Functions Variables

Variables, Functions and Equations
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Economists are interested in examining types of relationships. For example an

economist may look at the amount of money a person earns and the amount that
person chooses to spend. This is a consumption relationship or function. As
another example an economist may look at the amount of money a business firm
has and the amount it chooses to spend on new equipment. This is an investment
relationship or investment function.
A function tries to define these relationships. It tries to give the relationship a

mathematical form. An equation is a mathematical way of looking at the
relationship between concepts or items. These concepts or items ar represented by
what are called variables.
A variable represents a concept or an item whose magnitude can be represented by

a number, i.e. measured quantitatively. Variables are called variables because they
vary, i.e. they can have a variety of values. Thus a variable can be considered as a
quantity which assumes a variety of values in a particular problem. Many items in
economics can take on different values. Mathematics usually uses letters from the
end of the alphabet to represent variables. Economics however often uses the first
letter of the item which varies to represent variables. Thus p is used for the variable
price and q is used for the variable quantity.
An expression such as 4x3 is a variable. It can assume different values because x

can assume different values. In this expression x is the variable and 4 is the
coefficient of x. Coefficient means 4 works together with x. Expressions such as
4x3 which consists of a coefficient times a variable raised to a power are called
monomials.
A monomial is an algebraic expression that is either a numeral, a variable, or the

product of numerals and variables. (Monomial comes from the Greek word,
monos, which means one.) Real numbers such as 5 which are not multiplied by a
variable are also called monomials. Monomials may also have more than one
variable. 4x3y2 is such an example. In this expression both x and y are variables
and 4 is their coefficient.
The following are examples of monomials:
x, 4x2, -6xy2z, 7
One or more monomials can be combined by addition or subtraction to form what

are called polynomials. (Polynomial comes from the Greek word, poly, which
means many.) A polynomial has two or more terms i.e. two or more monomials. If
there are only two terms in the polynomial, the polynomial is called a binomial.
The expression 4x3y2 - 2xy2 +3 is a polynomial with three terms.
These terms are 4x3y2, - 2xy2, and 3. The coefficients of the terms are 4, -2, and 3.
The degree of a term or monomial is the sum of the exponents of the variables. The
degree of a polynomial is the degree of the term of highest degree. In the above
example the degrees of the terms are 5, 3, and 0. The degree of the polynomial is 5.
Remember that variables are items which can assume different values. A function
tries to explain one variable in terms of another.
Consider the above example where the amount you choose to spend depends on
your salary. Here there are two variables: your salary and the amount you spend.
Independent variables are those which do not depend on other variables.

Dependent variables are those which are changed by the independent variables.
The change is caused by the independent variable. In our example salary is the
independent variable and the amount you spend is the dependent variable.
To continue with the same example what if the amount you choose to spend
depends not only on your salary but also on the income you receive from
investments in the stock market. Now there are three variables: your salary and
your investment income are independent variables and the amount you spend is the
dependent variable.
Definition: A function is a mathematical relationship in which the values of a

single dependent variable are determined by the values of one or more
independent variables. Function means the dependent variable is determined
by the independent variable(s).
A goal of economic analysis is to determine the independent variable(s) which

explain certain dependent variables. For example what explains changes in
employment, in consumer spending, in business investment etc.?
Functions with a single independent variable are called univariate functions. There
is a one to one correspondence. Functions with more than one independent variable
are called multivariate functions.
The independent variable is often designated by x. The dependent variable is often
designated by y.
We say y is a function of x. This means y depends on or is determined by x.
Mathematically we write y = f(x)
It means that mathematically y depends on x. If we know the value of x, then we

can find the value of y.
In pronunciation we say " y is f of x." This does not mean that y is the product of
two separate quantities, f and x but rather that f is used to indicate the idea of a
function. In other words the parenthesis does not mean that f is multiplied by x.
It is not necessary to use the letter f. For example we could say

y = g(x) which also means that y is a function of x or we could say y = h(x) which
too means that y is a function of x.
We may look at functions algebraically or graphically. If we use algebra we look at

equations. If we use geometry we use graphs.
A simple example of functional notation
Qd = the number of pizzas (quantity) demanded
Pp = the price of a pizza
Pt = the price of tomato sauce
Pc = the price of cheese
Pd = the price of pizza dough
N = the number of potential pizza eaters
Pp = f(Pt, Pc, Pd)
This is an example of a function that says the price of pizza depends on the prices
of tomato sauce, cheese, and pizza dough. There is one dependent variable, the
price of pizza and there are three independent variables, the prices of tomato sauce,
cheese, and pizza dough.
Qd = f(Pp, N)
This is another example of a function. It says that the quantity of pizza demanded
depends on the price of pizza and the number of potential pizza eaters. There is one
dependent variable, the quantity of pizza demanded, and there are two independent
variables, the price of pizza and the number of potential pizza eaters.
A common economic example of functional notation
C = consumption, the amount spent on goods and services
Y = income, the amount available to spend
C = C(Y)
This is an example of a function that says the amount spent on consumption

depends on income. This is a very general form of the consumption function. In
order to use it economists must put it into a more precise mathematical form. For
example
C = 25 + .75Y
This is a function which says that consumption is 25 regardless of the level of

income and that for every extra dollar of income 75 cents are spent on
consumption.
The use of functional notation: some examples
Example 1
y = f(x) = 3x + 4
This is a function that says that, y, a dependent variable, depends on x, an

independent variable. The independent variable, x, can have different values.
When x changes y also changes.
Find f(0). This means find the value of y when x equals 0.
f(0) = 3 times 0 plus 4
f(0) = 3(0) + 4 = 4
Find f(1). This means find the value of y when x equals 1.
f(1) = 3 times 1 plus 4
f(1) = 3(1) + 4 = 7
Find f(-1). This means find the value of y when x equals -1.
f(-1) = 3 times (-1) plus 4
f(1) = 3(-1) + 4 = 1
Example 2
d(p) = p2 -20p + 125
This is a function that describes the demand for an item where p is the dollar price
per item. It says that demand depends on price.
Find the demand when one item costs $2.
d(2) = 22 - 20(2) + 125 = 89
Find the demand when one item costs $5.
d(5) = 52 - 20(5) + 125 = 50
Notice that, as we might expect, the demand declines as the price rises.
Example 3
Two or more functions can be added, subtracted, multiplied or divided.
g(x) = x - 3 h(x) = x2 + 2
Find g(0) + h(0)
g(0) = 0 - 3 = -3
h(0) = 02 + 2 = 2
g(0) + h(0) = -3 + 2 = -1
Find g(1) h(2)
g(1) = 1 - 3 = -2
h(2) = 22 + 2 = 6
g(1) h(2) = (-2) ( 6) = -12

Problem Set
Functional Notation
HIDE SOLUTIONS
1. f(x) = x2 + 5x –24
a. Find f(0)
Answer:
f(0) = (0)2 + 5(0) –24 = -24
b. Find f(-1)
Answer:
f(-1) = (-1)2 + 5(-1) –24 = -28
c. Find f(3)
Answer:
f(3) = (3)2 + 5(3) –24 = 0
2. f(x) = 3x2 –4
a. Find f(0)
Answer:
f(0) = 3(0)2 –4 = -4
b. Find f(-1)
Answer:
f(-1) = 3(-1)2 –4 = -1
c. Find f(1)
Answer:
f(1) = 3(1)2 –4 = -1
d. Find f(.5)
Answer:
f(.5) = = (.5)2 –4 = -3.25
3. Consider the following demand function:
d(p) = p2 –20p + 125
a. find d(2)
Answer:
d(2) = 22 –20(2) + 125 = 89
b. find d(5)
Answer:
d(5) = 52 –20(5) + 125 = 50
c. find d(8)
Answer:
d(8) = 82 –20(8) + 125 = 29
d. find d(10)
Answer:
d(10) = 102 –20(10) + 125 = 25
4.
a. find f(4)
Answer:
b. find f(6)
Answer:
c. find f(15)
Answer:
5. f(x) = x – 3 and g(x) = x2 + 2
a. find f(0) + g(0)
Answer:
f(0) + g(0) = (1-3) + (02 + 2) = -1
b. find [f(1)] [g(2)]
Answer:
[f(1)] [g(2)] = [1 – 3] [22 + 2] = -12
6.
a. Find f(2)
Answer:
b. Find f(0)
Answer:
c. Find f(-4)
Answer:
7. A firm spends x dollars on product development and y dollars on advertising.

Its profit is described by the following relationship:
a. What is profit if the firm spends $2,000 on product development and $5,000 on
advertising?
b. What is profit if the firm spends $10,000 on product development and $8,000 on
advertising?
Solution:
a.
Profit is $366,000.
b.
Profit is $1,476,000.
Graphs of Two Variable Functions
Many types of economic problems require that we consider two variables at the
same time. A typical example is the relation between price of a commodity and the
demand or supply of that commodity. The relation can be described algebraically
by a two variable function or equation. But it is often useful to represent the
relation in a two-dimensional graph. Such a graph is known as a scatter diagram.
This is a useful device because if there is a simple relationship between the two
variables, it is readily observable once the data are plotted. As the proverb says, “a
picture is worth a thousand words.”
To represent a function graphically we use two perpendicular lines called axes.

Their point of intersection is called the origin. This method of representation is
called the Cartesian coordinate system or plane. The numerical value of one
variable is measured along the bottom or horizontal axis. The horizontal axis is
called the x axis. The numerical value of the other variable is measured along the
side or vertical axis. The vertical axis is called the y axis. The four sections into
which the graph is divided are called quadrants. Units of length are indicated along
the two axes.
Note that there are four quadrants. If x is positive we move to the right. If x is
negative we move to the left. If y is positive we move up. If y is negative we move
down.
Coordinates
Coordinates allow us to look at the relationship between pairs of numbers and

points in the plane. Coordinates give the location of a point, P, in relation to the
origin.
We have an x coordinate and a y coordinate.
Let (x, y) represent the point whose coordinates are the numbers x and y. Note that
the x coordinate comes first. The two coordinates tell us how far we must go first
along the x axis and then along the y axis until the point is reached.
Plotting coordinates: some examples
Example 1
Find the following points
point a (2, 4)
point b (4,-6)
point c (-2,-6)
point d (-6, 2)
Example 2
p = the price per dollar of a crate of vegetables

f(p) = the supply in thousands of crates
A store manager has the following data which relate the price of a crate of
vegetables to the supply:
price 4 6 8 10 14
supply 2 14 23 27 29
What do the data tell us? The graph shows that as we might expect an increase in
price is associated with an increase in supply.
Summation Notation
Often mathematical formulae require the addition of many variables Summation or

sigma notation is a convenient and simple form of shorthand used to give a concise
expression for a sum of the values of a variable.
Let x1, x2, x3, …xn denote a set of n numbers. x1 is the first number in the set.
xi represents the ith number in the set.
Summation notation involves:
The summation sign

This appears as the symbol, , which is the Greek upper case letter, S. The
summation sign, , instructs us to sum the elements of a sequence. A typical
element of the sequence which is being summed appears to the right of the
summation sign.
The variable of summation, i.e. the variable which is being summed

The variable of summation is represented by an index which is placed beneath the
summation sign. The index is often represented by i. (Other common possibilities
for representation of the index are j and t.) The index appears as the expression i =
1. The index assumes values starting with the value on the right hand side of the
equation and ending with the value above the summation sign.
The starting point for the summation or the lower limit of the summation
The stopping point for the summation or the upper limit of summation
Some typical examples of summation
This expression means sum the values of x, starting at x1 and ending with xn.
This expression means sum the values of x, starting at x1 and ending with x10.
This expression means sum the values of x, starting at x3 and ending with x10.
The limits of summation are often understood to mean i = 1 through n. Then the notation
below and above the summation sign is omitted. Therefore this expression means sum the
values of x, starting at x1 and ending with xn.
This expression means sum the squared values of x, starting at x1 and ending with xn.
Arithmetic operations may be performed on variables within the summation.

