Appendix to Chapter 1

Mathematics
Used in
Microeconomics

2004 Thomson Learning/South-Western

Functions of One Variable

Variables:

The basic elements of algebra,

usually called X, Y, and so on, that may be
given any numerical value in an equation
Functional notation: A way of denoting the
fact that the value taken on by one variable
(Y) depends on the value taken on by some
other variable (X) or set of variables

Y f (X )
2

Independent and Dependent

Variables
Independent

Variable: In an algebraic
equation, a variable that is unaffected by the
action of another variable and may be
assigned any value
Dependent Variable: In algebra, a variable
whose value is determined by another variable
or set of variables

Two Possible Forms of Functional

Relationships
Y

is a linear function of X

Y a bX

Table 1.A.1 shows some value of the linear

function Y = 3 + 2X

is a nonlinear function of X
This includes X raised to powers other than 1
Table 1.A.1 shows some values of a quadratic
function Y = -X2 + 15X

Table 1A.1: Values of X and Y for Linear

and Quadratic Functions

x
-3
-2
-1
0
1
2
3
4
5
6

Linear Function
Y = f(X)
= 3 + 2X
-3
-1
1
3
5
7
9
11
13
15

x
-3
-2
-1
0
1
2
3
4
5
6

Quadratic Function
Y = f(X)
2
= -X + 15X
-54
-34
-16
0
14
26
36
44
50
54

Graphing Functions of One Variable

Graphs

are used to show the relationship

between two variables
Usually the dependent variable (Y) is shown on
the vertical axis and the independent variable
(X) is shown on the horizontal axis

However, on supply and demand curves, this

approach is reversed

Linear Function
A linear

function is an equation that is

represented by a straight-line graph
Figure 1A.1 represents the linear function
Y=3+2X
As shown in Figure 1A.1, linear functions may
take on both positive and negative values

Figure 1A.1: Graph of the Linear

Function Y = 3 + 2X
Y-axis
10
5
Y-intercept

3
X-axis

-10

-5

X-intercept

1 5

10

-5

-10

Intercept
The

general form of a linear equation is

Y = a + bX
The Y-intercept is the value of Y when when X
equals 0

Using the general form, when X = 0, Y = a, so this is

the intercept of the equation

Slopes

The slope of any straight line is the ratio of the change

in Y (the dependent variable) to the change in X (the
independent variable)
The slope can be defined mathematically as

Change in Y Y
Slope

Change in X X

10

where means change in

It is the direction of a line on a graph.

Slopes
For

the equation Y = 3 + 2X the slope equals 2

as can be seen in Figure 1A.1 by the dashed
lines representing the changes in X and Y
As X increases from 0 to 1, Y increases from 3
to 5

Y 5 3
Slope

2
X 1 0
11

Figure 1A.1: Graph of the Linear

Function Y = 3 + 2X
Y-axis
10
5
Y-intercept

-10

-5

X-intercept

Y
X
53

2
1 0

Slope

Y
X

1 5

X-axis
10

-5

-10

12

Slopes
The

slope is the same along a straight line.

For the general form of the linear equation the
slope equals b
The slope can be positive (as in Figure 1A.1),
negative (as in Figure 1A.2) or zero
If the slope is zero, the straight line is
horizontal with Y = intercept
13

Slope and Units of Measurement

The

slope of a function depends on the units in

which X and Y are measured
If the independent variable in the equation Y =
3 + 2X is income and is measured in hundreds
of dollars, a $100 increase would result in 2
more units of Y

14

Slope and Units of Measurement

If

the same relationship was modeled but with

X measured in single dollars, the equation
would be Y = 3 + .02 X and the slope would
equal .02

15

Changes in Slope
In

economics we are often interested in

changes in the parameters (a and b of the
general linear equation)
In Figure 1A.2 the (negative) slope is doubled
while the intercept is held constant
In general, a change in the slope of a function
will cause rotation of the function without
changing the intercept
16

FIGURE 1A.2: Changes in the Slope of

a Linear Function
Y

10
5

17

10

FIGURE 1A.2: Changes in the Slope of

a Linear Function
Y

10
5

18

10

Changes in Intercept
When

the slope is held constant but the

intercept is changed in a linear function, this
results in parallel shifts in the function
In Figure 1A.3, the slope of all three functions
is -1, but the intercept equals 5 for the line
closest to the origin, increases to 10 for the
second line and 12 for the third

19

These represent Shifts in a linear function.

