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MATH REVIEW
OUTLINE
1. Functions
• Definition
• Inverse functions
• Convex and Concave functions
• Definition
• Rules for finding a derivative
• Some applications to economics
• Definition
• Partial Derivatives
• Total differentiation
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• Second order conditions(SOC)- sufficient
• Some applications to economics
• Substitution Method
• Lagrange Multiplier Method
• Applications to economics
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1 Functions
Definition 1 A function f is a mapping from some set A (called the domain of
the function) to some set B (called the range of the function) which satisfies a
condition that to every element in A, f assigns a unique element from the set B.
In short we write: f : A → B
Example Demand function specifies what the quantity demanded will be for
a given price, e.g. Qd (p) = 100 − 5p.
Inverse demand function tells us what the price should be at a given quantity,
e.g. Pd (q) = 20 − 51 q.
NOTE: Make sure you know how to find the inverse of a given function!
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We say that the function f is concave if for all a1 ∈ A, for all a2 ∈ A and for all
λ ∈ (0, 1) we have:
Examples
1. Function f (x) = x2 is convex. To see this take for example x1 = 0, x2 = 2
and λ = 41 . Then check that the inequality holds. (NOTE: If you want to
completely prove that this function is convex, you need to show that the
inequality holds for any x1 , x2 ,and λ)
√
2. Function f (x) = x is concave. Try the same numbers as above. You can
also try different numbers.
• Sign of the derivative gives information about the behavior of the function.
If f 0 > 0, then f is strictly increasing; similarly, if f 0 < 0, then f is strictly
decreasing.
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2.1 Rules for finding derivatives
1. If k ∈ R, i.e. it is a constant, then
dk
=0
dx
2. Multiplication by a constant k,
d[kf (x)]
= kf 0 (x)
dx
3. If k is a constant, then
dxk
= k.xk−1
dx
d(lnx) 1
4. dx
= x
d(kx )
5. dx
= k x .lnk for any constant k ∈ R.
d(ex )
In particular, dx
= ex .lne = ex .
6. Derivative of sum-difference
d[f (x) ± g(x)]
= f 0 (x) ± g 0 (x)
dx
7. Derivative of multiplication of two functions (Product Rule)
d[f (x).g(x)]
= f 0 (x).g(x) + g 0 (x).f (x)
dx
8. Quotient Rule
d[f (x)/g(x)] f 0 (x).g(x) − f (x).g 0 (x)
=
dx [g(x)]2
9. Chain rule
d[f (g(x))]
= f 0 (g(x)).g 0 (x)
dx
or you can denote chain rule as,
if y = f (x) and x = g(z)
dy dy dx
= .
dz dx dz
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2.2 Second derivative
Definition 7 Second derivative of a function f at x∗ is defined as:
f 0 (x∗ + h) − f 0 (x∗ )
f 00 (x∗ ) ≡ lim
h→0 h
NOTE: second derivative is simply a derivative of the derivative.
Now, we are after how much the utility, cost or profit changes if we increase the
amount consumed or produced by a very very small amount. So, to find marginal
changes, we’ll find the derivatives of utility, cost or profit functions.
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3 Derivative of Multi-variable Functions
Economic problems usually involve functions of more than one variable. For
example, a consumer’s utility generally depends on more than one type of good.
Similarly, cost function of a firm depends on more than one type of input, i.e.
cost of labor, cost of physical capital and cost of land. Problems with multi-
variables are of interest since trade-offs must be made among these variables. The
dependence of one variable y on a series of other variables (x1 , x2 , ..., xi , ..., xn )
is denoted by y = f (x1 , x2 , ..., xi , ..., xn ).
It is easy to calculate partial derivatives. If you take partial derivative with re-
spect to xi , you have to treat other arguments as constants. The intuition is that
we keep the values of all other variables fixed.
Example
∂C ∂C
= 8l = 6k
∂l ∂k
∂U 2 ∂U 3
= =
∂x x ∂y y
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The boldface letters denote vectors.
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3.2 Total differentiation
If all the x’s are varied by a small amount, the total effect on y will be the sum
of effects. In other words, total change in y can be decomposed into changes
resulting from changes of x1 , x2 , ..., xi , ..., xn .
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3.3 Application to economics
• Again, partial derivatives are used to analyze the trade-off among differ-
ent variables. We’ll see the concepts such as marginal rate of substitution
among two different goods; marginal rate of technical substitution among
factors of production.