For example:
This expression means sum the values of x, starting at x1 and ending

with xn and then square the sum.
Arithmetic operations may be performed on expressions containing more than

one variable. For example:
This expression means form the product of x multiplied by y, starting at x1 and y1 and
ending with xn and yn and then sum the products.
In this expression c is a constant, i.e. an element which does not involve the
variable of summation and the sum involves n elements.
Problems
Data
i xi
1 1
2 2
3 3
4 4
1. Find
2. Find
Data
i xi
1 -1
2 3
3 7
and c which is a constant = 11
3. Find
4. Find
5. Find
Data
i xi yi
1 10 0
2 8 3
3 6 6
4 4 9
5 2 12
6. Find
7. Find
8. Find
9. Find
Greek Symbols
Letters of the Greek alphabet are often used in mathematics.
Some of the letters commonly used and their pronunciation are as follows
Lower case Upper case
 alpha
 beta
 gamma  gamma
 delta  delta
 epsilon
 eta
 theta
 lambda  lambda
 mu
 omicron
 pi  pi
 rho
 sigma  sigma
 tau
 phi
Linear Functions
The linear function is popular in economics. It is attractive because it is simple and

easy to handle mathematically. It has many important applications.
Linear functions are those whose graph is a straight line.
A linear function has the following form
y = f(x) = a + bx
A linear function has one independent variable and one dependent variable. The
independent variable is x and the dependent variable is y.
a is the constant term or the y intercept. It is the value of the dependent variable
when x = 0.
b is the coefficient of the independent variable. It is also known as the slope and
gives the rate of change of the dependent variable.
Graphing a linear function
To graph a linear function:
1. Find 2 points which satisfy the equation
2. Plot them
3. Connect the points with a straight line
Example:
y = 25 + 5x
let x = 1
then
y = 25 + 5(1) = 30
let x = 3
then
y = 25 + 5(3) = 40
A simple example of a linear equation
A company has fixed costs of $7,000 for plant and equipment and variable costs of
$600 for each unit of output.
What is total cost at varying levels of output?
let x = units of output

let C = total cost
C = fixed cost plus variable cost = 7,000 + 600 x
output total cost

15 units C = 7,000 + 15(600) = 16,000
30 units C = 7,000 + 30(600) = 25,000
Combinations of linear equations
Linear equations can be added together, multiplied or divided.
A simple example of addition of linear equations
C(x) is a cost function
C(x) = fixed cost + variable cost
R(x) is a revenue function
R(x) = selling price (number of items sold)
profit equals revenue less cost
P(x) is a profit function
P(x) = R(x) - C(x)
x = the number of items produced and sold
Data:
A company receives $45 for each unit of output sold. It has a variable cost of $25
per item and a fixed cost of $1600.
What is its profit if it sells (a) 75 items, (b)150 items, and (c) 200 items?
R(x) = 45x C(x) = 1600 + 25x

P(x) = 45x -(1600 + 25x)
= 20x - 1600
P(75) = 20(75) - 1600 = -100 a
let x = 75
loss
let x = 150 P(150) = 20(150) - 1600 = 1400
let x = 200 P(200) = 20(200) - 1600 = 2400
Problem Set
Graphing Linear Functions
HIDE SOLUTIONS
1. Graph the function 3x + 2y = -4
Solution:
Step 1. Rewrite in the form y = a + bx and simplify
Step 2. Find a set of points which satisfy the equation and plot them.
let x = 0 then
let x = 2 then
let x = -2 then
2. Graph the function 2x –y = -1
Solution:
Step 1. Rewrite in the form y = a + bx and simplify
y = 1 + 2x
Step 2. Find a set of points which satisfy the equation and plot them.
let x = 0
let x = 2
let x = 1
3. A copy shop can produce a course reader at a cost of $25 per copy. The monthly
fixed costs are $10,000.
a. Determine the total monthly cost as a function of the number of copies
produced.
b. Graph the total monthly cost function.
Solution:
a. Total cost = fixed cost + variable cost
C(q) = 10,000 + 25 q
b. Find a set of points which satisfy the equation and plot them
q C(q)
0 10,000
100 12,500
500 22,500
1,000 35,000
4. A chemical plant was found to be discharging toxic waste into a waterway. The
state in which the chemical plant was located fined the company $125,000 plus
$1,000 per day for each day on which the company continued to violate water
pollution regulation.
a. Express the total fine as a function of the number of days in which the company
remains in non-compliance.
b. Graph the relationship.
Solution:
a. Let d = the number of days in which the company remains in non-compliance
f(d) = 125,000 + 1000d
b. Find a set of points which satisfy the equation and plot them
d f(d)
0 125,000
1 126,000
5 130,000
10 135,000
Slope of Linear Functions
The concept of slope is important in economics because it is used to measure the

rate at which changes are taking place. Economists often look at how things
change and about how one item changes in response to a change in another item.
It may show for example how demand changes when price changes or how
consumption changes when income changes or how quickly sales are growing.
Slope measures the rate of change in the dependent variable as the independent
variable changes. The greater the slope the steeper the line.
Consider the linear function:
y = a + bx
b is the slope of the line. Slope means that a unit change in x, the independent
variable will result in a change in y by the amount of b.
slope = change in y/change in x = rise/run
Slope shows both steepness and direction. With positive slope the line moves
upward when going from left to right. With negative slope the line moves down
when going from left to right.
If two linear functions have the same slope they are parallel.
Slopes of linear functions
The slope of a linear function is the same no matter where on the line it is
measured. (This is not true for non-linear functions.)
An example of the use of slope in economics
Demand might be represented by a linear demand function such as
Q(d) = a - bP
Q(d) represents the demand for a good
P represents the price of that good.
Economists might consider how sensitive demand is to a change in price.
This is a typical downward sloping

demand curve which says that demand
declines as price rises.
This is a special case of a horizontal

demand curve which says at any price
above P* demand drops to zero. An
example might be a competitor's product
which is considered just as good.
This is a special case of a vertical demand

curve which says that regardless of the
price quantity demanded is the same. An
example might be medicine as long as the
price does not exceed what the consumer
can afford.
Supply might be represented by a linear supply function such as
Q(s) = a + bP
Q(s) represents the supply for a good
P represents the price of that good.
Economists might consider how sensitive supply is to a change in price.

This is a typical upward sloping supply
curve which says that supply rises as
price rises.
An example of the use of slope in economics
The demand for a breakfast cereal can be represented by the following equation
where p is the price per box in dollars:
d = 12,000 - 1,500 p
This means that for every increase of $1 in the price per box, demand decreases by
1,500 boxes.
Calculating the slope of a linear function
Slope measures the rate of change in the dependent variable as the independent
variable changes. Mathematicians and economists often use the Greek capital letter
D or  as the symbol for change. Slope shows the change in y or the change on the
vertical axis versus the change in x or the change on the horizontal axis. It can be
measured as the ratio of any two values of y versus any two values of x.
Example 1
Find the slope of the line segment connecting the following points:
(1,1) and (2,4)
x1 = 1 y1 = 1
x2 = 2 y2 = 4
Example 2
(-1,-2) and (1,6)
x1 = -1 y1 = -2
x2 = 1 y2 = 6
Example 3
(-1,3) and (8,0)
x1 = -1 y1 = 3
x2 = 8 y2 = 0
Problem Set
Slope of a Linear Function
HIDE SOLUTIONS
1. Find the slope of the following line:
y = 3x
Answer: slope is 3.
2. Find the slope of the following line:
5y – 3x = 4
Answer: slope is 3/5
Solution
Rewrite in the form y = a + bx
3. Find the slope of the line segment connecting the following points:
(3,-1) and (-2,5)
Answer: slope is –1.20
x1 = 3 y1 = 1
x2 = - 2 y2 = 5
(-1,-1) and (1,3)
Answer: slope is 2
x1 = -1 y1 = -1
x2 = 1 y2 = 3
(-4,2) and (1,2)
Answer: slope is 0. The line is horizontal.
x1 = -4 y1 = 2
x2 = 1 y2 = 2
(-3,3) and (-3,-2)
Answer: slope is infinite. The line is vertical.
x1 = -3 y1 = 3
x2 = -3 y2 = -2
Intercepts of a Linear Equation
The x intercept is the point where the line
x intercept
crosses the x axis. At this point y = 0.
The y intercept is the point where the line
y intercept
crosses the y axis. At this point x = 0.
Consider the following equation:
6x +3y = 18
To find the x intercept set y = 0.
6x + 3(0) = 18
6x = 18
x 3 The x intercept is (3,0)
To find the y intercept set x = 0.
6(0) +3y = 18
3y = 18
y = 6 The y intercept is (0,6)
Slope Intercept Form of a Linear Equation
The slope intercept form of a linear equation has the following form where the
equation is solved for y in terms of x:
y = a + bx
b is the slope
a is a constant term. It is the y intercept, the place where the line crosses the y
axis.
Example 1
y = -13 + 7x
This equation is in slope intercept form. The y intercept is (0,-13) and the slope is
7.
Example 2
4x + 3y = 12
Rewrite this equation in slope intercept form.
3y = 12 - 4x
The equation is now in slope intercept form. The y intercept is (0,4) and the slope
is -4/3.
Example 3
5x - 3y - 15 = 0
Rewrite this equation in slope intercept form.
3y = -15 + 5x
The equation is now in slope intercept form. The y intercept is (0,-5) and the slope
is
5/3.
Example 4
The equation is now in slope intercept form. The y intercept is (0,-7.5) and the
slope is
1.5.
Finding the Equation of a Line
To write the equation of a line it is necessary to know the slope and the y intercept.
There are three possibilities which depend on the data available.
Possibility 1
In this case both the slope and the y intercept are known and the equation can be
written directly.
For example if the slope is -2 and the y intercept is (0,6), then the equation is
y = 6 - 2x
Possibility 2
In this case the slope and one set of coordinates are known. This case involves the
use of the point-slope formula.
The point-slope formula
Here in the final term x1 and y1 are known coordinates and x and y are unknown
coordinates. Therefore the slope can be given as:
This expression is the point-slope formula. It can be

rearranged to produce a working version.
y - y1 = b (x - x1)
y = y1 + b (x - x1)
Example
Find the equation of the line which has a slope of 4 and a set of coordinates (3,-2).
Here x1 = 3 and y1 = -2.
y = y1 + b (x - x1)
y = -2 + 4(x-3)
y = -2 + 4x -12
y = -14 + 4x
Possibility 3
In this case two sets of coordinates are known but the slope is not known. This case
involves the use of the two-point formula. Since the slope of a linear function is the
same at any point on the line we may set an expression for the value of the slope at
one point equal to the value of the slope at any other point.
This expression is the two-point formula.
Example
Find the equation of the line which passes through the points (-2,3) and (3,8).
x1 = -2 y1 = 3
x2 = 3 y2 = 8
Problem Set
Equation of a Line
HIDE SOLUTIONS
1. Find the equation of the line which passes through the points (5,1) and has a
slope of .5.
y = y1 + b (x - x1)
y = 1 + .5(x-5)
y = 1 + .5x – 2.5
y = -1.5 + .5x
2. Find the equation of the line which passes through the points (2,0) and has a
slope of 1.
y = y1 + b (x - x1)
y = 0 + 1(x-2)
y = x-2
y = -2 + x
3. Find the equation of the line which passes through the points (5, -2) and has a
slope of -.5.
y = y1 + b (x - x1)
y = -2 + -.5(x-5)
y = -2 - .5x + 2.5
y = .5 - .5x
4. Find the equation of the line which passes through the points ( 3, -2) and (1, 5).
involves the use of the two-point formula. Since the slope of a linear function is
the same at any point on the line we may set an expression for the value of the
slope at one point equal to the value of the slope at any other point.
x1 = 3 y1 = -2
x2 = 1 y2 = 5
5. Find the equation of the line which passes through the points ( 1,0) and (0,1).
involves the use of the two-point formula. Since the slope of a linear function is
the same at any point on the line we may set an expression for the value of the
slope at one point equal to the value of the slope at any other point.
x1 = 1 y1 = 0
x2 = 0 y2 = 1
Applications of Linear Functions
Simple interest
With simple interest, interest is earned (charged) only on the amount lent
(borrowed).
P = principal
the amount lent or borrowed
i = the interest rate
n = the number of years
A = the future value

the amount received or due at the end of n years
i(n)(P) = interest on lending or borrowing
A = P + P (i) (n)
A = P [1+(i)(n)] The P is factored out.
Example 1
$12,000 is borrowed at a rate of 9 %. How much is owed after n years?
A = 12,000 (1+.09n)
The independent variable is n, the length of the loan. The dependent variable is A,
the amount which must be repaid.
Example 2
You borrow $3,200 and want to pay it back in a lump sum after 4 years. How
much will you have to pay if you are being charged 8% simple interest?
A = 3,200 [1+.08(4)]
A = 4,224
How much will you have to pay if you are being charged 10 % simple interest?
A = 3,200 [1+.10(4)]
A = 4,480
Systems of Linear Equations
Often it is necessary to look at several functions of the same independent variable.