FIGURE 1A.3: Changes in the YIntercept of a Linear Function

Y
12
10

Y X 5

5
0

20

1012 X

FIGURE 1A.3: Changes in the YIntercept of a Linear Function

Y
12
10

Y X 10
Y X 5

5
0

21

1012 X

FIGURE 1A.3: Changes in the YIntercept of a Linear Function

Y

Y X 12
Y X 10
Y X 5

12
10
5
0

22

1012 X

Nonlinear Functions
Figure

1A.4 shows the graph of the nonlinear

function Y = -X2 + 15X
As the graph shows, the slope of the line is not
constant but, in this case, diminishes as X
increases
This results in a concave graph which could
reflect the principle of diminishing returns
23

FIGURE 1.A.4: Graph of the Quadratic

Function Y = X2 + 15X
Y
60
50

40
30
20
10
0

24

FIGURE 1.A.4: Graph of the Quadratic

Function Y = X2 + 15X
Y
60
B
50

40
30
20
10
0

25

The Slope of a Nonlinear Function

The

graph of a nonlinear function is not a

straight line
Therefore it does not have the same slope at
every point
The slope of a nonlinear function at a particular
point is defined as the slope of the straight line
that is tangent to the function at that point.
26

Marginal Effects
The

marginal effect is the change in Y brought

about by one unit change in X at a particular
value of X (Also the slope of the function)
For a linear function this will be constant, but
for a nonlinear function it will vary from point to
point

27

Average Effects
The

average effect is the ratio of Y to X at a

particular value of X (the slope of a ray to a
point)
In Figure 1A.4, the ray that goes through A
lies about the ray that goes through B
indicating a higher average value at A than at
B

28

APPLICATION 1A.1: Property Tax

Assessment
The

bottom line in Figure 1 represents the

linear function Y = $10,000 + $50X, where Y is
the sales price of a house and X is its square
footage
If, other things equal, the same house but with
a view is worth $30,000 more, the top line Y =
$40,000 + $50X represents this relationship

29

FIGURE 1: Relationship between the Floor Area of a

House and Its Market Value
House value
(dollars)
160,000

House without
view

110,000

40,000
10,000
0

30

2,0003,000

Floor area
(square feet)

FIGURE 1: Relationship between the Floor Area of a

House and Its Market Value
House value
(dollars)
House with view
160,000
House without
view
110,000

40,000
10,000
0

31

2,0003,000

Floor area
(square feet)

Calculus and Marginalism

In

graphical terms, the derivative of a function

and its slope are the same concept
Both provide a measure of the marginal inpact
of X on Y
Derivatives provide a convenient way of
studying marginal effects.

32

APPLICATION 1A.2: Progressive and

Flat Taxes
Advocates

of tax fairness argue that income

taxes should progressive so that richer people
should pay a higher fraction of their incomes in
taxes

33

This is illustrated in Figure 1 by the nonlinear line

OT that becomes steeper as taxable income
increases
This represents an increasing marginal tax rate

FIGURE 1: Progressive Rates

Compared to a Flat Tax Schedule
Tax
Liability
$1,000
50

OT

40

30
20
10

34

25

50

75

100

125

150

175 Taxable
income
($1,000)

APPLICATION 1A.2: Progressive and

Flat Taxes
Opponents

of progressive taxes have argued

for a flat tax
The straight line OT represents a proposal
where the first $18,000 of taxable income
would not be taxed with a flat tax of 17
percent on additional taxable income

35

This would also be progressive but not as much as

in the current system

FIGURE 1: Progressive Rates

Compared to a Flat Tax Schedule
Tax
Liability
$1,000
50

OT

40
OT

30
20
10

36

25

50

75

100

125

150

175 Taxable
income
($1,000)

Functions of Two or More Variables

The

dependent variable can be a function of

more than one independent variable
The general equation for the case where the
dependent variable Y is a function of two
independent variables X and Z is

