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Intermediate Microeconomics
Algebra Review
This course does not require any calculus or high level mathematical techniques.
However, a comprehensive understanding of basic, elementary algebra and
complementary graphs is required. Although most of the mathematics used in this course
will have been covered in highschool (grades 9, 10 and 11), it is important that you take
this review and preparation of algebra seriously. Many students never fully understand
the models used in economics simply because they lack a full understanding of the
simple mathematics underlying them. If you havent recently taken a course with a
substantial amount of algebra in it, you may have forgotten some of the basics.
So check out this algebra review. Do the Pre-Test to determine your current
level of understanding of relevant algebra and graphs. If it isnt completely solid spend
some time on the learning modules. Then re-do the Pre-Test. If you are still having
some difficulty with the material you should get a textbook on elementary algebra or
perhaps an appropriate Schaums Outlines on Elementary Algebra and spend some time
becoming comfortable with the required mathematics. A review of relevant arithmetic
and algebra is also provided in the book Mathematics for Economics Students
Solutions Manual, by M. Hoy, J. Livernois, C. McKenna, R. Rees, and T. Stengos,
Addison Wesley Publishers, 1996, Chapter 1 Algebra and Arithmetic Reviews and
Self-tests (pages 1 to 26).
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Fall 2001
Algebra Pre-Test
You should be able to solve these problems correctly within a couple of hours or
so. If you dont obtain correct solutions for most of these, you definitely should work
through the Learning Modules which follow, where complete solutions to questions from
this Pre-Test are worked out. The re-do the Pre-Test. If you still arent performing at a
high level, then you should do some more review using one or more of the sources listed
above.
1.
2.
3.
Simplify (24)(23)/(22).
4.
5.
Simplify (161/2)(161/4).
6.
Simplify 161/2/161/4
7.
8.
9.
.2k
. Solve for k.
(x y)(x y) (2x 1) (x
y )(y 2xy x
x)
to obtain
3x (x
10.
y )
Show how to obtain the following expression by simplification of the left side.
1
x y
x y x y x y
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Fall 2001
11.
Draw the graph of the function q=25-2p, placing q on the horizontal axis and p on
the vertical axis.
12.
Draw the graph of the function q=-5+p, placing q on the horizontal axis and p on
the vertical axis.
13.
Let Q=aL, a>0 a parameter, be a function representing the total product of labour.
Sketch this graph and illustrate the fact that a given increase in L (labour) always
leads to the same increase in Q (output) regardless of the initial level of L.
14.
Sketch the graph for the function Q=10L1/2. Indicate the values of Q at L=1, L=4,
L=9 and illustrate the fact that increasing L has a lesser impact on increasing Q the
greater is the level of L.
15.
Sketch the graph for the function Q=L2. Indicate the values of Q at L=1, L=4,
L=9 and illustrate the fact that increasing L has a greater impact on increasing Q
the greater is the level of L.
16.
Draw the function for the equality 4x1 + x2 = 120, with x2 on the vertical axis and
x1 on the horizontal axis. Restrict x1 and x2 to be non-negative (i.e., x1 0 and x2
0). Shade in those points which satisfy the inequality 4x1 + x2 120.
17.
Find the partial equilibrium solution (demand = supply) for the following:
demand:
q = 25 - 2p
supply:
q = -5 + p
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Fall 2001
Brief Solutions
1. 25
2. 3
3. 25 = 32
4. 4
5. 163/4 = 8
6. 161/4 = 2
7. k = 16. See Module 1: sections on Power Rules
8.
9.
10..
11.
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Fall 2001
12.
NOTE: for more discussion of solutions to questions 10 and 11 see Module 2: Linear
Functions and
Their Graphs
13.
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Fall 2001
14.
L
1
0
20
30
1
0
2.6
8
1.7
2
Q=10 L or
Q=10L1/2
We sketch
function,
L below
this
Q=10
15.