Consider the prior example where x, the number of items produced and sold, was
the independent variable in three functions, the cost function, the revenue function,
and the profit function.
In general there may be:
n equations
v variables
Solving systems of equations
There are four methods for solving systems of linear equations:
a. graphical solution
b. algebraic solution
c. elimination method
d. substitution method
Graphical solution
Example 1
given are the two following linear equations:
f(x) = y = 1 + .5x
f(x) = y = 11 - 2x
Graph the first equation by finding two data points. By setting first x and then y
equal to zero it is possible to find the y intercept on the vertical axis and the x
intercept on the horizontal axis.
If x = 0, then f(0) = 1 + .5(0) = 1
If y = 0, then f(x) = 0 = 1 + .5x
-.5x = 1
x = -2
The resulting data points are (0,1) and (-2,0)
Graph the second equation by finding two data points. By setting first x and then
y equal to zero it is possible to find the y intercept on the vertical axis and the x
If x = 0, then f(0) = 11 - 2(0) = 11
If y = 0, then f(x) = 0 = 11 - 2x
2x = 11
x = 5.5
The resulting data points are (0,11) and (5.5,0)
At the point of intersection of the two equations x and y have the same values.
From the graph these values can be read as x = 4 and y = 3.
Example 2

f(x) = y = 15 - 5x
f(x) = y = 25 - 5x
Graph the first equation by finding two data points. By setting first x and then y
If x = 0, then f(0) = 15 - 5(0) = 15
If y = 0, then f(x) = 0 = 15 - 5x
5x = 15
x = 3
The resulting data points are (0,15) and (3,0)
Graph the second equation by finding two data points. By setting first x and then y
If x = 0, then f(0) = 25 - 5(0) = 25
If y = 0, then f(x) = 0 = 25 - 5x
5x = 25
x = 5
The resulting data points are (0,25) and (5,0)
From the graph it can be seen that these lines do not intersect. They are parallel.
They have the same slope. There is no unique solution.
Example 3
21x - 7y = 14
-15x + 5y = -10
Rewrite the equations by putting them into slope intercept form.
The first equation becomes
7y = -14 + 21x
y = -2 + 3x
The second equation becomes
5y = -10 + 15x
y = -2 + 3x
Graph either equation by finding two data points. By setting first x and then y
If x = 0, then f(0) = -2 +3(0) = -2
If y = 0, then f(x) = 0 = -2 + 3x
3x = 2
x = 2/3
The resulting data points are (0,-2) and (2/3,0)
From the graph it can be seen that these equations are equivalent. There are an
infinite number of solutions.
Algebraic solution
This method will be illustrated using supply and demand analysis. This type of
analysis is derived from the work of the great English economist Alfred Marshall.
Q = quantity and P = price
P (s)= the supply function and P (d) = the demand function
When graphing price is placed on the vertical axis. Thus price is the dependent
variable. It might be more logical to think of quantity as the dependent variable
and this was the approach used by the great French economist, Leon Walras.
However by convention economists continue to graph using Marshall’s analysis
which is referred to as the Marshallian cross.
The objective is to find an equilibrium price and quantity, i.e. a solution where
price and quantity will have the same values in both the supply function and the
price function.
QE = the equilibrium quantity PE = the equilibrium price
For equilibrium
supply = demand
or P (s) = P (d)
Given the following functions
P (s) = 3Q + 10 and P (d) = -1/2Q + 80
Set the equations equal to each other and solve for Q.
P (s) = 3Q + 10 = -1/2Q + 80 = P (d)
3.5Q = 70
Q = 20 The equilibrium quantity is 20.

Substitute this value for Q in either equation and solve for P.
P (s) = 3(20) + 10
P (s) = 70
P (d) = -1/2(20) + 80
P (d) = 70 The equilibrium price is 70.
Elimination method
This method involves removing variables from the equations. Variables are
removed successively until only a single last variable is left, i.e. until there is one
equation with one unknown. This equation is then solved for the one unknown.
The solution is then used in finding the second to last variable. The procedure is
repeated by adding back variables as their solutions are found.
Example 1
2x + 3y = 5
-5x - 2y = 4
Procedure: eliminate y. The coefficients of y are not the same in the two equations
but if they were it would possible to add the two equations and the y terms would
cancel out. However it is possible through multiplication of each equation to
force the y terms to have the same coefficients in each equation.
Step 1: Multiply the first equation by 2 and multiply the second equation by
3. This gives
4x + 6y = 10
-15x - 6y = 12
Step 2: Add the two equations. This gives
-11x = 22
x = -2
Step 3: Solve for y in either of the original equations
2(-2) + 3y = 5
3y = 9
y = 3 or
-5(-2) - 2y = 4
10 - 2y = 4
2y = 6
y = 3
Alternate Procedure: eliminate x. The coefficients of x are not the same in the two
equations but if they were it would possible to add the two equations and the y
terms would cancel out. However it is possible through multiplication of each
equation to force the x terms to have the same coefficients in each equation.
Step 1: Multiply the first equation by 5 and multiply the second equation by
2. This gives
10x + 15y = 25
-10x - 4y =8
Step 2: Add the two equations. This gives
11y = 33
y = 3
Step 3: Solve for x in either of the original equations
2x + 3(3) = 5
2x = -4
x = -2 or
-5x - 2(3) = 4
- 5x = 10
x = -2
Example 2
2x1 + 5x2 + 7x3 = 2
4x1 - 4x2 - 3x3 = 7
3x1 - 3x2 - 2x3 = 5
In this example there are three variables: x1, x2, and x3. One possible procedure is
to eliminate first x1, to eliminate next x2, and then to solve for x3. The value
obtained for x3 is used to solve for x2and finally the values obtained for x3 and
x2 are used to solve for x1.
Procedure Part A First eliminate x1.
Step 1 Multiply the first equation by 2 and subtract the second equation
from the first equation. This gives
4x1 + 10x2 + 14x3 = 4 first equation
4x1 - 4x2 - 3x3 = 7 second equation
14x2 + 17x3 = -3 second equation subtracted

from the first
Step 2 Multiply the first equation by 3, multiply the third equation by 2,

and subtract the third equation from the first equation. This gives
6x1 + 15x2 + 21x3 = 6 first equation
6x1 - 6x2 - 4x3 = 10 third equation
21x2 + 25x3 = -4 third equation subtracted from

the first
Procedure Part B Second eliminate x2. From Part A there are two equations
left. From these two equations eliminate x2.
14x2 + 17x3 = -3 first equation
21x2 + 25x3 = -4 second equation
Step 1 Multiply the first equation by 21, multiply the second equation by
14. and subtract the second equation from the first equation. This gives
294x2 + 357x3 = -63 first equation
294x2 + 350x3 = -56 second equation
7x3 = -7 second equation subtracted

from first
x3 = -1
Part C Solve for x2 by inserting the value obtained for x3 in either equation
from Part B.
14x2 + 17(-1) = -3
1 4x2 = 14
x2 = 1 or
21x2 + 25(-1) = -4
21x2 = 21
x2 = 1
Part D Solve for x1 by inserting the values obtained x2 andx3 in any of the
three original equations.
2x1 + 5x2 + 7x3 = 2 first original equation
2x1 + 5(1) + 7(-1) = 2
2x1 = 4
x1 = 2 or
4x1 - 4x2 - 3x3 = 7 second original equation

4x1 - 4(1) - 3(-1) = 7
4x1 = 8
x1 = 2 or
3x1 - 3x2 - 2x3 = 5 third original equation
3x1 - 3(1) -2(-1) = 5
3x1 = 6
x1 = 2
Substitution method
This involves expressing one variable in terms of another until there is a single
equation in one unknown. This equation is then solved for that one unknown. The
result is then used to solve for the variable which was expressed in terms of the
variable whose solution has just been found.
Example
12x - 7y = 106 first equation
8x + y = 82 second equation
Solve the second equation for y and then substitute the value obtained for y
in the first equation.
y = 82 - 8x second equation solved for y
12x - 7(82 – 8x) = 106 first equation rewritten in terms of x
12x - 574 +56x = 106
68x = 680
x = 10
Substitute the value obtained for x in either of the original equatioins.
12x - 7y = 106 first equation
12(10) - 7y = 106
7y = 14
y = 2
8(10) + y = 82 second equation
y = 2
Problem Set
Solving Systems of Linear Equations
HIDE SOLUTIONS
1. Solve the following system of equations by elimination.
Answer: x = .5; y = 1.67
Solution:
Rewrite in order to align the x and y terms
Add the second equation to the first equation and solve for x.
Substitute the value obtained for x into either of the original equations.
or
Answer: x = -2; y = 5
Solution:
Multiply the first equation by 2.
Subtract the first equation from the second equation and solve for y.
Substitute the value obtained for y into either of the original equations.
or
1st original equation
2nd original equation
3rd original equation
Answer: x1 = 2; x2 = 1; x3 = -2
Solution:
Part A First eliminate x3.
Step 1. Add the 1st original equation and the 3rd original equation.
+
=
Step 2. Multiply the 2nd original equation by 2, multiply the 3rd original equation
by 5 and add the 2nd original equation to the 3rd original equation.
Part B. From Part A there are two new equations.
1st new equation
2nd new equation
Step 1. Multiply the 1st new equation by 7, subtract the second new equation from
the first new equation, and solve for x2.
Part C. Solve for x1 by substituting the value received for x2 in either of the new
equations in Part B.
1st new equation
or
2nd new equation
Part D. Solve for x3 by substituting the values obtained for x1 and x2 in any of the
original equations.
1st original equation
or
2nd original equation
or
3rd original equation
4. A manufacturer produces two items which are sold at prices of p1 dollars and
p2 dollars each. The supply and demand functions in units for the items are as
follows:
P(s1) = the supply function for the first item.
P(d1) = the demand function for the first item.