Y f (X, Z)
37

A Simple Example
Suppose

the relationship between the

dependent variable (Y) and the two
independent variables (X and Z) is given by

Y X Z
Some

values for this function are shown in

Table 1A.2

38

TABLE 1A.2: Values of X, Z, and Y that

satisfy the Relationship Y = XZ

39

X
1
1
1
1
2
2
2
2
3
3
3
3
4
4
4
4

Z
1
2
3
4
1
2
3
4
1
2
3
4
1
2
3
4

Y
1
2
3
4
2
4
6
8
3
6
9
12
4
8
12
16

Graphing Functions of Two

Variables
Contour

lines are frequently used to graph

functions with two independent variables
Contour lines are lines in two dimensions that
show the sets of values of the independent
variables that yield the same value for the
dependent variable
Contour lines for the equation Y = XZ are
shown in Figure 1A.5
40

FIGURE 1A.5: Contour Lines for Y = XZ

Z
9

4
3

Y 9

Y 4

Y 1

41

Simultaneous Equations
These

are a set of equations with more than

one variable that must be solved together for
a particular solution
When two variables, say X and Y, are related
by two different equations, it is sometime
possible to solve these equations to get a set
of values for X and Y that satisfy both
equations
42

Simultaneous Equations
The equations [1A.17]

X Y 3
X Y 1
can be solved for the unique solution

X 2
Y 1
43

Changing Solutions for

Simultaneous Equations
The equations [1A.19]

X Y 5
X Y 1

can be solved for the unique solution

X 3
Y 2
44

Graphing Simultaneous Equations

The

two simultaneous equations systems,

1A.17 and 1A.19 are graphed in Figure 1A.6
The intersection of the graphs of the equations
show the solutions to the equations systems
These graphs are very similar to supply and
demand graphs

45

Figure 1A.6: Solving Simultaneous

Equations
Y
5

Y X 1
3

Y 3 X

2
1

46

Figure 1A.6: Solving Simultaneous

Equations
Y
5

Y 5 X

Y X 1

Y 3 X

2
1

47

APPLICATION 1A.3: Can Iraq Affect Oil

Prices?
Assumethedemandforcrudeoilisgivenby

QD 80 0.4 P
where QD is crude oil demanded (in millions of barrels
per day) and P price in dollars per barrel.
Assume the supply of crude oil is given by

QS 55 0.6 P

The solution to these equations, market equilibrium,

is P = 25 and QS = QD = 70 and can be found by
48

80 0.4 P 55 0.6 or P 25, Q 70

APPLICATION 1A.3:Can Iraq Affect

Oil Prices?
Iraq produces about 2.5 million barrels of oil per day.
The impact of the decision to sell no oil can be evaluated
by assuming that the supply curve in Figure 1 shifts to S
whose equation is given by

QS (55 2.5) 0.6 P 52.5 0.6 P

49

Repeating the algebra yields a new equilibrium, as

shown in Figure 1, of P=27.50 and Q = 69. The
reduction in oil supply raised the price and decreased
consumption. The higher price caused non-OPEC
producers to supply about 0.5 million additional barrels.

FIGURE 1: Effect of OPEC Output

Restrictions on World Oil Market
Price
($/barrel)

32
30
28
26
24
22
20

D
62 64 66 68 70 68 70 72

50

((millions
74
barrels)

FIGURE 1: Effect of OPEC Output

Restrictions on World Oil Market
Price
($/barrel)

S
S

32
30
28
26
24
22
20

D
66

51

68

70 68 70 72

((millions
74
barrels)

Empirical Microeconomics and

Econometrics
Economists

test the validity of their models by

looking at data from the real world
Econometrics is used for this purpose
Two important aspects of econometrics are

52

random influences
the ceteris paribus assumption

Random Influences
No

economic model exhibits perfect accuracy

so actual price and quantity values will be
scattered around the true demand curve
Figure 1A.7 shows the unknown true demand
curve and the actual points observed in the
data from the real world
The problem is to infer the true demand curve
53

FIGURE 1A.7: Inferring the Demand Curve

from Real-World Data
Price
(P)

D
Quantity (Q)

54

Random Influences
Technically,

the problem is statistical

inference: the use of actual data and statistical
techniques to determine quantitative economic
relationships
Since no single straight line will fit all of the
data points, the researcher must give careful
consideration to the random influences to get
the best line possible
55

The Ceteris Paribus Assumption

To

control for the other things equal

assumption two things must be done

Data should be collected on all of the other factors

that affect demand, and
appropriate procedures must be used to control
for these measurable factors in the analysis

Generally

the researcher has to make some

compromises which leads to many
controversies in testing economic models

56