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Fall 2001
Q=L2
16
81
17
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Fall 2001
NOTE: For
details on
solutions for
s 12, 13 and
Module 3:
Nonlinear
ns and
Graphs.
more
the
question
14, see
Simple
Functio
Their
16. Rewrite
equation as
- 4x1 makes
to graph.
region that
be shaded in
ts the set of
which
the
y
4x1 + x2
the
x2 = 120
this easy
The
should
represen
points
satisfy
inequalit
120.
17.
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Fall 2001
NOTE: For more discussion of the solution to question 15 see Module 4: Functions and
Inequalities. For more discussion of the solution to question 16 see Module 5: Solving
Systems of Linear Equations.
Learning Modules
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Fall 2001
Note that these learning modules are not comprehensive reviews of the
mathematical topics addressed but rather are intended to be short reviews to help those
who have forgotten some of the basics that are essential to this course. When possible,
we use applications from economics that you have already learned in introductory
economics or ideas for which no economics background is required. If this review
material proves not to be sufficient for you, then you will need to take a more aggressive
approach to reviewing the mathematical background required for this course.
Module 1: Basic Arithmetic Operations, Including Powers
In this, and following modules, letters such as a, b, c, d, x, y, z are used to
represent real number values. Rules for manipulating expressions are generally given in
terms of unspecified numbers but we will usually provide specific examples with
specific numbers as well. These rules are used to manipulate and simplify or solve for
expressions.
Step 2
Fall 2001
If there are more than two terms to be added in one of the brackets then the associative
law continues to apply, just iteratively. Thus, (a+b)(c+d+e) = (a+b)((c+d)+e) =
(a+b)(c+d)+(a+b)e = ac+ad+bc+bd+ae+be = ac+ad+ae+bc+bd+be. In words, to expand
this expression multiply the first element in the left hand bracket (a) by each of the
elements in the right hand bracket (c,d,e), adding all the results together (ac+ad+ae), and
then do the same with the second element in the left hand bracket (b) to get (bc+bd+be),
and then add all terms together.
You can check the associative law with a specific numerical example, such as
(5+2)(6+8) = (56)+(58)+(26)+(28) = 30+40+12+16 = 98, noting that (5+2)(6+8) =
(7)(14) = 98.
Powers and Roots
There are several useful rules for simplifying expressions involving powers
(exponents) and roots. Although you would profit from a more thorough review of
powers (see Mathematics for Economics Students Solutions Manual, by Hoy, et al.,
pages 4 to 6) the following condensed review contains most of the operations you will
require.
The square of a number is obtained by multiplying the number by itself (e.g., the
square of 5 is just 55 = 25). The square root is the inverse operation - that is, finding
the square root of a number, z (often written z), is finding that number which, when
multiplied by itself, gives the result z (e.g., the square root of 9 is 3, written 9 = 3).
Since finding the square root of a number, z, is the inverse operation of finding the
square of a number, we also write z as z1/2. The rationale for this notation is that is
the inverse of the number 2. If we multiply a number by itself 3 times we indicate this as
zzz = z3 and refer to the result as the cube of z. So, for example, the cube of 4 is 64
and we can write 43 = 444 = 64. The number, which when multiplied by itself three
times gives the value of some original number, say y, is called the cube root of y. So, for
example, the cube root of 64 is 4. Since finding the cube root is the inverse operation of
finding the cube of a number we write the cube root of a number y as y1/3. Thus, we say
641/3 = 4.
The above operations of multiplying a number by itself two or three times can be
extended to any number of times, n, and so we use the notation zn to represent the result
of multiplying the number z by itself n times and y1/n represents the result of finding the
number which, when multiplied by itself n times will give the number y. That is:
zzz...zz = zn and y1/ny1/ny1/n...y1/n y1/n = y , where in each case there are n
multiplications.
The following rules of powers follow directly from these definitions:
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Fall 2001
This result is not generally noted explicitly as a rule for powers since it is really just a
restatement of the inverse operation of taking powers (e.g., the relationship between
finding the square of a number or the inverse operation of finding the square root of a
number). However, it is so useful it is included here explicitly.
Power Rule for Multiplication: (ya)(yb) = ya+b
For example, (25 )(22) = 25+2 = 27 since (22222)(22) gives the result of 2 being
multiplied by itself 7 times.