P(s2) = the supply function for the second item.
P(d2) = the demand function for the second item.
How should prices be set for each item to equate supply and demand? What are
the equilibrium quantities for each item?
Answer: The price of the first item should be set at $1.80 and the price of the
second item should be set at $1.50. The equilibrium quantity for the first item is
82 units and the equilibrium quantity for the second item is 181 units.
Solution:
Part A.
Step 1. Set the supply function for item 1 equal to the demand function for item 1
and collect terms.
P(s1) = P(d1)
Step 2. Set the supply function for item 2 equal to the demand function for item 2
and collect terms.
P(s2) = P(d2)
Part B. From Part A the following system of equations has been obtained.
Solve this system for the prices by elimination.
1st equation from Part A
2nd equation from part A

Step 1. Multiply the 1st equation by 7 ,add the 1st and second equations, and solve
for p1.
Step 2 . Substitute the value obtained for p1 in either equation from Part A and
solve for p2.
1st equation from Part A
or
2nd equation from part A
Part C. Determine equilibrium for each item by substituting the prices obtained in
Part B in either the demand function or the supply function.
For item 1
or
For item 2
or
Non-Linear Functions
Often in economics a linear function cannot explain the relationship between variables. In
such cases a non-linear function must be used. Non-linear means the graph is not a straight
line. The graph of a non-linear function is a curved line. A curved line is a line whose
direction constantly changes.
A cautionary note: Economists are accustomed to designate all lines in graphs as curves -
both straight lines and lines which are actually curved.
Although the slope of a linear function is the same no matter where on the line it is measured,
the slope of a non-linear function is different at each point on the line. Thus there is no single
slope for a non-linear function. However the slope can be determined at any point on the
line. The techniques of differential calculus are used to determine the slopes of non-linear
functions.
Three non-linear functions commonly used in economics are
 the exponential function

 the quadratic function
 the logarithmic function
Exponents
What are exponents? Exponential notation is a form of mathematical shorthand

which allows us to write complicated expressions more succinctly. An exponent is
a number or letter written above and to the right of a mathematical expression
called the base. It indicates that the base is to be raised to a certain power. x is the
base and n is the exponent or power.
Definition: If x is a positive number and n is its exponent, then xn means x is

multiplied by itself n times.
Examples:
32 = 3 x 3
35 = 3 x 3 x 3 x 3 x 3
Rules of exponents
Problem Set
Laws of Exponents
SHOW SOLUTIONS
Simplify the following expressions using the rules of exponents;
1.
2.
3.
4.
5.
6.
7.
8.
Problem Set
Laws of Exponents
HIDE SOLUTIONS
Simplify the following expressions using the rules of exponents;
1.
answer
2.
answer
3.
answer
4.
answer
5.
answer
6.
answer
7.
answer
8.
answer
Logarithms
A logarithm is an exponent. A logarithm is an exponent which indicates to what power a base must
be raised to produce a given number.
y = bx exponential form
x = logb y logarithmic form
x is the logarithm of y to the base b
logby is the power to which we have to raise b to get y
We are expressing x in terms of y
Examples
x = logb y
x = log2 8 This means the logarithm of 8 to the base 2. It is the exponent

to which 2 must be raised to get 8. We know that 2(2)(2) = 8.
Therefore x = 3.
x = log6 36 This means the logarithm of 36 to the base 6. It is the exponent

to which 6 must be raised to get 36. We know that 6(6) = 36.
Therefore x = 2.
x = log10 10,000 This means the logarithm of 10,000 to the base 10. It is the
exponent to which 10 must be raised to get 10,000. We know
that 10(10)(10)(10) = 10,000. Therefore x = 4.
log b b = 1 The logarithm of any number to the same base equals 1.
x = log 11 11 This means the logarithm of 11 to the base 11. It is the exponent
to which 11 must be raised to get 11. We know that 1 (1) = 11.
Therefore x = 1.
log b 1 = 0 The logarithm of 1 always equals 0.
Any number can serve as b, the base.
Common (Briggsian) logarithms The base is 10.

Logarithms to the base 10 are widely used. Thus it is common to drop the
subscript. If the base does not appear it is understood that the base is 10.
log10 y = log y
Natural (Naperian) logarithms The base is e.

Remember e is the irrational number where e = 2.71828... The symbol "ln" refers
to natural logarithms.
loge x = ln x ln x is the exponent to which e must be raised to get x.
Why do we want to use logarithms? To simplify calculations in many cases.
Rules for logarithms

Product rule
Quotient rule
Power rule This rule is useful because it allows us to solve

equations where the variable is an exponent.
Exponential and Logarithmic Functions are inverse functions

Consider the following tables and the associated graphs:
x f(x) = ex x f(x)= ln x
0 1 1 0
1 2.7 2.7 1
2 7.39 7.39 2
3 20 20 3
Problem Set
Logarithms
SHOW SOLUTIONS
1. Change the following equations from exponential to logarithmic form.
a.
b.
c.
d.
e.
f.
g.
2. Change the following equations from logarithmic to exponential form and solve
for x..
a.
b.
c.
d.
e.
f.
g.
3. Solve the following expressions.
a.
b.
Problem Set
Logarithms
HIDE SOLUTIONS
1. Change the following equations from exponential to logarithmic form.
a.
answer:
b.
answer:
c.
answer:
d.
answer:
e.
answer:
f.
answer:
g.
answer
2. Change the following equations from logarithmic to exponential form and solve
for x..
a.
answer:
b.
answer:
c.
answer:
d.
answer:
e.
answer:
f.
answer:
g.
answer:
3. Solve the following expressions.
a.
answer:
b.
answer:
The Exponential Function
The exponential function has the form:
F(x) = y = abx
where a  0 and b is a constant called the base of the exponential function. b > 0 and b  1
x is the independent variable. It is the exponent of the constant, b. Thus exponential functions have
a constant base raised to a variable exponent
In economics exponential functions are important when looking at growth or decay. Examples are
the value of an investment that increases by a constant percentage each period , sales of a company
that increase at a constant percentage each period, models of economic growth or models of the
spread of an epidemic.
Notice that as the value of x increases, the value of y increases or decreases more and more rapidly.
Examples of the exponential function

Applications of exponential functions
An exponential demand function
Demand for a product in thousands of units can be expressed by the following exponential demand
function where p is the price in dollars:
Compound interest - The time value of money
Financial decision making, whether by the private sector, the government or by households requires
the evaluation of whether an expenditure is justified by the benefits it is expected to confer. The
investment decision involves acquiring something in the expectation that it will be worth more in
the future. In financial terms this means purchasing an asset or assets which will provide future
income. Typically the expenditure and the benefits occur at different points in time. Therefore sums
of money occurring at different dates must be compared.
Examples of investment income include
 earnings of a business
 revenues from a toll road
 rent from property
 interest on a bond
 dividends or capital gains from stock
The investment decision is the acquisition of a productive asset.
expenditure receipt(s)
outflow inflow(s)
The cash outflow is the expenditure of money in the present because of the
expectation of the receipt of money in the future.
The cash inflow is the receipt of money in a future period or periods.

If the expected future inflow is greater than the present outflow then there is the
expectation of a positive return which favors making the investment decision.
Therefore the analysis of investment requires comparison of outflows with
expected inflows.
Problem The expenditure and the expected receipts occur at different periods In
time. Values of different periods are different values. A value received in the
future is not equivalent to a value received in the present. Values occurring at
different points in time cannot be immediately compared nor aggregated.
Solution It is necessary to get a standardized unit of measurement. The values of

all the different periods must be transformed into units of standardized value.
They must be brought to the same point in time and then they can be compared and
aggregated.
Thus to analyze an investment the cash outflows and the expected future receipts must be
transformed into units of standardized value and then compared. Then if the inflows are greater
than the outflows the investment has a positive rate of return and should be accepted.
Why does this problem exist? An amount received in the future is not equivalent to an amount held
in the present because money, if invested at some rate of interest, grows to a larger amount. The
interest rate is the rate at which an individual or an entity is compensated for exchanging money
held in the present for money to be received at a future date. Thus money has a time value and this
value is called interest.
The standardization process: transforming values of different periods into values of the same
period
Compounding Compounding means converting values of the present into values

of the future. It involves movement forward in time. Compounding finds future
values. Compounding is used to find values at the ending point of an analysis.
Discounting Discounting means converting values of future periods to values of

the present period. It involves movement backward in time. Discounting finds
present values. Discounting is used to find values at the beginning point of an
analysis.
Although the two procedures always yield the same decision, the discounting process is more
commonly used for financial decision making.
Notation
PV Present value
a value at time = 0
FV Future value
a value in some future period
the beginning amount plus accumulated compound interest
because the future has an infinite number of periods, these

periods are distinguished from each other by the use of subscripts.
FV1 = the value at the end of the first period
FV2 = the value at the end of the second period
FVn = the value at the end of the nth period
It is important to note that in the future value notation, the future values are understood to occur at
the end rather than at the beginning of the relevant future period. The standard financial tables,
financial calculators, and the spreadsheet Excel are all constructed with this understanding.
r the interest rate per period
the discount rate
n the number of periods in the analysis
Note In finance discounting is the procedure for calculating present values. However in retailing
discounting is the procedure of reducing selling price in order to increase sales.
Future Values and compounding (single payments)

Compounding is the process of converting values of the present to values of the future.
We begin with present value.
What do we have at the end of the first period, i.e. what is FV1?
At the end of the first period we have our initial value, PV, plus the interest earned on that initial
value, rPV.
FV1 = PV + rPV
FV1 = PV (1+r)
What do we have at the end of the second period, i.e. what is FV2?
We begin the second period with FV1.
At the end of the second period we have what we began with, FV1, plus the interest earned on FV1.
FV2 = FV1 + r FV1
FV2 = FV1 (1+r)
FV2 = PV (1+r) (1+r)
FV2 = PV (1+r)2
If we continued to calculate future values for all future periods we would note the subscript for the
relevant future period is the same numerical value as the exponent for the expression (1+r).
It is thus possible to find a general expression for any future value
FVn = PV (1+r)n This is an exponential function of the form

y = a bn where PV = a and (1 + r) = b
In this expression the future value is determined by the value of r, the interest rate, and n, the time
period. Financial tables have been constructed for many possible values of r and n. The expression,
(1+r)n, is known as the future value interest factor for a single payment, FVIFr,n where r is the
interest rate and n is the number of periods.
Examples
1. Deposit 100 and leave it for twenty periods in an account which earns 4 percent per period. How
much will be in the account at the end of twenty periods?
FV20 = ?
FV20 = 100 (1.04)20
FV20 = 100 (2.1911)
FV20 = 219.11
2. Invest 2,000 in stock whose expected annual rate of return is 8 percent. How much will you
have at the end of ten years?
FV10 = ?
FV10 = 2,000 (1.08)10
FV10 = 2,000 (2.1589)

FV10 = 4,317.80
Present Values and discounting (single payments)
Discounting is the process of converting expected future values to present values.
We begin with a future value.
FVn = PV (1+r)n
PV = FV (PVIF n,r)
In this expression the present value is determined by the value of r, the interest rate, and n, the
time period. Financial tables have been constructed for many possible values of r and n. The
expression, in square brackets, is known as the present value interest factor for a single payment,
PVIF r,n where r is the interest rate and n is the number of periods. Note that the present value
interest factor for a single payment is the inverse of the future value interest factor.
Examples
1. A financial instrument is expected pay 5,000 in ten years. The interest rate available today is 10
percent. What would be a fair price for the claim to receive that 5,000 in ten years?
PV = ?
PV = 5,000 (.3855)
PV = 1927.50
2. An investment today is expected to generate a series of cash flows in the future such as the
following:
0 -1,000 investment expenditure
1 200
2 400 receipts from the investment
3 700
An unsophisticated analyst might consider this a good investment because the sum of the receipts,
1,300, is greater than the investment expenditure, 1,000. Such an analyst might consider that the
investment offers a gain of 300.
However this is the wrong approach. Values of different periods can never be aggregated before
they are standardized. Failure to do so ignores the fact that funds available in the present can be
invested to grow to some future value. The correct approach to analyzing this investment is to
discount each of the individual future values, then to aggregate them, and finally to compare the
result to the initial investment expenditure. If the available interest rate is 14 percent then
-1,000 + 200 (.8772) + 400 (.7695) + 700 (.6750) = -44.26
Accepting this investment would actually create an immediate loss of 44 rather than a gain of 300.
This is an example of one of the basic methods of investment analysis, the net present value method
or NPV. It is called net present value because it adds the receipts net of the expenditure.
Note that the present value of a future value decreases as the discount rate increases and decreases
the further into the future the cash flow occurs.
The Quadratic Function
The quadratic function has the form:
F(x) = y = a + bx + cx2
where a, b, and c are numerical constants and c is not equal to zero.
Note that if c were zero, the function would be linear.
An advantage of this notation is that it can easily be generalized by adding more terms. We could
for example write equations such as
y = a + bx + cx2 + dx3
y = a + bx + cx2 + dx3 + ex4
The quadratic formula
In many books quadratic equations are written as
ax2 + bx + c = 0
In this case the quadratic formula is given by
Note that the denominator is then 2a instead of 2c.
Some common examples of the quadratic function
Notice that the graph of the quadratic function is a parabola. This means it is a curve with a single
bump. The graph is symmetric about a line called the axis of symmetry. The point where the axis of
symmetry intersects the parabola is known as the vertex.
Graphing the quadratic function
Construct a table with values of x and f(x).
Plot the data points.
Connect the data points with a smooth line.
This is easily done with Excel.
Example 1 f(x) = 12 - 8x +x2

Example 2 f(x) = -4 + 5x -x2
The quadratic formula, an example.
In general the supply of a commodity increases with price and the demand decreases. The market
for the commodity is in equilibrium when supply equals demand.
In this example we are considering two functions of the same independent variable, price. We want
to find the equilibrium price and the corresponding demand.
The supply function is a quadratic equation given by S(p) = 2p + 4p2
The demand function is a linear function given by D(p) = 231 - 18p

To find the intersection of the two curves set supply equal to demand and solve for p.
S(p) = 2p + 4p2 = 231 - 18p = D(p)
After collecting terms we obtain the quadratic equation
231 - 20p -4p2 = 0
Note that this has the form of the quadratic equation
y = a + bx + cx2
0 = 231 -20p -4p2
Solve the equation by means of the quadratic formula where a = 231, b = -20, and c = -4.
and
Since price cannot be negative the value of -10.5 can be eliminated. Supply will equal demand when
the price is $5.50. At that price it is possible to find the corresponding demand and supply.
D(5.50) = 231 - 18(5.50) = 132
S(5.50) = 2(5.50) + 4(5.502 = 132

Problem Set
Quadratic Function
SHOW SOLUTION
1. The publisher of an medical newsletter estimates that with x thousand

subscribers its monthly revenue and cost (in thousands of dollars) are given by the
following:
R(X) = 32x - .21x2
C(x) = 195 + 12x
Determine the number of subscribers needed for the publisher to break-even.

