EC270: Microeconomic Theory I

.
Chapter 2
Mathematics for Microeconomics
Dr. Logan McLeod, PhD
Wilfrid Laurier University, School of Business & Economics

September 4, 2014

Functions
Function: describe the relationship between input and output
variables
I For each input (independent) variable x, a function
assigns a unique number to the output (dependent)
variable y according to some rule

= 2x

= x2

we may want to indicate y depends x without a specific

algebraic relationship:
y = f (x)

I
I

Frequently, y depends on several variables (x1 , x2 , . . . , xn )

We write y = f (x1 , x2 , . . . , xn )

Graphs
Graph: depicts the behaviour of a
function pictorially
I x is usually on the horizontal

axis

Figure: (A.1) Graphs of functions

I y is depicted on the vertical

axis
However. . .
I in economics, it is common

to graph functions with the

independent variable on the
vertical axis and the
dependent variable on the
horizontal axis
I

e.g. demand functions

Properties of Functions
Continuous function: can be drawn without lifting a pencil
from the paper
I

there are no jumps in a continuous function

Smooth function: has no kinks or corners

Monotonic function: always increases or always decreases
I

a positive monotonic function always increases as x

increases

a negative monotonic function always decreases as x

increases

Inverse Functions
Recall:
I A function assigns a unique number y for each x
I A monotonic function is always increasing or always decreasing
I Thus, a monotonic function will have a unique value of x associated
with each value of y
Inverse function: a function assigns a unique number x to each y
I For example, y = 2x:

y = 2x
I

y
2

inverse function exists: a unique value of x is associated with

each value of y

I What about y = x 2

y = x2
I

x=

x = y

inverse function does not exist: not a unique value of x associated

with each value of y

Equations and Identities

Equations asks when a function is equal to some particular number.
Equation

Solution

2x = 8

x =4

x2 = 9

x = 3 or x = 3

f (x) = 0

x = x

Solution: a value of x satisfying the equation

Identity: a relationship between variables that holds for all values of
the variables
(x + y )2

x 2 + 2xy + y 2

2(x + 1) 2x + 2
I

The symbol means that the left-hand side and the right-hand
side are equal for all values of the variables

Linear Functions

Linear function: a function of the form y = mx + b

I

where m and b are constants

They can also be expressed implicitly: ax + cy = d

I

we would often solve for y as a function of x, to convert

this to the standard form
y=

a
d
x
c
c

Changes and Rates of Change

The change in x: x
I

A change in x from x1 to x2 is x = x2 x1

Marginal change: very small changes in x

I

we are generally interested in only very small changes in x

Rate of change: the ratio of two changes

I

assume y = f (x)

then the rate of change of y with respect to x is

f (x + x) f (x)
y
=
x
x

Changes and Rates of Change

f (x + x) f (x)
y
=
x
x
Note:
I

for a linear function (y = mx + b) has a constant rate of change

of y with respect to x:
y
[b + m(x + x)] [b + mx]
mx
=
=
=m
x
x
x

for a non-linear function, the rate of change will depend on the

value of x. For example y = x 2 :
y
[(x + x)2 ] [x 2 ]
x 2 + 2xx + (x)2 x 2
=
=
= 2x + x
x
x
x

Slopes and Intercepts

For example:
5
y = x +5
3

Y Axis

Slope of the function is the rate of change of y as x changes

I we commonly interpret the rate of change of a function
graphically as the slope of the function
6
5
4

I vertical intercept: the

value of y when x = 0
(which is y = 5)

3
2

I horizontal intercept:

the value of x when

y = 0 (which is x = 3)
I slope is 5
3

1
0
0

4
X Axis

Slopes and Intecepts

if a linear function has the standard form y = mx + b, then

vertical intercept
horizontal intercept
slope

b
b
m
m

if a linear function has the form: ax1 + cx2 = d, then

vertical intercept
horizontal intercept
slope

d
c
d
a
a
c

Slopes and Intercepts

A nonlinear function has the property that its slope changes as x changes
I A tangent to a function at some point x is a linear function that has the

same slope

Figure: (A.2B) slope of y = x 2 at x = 1

Example:
I If y whenever x , then

y will always have the

same sign as x (slope
will be positive)
I If y () whenever

x (), then y and x

will have opposite signs
(slope will be negative)

Absolute Values and Logarithms

Absolute value of a number |x| is a function f (x) defined by:
(
x
if x 0
f (x) =
x if x < 0
Logarithm (or log) of x describes an inverse function of the exponential
function f (x) = ax : y = log x or y = log(x)
I a logarithm of base a is an inverse function of: f (x) = ax
I

the exponent to which base a must be raised to give x.