Power Rule for Division:
ya/yb = ya-b
production function, k the per capita capital stock, and is the capital depreciation rate. If
savings (addition to the capital stock as savings equals investment) equals depreciation (the
reduction in the capital stock) the net gain in capital is zero and we say the economy is in
a steady state (capital is unchanging).
Suppose the per capita production function is given by ak 1/2 . When savings equals
depreciation the steady state capital stock can be found by solving for k in the equation
sak 1/2
Using the power rule for division this equation can be rewritten as
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Fall 2001
k 1/2)
sa
Dividing both sides of the equation by the depreciation rate and using the power rule for
inversions (squaring both sides of the equation) yield the per capita steady state capital
stock
k
sa
Fall 2001
expand it. For example, to simplify (a+b)(a+b)-2ab expand (a+b)(a+b) to get (a+b)(a+b)
= a2 + ab + ba + b2 = a2 + 2ab +b2, since ba=ab by the commutative law. Thus, we obtain
(a+b)(a+b)-2ab = a2 + 2ab +b2 - 2ab = a2 + b2. To simplify expressions it is sometime
better not to expand every sub-expression and then collect terms but rather to artfully
combine factoring and expanding. For example, to simplify the expression
(x y)(x y)2(2x 1) (x 2 y 2)(y 2xy x 2 x)
note that x2-y2 = (x-y)(x+y) and so we can rewrite the above equation as
(x y)(x y)2(2x 1) (x y)(x y)(y 2xy x 2 x)
and so noting that (x-y)(x+y) represents a common factor in both sub-expressions we can
rewrite the equation as
(x y)(x y)[(x y)(2x 1) (y 2xy x 2 x)]
Expanding and collecting terms in for that part of the expression in square brackets, [ ],
gives
(x y)(x y)[2x 2 x 2xy y y 2xy x 2 x]
or
3x 2(x 2 y 2)
1
2
1
4
1
2
Fall 2001
2
4
!
1
2
and so we have
"
1
4
2
4
1
4
"
= (2 4 1) =
"
3
4
. Once one
takes into consideration more complicated expressions appearing in the denominator one
needs to be a bit more methodical about this. For example, consider the following
simplification:
Notice that to compute expressions such as the above first find the common
denominator by multiplying together the denominators of each fraction in the series
(278) and then for each fraction we multiply the numerator by the values of the
denominators of the other fractions. The rule is easiest to see when using fractions which
are ratios of variable names, such as the following:
a e (af) (eb) af eb
b f
bf
(bf)
So, you can use this simple rule to obtain simplifications of expressions such as
1
x y
x y x y x y
To see how to obtain this result note that the common denominator for this expression is
(x+y)(x-y) and so this expression can be expanded and then simplified as shown below.
1
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Fall 2001
Then just collect terms on the numerator and divide out the (x-y) part.
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Fall 2001
y b
m m
%
It is often useful to write linear equations in both direct form and inverse form in
order to easily find the intercept terms which are helpful in plotting the graph of the
function. For the case above, the y intercept (i.e., the value of y when x is zero) is b
while the x intercept (i.e., the value of x when y is zero) is -b/m. The term m represents
the slope of the linear function and the fact that this slope is the same regardless of the
choice of the value of x is the key property of a linear function. If m is a positive value
(m>0) that means the function has a positive slope while if m is a negative number (m<0)
that means the function has a negative slope. If m=0 then the value of y is the same
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Fall 2001
(y=b) for all values of x. Each of these cases is illustrated in the following graphs.
Note that in each case above we placed y on the vertical axis and x on the
horizontal axis. Although this is often the choice made any such choice is,
mathematically speaking, arbitrary.
In economics we consider the demand function as quantity demanded being a
function of price, and write q = f(p) (or qd = f(p), with the subscript d included sometimes
just to indicate that the quantity refers to demand and not supply). Thus, one might
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Fall 2001
expect that we would use the horizontal axis to measure price, p, and the vertical axis to
measure quantity, q. However, the convention is just the opposite. Thus, if given the
function q = 25-2p it is a good idea to also write it in its inverse form, p = 12.5-0.5q in
order to facilitate graphing the function with q on the horizontal axis and p on the
vertical axis. It is also useful to write out demand and supply functions (and many others
as well) in direct (or original) form and also the inverse form as this makes it very simple
to compute the intercepts and hence more easily draw the graph.
