = f (b) ]

x  b-
iii) f( x) is continuous at x = c[ i.e., a < c < b ]
As a given function in our example is a polynomial function, it is continuous in between

0 and 1.
f (0) = 06+ 3(0) 2 - 2 (0) - 1 = -1
f (1) = 16+ 3 (1)2 - 2(1) -1 = 1+3-2-1 = 4-3 =1
We have seen that f (0) and f (1) have different signs. Therefore, according to the
intermediate value theorem there is at least one number that is c  [0, 1] so that f (c) = 0.
In other words, the above equation has at least one solution in between 0 and 1.
2. Prove that the equation 2 x 2  3x  2 has at least one solution in between 0 and 1,
i.e. [0, 1].
First make it in to polynomial function by squaring both sides of the equation as

( 2 x 2  3x ) 2 = 22
2x2 + 3x = 4
2x2 + 3x - 4 = 0, then f(x) = 2x2 + 3x - 4
As the function is polynomial it is continuous in between 0 and 1.

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f (0) = 2(0)2 + 3 (0) - 4 = -4, f (1) = 2+3 - 4 = 1

The value of this function has different signs at x= 0 and x = 1 which implies that there is
at least one solution for the equation in between 0 and 1.
3. Show that the equation x 2  1  3x has at least one solution in between 0 and 1.
Solution
Initially change the equation in to polynomial function by squaring both sides as
( x 2  1) 2  (3x) 2
x 2  1  9x 2
 8x 2  1  0
Therefore, f ( x)  8x  1
2
As the function is a polynomial function, it is continuous in between 0 and 1.

f (0) = 1 and f (1) = - 8 (1)2 +1 = - 7
We have observed that f (0) and f (1) have different signs. As a result, the equation has
at least one solution in between 0 and 1.
B. Newton's Method
The intermediate value theorem does not provide information concerning the location at
which the solution resides. Rather it indicates the range in which the solution can be
found. Newton's method, however, leads to a better approximate solution of the equation
under consideration.
Given the function y = f(x) and assume f(x) = 0 at x = a, estimate a. To carry out this
activity, let us begin with an initial estimate x 0 of a. Constructing a tangent line which
passes through [ x0 , f ( x0 )] we get x1 near to a as shown in the following figure.

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Undertaking the same procedure we get the estimate x1 by drawing a tangent line
at [ x1 , f ( x1 )] . Continuing this process enables us to estimate the value of a. However, we
can also easily find the formula for x n derived by the Newton's method.
What is the equation of the tangent line which passes through [ x0 , f ( x0 )] and with slope
m? The slope of this line can be calculated as
y  y0 f ( x)  f ( x0 )
m= =
x  x0 x  x0
f ( x)  f ( x0 )
 m Using cross multiplication
( x  x0 )
f ( x)  f ( x0 ) = m ( x  x0 ) , m represents the slope of the function at x  x0
f ( x)  f ( x0 ) = f ( x0 )( x  x0 )
When x  x1 , f ( x)  0 (for the tangent line passing through [ x0 , f ( x0 )]
Therefore, 0  f ( x0 ) = f ( x0 )( x1  x0 )
Rearranging this equation gives as
 f ( x0 )
= ( x1  x0 )
f ( x0 )
f ( x0 )
This implies that x1  x0 
f ( x0 )
f ( x1 ) f ( x2 )
Similarly x2  x1  , x3  x 2 
f ( x1 ) f ( x2 )
In general the points generated by the Newton method are obtained by
f ( xn )
xn1  xn 
f ( xn )
Example
1. Find the approximate values of the equation f ( x)  x 6  3x 2  2 x  1 in the interval
[0, 1] using the Newton's method once.
Solution
In this case n = 0, and x 0 = 1
f ( x0 )
We know that x1  x0 
f ( x0 )
f ( x0 ) = f (1) = 1+3 -2- 1 = 4-3 =1

