Total Differentation

EC115 - Methods of Economic Analysis
Spring Term, Lecture 6

Total Dierentiation
Renshaw - Chapter 15
University of Essex - Department of Economics
Week 21
Domenico Tabasso (University of Essex - Department of Economics) Lecture 6 - Spring Term Week 21 1 / 29
Introduction
Suppose z = f (x
1
, x
2
, ..., x
n
) (a function with more
than one variable).
We use partial dierentiation when we want to analyze
how z changes when we change one of the independent
variables holding the others constant.
This technique is useful in economics as it helps us to
understand economic concepts such as:
the marginal utility from consuming a good; and
the marginal product from using an input,

It also turns out to be useful when we are dealing with
maximization and minimization problems.
In particular, it enables us to formulate:
rst order conditions (using rst order partial derivatives), and
second order conditions (using second order own and cross partial
derivatives),
which we can use to solve such problems.
Total Dierentiation
Total dierentiation builds on this concept but gives a
measure of the change in z(= f (x
1
, x
2
, ..., x
n
)) when all
the variables x
1
, x
2
, ..., x
n
change at the same time.
This concept is useful in economics as it allows us to
analyze things like:
returns to scale in production;
direct and indirect eects an independent variable might have on z; and
the marginal rate of substitution (in consumption) and marginal rate of

technical substitution (in production).
Generalising the concept of the slope of a surface
Consider any function z = f (x, y) and suppose we are
at some initial position P = (x
0
, y
0
, z
0
) on its surface.
From our analysis on partial derivatives we know that if
we increase y from y
0
to y
1
, such that dy = y
1
y
0
,
but hold x constant at x = x
0
then the change in z can
be approximated by the slope of the tangent at P in
the (y, z) plane multiplied by the change in y.
This comes from the following mathematical relation:
lim
dy0
dz
dy
=
f (x
0
, y
0
)
y
.
By re-arranging that expression we can obtain an
approximate of the change in z that occurs when y
changes holding constant x:
dz
y
=
f (x
0
, y
0
)
y
dy.
Similarly if we increased x from x
0
to x
1
, such that
dx = x
1
x
0
, while keeping y constant then the change
in z can be approximated by the slope of the tangent at
P in the (x, z) plane. This comes from:
lim
dx0
dz
dx
=
f (x
0
, y
0
)
x
.
Again, by re-arranging this expression we can obtain an
approximate of the change in z that occurs when x
changes holding constant y:
dz
x
=
f (x
0
, y
0
)
x
dx.
The terms dz
x
and dz
y
are called partial dierentials.
Partial Dierentials
dz
y
=
f (x
0
, y
0
)
y
dy
dz
x
=
f (x
0
, y
0
)
x
dx
Now consider the eect of simultaneous changes in x
and y. Namely, let x and y change by dx and dy,
respectively.
The resulting total change in z would be given by:
z
1
z
0
= f (x
0
+ dx, y
0
+ dy) f (x
0
, y
0
).
For any function z = f (x, y), if x and y change by a
small amount then the resulting change in z can be
approximated by the sum of the partial
dierentials:
dz = dz
x
+ dz
y
=
f (x
0
, y
0
)
x
dx +
f (x
0
, y
0
)
y
dy.
We call dz the total dierential.
If the surface of z = f (x, y) is a plane, i.e.
z = a + bx + cy, then this approximation is exact since
z
x
= b and
z
y
= c.
However, if the surface of z = f (x, y) is not a plane
then there will be some error in the approximation.
Example 1
Find the total dierential for each of the following
functions:
z = x
2
+ xy + y
2
1
Solution dz = (2x + y)dx + (2y + x)dy
z = x
1/4
y
1/2
Solution dz =
_
1
4
x
3/4
y
1/2
_
dx +
_
1
2
x
1/4
y
1/2
_
dy
z = (x
2
+ y
3
)
1/2
Solution dz = (1/2)(x
2
+ y
3
)
1/2
(2xdx + 3y
2
dy)
If z = x
2
+ y
2
, suppose x increases from 5 to 5.1 and y
increases from 10 to 10.1. What error occurs when we
use the total dierential, dz, of the function to
calculate the resulting change in z?
Computing the variation directly we get z = 3.02.
Using the total dierential we get:
dz = 2x dx + 2y dy
=dz = 2(5)(0.1) + 2(10)(0.1) = 3
Thus z dz = 0.01 which is an error of one third of
one percent.
Dierentiating a function of a function
Up to this point we have considered cases in which the
changes in x and y are independent. That is, a change
in x does not aect the value of y (and vice versa).
However, in economics there are many applications in
which a change in x does aect the value of y.
For example, consider the case of a prot maximizing
monopolist that faces the following inverse market
demand function:
p = D(q),
where p and q denote the price and quantity of the
good produced by the monopolist.
Let TR(p, q) = pq denote the total revenue of the
monopolist.
The total change in revenue when both the price and
quantity increase is given by
dTR =
TR(p, q)
q
dq +
TR(p, q)
p
dp.
The inverse demand tells us that if the quantity
produced increases, consumers will not be willing to pay
the same price as before. Price must decrease by:
dp
dq
=
dD(q)
dq
.
This implies that changes in q are not independent
from changes in p.
We must take this into account when analyzing the
change in total revenues.
To do this we can use the total dierential:
dTR =
TR(p, q)
q
dq +
TR(p, q)
p
dp
From this we obtain:
dTR
dq
=
TR(p, q)
q
dq
dq
+
TR(p, q)
p
dp
dq
But
dq
dq
= 1 so:
dTR
dq
=
TR(p, q)
q
+
TR(p, q)
p
dp
dq
.
In addition since TR = pq then
TR(p,q)
q
= p and
TR(p,q)
p
= q.
Therefore:
dTR
dq
= p(q) + q
dp(q)
dq
= MR(q),
where MR(q) equals marginal revenue function which
tells us total revenue when quantity changes.
For a monopolist this can be decomposed into two
eects:
Direct eect = When she sells more she gets revenue