We draw the graph for the above mentioned example below. Note that, since
q = 25-2p or, in inverse form, p = 12.5-0.5q, the q-intercept is 25 while the p-intercept is
12.5. Since the function is linear the graph of the function can be drawn by simply
drawing a
straight line which
connects the
intercept points
(q,p)=(0,12.5)
for the p-intercept
and (q,p) =
(25,0) for the qintercept. The
graph is illustrated
below.
Since negative values for a price or a quantity are not meaningful, we often do not
extend the demand function into the regions where q<0 or p<0. The p-intercept for
demand functions (12.5 in this example) is sometimes referred to as the choke price since
it is the (smallest) price at which quantity demanded becomes zero (i.e., demand is
choked off). The q-intercept value for demand functions (q=25 in this example) is the
quantity that would be demanded if price were zero.
Consider next an example of a linear supply function, also quantity being a
19 - 31
Fall 2001
function of price. Suppose q=-5+p, so that the slope of the supply function is 1 and the
intercepts are q=-5 for the q intercept and p=5 for the p intercept. The p intercept is the
value of p when q=0 and so for this example we have that unless p exceeds the value of
5, output will be zero. Of course, according to the function when p is less than zero the
value of q is negative, but negative values cant be produced by the firm and so that just
means no
output is
produce for
p<5. The q
intercept of -5
is not really
meaningful in
an economic
sense since
negative
quantities cant
be produced.
So for any
values of p
which induce
values of q
which are
negative, the
actual amount
produced is
presumed to be
zero. In fact,
the relevant
parts of the
graphs for both
demand and
supply
functions are
those parts that
lie in the
positive
quadrant (i.e.,
where both
p 0 and q 0).
The supply function q=-5+p, which can also be written in its inverse form, p=q+5,
is illustrated in the graph below.
&
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&
Fall 2001
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Fall 2001
Since the amount of capital (machinery) is fixed it makes sense that the amount of
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Fall 2001
extra output generated by adding more labour will depend on the existing amount of
labour employed. The more labour already using the fixed amount of machinery, the less
might be the added amount of output per additional unit of labour employed. If this is
the case, we would say that labour is subject to the law of diminishing marginal
productivity. Since the slope of a function indicates the rate at which the variable on the
vertical axis rises (or falls for a negative sloped function) and a flatter function means
this rate is lower, then according to our above description of what might happen when
more labour is used we should expect the slope of the total product of labour curve to fall
as more labour is added. A function with this property is Q=10 L or Q=10L1/2. The
following table gives some values which can be used to plot this function. From the
table, it is also clear that adding an extra unit of labour indicates less and less of an
increase in output.
'
L
Q= L
)
10
10
14.1
17.3
20
22.36
24.5
26.5
28.3
30
31.62
10
4.14
3.18
2.7
2.36
2.14
1.96
1.84
1.72
1.62
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Fall 2001
10
Q=L2
16
25
36
49
64
81
100
11
13
15
17
19
Q
We sketch this
Q=L2 below.
function,
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Fall 2001
A function which is increasing with the slope becoming flatter as one moves from
right to left, such as the function Q=10 L , is concave. A function which is increasing
with the slope becoming steeper, such as the function Q=L2, is convex. A function with a
constant slope, of course, is linear. It is, of course, possible that a function will have
some segments which are convex and concave, and also may include segments which are
linear. In particular, suppose we think about the total product of labour function, and its
graph, in light of our above discussion. A plausible scenario is that the shape of the total
product curve is convex for low levels of labour but that it becomes concave at levels of
labour
sufficie
ntly high
that the
law of
diminis
hing
margin
al
product
ivity
applies.
Such a
functio
n would
have
the shape
illustrat
ed in the
graph
below.
-
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Fall 2001
The simplest function which has the above shape for its graph is a cubic function.