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f ( x0 ) = 6x 5 + 6x - 2  f ( x0 ) = f (1) = 6+6 -2 = 10
1
Therefore, x1  1   0.9
10
If we check for f ( x1 ) = f (0.9)
6 2
= (0.9) + 3 (0.9) - 2(0.9) -1
= 0.53441 + 2.43 - 1.8 -1
f (0.9) = 0.161441
Applying Newton's method twice
f ( x1 )
x 2 = x1 -
f ( x1 )
f (0.9)
= 0.9 -
f (0.9)
0.161441
= 0.9 -
6.94294
x2  0.877
Thus, f (0.877) = (0.877)6+ 3(0.877) 2 - 2 (0.877) - 1
= 0.0084 which is more approximate to zero.
2. Determine the approximate value of the equation x 2  1  3x in the interval [0, 1]

using Newton's method once.
Solution
Squaring both sides of the equation gives us f (x) = - 8x2 + 1. In this case also n = 0,
x0  1
f ( x0 )
x1  x0 
f ( x0 )
f ( x0 ) = (1) 2 (-8) + 1 = - 7
f ( x0 ) = f (1) = - 16 (1) = -16
Therefore
(7)
x1  1 
(16)
= 1- 0.4375
x1 = 0.5625  0.56
If we check the original function at this value of x, we get f (0.56)  8(0.56)2 +1

= - 2.5088 +1
f (0.56) = - 1.5088

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Applying the Newton method twice gives us

f ( x1 )
x2  x1 
f ( x1 )
f (0.56)
x2  0.56 
f (0.56)
(1.5088)
x2  0.56   0.392
(8.96)
Then f (0.392)  8(0.392) 2  1  0.2293 which is more approximate to the solution
than the earlier value. This shows that we can determine the most approximate value of
the solution by applying this procedure continuously.
2.3 Multivariate Calculus

Some functions involve one dependent and more than one independent variable. These
functions are said to be multivariate functions. For example, the production function Q =
f (K, L) has one dependent and two independent variables, labor L and capital K.
2.3.1 Partial Derivatives
Partial differentiation is a technique of deriving the rate of change of the function with
respect to change in one of the independent variable when all other variables in the
function are held constant. Thus, if the production function Q = f (K, L) is differentiated
with respect to L, with K being constant, we obtain the rate of change of total product
with respect to labor, i.e., Marginal product of labor ( MPL ) .
Partial differentiation follows the normal rules of differentiation apart from the fact that
all variables other than the one the function is being differentiated with respect to are
assumed to be constant.
Given the function, y  f ( x1 , x2 ) the usual notation for the partial derivative of the
function with respect to x1 is
y y
= f x1 and that of with respect to x 2 is = f x2
x1 x 2
Example
1. If the function is given by y  4 x12 x23  6 x12 x2  x14  7 x23 , find f x1 and f x2 .
f x1  8x1 x23  12 x1 x2  4 x13 ( x 2 is assumed to be constant)

f x  12 x12 x22  6 x12  21x22 ( x1 is assumed to be constant )
2

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Economic Applications
Partial differentiation is frequently applied in economic analysis as the economy is a

complex system to understand. Economists usually observe the effect of changes in one
variable supposing all other variables constant.
A. Elasticity
As we know quantity demanded for a product depends on various factors such as price of
the good , ( p) consumer's income ( y ) , price of related goods, and population ( n) .
Qdd  f ( p, y, pc , ps , n) where p c is price of complement.
p s is price of substitutes.
And we also know that price elasticity of demand E p is
dQ p
Ep = ( )
dp Q
But with the existence of these determinants in the demand function
Q P
Ep  ( )
P Q
Example
Given the demand function as Q  35  0.4P  0.15 y  0.25Pc  0.12P s 0.003n , what is
the price elasticity of demand when price is 24?
Q P Q
Ep  ( ) , you are required to get .
P Q p
Q
 - 0.4 (all factors other than the price of the product are constant)
P
(0.4)(24)
Ep 
35  0.4(24)  0.15 y  0.25Pc  0.12 Ps  0.003n
(9.6)
Thus, Ep 
25.4  0.15 y  0.25Pc  0.12 Ps  0.003n
The exact price elasticity of demand can be calculated if the values of the remaining
variables are given.
B. Utility Functions
According to the cardinality approach the consumer who consumes only two products A
and B will have the utility function
U  U ( A, B)
We can determine the marginal utility of each good from this function using the
technique of partial differentiation.
Example
If the utility function of the consumer is given by U  2 A0.4 B 0.4 , where A and B
represent the quantity of the two goods consumed; find marginal utility of each good.