from the added output she sells. The direct eect is given by:
TR(p, q)
q
dq
dq
= p(q)
Indirect eect = But selling more lowers the price so she

loses revenue on the output she was already selling. The
indirect eect is given by:
TR(p, q)
p
dp
dq
= q
dp(q)
dq
Moreover, the trade-o faced by the monopolist is
aected by the elasticity of the market demand.
The price elasticity of demand shows the percentage
change in quantity demanded over the percentage
change in price:
p
=
_
dq
q
_
/
_
dp
p
_
=
dq
dp
p
q
< 0.
We can use the inverse of the price elasticity to re-write
the marginal revenue:
MR(q) = p(q) +
p(q)
p
(p)
= p(q)
_
1 +
1
p
_
Chain Rule
We sometimes encounter functions that are interrelated
in the following way:
z = f (y, r ) where y = g(x) and r = h(x).
In these cases, we can obtain the change in z when x
changes by applying a similar logic as before:
dz =
f (y, r )
y
dy +
f (y, r )
r
dr
dz
dx
=
f (y, r )
y
dg(x)
dx
+
f (y, r )
r
dh(x)
dx
,
Example 2
Use the dierential dz to nd the total derivative
dz
dx
, of the
following functions:
z = x
3
+ y
2
, where y = x
2
Solution
dz
dx
=
z
x
dx
dx
+
z
y
dy
dx
=
3x
2
+2y 2x = 3x
2
+ 4x
3
z = uv where u = 3x + 2 and v = 3x
2
Solution
dz
dx
=
z
u
du
dx
+
z
v
dv
dx
=
v 3 +u 6x = 9x
2
+ (3x + 2)6x
Example 2
Use the dierential dz to nd the total derivative
dz
dx
, of the
following functions:
z = x
3
+ y
2
, where y = x
2
Solution
dz
dx
=
z
x
dx
dx
+
z
y
dy
dx
=
3x
2
+2y 2x = 3x
2
+ 4x
3
z = uv where u = 3x + 2 and v = 3x
2
Solution
dz
dx
=
z
u
du
dx
+
z
v
dv
dx
=
v 3 +u 6x = 9x
2
+ (3x + 2)6x
Implicit Function Theorem
Note that the functions that we have been studying are
given by:
z = f (x
1
, x
2
, ..., x
n
),
where z is the dependent variable and x
1
, ..., x
n
are the
independent variables. In this case, we say that z is an
explicit function of the independent variables.
However, we might encounter cases in which z is given
as an implicit function of the dependent variables
dened by an equation of the form:
G(x
1
, x
2
, ..., x
n
, z) = 0.
For example, the equation:
2x + y 5 = 0
gives us y as an implicit function of x.
This equation can be easily re-written in an explicit
format as:
y = 5 2x
Another example is:
y
5
5xy + 4x
2
= 0
The rst equation can be easily solved to give y as an
explicit function of x. However, it is not possible to do
the same with the last equation.
2x + y 5 = 0
format as:
y = 5 2x
Another example is:
y
5
5xy + 4x
2
= 0
2x + y 5 = 0
format as:
y = 5 2x
Another example is:
y
5
5xy + 4x
2
= 0
2x + y 5 = 0
format as:
y = 5 2x
Another example is:
y
5
5xy + 4x
2
= 0
Even if we cannot make a function explicit, we still
would like to know its properties. In particular, we
would like to know if:
1
a function y = f (x) can be obtained from its implicit form
G(x, y) = 0, at least around some point (x
0
, y
0
)
2
if the function f (x) is dierentiable at x = x
0
.
The implicit function theorem gives conditions that