We wont investigate further here how to determine the graph of a cubic function as such
specific exercises are not so important in this course. However, you do need to
understand the meaning of convex and concave shapes of functions in a number of
contexts, most notably the total product of labour concept discussed here.
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Fall 2001
x 5 (read x is less
than or equal to 5"),
1
x -3 (read x is
greater or less than
-3"),
2
x > 8 (read x is
greater than 8")
The above are sets of real numbers and these sets are drawn in a single dimension.
In economics one important concept involving sets described by an equality relation is
the budget set for consumers. Given a certain income, or budget amount, we need to find
a convenient method of describing this graphically. Although a typical consumer selects
his/her consumption from a wide variety of goods, it turns out that much of the economic
intuition concerning this choice problem can be described by using the budget line and
corresponding budget set for two goods. Let x1 and x2 represent the consumption
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Fall 2001
amounts for two commodities (good 1 and good 2, respectively) which can be purchased
at unit prices of p1 and p2 (respectively). Letting M represent the consumers income
level (or budget amount for these two goods) it turns out that one can describe the
consumers budget set by shading in all points (x1,x2) such satisfying the following
property:
x1, x2 such that p1x1 p2x2
3
M
4
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Fall 2001
Supply:
There are several techniques for solving systems of linear equations. When there
are just two equations and two unknowns, the simplest method is to write one variable in
terms of the other variable in one of the two equations and then substitute out for that
variable in the other equation. This provide a solution for one of the two variables. One
can then substitute this solution into either of the equations to solve for the other
variable. This is particularly simple in demand-supply models since generally q is
written explicitly as a function of price in both equations. Thus, equilibrium price can be
solved determined by simply noting that quantity demanded = quantity supplied, which
eliminates our q variable as follows:
quantity demanded = quantity supplied implies 25-2p = -5+p
Thus, taking the -2p term to the right side of the equality and taking all numerical
values to the left side gives 30 = 3p or p = 10 as the equilibrium price, which we will
write here as pe. Substituting this value into either the demand or supply function gives
equilibrium quantity qe=5. (Note that since pe is found by setting quantity demanded
equal to quantity supplied it must be the case that one gets the same value when
determining quantity demanded or supplied at this price.) The following diagram
illustrates this solution.
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Fall 2001
Another Example: In Macroeconomics the IS-LM diagram is used to find the short run
equilibrium output level and real interest rate. The IS curve represents the interest rate
and output pairs that equate planned and actual expenditure in the goods market (or
equivalently, the demand and supply of loanable funds). The LM curve represents the
interest rate and output pairs that equate the demand and supply of real money balances
in the money market.
Suppose that we are given the following information.
C = 250 + 0.8 [Y - T]
I = 200 - 50r
(M/P)d = Y - 50r
where C is consumption, Y is output, T is taxes, I is investment, r is the real interest rate, and
M/P are real money balances. Let government spending, G, equal 210, and taxes, T, be equal to
200. Let the money supply, M, be 2000 and the price level, P, be 2. Y is income and r is the real
interest rate in percent.
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Fall 2001
Equilibrium in the goods market (the IS curve) is found by setting actual expenditures, Y, equal
to planned expenditure, C + I + G.
I
6
0.8Y
7
0.2Y
Y
500
5
250
5
250
5
2500
5
G
6
160
7
200
6
200]
7
210
6
200
6
50r
7
210
6
50r
7
50r
7
250r
7
0.8 [Y
6
or
10
Equilibrium in the money market is found by setting the supply of real money balances equal to
the demand for real money balances.
M
P
S
5
so that Y
2000
2
1000
5
1000
5
Y
5
50r
6
50r
or
M
P
5
Y/50
5
20 (The LM curve)
7
Equating the IS and LM curve we can solve for the economy wide equilibrium values of r and Y .
Solving first for the equilibrium real interest rate we find that
2500
1500
250r
7
1000
300r
50r
r
so that
Substituting the value for the real interest rate into either the IS or LM equation gives the
equilibrium level of output.
Y
Y
2500
5
1000
250r
6
50r
5
2500
1000
6
(250) (5)
(50)(5)
5
2500
1000
6
1250
250
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