4 (Unconstrained) Optimization
We are interested in problems such as consumer maximizing utility, consumer
minimizing expenditure, firm maximizing profit or firm minimizing cost. We can
find solutions to maximization and minimization problems by applying simple
calculus techniques.
Remark: This theorem does not say that if f 0 (x∗ ) = 0 then f has a maxi-
mum/minimum at the point. In particular, we are not able to distinguish between
maximum and minimum. It can also happen that neither one occurs.
The next two theorems help us determine whether the function attains a maxi-
mum or a minimum.
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Theorem 4 Sufficient Condition for maximum (SOC)
Let f be a real-valued function of one variable. Suppose that f 00 (x∗ ) exists and
suppose that f 0 (x∗ ) = 0 and f 00 (x∗ ) < 0. Then f has a local maximum at x∗ .
Examples
2. Consider a function f (x) = 16x − 2x2 . We can verify that the function
has
∗ 0
a local maximum at a point x = 4. We have that f (4) = 16 − 4xx=4 =
16 − 4 · 4 = 0. FOC is satisfied. We can calculate f 00 (4) = −4 < 0, hence
the sufficient condition is satisfied. Function f has a local maximum at 4.
3. This example will highlight the difference between a local and a global
maximum/minimum. Suppose that we have a function f : R+ → R, i.e.
f is a real-valued function defined on the set of non-negative real numbers.
Assume f (x) = 13 x3 − 23 x2 + 2x + 10. We want to find local and global
maximuma/minima. FOC for maximum/minimum is: f 0 (x) = x2 −3x+2 =
0, which can be solved for x to give x = 1 or x = 2. Now we notice that
f 00 (x) = 2x − 3, hence f 00 (1) = −1 < 0 and f 00 (2) = 1 > 0, so there is a
local maximum at x = 1 and a local minimum at x = 2. We can evaluate
the function at x = 1 and at x = 2: f (1) = 10 56 and f (2) = 10 64 . However,
f (0) = 10 < 10 46 = f (2), so global minimum is not at x = 2 (it’s actually
at x=0). We also have that limx→∞ f (x) = ∞, so the function doesn’t have
global maximum.
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4.1 Unconstrained optimization with more than one variable
Now assume that we have a real-valued function y = f (x1 , ..., xn ), where all
x0 s ∈ R.
Intuitively, if one of the partials were greater or less than 0, then y could be
increased by increasing or decreasing xi .
5 Constrained Optimization
Consider the following problem: There is a consumer who gets utility by consum-
ing pizza and beer. Suppose this consumer has 24 dollars to spend on these goods.
The price of one slice of pizza is 2 dollars, the price of one beer is 3 dollar. The
utility function of the consumer is given by:
subject to
2p + 3b = 24 (BudgetConstraint)
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FOC (necessary) implies
dU 2 2/3
= − =0
dp p (8 − 23 p)
y = f (x1 , ..., xn )
subject to
g(x1 , ..., xn ) = c
First, we set up Lagrangian
where λ is the additional variable called the Lagrange multiplier. (We’ll treat
λ as a variable in addition to x’s.) Note that when the constraint holds L and
f have the same value. So, if we restrict attention only to x’s that satisfy the
constraint, finding the constraint maximum value of f is equivalent to finding
optimal(critical) values of L. The following are conditions for a critical point for
the function L. Note that there are n + 1 equations with n + 1 unknowns.
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From Equation 1, the FOCs for an optimum (critical) point are:
∂L ∂f ∂g
= +λ =0
∂x1 ∂x1 ∂x1
∂L ∂f ∂g
= +λ =0
∂x2 ∂x2 ∂x2
.
.
∂L ∂f ∂g
= +λ =0
∂xn ∂xn ∂xn
∂L
= [c − g(x1 , ..., xn )] = 0.
∂λ
Let’s apply this method to the consumer’s problem. The objective function is
U (p, b) = 2ln(p) + ln(b) and the constraint function is g(p, b) = 2p + 3b and
c = 24. The Lagrangian function is:
L = 2ln(p) + ln(b) + λ[24 − (2p + 3b)]
FOCs of the Lagrangian are:
∂L 2
= ∗ − 2λ∗ = 0
∂p p
∂L 1
= ∗ − 3λ∗ = 0
∂b b
∂L
= [24 − (2p + 3b)] = 0
∂λ
.
Note that the last equation simply says that the budget constraint in the maxi-
mization problem has to hold. The above system has 3 equations and 3 unknowns
(p∗ ,b∗ and λ∗ ) and easy to solve. You’ll see λ∗ = 1/8, p∗ = 8 and b∗ = 8/3. (Do
it!)
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