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MUA = 2(0.4)0.4
A-0.6 B0.4
0.8B
=
A0.6
MUB = 0.4(2)0.4A0.4 B- 0.6

0.8 A
=
B 0.6
As the consumption of good A increases, MUA decrease and as the consumption of B
increases MUB decreases. As a result the law of diminishing marginal utility holds for
both goods.
C) Production Function
When the firm produces a product using two or more variable inputs, then we can
determine the rate of change of total product with respect the change in each input using
the method of partial differentiation.
Example
If the production function for a product is given by Q = 20K 0.5 L 0.5 where K is capital
and L is labor, Find the marginal Product of each input.
Marginal product of labor (MPL) = 0.5 (20) K0.5 L-0.5
10 K 0.5
MPL 
L0.5
Marginal Product of capital (MPK) = 0.5 (20) K 0.5 L 0.5

10 L0.5
MPK 
K 0.5
Is the law of diminishing marginal productivity is satisfied for each input? Why
D) Revenue and Cost Functions
It is clear that in some cases firms may produce different products. If they use common
production facilities, the costs of each product will be related. Therefore, the marginal
cost function of the individual product can be determined by the method of partial
differentiation.
Example
A firm produces two products Q1 and Q2 and its total cost function is
C (Q1 , Q2 )  20(Q1  Q2 ) , what are the relevant marginal cost functions?
C = 20Q1 + 20Q 2
C
Thus, Marginal cost of Q1 =
Q1
MC 1 = 20
Marginal cost of Q2 (MC2) = 20
In other cases, the firm may produce different products which are complementary with
each other. This means, the price of one good will affect the quantity demanded of the

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other good. Thus, the marginal revenue of one good is the partial derivative of total
revenue with respect to that good assuming the price of the other good constant.
Example
Suppose a firm produces two products A and B which are complements. The relevant
demand functions are
Q A  850  12.5PA  3.8PB
QB  936  4.8PA  24 PB
What are the marginal revenue functions of the two goods?
Marginal revenue is usually expressed in terms of quantity. Thus, we should initially

rewrite the demand functions in the form of price in terms of quantity.
For good A,
Q A  850  12.5PA  3.8PB
12.5PA  850  3.8PB  Q A
850  3.8PB  Q A
PA 
12.5
PA  68  0.304 PB  0.08Q A
However, TRA  PAQA  68QA  0.304PB QA  0.08QA2
Therefore, the marginal revenue of product A is

TRA
MR A 
Q A
MR A  68  0.304 PB  0.16Q A
For good B,
QB  936  4.8PA  24 PB
24 PB  936  4.8PA  QB
936  4.8PA  QB
PB 
24
Q
PB  39  0.2 PA  B
24
Q B2
However, TR B = P B Q B = 39 Q B - 0.2 P A Q B -
24
TRB
MR B =
QB
1
MRB  39  0.2 PA  QB
12

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The marginal revenue functions of the above two goods show that when the demand for
the two goods are interrelated, the marginal revenue function for one good will depend on
the price level of the other good.
E) Keynesian Multiplier
If we incorporate the government sector and foreign trade, the basic Keynesian
macroeconomic model will be
Y= C+ I + G+ (X -M)
and the functional relationship with consumption is
C = c Yd
Where c is the marginal Propensity to consume, and imports
M = m Yd
Where m is marginal propensity to import,
Y d = (1-t) Y
is the disposable income c, m and t are parameters and Investment I, Government
expenditure G and export X are exogenously determined.
Therefore Y = c Y d + I + G + [X- (m Y d )]
Y = c (1-t) Y + I+ G+ X- m (1-t) Y
Y - c ( 1-t) Y + m ( 1-t) Y = I+ G+X
Y [1-c (1-t) + m (1-t)] = I+ G+ X
I G X I G X
Y= =
1  c(1  t )  m(1  t ) 1  (c  m)(1  t )
Dear colleague! If we are interested to determine the government expenditure multiplier,

we should partially different income with respect to G, holding Investment L and export
X constant as shown below.
Y 1
=
G 1  (c  m)(1  t )
Y Y Y
However, = =
G X I
Example
In a Keynesian Macroeconomic model of an economy
Y = C+ I + G+(X-M) I = 820
C = 0.75 Y d G = 960
M = 0.25 Y d Y d = (1-t) Y
X = 650 t = 0.3
Determine the equilibrium level of national income. Using the export multiplier find out
what will happen to the balance of trade if export exogenously increases by 100.