Problem Set
Quadratic Function
HIDE SOLUTION
1. The publisher of an medical newsletter estimates that with x thousand

subscribers its monthly revenue and cost (in thousands of dollars) are given by the
following:
R(X) = 32x - .21x2
C(x) = 195 + 12x
Determine the number of subscribers needed for the publisher to break-even.
Solution:
Profit equals revenue less cost. The breakeven point occurs where profit is zero or
when revenue equals cost.
Profit = R(x) - C(x)
set profit = 0
Solve using the quadratic formula where a = 195, b = 20, and c = .21.
Breakeven points occur where the publisher has either 12,000 or 84,000
subscribers. Between these two points the publisher will be profitable.
The Logarithmic Function
Linear functions are useful in economic models because a solution can easily be
found. However non-linear functions can be transformed into linear functions with
the use of logarithms.
Given the function
Taking logarithms of both sides this function can be rewritten as
The resulting function is linear in the log of the variables.
An application of the logarithmic function
A production function describes the relation between output and the inputs to a
given process. A simple production function might relate output to two inputs,
labor and capital. (Capital typically includes plant and equipment.) A production
function might be used to study tradeoffs in the use of capital and labor.
A well-known production function is the Cobb-Douglas Production function which

has the form
where
Q = the quantity of output
L = the quantity of labor
K = the quantity of capital

The Slope of a Non-linear Function
Finding the slope of a linear function is straightforward. Furthermore the slope is

the same at each point on the function. However this is not the case with non-
linear functions. A non-linear function does not have a constant slope.
Consider the non-linear function shown below. What is the slope at some point such as P? (P
can be at any point along the curve.) It can be seen that the slope of the function depends on
the position of P on the curve.
The problem is to find the slope of the function at point P. A possible solution is to draw a
line tangent to the non-linear function at point P as shown in the following chart. The
tangent line touches the function but does not intersect it. The slope of this tangent line is the
same as the slope of the non-linear function at point P.
The slope of a non-linear function is different at different points along the function. The
slope may be positive, negative or zero as indicated by the tangent lines in the following
chart. The value obtained for the slope depends on the point on the function where the
tangent line is drawn.
Additional Topics necessary for all MPA students and for MIA students planning
to take the Economic Analysis Sequence (This course is required for
concentrations in International Finance and Business, International Economic
Policy and International Energy Management and Policy, Environmental Policy.
The course is highly recommended for students planning careers in any other
area related to economics, for example, economic development, even if their
concentrations at SIPA do not require it.):
The necessity of calculus and some theory

to get started
The role of calculus in economic analysis
Policy economists analyze relationships between variables in order to understand,

predict, plan for, and influence behavior, among other things. In order to
understand the sophisticated, complex behavior of economic agents in the
marketplace, then, we have to be able to model that behavior using complex,
nonlinear functions, and then analyze our models appropriately.
More simply, real world behavior is not linear. Therefore, any attempt to
understand real economic behavior requires nonlinear modeling and the
appropriate use of calculus. Any other, simpler forms of analysis lack the detail
and sophistication essential to creating and evaluating policy.
Nonlinear functions and slope of a tangent line
A nonlinear function by definition has a different slope at every point along the
curve, unlike a linear function whose slope stays constant. In order to calculate a
constantly changing slope, we will use the techniques developed in calculus. Since
our focus is practical analysis, we'll review just enough theory to be confident that
our economic models are mathematically well founded.
Recall that a circle is an example of a nonlinear function. A tangent line is a

straight line that touches our circle only at a single point. As you move around a
circle, imagine drawing a tangent line for each point; it's clear to see that the slope
of that tangent line will constantly be changing, and can be used as an
approximation for the slope of the (nonlinear) circle at that particular point. Then
all we need to do is to correctly identify the tangent line associated with that point
on the curve, and then determine the slope of that (linear) tangent line.
Basic calculus, briefly, is the determination of the slope of a point on a nonlinear
function. The techniques are based on this idea of using a tangent line to
approximate the slope of a nonlinear function at a point. Lucky for us, Newton did
all the hard work proving the theory and developing the rules. For purposes of this
review, we will skip the proofs and go straight to the mechanics of the method of
differentiation.
One last caveat. While the upside of a "cookbook" review (i.e. just recalling the
how without worrying too much about the what or why), is found in its simplicity,
so is the downside. As you learn or review technique, or use technique in the
majority of cases, keep in mind that there are theoretical underlying assumptions
that are crucial to the integrity of your results. These assumptions are usually
treated as axiomatic, but as you become more sophisticated in your economic
analytic skills and/or use real world data, it is imperative that you increase your
theoretical sophistication as well by justifying your use of the assumptions as well
as properly proving your results.
Continuity of functions
The main assumption we need in order to use the techniques of calculus is

continuity.
Informally, a continuous function is one with no breaks in it. A more formal

definition will come later; for now, note that all polynomial functions are
continuous. In addition, all rational functions[link], except where undefined, that
is where their denominators are equal to zero, are also continuous.
If a function is continuous and the slope exists, we can find it using the techniques
of differentiation, our main calculus tool.
So, let's begin!

Rules of calculus - functions of one variable
Derivatives: definitions, notation, and rules
A derivative is a function which measures the slope. It depends upon x in some

way, and is found by differentiating a function of the form y = f (x). When x is
substituted into the derivative, the result is the slope of the original function y = f
(x).
There are many different ways to indicate the operation of differentiation, also
known as finding or taking the derivative. The choice of notation depends on the
type of function being evaluated and upon personal preference.
Suppose you have a general function: y = f(x). All of the following notations can
be read as "the derivative of y with respect to x" or less formally, "the derivative of
the function."
f'(x) f' y' df/dx dy/dx d/dx [f(x)].
[HINT: don't read the last three terms as fractions, read them as an operation.
For example, read: " dx/dy = 3x"
As: "the function that gives the slope is equal to 3x"
Let's try some examples. Suppose we have the function : y = 4x3 + x2 + 3.
After applying the rules of differentiation, we end up with the following result:
dy/dx = 12x2 + 2x.
How do we interpret this? First, decide what part of the original function (y =
4x3 + x2 + 3) you are interested in. For example, suppose you would like to know
the slope of y when the variable x takes on a value of 2. Substitute x = 2 into the
function of the slope and solve:
dy/dx = 12 ( 2 )2 + 2 ( 2 ) = 48 + 4 = 52.
Therefore, we have found that when x = 2, the function y has a slope of + 52.
Now for the practical part. How do we actually determine the function of the
slope? Almost all functions you will see in economics can be differentiated using
a fairly short list of rules or formulas, which will be presented in the next several
sections.
How to apply the rules of differentiation
Once you understand that differentiation is the process of finding the function of
the slope, the actual application of the rules is straightforward.
First, some overall strategy. The rules are applied to each term within a function
separately. Then the results from the differentiation of each term are added
together, being careful to preserve signs. [For example, the sum of 3x and negative
2x2 is 3x minus 2x2.].
Don't forget that a term such as "x" has a coefficient of positive one. Coefficients
and signs must be correctly carried through all operations, especially in
differentiation.
The rules of differentiation are cumulative, in the sense that the more parts a
function has, the more rules that have to be applied. Let's start here with some
specific examples, and then the general rules will be presented in table form.
Take the simple function: y = C, and let C be a constant, such as 15. The
derivative of any constant term is 0, according to our first rule. This makes sense
since slope is defined as the change in the y variable for a given change in the x
variable. Suppose x goes from 10 to 11; y is still equal to 15 in this function, and
does not change, therefore the slope is 0. Note that this function graphs as a
horizontal line.
Now, add another term to form the linear function y = 2x + 15. The next rule
states that when the x is to the power of one, the slope is the coefficient on that x.
This continues to make sense, since a change in x is multiplied by 2 to determine
the resulting change in y. We add this to the derivative of the constant, which is 0
by our previous rule, and the slope of the total function is 2.
Now, suppose that the variable is carried to some higher power. We can then form
a typical nonlinear function such as y = 5x3 + 10. The power rule combined with
the coefficient rule is used as follows: pull out the coefficient, multiply it by the
power of x, then multiply that term by x, carried to the power of n - 1. Therefore,
the derivative of 5x3 is equal to (5)(3)(x)(3 - 1); simplify to get 15x2. Add to the
derivative of the constant which is 0, and the total derivative is 15x2.
Note that we don't yet know the slope, but rather the formula for the slope. For a
given x, such as x = 1, we can calculate the slope as 15. In plainer terms, when x
is equal to 1, the function ( y = 5x3 + 10) has a slope of 15.
These rules cover all polynomials, and now we add a few rules to deal with other
types of nonlinear functions. It is not as obvious why the application of the rest of
the rules still results in finding a function for the slope, and in a regular calculus
class you would prove this to yourself repeatedly. Here, we want to focus on the
economic application of calculus, so we'll take Newton's word for it that the rules
work, memorize a few, and get on with the economics! The most important step
for the remainder of the rules is to properly identify the form, or how the terms are
combined, and then the application of the rule is straightforward.
For functions that are sums or differences of terms, we can formalize the strategy
above as follows:
If y = f(x) + g(x), then dy/dx = f'(x) + g'(x). Here's a chance to practice reading the
symbols. Read this rule as: if y is equal to the sum of two terms or functions, both
of which depend upon x, then the function of the slope is equal to the sum of the
derivatives of the two terms. If the total function is f minus g, then the derivative
is the derivative of the f term minus the derivative of the g term.
The product rule is applied to functions that are the product of two terms, which
both depend on x, for example, y = (x - 3)(2x2 - 1). The most straightforward
approach would be to multiply out the two terms, then take the derivative of the
resulting polynomial according to the above rules. Or you have the option of
applying the following rule.
Given y = f(x) g(x); dy/dx = f'g + g'f. Read this as follows: the derivative of y with
respect to x is the derivative of the f term multiplied by the g term, plus the
derivative of the g term multiplied by the f term. To apply it to the above problem,
note that f(x) = (x - 3) and g(x) = (2x2 - 1); f'(x) = 1 and g'(x) = 4x. Then dy/dx =
(1)(2x2 - 1) + (4x)(x - 3). Simplify, and dy/dx = 2x2 - 1 + 4x2 - 12x, or 6x2 - 12x -
1.
The quotient rule is similarly applied to functions where the f and g terms are a
quotient. Suppose you have the function y = (x + 3)/ (- x2). Then follow this rule:
Given y = f(x)/g(x), dy/dx = (f'g - g'f) / g2. Again, identify f= (x + 3) and g = -x2 ;
f'(x) = 1 and g'(x) = - 2; and g2 = x4. Then substitute in: dy/dx = [(1)(- x2) - (- 2)(x
+ 3)] / x4 . Simplify to dy/dx = (-x2 + 2x + 6)/ x4 .
Now, let's combine rules by type of function and their corresponding graphs.
Type of Form of Graph Rule Interpretation