guarantee a positive answer to these questions
Consider the implicit function G(x, y) = 0 and dene a
new variable z such that:
z = G(x, y) or G(x, y) z = 0.
We can now apply total dierentiation to this function
and obtain:
dz =
G
x
dx +
G
y
dy
We then set dz = 0 to reect the fact that z is a
constant and equal to zero when the given equation is
satised. This gives:
0 =
G
x
dx +
G
y
dy
By rearranging the terms we get:
dy
dx
=
_
G
x
_
/
_
G
y
_
The implicit function theorem says that if G/y = 0,
at least around (x
0
, y
0
), there exists a continuous and
dierentiable function y = f (x) around the point
(x
0
, y
0
) such that y
0
= f (x
0
).
Application: Indierence Curves
For any utility function u = U(x, y), we have that
u
0
= U(x, y) along the indierence curve since the
indierence curve is the set of all combinations of x, y
that give the same utility.
Note that by dening u
0
= U(x, y) we are dening an
implicit function between x and y. Hence along the
indierence curve:
du
0
=
U(x, y)
x
dx +
U(x, y)
y
dy = 0.
The implicit function theorem then tells us that if
U/y = 0 for all (x, y), there exists a function
y = f (x) that is continuous and dierentiable such that
for all points (x, f (x)) we obtain the same level of
utility u
0
and the rst derivative of this function is:
dy
dx
=
_
U(x, y)
x
_
/
_
U(x, y)
y
_
.
If the implicit function theorem holds, we are
guaranteed that our utility function have well dened
indierence curves and that the slope of these curves
describe the marginal rate of substitution between x
and y.
Furthermore, by applying total dierentiation once
again to the above expression, we can obtain conclusion
with respect to:
d
2
y
dx
2
=
1
U
3
y
_
U
2
y
U
xx
2U
x
U
y
U
xy
+ U
2
x
U
yy
U
y
, U
x
describe the rst order partial derivatives.
U
xx
, U
yy
and U
xy
describe the second order partial and
cross partial derivatives.
What conditions guarantee that the indierence curves
of U(x, y) are decreasing and convex? [dicult]
Example: the Cobb-Douglas
Consider the Cobb-Douglas utility function
U(x, y) = x
0.5
y
0.5
.
We have that for any utility level u
0
= U(x, y) > 0 the
indierence curve is given by:
y =
_
u
0
x
0.5
_
1/0.5
=
u
2
0
x
.
We can obtain the change in y given a change in x
along the indierence curve:
dy
dx
u=u
0
= MRS
x,y
=
_
u
0
x
_
2
< 0,
d
2
y
dx
2
u=u
0
= 2
u
2
0
x
3
> 0.

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EC115 - Methods of Economic Analysis

Spring Term, Lecture 6

the marginal utility from consuming a good; and

the marginal product from using an input,

rst order conditions (using rst order partial derivatives), and

returns to scale in production;

direct and indirect eects an independent variable might have on z; and

the marginal rate of substitution (in consumption) and marginal rate of

Direct eect = When she sells more she gets revenue

Indirect eect = But selling more lowers the price so she

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