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Initially, we should solve the relationship between income (Y) with consumption and
Import.
C= 0.75 Y d = 0.75 (1-t) Y = 0.75(1-0.3) Y
= 0.75 (0.7) Y
C = 0.525 Y
M = 0.25Y d = 0.25 (1- 0.3) Y
= 0.25 (0.7) Y
M = 0.175 Y
Therefore, the equilibrium level of national income is

Y = 0.525Y+ 820 + 960 + 650 - 0. 175Y
Y - 0.525Y + 0.175Y = 2430
0.65Y =2430
2430
Y= = 3,738.46
0.65
At this equilibrium level of income, import will be
M= 0.25 (0.7) (3,738.46)
M = 654.23
Thus, the balance of payment will be
X- M = 650 - 654.23
= -4.23 which is negative trade balance.
However, as export increases by 100, then the equilibrium level of income will be
increased by change in export times export multiplier, i.e.,
Y 1
Y  X = 100 [ ]
X 1  (c  m)(1  t )
1
=100[ ]
1  (0.75  0.25)(1  0.3)
1
=100 [ ]
1  (0.5)(0.7)
1
= 100 [ ]
0.65
Y  153.85
As a result, equilibrium level of income increases from 3,738.46 to 3,892.31 when export
increases from 650 to 750. At this new level of equilibrium income, import will be
M = 0.175 (3,892.31)
M = 681.15
And the new balance of trade will be
X - M = 750 - 681.15
= 68.85
Therefore, the balance of trade changes from 4.23 deficits to 68.85 surpluses when
export exogenously increases by 100.

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2.3.2 Second Partials and Young’s Theorem
As you know, if the first order partial derivatives of the function are continuous and
differentiable, differentiating these functions will result in second order partial
derivatives. Given the function Z=ƒ(x, y), if it is differentiable, it has two first order
Z Z
partial derivatives such as Zx= and Zy = . In addition to these, this function has
x y
four second order partial derivatives (direct and cross partial derivatives). These are
2Z
Z xx =
x 2
2Z
Z yy =
y 2
These two derivatives are referred to as direct second order partial derivatives where a as
z Z
Z xy = y and Z yx = x are said to be second order cross partial
x y
derivatives. According to the young's theorem, the mixed (cross) partial derivatives for a
given function are always equal if both cross partials exist and they are continuous. This
means
Z y Z x
Z xy  Z yx = 
x y
Example
1. Given the demand function for the two commodities Q1 and Q2
Q1  P11.7 P20.8 And Q2  P10.5 P20.2
Find the first and second order partial derivatives of the function and determine whether
the two goods are complementary or substitute. Show that whether young's theorem is
satisfied or not.
Q1 Q2
 1.7 P1 2.7 P20.8  0.5 P1 0.5 P2 0.2
P1 p1
Q1 Q2
 0.8 P11.7 P20.2  0.2 P10.5 P21.2
P2 p2
From these first order partial derivatives we have observed that an increase in the price
of commodity Q1 results in an increase in the quantity demanded of commodity Q2.
Therefore, Q1 and Q2 are substitute goods.
The second order direct partial derivatives are

 2 Q1
 (1.7)(2.7) P13.7 P20.8
P1 2
= 4.59 P13.7 P20.8

 2Q2
= 0.24 P 10.5 P 22.2
P22

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The second cross partial derivatives are

(Q1 P1 )
= (0.8) (-1.7) P 12.7 P 20.2
P2
=  1.36P12.7 P20.2 ------------------------------- (a)
Q1
 ( )
P2
 (1.7)(0.8) P12.7 P20.2
P1
=  1.36P12.7 P20.2 --------------------------------- (b)
(Q2 P 2 )
= (- 0.2) (0.5) P10.5 P21.2
P1
= - 0.1 P10.5 P21.2 ----------------------------------(c)
(Q2 p1 )
= (-0.2) (0.5) P 10.5 p 21.2
P2
= - 0.1 P10.5 P21.2 ----------------------------------- (d)
Equation a is equal to that of b and equation c is equal to equation d. It indicates that the
Young’s theorem is satisfied.
2. Given the production function Q= 6K+ 0.3 K2L + 1.2L2 derive the four second order
partial derivatives and interpret their meaning.
The two first order partial derivatives are

Q Q
= 6+ 0.6 KL and = 0.3 K2 + 2.4 L
K L
They represent the marginal product function of the two inputs.
The four second order partial derivatives are

 2Q
i)  0.6 L
K 2
This represents the rate of change of marginal product of capital function with respect to
capital. It indicates that marginal productivity of capital increases as labor increases.
 2Q
ii)  2.4
L2
It represents the slope of marginal product of labor function which is independent of
capital.
 2Q
iii)  0.6 K
LK
This tells us that MP L increases if K is increased, for any given value of L.
 2Q
iv)  0.6 K
LK
This tells us that MP K increases if L is increased, for any given value of L.