function function
y = constant y=C Horizontal line dy/dx = 0 Slope = 0;
y = linear y = ax + b Straight line dy/dx = a Slope =
function coefficient on x
y = polynomial y = axn + b Nonlinear, one dy/dx = anxn-1 Derivative is a

of order 2 or or more turning function, actual
higher points slope depends
upon location (ie
value of x)
y = sums or y = f(x) + g(x) Nonlinear dy/dx = Take derivative of
differences of 2 f'(x) + g'(x). each term
functions separately, then
combine.
y = product of y = [ f(x) g(x) Typically dy/dx = f'g + g'f. Start by identifying

two functions, ] nonlinear f, g, f', g'
y = quotient or y = f ( x) / g ( Typically dy/dx = (f'g - g'f) Start by identifying

ratio of two x) nonlinear / g2. f, g, f', g', and g2
functions
Not-so-basic rules of differentiation
There are two more rules that you are likely to encounter in your economics
studies. The hardest part of these rules is identifying to which parts of the
functions the rules apply. Actually applying the rule is a simple matter of
substituting in and multiplying through. Notice that the two rules of this section
build upon the rules from the previous section, and provide you with ways to deal
with increasingly complicated functions, while still using the same techniques.
The power function rule:
In the previous rules, we dealt with powers attached to a single variable, such as
x2 , or x5. Suppose, however, that your equation carries more than just the single
variable x to a power. For example,
y = (2x + 3)4
In this case, the entire term (2x + 3) is being raised to the fourth power. To deal
with cases like this, first identify and rename the inner term in the parenthesis: 2x
+ 3 = g(x). Then the problem becomes
Now, note that your goal is still to take the derivative of y with respect to x.
However, x is being operated on by two functions; first by g (multiplies x by 2 and
adds to 3), and then that result is carried to the power of four. Therefore, when we
take the derivatives, we have to account for both operations on x. First, use the
power rule from the table above to get:
.
Note that the rule was applied to g(x) as a whole. Then take the derivative of g(x)
= 2x + 3, using the appropriate rule from the table:
Note the change in notation. "g" is used because we were finding the change in g,
with respect to a change in x. Now, both parts are multiplied to get the final result:
Recall that derivatives are defined as being a function of x. Replace the g(x) in the
above term with (2x + 3) in order to satisfy that requirement. Then simplify by
combining the coefficients 4 and 2, and changing the power (4-1) to 3:
Now, we can set up the general rule. When a function takes the following form:
Then the rule for taking the derivative is:
The chain rule:
The second rule in this section is actually just a generalization of the above power
rule. It is used when x is operated on more than once, but it isn't limited only to
cases involving powers. Since you already understand the above problem, let's
redo it using the chain rule, so you can focus on the technique.
Given the same problem:
rename the parts of the problem as follows:

and
Then the entire problem can be expressed as:
This type of function is also known as a composite function. The derivative of a

composite function is equal to the derivative of y with respect to u, times the
derivative of u with respect to x:
specifically in our problem:
Recall that a derivative is defined as a function of x, not u. Substitute in 2x + 3 for

u:
and the problem is complete. The formal chain rule is as follows. When a
function takes the following form:
Then the derivative of y with respect to x is defined as:
Updated table of derivatives
Let's add these two rules to our table of derivatives from the previous section:
Type of Form of function Graph Rule Interpretation

function
y = constant y=C Horizontal dy/dx = 0 Slope = 0;
line
y = linear y = ax + b Straight line dy/dx = a Slope =
function coefficient on x
y = y = axn + b Nonlinear, dy/dx = anxn-1 Derivative is a

polynomial of one or more function, actual
order 2 or turning points slope depends
higher upon location
(i.e. value of x)
y = sums or y = f(x) + g(x) Nonlinear dy/dx = f'(x) + g'(x). Take derivative
differences of of each term
2 functions separately, then
combine.
y = product of y = [ f(x) g(x) ] Typically dy/dx = f'g + g'f. Start by

two functions nonlinear identifying
f, g, f', g'
y = quotient y = f ( x) / g ( x) Typically dy/dx = (f'g - g'f) / g2. Start by

or ratio of two nonlinear identifying
functions f, g, f', g', and g2
y=generalized Nonlinear Identify g(x)

power
function
y=composite Nonlinear y is a function
function/chain of u, and u is a
rule function of x.
Special cases
There are two special cases of derivative rules that apply to functions that are used
frequently in economic analysis. You may want to review the sections on natural
logarithmic functions and graphsand exponential functions and graphs before
starting this section.
Natural logarithmic functions
When a function takes the logarithmic form:
Then the derivative of the function follows the rule:

If the function y is a natural log of a function of y, then you use the log rule and the
chain rule. For example, If the function is:
Then we apply the chain rule, first by identifying the parts:
Now, take the derivative of each part:
And finally, multiply according to the rule.
Now, replace the u with 5x2, and simplify
Note that the generalized natural log rule is a special case of the chain rule:
Exponential functions
Taking the derivative of an exponential function is also a special case of the chain
rule. First, let's start with a simple exponent and its derivative. When a function
takes the logarithmic form:
Then the derivative of the function follows the rule:

.
No, it's not a misprint! The derivative of ex is ex .
If the power of e is a function of x, not just the variable x, then use the chain rule:
For example, suppose you are taking the derivative of the following function:
Define the parts y and u, and take their respective derivatives:
Then the derivative of y with respect to x is:
Updated table of derivatives
Now we can add these two special cases to our table:
Type of Form of function Graph Rule Interpretatio

function n
y = constant y=C Horizontal dy/dx = 0 Slope = 0;
line
y = linear y = ax + b Straight dy/dx = a Slope =
function line coefficient on
x
y = y = axn + b Nonlinear, dy/dx = anxn-1 Derivative is a
polynomial one or function,
of order 2 or more actual slope
higher turning depends upon
points location (i.e.
value of x)
y = sums or y = f(x) + g(x) Nonlinear dy/dx = f'(x) + g'(x). Take derivative
differences of each term
of 2 separately,
functions then combine.
y = product y = [ f(x) g(x) ] Typically dy/dx = f'g + g'f. Start by

of two nonlinear identifying
functions, f, g, f', g'
y = quotient y = f ( x) / g ( x) Typically dy/dx = (f'g - g'f) / Start by

2 identifying
or ratio of nonlinear g.
two functions f, g, f', g', and
g2
y=generalize Nonlinear identify g(x)

d power
function
y=composite Nonlinear y is a function
function/ of u, and u is
a function of
chain rule x.
y=natural log Natural log Special case
function of chain rule
y=exponentia Exponentia Special case

l function l of chain rule
Higher order derivatives
Just as a first derivative gives the slope or rate of change of a function, a higher
order derivative gives the rate of change of the previous derivative. We'll tak more
about how this fits into economic analysis in a future section, [link: economic
interpretation of higher order derivatives] but for now, we'll just define the
technique and then describe the behavior with a few simple examples.
To find a higher order derivative, simply reapply the rules of differentiation to the
previous derivative. For example, suppose you have the following function:
According to our rules, we can find the formula for the slope by taking the first
derivative:
Take the second derivative by applying the rules again, this time to y', NOT y:
If we need a third derivative, we differentiate the second derivative, and so on for

each successive derivative.
Note that the notation for second derivative is created by adding a second prime.
Other notations are also based on the corresponding first derivative form. Here are
some examples of the most common notations for derivatives and higher order
derivatives.
Function First derivative Second derivative Third derivative
Now for some examples of what a higher order derivative actually is. Let's start
with a nonlinear function and take a first and second derivative. Recall from
previous sections that this equation will graph as a parabola that opens
downward [link: graphing binomial functions].
Function First derivative Second derivative
In order to understand the meaning of derivatives, let's pick a couple of values of x,

and calculate the value of the derivatives at those points.
Value of Value of function first derivative at second
x at x x derivative at x
x=0
x=1
x=2
So, how do we interpret this information? When x equals 0, we know that the
slope of the function, or rate of change in y for a given change in x (from the first
derivative) is 6. Similarly, the second derivative tells us that the rate of change of
the first derivative for a given change in x is -2. In other words, when x changes,
we expect the slope to change by -2, or to decrease by 2. We can check this by
changing x from 0 to 1, and noting that the slope did change from 6 to 4, therefore
decreasing by 2.
To sum up, the first derivative gives us the slope, and the second derivative gives
the change in the slope. In economics, the first two derivatives will be the most
useful, so we'll stop there for now.
Problem Set
SHOW SOLUTIONS
The first multiple choice quiz in this section is designed for those new to calculus.
If you choose the wrong answer, you will get feedback about probable mistakes
and a link to the correct rule to use as well as a step-by-step solution.
The second quiz is more extensive and is designed for you to use as a final test of
your understanding of the principles presented in this section.
Quiz 1
Take the derivative of the following functions, and calculate the value of the slope
when x is equal to 1:
1.
a.
b.
c.
d.
2.
a.
b.
c.
d.
3.
a.
b.
c.
d.
4.
a.
b.
c.
d.
5.
a.
b.
c.
d.
6.
a.
b.
c.
d.
7.
a.
b.
c.
d.
8.
a.
b.
c.
d.
Quiz 2
1. Find the formula for the slope of the following function:

a.
b.
c.
d.
2 Find the formula for the slope of the following function
a.
b.
c.
d.
a.
b.
c.
d.
4. Find the formula for the slope of the following function
a.
b.
c.
d.
a.
b.
c.
d.
6. Determine the slope and the rate of change of the slope of the following
function when x=1:
a.
b.
c.
d.
7. Use the product rule and the exponent rule to find the derivative of the function:
a.
b.
c.
d.
8. Although you can always simplify before using differentiation techniques, for
practice use the exponent rule and the generalized power rule before simplifying to
find the formula for the slope of the following function:
a.
b.
c.
d.
9. In the following function determine the value of the function, the slope, and the
rate of change of the slope when x=-1.
a.
b.
c.
d.
Problem Set
The first multiple choice quiz in this section is designed for those new to calculus.
If you choose the wrong answer, you will get feedback about probable mistakes
and a link to the correct rule to use as well as a step-by-step solution.
The second quiz is more extensive and is designed for you to use as a final test of
your understanding of the principles presented in this section.
Quiz 1
Take the derivative of the following functions, and calculate the value of the slope
when x is equal to 1:
1.
answer comments links
a. correct rule:y=constant
rule: y=linear
function
b. incorrect rule:y=constant
16 =the value of the rule: y=linear
function when x=1. The function
slope is always 6, which
is why there's no x in the
y' formula.
c. incorrect rule: y=linear
Drop the x if its power is function
1
d. incorrect rule:y=constant
derivative of a constant
always 0.
Solution to 1:
2.
a. correct rule: y =
polynomial
rule: y =
sum/difference
b. incorrect rule: y =
polynomial
subtract 1 from original
power
c. incorrect rule: y =
polynomial
don't forget coefficients
d. incorrect rule: y =
polynomial
drop constants, drop
variables with power of 1
Solution to 2:
3.
a. correct rule: y =
sum/difference
b. incorrect rule: y =
sum/difference
watch sign of second term
c. incorrect rule: y =
sum/difference
signs must be consistent with
original problem
d. incorrect rule: y =
polynomial
subtract 1 from powers in
each term
Solution to 3:
4.
a. correct y=product rule

b. incorrect y=product rule
use product rule, not just

multiply individual
derivatives
c. incorrect y=product rule
add terms for product rule, not