I if f (x) = ax , the loga (x) is the exponent to which base a must be raised

to give x
I the natural log of x is ln(x), which has base e (i.e., ex )

Properties of the logarithm:

ln(xy ) = ln(x) + ln(y )

x
ln
= ln(x) ln(y )
y
ln(e) = 1
ln(x y ) = y ln(x)

for all positive numbers x and y

for all positive numbers x and y
e = 2.7183 . . .

Derivatives

Derivatives
Derivative is the limit of the rate of change of y with respect to
x as the change in x goes to zero
I

gives precise meaning to the phrase the rate of change of

y with respect to x for small changes in x

for y = f (x), the derivative (f 0 (x)) is:

f (x + x) f (x)
df (x)
= lim
dx
x
x0

Derivatives of Linear Functions

I

Recall, the rate of change of y = mx + b is a constant (m)

Thus, if f (x) = mx + b then

df (x)
=m
dx

Derivatives
Derivatives of Non-Linear Functions
I recall the rate of change of y with respect to x will usually depend on x
I for example: y = x 2 y = 2x + x
x
I the derivative of y with respect to x will be a function of x:

df (x)
= lim 2x + x = 2x
x0
dx
Useful derivatives to know:
Family
Constant

f (x)
c

df (x)
dx

Power

xc

cx c1

Exponential

ex

ex

Logarithmic

ln x

1
x

The Power Rule

Assume: f (x) = cx , where c and are constants

I

then

multiply x by its exponent and subtract one from the

exponent you began with to find the derivative.

df (x)
= cx 1
dx

Example: if f (x) = x 3 , what is

df (x)
dx ?

The Product Rule

Assume: g(x) and h(x) are both functions of x

I

define f (x) = g(x)h(x) (i.e., the product of two functions)

then

the first times the derivative of the second, plus the

second times the derivative of the first

dh(x)
dg(x)
df (x)
= g(x)
+ h(x)
dx
dx
dx

Example: if g(x) = x 2 and h(x) = x 2 + 3, what is

df (x)
dx ?

The Chain Rule

Composite function:
I given two functions y = g(x) and z = h(y )
I the composite function is f (x) = h(g(x))
Chain Rule: the derivative of a composite function, f (x), with respect to x is
df (x)
dh(y ) dg(x)
=

dx
dy
dx
Example:
Assume

Then

g(x)

x2 = y

h(y )

2y + 3

f (x)

2x 2 + 3

dg(x)
dx
dh(y )
dy
df (x)
dx

2x

2 2x = 4x

Second Derivatives
Second derivative of a function:
I

the derivative of the derivative of that function

if

y = f (x)

then the 1st derivative is

df (x)
or f 0 (x)
dx

then the 2nd derivative is

d 2 f (x)
or f 00 (x)
dx 2

measures the curvature of a function

2nd derivative
f 00 (x) < 0
f 00 (x) > 0
f 00 (x) = 0

implies f (x) is
concave near that point (slope is decreasing)
convex near that point (slope is increasing)
flat near that point (possible inflection point)

Partial Derivatives
Assume z = f (x, y )
Partial derivative of f (x, y ) with respect to x is just the
derivative of the function with respect to x, holding y fixed:
f (x + x, y ) f (x, y )
f (x, y )
= lim
x
x
x0
Similarly, the partial derivative with respect to x2
f (x, y )
f (x, y + y ) f (x, y )
= lim
y
y
y 0
Partial derivatives have exactly the same properties as ordinary
derivatives

Example: Partial Derivatives

Assume a Cobb-Douglas function:
f (x, y ) = x y 1
Partial Derivative, with respect to x
I Use the power rule to get

f (x,y )
:
x

y 1
f (x, y )
= x 1 y 1 =
x
x
Second Partial Derivative, with respect to x
2 f (x, y )
= ( 1)x 2 y 1
x 2
Cross Partial Derivative, of

f (x,y )
x

with respect to y

2 f (x, y )
= (1 )x 1 y
xy

Youngs Theorem
Youngs Theorem: the order in which partial differentiation is
conducted to evaluate second-order partial derivatives does not
matter.
fij = fji
for any pair of variables xi , xj .
Example: f (x1 , x2 ) = x12 x23
f1 = 2x1 x23

f2 = 3x12 x22

f12 = 6x1 x22

f21 = 6x1 x22

Total Differentiation
Totally differentiating a function:
I

Tells us the total change in a function from a combined

change in x and y .