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2.3.3 Multivariate Chain Rule
As we know many economic models involve composite functions. Thus differentiation of

such functions requires the application of chain rule.
Chain rule for functions of one variable

dy dy dx
Given y = f(x) and x= g (t), then 
dt dx dt
Chain rule for multivariate function

Suppose z= ƒ (x, y), x = ƒ (t) and y = ƒ (t), in this case we should use the total derivative.
dz z dx z dy
 ( ) ( )
dt x dt y dt
Given the function y = ƒ (x, w) and x  g (w) to get this total derivative, let us initially
determine the total differential dy  f x dx  f w dw . If we divide both sides of this equation
by dw , we obtain
dy dx dw
 fx  fw
dw dw dw
dy dx
 fx  fw
dw dw
dx
fx Measures the indirect effect of w on y and, f w shows the direct effect of w on y.
dw
Example
1. Suppose that the relationship between revenue R, output Q produced and sold each
week is given by
R = 400Q - Q2
In addition, suppose that Q is a function of t, i.e. time period, Q = ƒ(t)
dR dR dQ

Thus dt dQ dt
dQ
 (400  2Q)
dt
When Q = 30 and that the Management is considering to increase production by five
units per week,

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 400  2(30)5
dR
dt
 (400  60)5
dR
 (340)5  1700
dt
Interpretation
The management decision to increase production by five units per week increases total
revenue by 1,700 units
2. Given the utility function U = x2+ x y + y2, x = t3 + 1 and y = t - t3

du u dx u dy
 ( ) ( )
dt x dt y dt
= (2x+y) (3t ) + (y+ 2y) (1-3 t2)
2
2.3.4 Homogenous Functions and Euler's Theorem
A function y  f ( x1 , x2 ,....xn ) is referred to as homogenous of degree r if and

only if
f (tx1 , tx 2 ,....., tx n )  t r f ( x1 , x x ,..., xn ) , where t is any parameter.
Multiplying all the independent variables by a factor t will multiply the value of the
function by the factor t  .
Example
1. If ƒ(x, y) = 3x 3  5x 2 y  2 y 3 , then
ƒ (t x, t y) = 3 (t3 x)3 3+ 52(t2x)2(t y3) + 2(t y )3
= 3t x  5t x y  2t y
3
 3t 3 x 3  5t 3 x 2 y  2t 3 y 3
 t 3 (3x3  5x 2 y  2 y3 )
Therefore, the function is homogenous of degree 3.
2. Consider the Cobb- Douglas production function

Q  bL K 1

lOMoARcPSD|40326715
f ( Lt, kt)  b( Lt ) (kt)1

 b t  L k 1 t1
 b t  1 L k 1
 b t L k 1
 t b L k 1
Thus, the production function is homogenous of degree 1.
Given the function f ( tx1 , tx 2, tx3, ... , tx n )  t  f ( x1 x2 , x3, ....xn )
If r = 1, a function exhibits constant returns to scale
If r > 1, a function exhibits increasing returns to scale
If r < 1, a function exhibits decreasing rectums to scale
Euler's Theorem 1
If the function y = f ( x1 , x2 , x3 ) is homogenous of degree r, then according to the Euler's
theorem
f f f
x1 + x2 + x3 = rf ( x1 , x2 , x3 )
x1 x 2 x3
Example
Find the degree of homogeneity of the function
f ( x, y)  x 4  x 2 y 2 Using Euler's theorem
f x x  f y y  r(x 4  x 2 y 2 )
(4 x 3  2 xy 2 ) x  (2 x 2 y) y  r ( x 4  x 2 y 2 )
= 4x 4  2x 2 y 2  2x 2 y 2
= 4x  4x y
4 2 2
= 4( x 4  x 2 y 2 )
Thus, the function is homogenous of degree 4.
Euler's Theorem 2
If a function y  f ( x1 , x2 ,....xn ) is homogenous of degree r, then according to this

theorem the first partials f x1 , f x2 , f x3 are homogenous of degree (r  1) .
Example
1. Given the function f ( x, y)  x 4  x 2 y 2 ,
f  4 x 3  2 xy 2 , f y  2 x y
2
x
f x (tx, ty )  4(tx ) 3  2(tx )(ty ) 2

= 4t 3 x 3  2t 3 xy 2
= t 3 (4 x 3  2 xy 2 )
Thus, the function f x is homogenous of degree 3.
f y (tx, ty )  2(tx ) 2 (ty )
= 2t 2 x 2 ty

lOMoARcPSD|40326715
= 2t 3 x 2 y  t 3 (2 x 2 y)
This means, f y is homogenous of degree 3.
2. Given the Cobb - Douglas production function

3 1
f (L, K) = 60 L 4 K 4
Find the degree of homogeneity of f L and f k using Euler's theorem.
The first partial derivatives are
3 1 1 1 3 3
f L = 60 ( ) L 4 K 4 f k = (60) L 4 K 4
4 4
1
3
4 4
45 K 15 L
fL = 1
fK = 3
4 4
L K
1 1
Thus, f L (tL, tK )  45(tL ) 4 (tK ) 4
1 1 1 1
4 4 4 4
= 45L t K t
1 1 1 1
(  )
4 4
= 45(t ) L4 K 4
1 1
0 4 4
= t (45L K )
3 3
And f K (tL, tK )  15(tL ) (tK ) 4 4
3 3 3 3
4 4 4 4
= 15L t K t
3 3 3 /3
(  )
4 4
= 15(t ) L4 K 4
3 3
0 4 4
= t (15L K )
What we have seen from this is both of f L and f k is homogenous of degree 0. In other
words, the original Cobb-Douglas production is homogenous of degree 1.
2.3.5. Total Differential and Implicit Differentiation
Given the function y = f(x), the differential is dy  f ( x)dx .The concept of differential
can be extended to functions with two or more independent variables.
Given the utility function, U  f ( x1 , x2 ) , assuming that U is continuous and

differentiable
U
U x1  = Marginal utility of x1
x1
U
U x2  = Marginal utility of x 2
x 2

lOMoARcPSD|40326715
U
Change in U which is resulted from small change in x1 is dx1 and from small change
x1
in x 2 is .
Thus the total change in utility is
If the two variables x and y are related by the implicit function

, the total differential of the function is
If we rearrange this equation, we get
As you remember in your microeconomic studies, the theory of

production states that the slope of the isoquant represents the marginal rate of technical
substitution (MRTS) between two inputs. In this case, the use of total differential can
help us to show the reality that MRTS between the two inputs is equal to the ratio of the
marginal products of the two inputs. If the producer use capital (K) and labor (L) in the
production process,
Given the production function , the total differential is
=
Once the isoquant is determined, there is no change in output along the same isoquant.
This means change in Q is zero. Therefore,
MRTS =

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Mathematical Economics(Econ2051) 2019/20

1.1 Basic Concepts from Calculus

1.1.1 Differential Calculus - Differentiation

1.Constant function Rule

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2.Linear function Rule

Example If ƒ (x) = 3x + 5, then ƒ' (x) = 3

3.Power function rule

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= 1.6x + 3.2 - 60x 2 - 1.6

If we multiply the original function, we get

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2. If a monopoly faces a non- linear demand function

To differentiate y with respect to x, we use chain rule which states that

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i) Thus, using the chain rule

Where TR is total revenue and TC L is total cost of labor.

Thus, first we need TR, given P = 200 - 2q

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MRPL = 400 – 32L 0.5

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10. Logarithm and Exponential Function Rules

Log648 = 2. In general, if y = a x , then log y a = x where a >0 and a  1

Natural logarithmic function rule

Logarithmic function of base a

Natural exponential function rule

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Exponential Function Rule for Base a

dy  f ( x)dx It is the differential.

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ƒ (2) = 5(2 3 ) + 2(2 2 ) +2

from small change in x2 is u dx 2

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Example Find the total differential, given

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E p = Proportionate change in quantity demanded