Describes movement along a curve.

df (x, y ) =

f (x, y )
f (x, y )
dx +
dy
x
y

Interpretation of Total Differentiation:



f (x,y )
f (x,y )
I The partial derivatives
and
indicate the
x
y
rate of change in the x and x directions
I

dx and dy are the changes in x and y

Optimization

Optimization - One Variable

Optimization refers to the process of finding the largest value
(maximum) or the smallest value (minimum) a function
(y = f (x)) can take.
Maximum: f (x) achieves a maximum at x if
f (x ) f (x) for all x
I It can be shown that if f (x) is a smooth function that
achieves its maximum value at x , then:
df (x )
=0
First-order condition:
dx
(the slope of f (x) is flat at x )
d 2 f (x )
Second-order condition:
0
dx 2
(f (x) is concave near x )

Optimization - One Variable

Minimum: f (x) achieves a minimum at x if f (x ) f (x) for all x

I

It can be shown that if f (x) is a smooth function that achieves its

maximum value at x , then:
First-order condition:
Second-order condition:

df (x )
=0
dx
d 2 f (x )
0
dx 2
(f (x) is convex near x )

Optimization - Multiple Variables

Multivariate Case: if y = f (x1 , x2 ) is a smooth function that achieves

a maximum or minimum at some point (x1 , x2 ), then we must satisfy:
f (x1 , x2 )
x1
f (x1 , x2 )
x2
I

These are referred to as the first-order conditions.

The Envelope Theorem

Envelope Theorem: concerns how the optimal value for a particular
function changes when a parameter of the function changes
I

provides a shortcut to calculate the effect of changing a

parameter on the value of a function

e.g., the effects of changing the market price of a commodity will

have on an individuals purchases

Example: y = x 2 + ax
I

Function represents an inverted parabola

Optimal values of x (x ) depend on the parameter a

Value of a
0
1
2
3
4
5
6

Value of x
0

Value of y
0

1
2

1
4

3
2

9
4

5
2

25
4

The Envelope Theorem - Direct Approach

y = x 2 + ax
First: Calculate the slope
dy
= 2x + a = 0
dx
which implies:

a
2
Second: substitute x into the original function
x =

= (x ) + ax
 a 2
a
=
+a
2
2
2
a
=
4

The Envelope Theorem - Shortcut

Envelope Theorem states: for small changes in a, dy
da can be


computed by holding x constant at its optimal value x = a2 and
simply calculating y
a from the objective function directly
First:

y
=x
a

Second: evaluate at x :

y 
a
=
a x =a/2
2
Note: this is the same results obtained earlier
Envelope Theorem: states the change in the optimal value of a
function (with respect to a parameter) can be found by partially
differentiating the objective function while holding x constant at its
optimal value
dy
y
=
{x = x (a)}
da
a

Constrained Optimization

Constrained Optimization

Constrained Optimization: finding a maximum or minimum of

some function over a restricted values for (x1 , x2 )
I

The notation:
max

f (x1 , x2 )

x1 ,x2

such that

g(x1 , x2 ) = c.

objective function: f (x1 , x2 )

constraint function: g(x1 , x2 ) = c

Interpretation:

find x1 and x2 such that f (x1 , x2 ) f (x1 , x2 ) for all values of

x1 and x2 that satisfy the equation g(x1 , x2 ) = c.

Solving Constrained Optimization

Assume a linear constraint function:
g(x1 , x2 ) = p1 x1 + p2 x2 = c
Constrained Maximization Problem
max
x1 ,x2

such that

f (x1 , x2 )
p1 x1 + p2 x2 = c.

There are two ways to solve this problem:

1. Direct Substitution
2. Lagrange Method

Direct Substitution
1. Solve the constraint for one variable:
p1
c
x1
x2 (x1 ) =
p2 p2
2. Substitute x2 (x1 ) into the objective function:
f (x1 ,

p1
c
x1 )
p2 p2

3. Solve the unconstrained maximization problem:

max
x1

(F .O.C.)

c
p1
x1 )
p2 p2
f (x1 , x2 (x1 )) f (x1 , x2 (x1 )) x2
+
=0
x1
x2
x1

f (x1 ,

Lagrange Method
Solves the constrained maximization problem by using Lagrange
multipliers.
I

define an auxiliary function known as the Lagrangian:

L = f (x1 , x2 ) (p1 x1 + p2 x2 c)

the new variable () is the Lagrange multiplier

The Lagrange method says that an optimal choice (x1 , x2 ) must

satisfy three first-order conditions
f (x1 , x2 )
L
=
p1 = 0
x1
x1
f (x1 , x2 )
L
=
p2 = 0
x2
x2
L
= p1 x1 + p2 x2 c = 0

(1)
(2)
(3)

EC270: Microeconomic Theory I

.
Chapter 2
Mathematics for Microeconomics
Dr. Logan McLeod, PhD
Wilfrid Laurier University, School of Business & Economics

September 4, 2014