subtract
d. incorrect y=product rule
use product rule, not just add

derivatives
Solution to 4:
5.
a. correct y=quotient
rule
b. incorrect y=quotient
rule
Denominator is g squared
c. incorrect y=quotient
rule
subtract terms in numerator,
not add
d. incorrect y=quotient
rule
use quotient rule, not product
rule y=product rule
Solution to 5:
6.
a. correct y=composite
fn/chain rule
or y=gen'l
power fn rule
b. incorrect y=gen'l power
fn rule
take derivative of inside term
also
c. incorrect y=gen'l power
fn rule
carry coefficients from inside
derivative y=polynomial
rule
d. incorrect y=composite
fn/chain rule
derivatives have to be
functions of x, last step is to
sub value of u back into
function
Solution to 6:
7.
a. correct y=exponential
function rule
b. incorrect y=exponential
function rule
take derivative of power of e
c. incorrect y=exponential
function rule
bring derivative down as
coefficient
d. incorrect y=exponential
function rule
multiply terms, not add
Solution to 7:
8.
a. correct y=natural
log fn rule
b. incorrect y=natural
log fn rule
deriv of ln is
reciprocal of term
c. incorrect y=natural
log fn rule
drop ln symbol when
take deriv
d. incorrect y=natural
log fn rule
need deriv of term
inside ln operation
Solution to 8:
Quiz 2
a. correct
b. incorrect
c. incorrect
d. incorrect
2 Find the formula for the slope of the following function
a. correct
b. incorrect
c. incorrect
d. incorrect
a. correct
b. incorrect
c. incorrect
d. incorrect
a. correct
b. incorrect
c. incorrect
d. incorrect
a. correct
b. incorrect
c. incorrect
d. incorrect
6. Determine the slope and the rate of change of the slope of the following
function when x=1:
a. correct
b. incorrect
c. incorrect
d. incorrect
7. Use the product rule and the exponent rule to find the derivative of the function:
a. correct
b. incorrect
c. incorrect
d. incorrect
8. Although you can always simplify before using differentiation techniques, for
practice use the exponent rule and the generalized power rule before simplifying to
find the formula for the slope of the following function:
a. correct
b. incorrect
c. incorrect
d. incorrect
9. In the following function determine the value of the function, the slope, and the
rate of change of the slope when x=-1.
a. correct
b. incorrect
c. incorrect
d. incorrect
Economic interpretation of calculus
operations - Univariate
Slope as marginal rate of change
A very clear way to see how calculus helps us interpret economic information and
relationships is to compare total, average, and marginal functions.
Take, for example, a total cost function, TC:
For a given value of Q, say Q=10, we can interpret this function as telling us that:
when we produce 10 units of this good, the total cost is 190. We would like to
learn more about how costs evolve over the production cycle, so let's calculate
average cost, which is total cost divided by the number of units produced, or Q:
Therefore, when we produce 10 units of this good, the average cost per unit is 19.
This is somewhat deceptive, however, because we still don't know how costs
evolve or change as we produce. For example, the first unit (Q = 1) cost 10 to
produce. Obviously, if the average ends up being 19, and the first unit cost 10,
then the cost of producing a unit must be changing as we produce different units.
Alternatively, to be more technical, the change in total cost is not the same every
time we change Q. Let's define this change in total cost for a given change in Q as
the marginal cost.
Sound familiar? The slope is defined as the rate of change in the Y variable (total
cost, in this case) for a given change in the X variable (Q, or units of the good).
Therefore, taking the first derivative, or calculating the formula for the slope can
determine the marginal cost for a particular good.
What about the change in marginal cost? That way, we can not only evaluate costs
at a particular level, but we can see how our marginal costs are changing as we
increase or decrease our level of production. Thanks to our calculus background,
it's clear that the change in marginal cost or change in slope can be calculated by
taking the second derivative.
These three equations now give us a considerable amount of information regarding
the cost process, in a very clear format. For example, calculate the marginal cost
of producing the 100th unit of this good.
Now, suppose your boss wants you to forecast costs for the 101st unit. You can
recalculate marginal cost, or you can note that the second derivative tells you that
the marginal cost is expected to change by an increase of two, for every one unit
increase in Q. Therefore,
To sum up, you can start with a function, take the first and second derivatives and
have a great deal of information concerning the relationship between the variables,
including total values, changes in total values, and changes in marginal values.
Characteristics of relative and absolute maxima and minima
The first and second derivatives can also be used to look for maximum and
minimum points of a function. For example, economic goals could include
maximizing profit, minimizing cost, or maximizing utility, among others.
In order to understand the characteristics of optimum points, start with

characteristics of the function itself. A function, at a given point, is defined as
concave if the function lies below the tangent line near that point. To clarify,
imagine a graph of a parabola that opens downward. Now, consider the point at
the very top of the parabola. By definition, a line tangent to that point would be a
horizontal line.
It's clear that the graph of the top section of the parabola, in the neighborhood of
the point, all lies below the tangent line, therefore, the graph is concave in the
neighborhood of that point.
Note how much care is being taken to limit the discussion of concavity to the part
of the function near the point being considered. Suppose the function is a higher
order polynomial, one that takes the shape of a curve with 2 or more turning
points. It would be easy to imagine a function where part was below the horizontal
tangent line, turned again, and came back up past the line. The definition of
concavity refers only to the part of the function near the point where the tangent
line touches the curve, it isn't required to hold everywhere on the curve.
Consider the tangent line itself. Recall from past section on linear functions that
the slope of a horizontal line or function is equal to zero. Therefore, the slope at
the top or turning point of this concave function must be zero. Another way to see
this is to consider the graph to the left of the turning point. Note that the function
is upward-sloping, ie has a slope greater than zero. The section of the graph to the
right of the turning point is downward-sloping, and has negative slope, or a slope
less than zero.
As you look at the graph from left to right, you can see that the slope is first
positive, becomes a smaller positive number the closer you get to the turning point,
is negative to the right of the turning point, and becomes a larger negative number
the further you travel from the turning point. Since this is a continuous function,
there must be a point where the slope crosses from positive to negative. In other
words, for an instant, the slope must be zero. This point we have already identified
as the turning-point.
There is a much easier way to identify what's going on, however. Recall that
second derivatives give information about the change of slope. We can use that in
conjunction with the first derivative at increasing points of x (as you travel left to
right on the graph) to determine identifying characteristics of functions.
For example, look at the following function and its graph:
x y f'(x) f''(x)
-2 -1 4 -2
0 3 0 -2
2 -1 -4 -2
Note that a negative second derivative means that the first derivative is always
decreasing for a given (positive) change in x, i.e., as x increases, (always reading
the graph from left to right). If the first derivative is always decreasing, AND we
know it goes through zero at the turning point, then it has to be the case that the
function is concave in the neighborhood of the turning point--i.e., the turning point
is a maximum point.
In order to fully appreciate this result, let's consider the opposite--a convex
function, i.e., a function that is above the line that is tangent to the turning point, in
the neighborhood of that point.
Moving left to right, note that the slope is negative, goes through zero at the
turning point, then becomes positive. Therefore, we would expect the underlying
function to be one where the first derivative is zero at the turning point, with a
positive second derivative in the neighborhood of the turning point, indicating an
increasing slope. These two conditions are characteristic of a function with a
minimum point.
Not only do these characteristics of first and second order derivatives describe
functions with maximum and minimum points, but they are sufficient to prove that
the points being considered are maximum or minimum points. Let's review the
characteristics:
A relative minimum at point x = a will have the derivatives f' (a) = 0 and f'' (a) > 0.
A relative maximum at point x = a will have the derivatives f' (a) = 0 and f'' (a) < 0.
Note, the word relative is used to indicate a maximum or minimum point in the
neighborhood of the point ( x = a) . Only if it can be proved that one and only one
max or min exists can it be considered the absolute optimum point. For our
purposes, this will only occur if the second derivative is a constant, meaning the
function goes through the turning point only once, and therefore has only one
maximum or minimum.
Unconstrained optimization
Now that we can use differentiation to collect so much information regarding the
characteristics of functions, the optimization of economic functions will be very
straightforward.
Given a continuous, differentiable function, follow these steps to find the relative
maximum or minimum of a function:
1. Take the first derivative of a function and find the function for the slope.
2. Set dy/dx equal to zero, and solve for x to get the critical point or points. This is
the necessary, first-order condition.
3. Take the second derivative of the original function.
4. Substitute the x from step 2 into the second derivative and solve, paying
particular attention to the sign of the second derivative. This is also known as
evaluating the second derivative at the critical point(s), and provides the sufficient,
second-order condition.
5. Use the following characteristics to determine whether the function evaluated at
the critical point or points is a relative maximum or minimum:
Relative Maximum Relative Minimum
You will probably always practice on functions where the maximum or minimum
does exist, but keep in mind that you will be doing public policy in the real world.
Just because you are looking for a quantity that optimizes profit or the production
level that minimizes cost doesn't mean it actually exists. That's why you always
need to follow all steps and confirm all results with both the necessary and
sufficient conditions. (Especially making sure that your optimum point is the type
you need, i.e. a max if you're maximizing and a min if you're minimizing!)
Consider the following examples.
Example 1: Find the critical values of the following function, and test to determine
whether the function is convex or concave and has a relative maximum or
minimum:
Solution 1: Take the first derivative and simplify, and then solve for the critical
value. This is the value of x where the slope of the function is equal to zero:
Evaluate the function at the critical point determined above (this is not a necessary
step, but for practice and to give context we'll solve for it):
Now, determine the second derivative and evaluate it at the critical point:
The second derivative is always negative, regardless of the value of x. This gives
us two pieces of information. First, that the function has a relative maximum (i.e.
is concave), and second, that the constant second derivative implies a single
turning point, and therefore the relative maximum is also an absolute maximum.
Example 2: Given the following total cost function, determine the level of
production that minimizes the average cost, and the level that minimizes the
marginal cost:
Solution 2: Convert the total cost function into an average cost function by
dividing by Q:
Now, to minimize the average cost function, follow the steps listed above. Start by
taking the first derivative, setting it equal to zero, and solving for critical points Q:
When Q = 12, the average cost function reaches a relative optima; now we test for
concavity by taking the second derivative of average cost:
Note the second derivative is positive for all values of Q, including the critical
point Q = 12, therefore by the second order test, the function has a relative
minimum at the critical point. Since the second derivative is constant, the relative
minimum is also an absolute minimum.
Note that we were able to prove average cost is minimized when Q is 12, without
having to actually determine the average cost.
Now, to minimize marginal cost. From the original function total cost, take the
first derivative to get the function for the slope, or rate of change of total cost for a
given change in Q, also known as marginal cost.
Now, follow the steps to minimize the marginal cost function. Even though MC is
the function for the slope of total cost, ignore that and treat it as a stand-alone
function, and take the first and second order derivatives according to the steps of
optimization.
When Q equals 8, the MC function is optimized. Test for max or min:
The second derivative of MC is positive for all values of Q, therefore the MC

function is convex, and is at a relative minimum when q is equal to 8.
Example 3: Find the optimum points of the profit function and determine what
level of production Q will maximize profit.
Start by taking first and second derivatives:

Set the first derivative equal to zero and solve for critical points:
Use the quadratic equation technique to solve the above equation.
Note that there are 2 critical points, but from an economic standpoint, only one is
available to us as a solution to our problem, since we can't produce a negative
quantity.
Evaluate the second derivative at Q equals 24 to determine concavity.
The second derivative is less than zero, which means our function is concave and
has a relative maximum when Q equals 24.
One last note: the title of this section was unconstrained optimization. The word
unconstrained refers to the fact that we placed no constraints on the functional
relationships we were optimizing. In other words, we assumed that any level of
the x variable was available to us, with the real world exception of negative values
of physical quantities (recall Q = -40 was ruled out).
Of course, this is not realistic, and as our models become more realistic in the
multivariate section, we will add constraints to our optimization problems. There is
no point in doing constrained optimization in univariate processes because it is
always easier to embed the constraint within one of the equations and use the same
process as outlined in this section.
Problem Set
operations - Univariate
SHOW SOLUTIONS
Practice problems
The following is a quiz on your understanding of univariate optimization,

concavity, and first and second order conditions. After you work through the
problems, you can link to a step-by-step solution to each problem.
1a.
b.
c.
d.
2a.
b.
c.
d.
3a.
b.
c.
d.
4a.
b.
c.
d.
5a.
b.
c.
d.
6a.
b.
c.
d.
7a.
b.
c.
d.
8a.
b.
c.
d.
9a.
b.
c.
d.
10a.
b. Can't prove using math

c.
d.
Problem Set
operations - univariate
HIDE SOLUTIONS
Practice problems
The following is a quiz on your understanding of univariate optimization,

concavity, and first and second order conditions. After you work through the
problems, you can link to a step-by-step solution to each problem.
1a. correct
b. incorrect
c. incorrect
d. incorrect
2a.
correct
b.
incorrect
c.
incorrect
d.
incorrect
3a.
correct
b.
incorrect
c.
incorrect
d.
incorrect
4a.
correct
b.
incorrect
c.
incorrect
d.
incorrect
5a.
correct
b. incorrect
c.
incorrect
d.
incorrect
6a. correct
b. incorrect
c. incorrect
d. incorrect
7a. correct
b. incorrect
c. incorrect
d. incorrect
8a. correct
b. incorrect
c. incorrect
d. incorrect
9a. correct
b. incorrect
c. incorrect
d. incorrect
10a.
correct
b. Can't prove using math incorrect

c.
incorrect
d.
incorrect
Rules of calculus - multivariate
Added variables, same techniques
In the real world, it is very difficult to explain behavior as a function of only one
variable, and economics is no different. More specific economic interpretations
will be discussed in the next section, but for now, we'll just concentrate on
developing the techniques we'll be using.
First, to define the functions themselves. We want to describe behavior where a

variable is dependent on two or more variables. Every rule and notation described
from now on is the same for two variables, three variables, four variables, and so
on, so we'll use the simplest case; a function of two independent variables.
Conventionally, z is the dependent variable (like y in univariate functions) and x
and y are the independent variables (like x in univariate functions):
For example, suppose that the following function describes some behavior:
Differentiating this function still means the same thing--still we are looking for
functions that give us the slope, but now we have more than one variable, and more
than one slope.
Visualize this by recalling from graphing what a function with two independent
variables looks like. Whereas a 2-dimensional picture can represent a univariate
function, our z function above can be represented as a 3-dimensional shape. Think
of the x and y variables as being measured along the sides of a chessboard. Then
every combination of x and y would map onto a square somewhere on the
chessboard. For example, suppose x=1 and y=1. Start at one of the corners of the
chessboard. Then move one square in on the x side for x=1, and one square up into
the board to represent y=1. Now, calculate the value of z.
The function z takes on a value of 4, which we graph as a height of 4 over the

square that represents x=1 and y=1. Map out the entire function this way, and the
result will be a shape, usually looking like a mountain peak in typical economic
analysis problems.
Now back to slope. Imagine standing on the mountain shape, facing parallel to the
x side of the chessboard. If you allow x to increase, while holding y constant, then
you would move forward in a straight line along the mountain shape. We define
the slope in this direction as the change in the z variable, or a change in the height
of the shape, in response to a movement along the chessboard in one direction, or a
change in the variable x, holding y constant.
Formally, the definition is: the partial derivative of z with respect to x is the
change in z for a given change in x, holding y constant. Notation, like before, can
vary. Here are some common choices:
Now go back to the mountain shape, turn 90 degrees, and do the same experiment.
Now, we define a second slope as the change in the height of the z function in
response to a movement forward on the chessboard (perpendicular to the
movement measured by the first slope calculation), or a change in the y variable,
holding the x variable constant. Typical notation for this operation would be
Therefore, calculus of multivariate functions begins by taking partial derivatives,

in other words, finding a separate formula for each of the slopes associated with
changes in one of the independent variables, one at a time. Before we discuss
economic applications, let's review the rules of partial differentiation.
Basic rules of partial differentiation
The rules of partial differentiation follow exactly the same logic as univariate
differentiation. The only difference is that we have to decide how to treat the other
variable. Recall that in the previous section, slope was defined as a change in z for
a given change in x or y, holding the other variable constant. There's our clue as to
how to treat the other variable. If we hold it constant, that means that no matter
what we call it or what variable name it has, we treat it as a constant. Suppose, for
example, we have the following equation:
If we are taking the partial derivative of z with respect to x, then y is treated as a

constant. Since it is multiplied by 2 and x and is constant, it is also defined as a
coefficient of x. Therefore,
Therefore, once all other variables are held constant, then the partial derivative
rules for dealing with coefficients, simple powers of variables, constants, and
sums/differences of functions remain the same, and are used to determine the
function of the slope for each independent variable. Let's use the function from the
previous section to illustrate.
First, differentiate with respect to x, holding y constant:
Note that there were no y variables in the first term, so differentiation was exactly
like the univariate process; in the last term there were no x variables, therefore the
derivative is zero, according to the constant rule, since y is treated as a constant.
Now, take the partial derivative with respect to y, holding x constant:
Again, note that the first term had no "variables" in it, since x is being treated as a
constant, therefore the derivative of that term is 0.
To make sure you have a clear picture of more than one slope in a function, let's
evaluate the two partial derivatives at the point on the function where x = 1 and y =
2:
How do we interpret this information? First, note that when x = 1 and y = 2, then
the function z takes on a value of 3. At this point on our "mountain' or 3
dimensional shape, we can evaluate the change in the function z in 2 different
directions. First, the change in z with respect to x is 10. In other words, the slope
in a direction parallel to the x-axis is 10. Now turn 90 degrees. The slope in a
direction perpendicular to our previous slope is 6, therefore not quite as steep.
Also, note that although each slope depends on the change in only one variable, the
position or fixed value of the other variable does matter; since you need both x and
y to actually calculate the numerical values of slope. We'll come back to this in the
next section, and look at the economic meaning behind this relatedness. But first,
back to the rules.
The product and quotient of functions rules follow exactly the same logic: hold all
variables constant except for the one that is changing in order to determine the
slope of the function with respect to that variable. To illustrate the product rule,
first let's redefine the rule, using partial differentiation notation:
Now use the product rule to determine the partial derivatives of the following
function:
To illustrate the quotient rule, first redefine the rule using partial differentiation
notation:
Use the new quotient rule to take the partial derivatives of the following function:
Not-so-basic rules of partial differentiation
Just as in the previous univariate section, we have two specialized rules that we
now can apply to our multivariate case.
First, the generalized power function rule. Again, we need to adjust the notation,
and then the rule can be applied in exactly the same manner as before.
When a multivariate function takes the following form:
Then the rule for taking the derivative is:
Use the power rule on the following function to find the two partial derivatives:
The composite function chain rule notation can also be adjusted for the
multivariate case:
Then the partial derivatives of z with respect to its two independent variables are
defined as:
Let's do the same example as above, this time using the composite function
notation where functions within the z function are renamed. Note that either rule
could be used for this problem, so when is it necessary to go to the trouble of
presenting the more formal composite function notation? As problems become
more complicated, renaming parts of a composite function is a better way to keep
track of all parts of the problem. It is slightly more time consuming, but mistakes
within the problem are less likely.
The final step is the same, replace u with function g:

Special cases in multivariate functions
The last two special cases in multivariate differentiation also follow the same logic
as their univariate counterparts.
The rule for differentiating multivariate natural logarithmic functions, with

appropriate notation changes is as follows:
Then the partial derivatives of z with respect to its independent variables are
defined as:
Let's do an example. Find the partial derivatives of the following function:
The rule for taking partials of exponential functions can be written as:
Then the partial derivatives of z with respect to its independent variables are
defined as:
One last time, we look for partial derivatives of the following function using the
exponential rule:
Higher order partial and cross partial derivatives
The story becomes more complicated when we take higher order derivatives of
multivariate functions. The interpretation of the first derivative remains the same,
but there are now two second order derivatives to consider.
First, there is the direct second-order derivative. In this case, the multivariate
function is differentiated once, with respect to an independent variable, holding all
other variables constant. Then the result is differentiated a second time, again with
respect to the same independent variable. In a function such as the following:
There are 2 direct second-order partial derivatives, as indicated by the following

examples of notation:
These second derivatives can be interpreted as the rates of change of the two slopes
of the function z.
Now the story gets a little more complicated. The cross-partials, fxy and fyx are
defined in the following way. First, take the partial derivative of z with respect to
x. Then take the derivative again, but this time, take it with respect to y, and hold
the x constant. Spatially, think of the cross partial as a measure of how the slope
(change in z with respect to x) changes, when the y variable changes. The
following are examples of notation for cross-partials:
We'll discuss economic meaning further in the next section, but for now, we'll just
show an example, and note that in a function where the cross-partials are
continuous, they will be identical. For the following function:
Take the first and second partial derivatives.
Now, starting with the first partials, find the cross partial derivatives:
Note that the cross partials are indeed identical, a fact that will be very useful to us
in future optimization sections.
Problem Set
SHOW SOLUTIONS
The following is a quiz on your understanding of multivariate differentiation.

After you work through the problems, you can click "Show Solutions above" to see
a step by step solution to each problem.
1a.
b.
c.
d.
2a.
b.
c.
d.
3a.
b.
c.
d.
4a.
b.
c.
d.
5a.
b.
c.
d.
6a.
b.
c.
d.
7a.
b.
c.
d.
8a.
b.
c.
d.
9a.
b.
c.
d.
10a.
b.
c.
d.
Problem Set
HIDE SOLUTIONS
The following is a quiz on your understanding of multivariate differentiation. You

may want to click "Hide Solutions" above to work through them on your own.
After you work through the problems, you can then see a step by step solution to
each problem.
1a. correct
b. incorrect
c. incorrect
d. incorrect
2a. correct
b. incorrect
c. incorrect
d. incorrect
3a. correct
b. incorrect
c. incorrect
d. incorrect
4a. correct
b. incorrect
c. incorrect
d. incorrect
5a. correct
b. incorrect
c. incorrect
d. incorrect
6a. correct
b. incorrect
c. incorrect
d. incorrect
7a. correct
b. incorrect
c. incorrect
d. incorrect
8a. correct
b. incorrect
c. incorrect
d. incorrect
9a. correct
b. incorrect
c. incorrect
d. incorrect
10a. correct
b. incorrect
c. incorrect
d. incorrect
operations - multivariate
The meaning of slope and rates of change in multivariate functions
Slope and marginal values have basically the same interpretation in multivariate
problems as they do in uinivariate problems. One of the benefits of multivariate
processes is that economists can get a much richer interpretation of how variables
act and interact.
Before we review the technical aspects of multivariate optimization, let's look at

some examples of how we can use information about marginal values and rates of
change.
Suppose that you are trying to understand the process of consumption and how
economic agents evaluate and trade off utility as they decide what goods to
purchase and consume. Without even knowing an exact utility function, we can
make some predictions regarding this process by using the concepts of partial
derivatives.
The partial derivative of utility with respect to consumption of good x can be

interpreted as the marginal utility of x, or the amount of utility gained when a little
more x is consumed. Suppose we are given the information that the ratio of the
marginal utility of x to the marginal utility of y is one to one. How can we
interpret this? Economists define this ratio as the marginal rate of substitution, and
ues it to interpret how consumers evaluate tradeoffs in consumption of goods.
In virtually every area of economic behavior, slopes and rates of change from
calculus operations can give information about how agents make decisions, such as
how they value the next unit of consumption or the next unit of production, or the
tradeoff between using labor vs. using capital, or the utility associated with one
more unit of income.
Before we can interpret the information, however, we have to adapt our univariate
techniques to multivariate functions.
Optimization of multivariate functions
The conditions for relative maxima and minima for multivariate functions are very
similar to those for univariate functions, with one additional requirement.
First, all first-order partial derivatives must equal zero when evaluated at the same
point, called a critical point. If we are considering a function z with two
independent variables x and y, then the three-dimensional shape taken by the
function z reaches a high or low point when evaluated at specific values of x and y;
these values are determined by setting the first derivatives equal to zero, and then
solving the resulting system of equations for the two variables.
Second, the second-order direct partial derivatives must both be the same sign
when evaluated at the critical point(s). For a maximum, they must both be
negative and for a minimum, both positive. This condition serves the same
purpose as the second-order derivative condition in univariate optimization. It
guarantees that the point where the slope is zero is indeed a high point, in the
direction of the x variable and also in the direction of the y variable. This
condition must be satisfied for both variables simultaneously, in order to rule out
shapes of functions such as "saddle points."
To understand a saddle point, imagine a three dimensional shape, at a point where

in one direction you are at the top of a hill (where the slope is zero), like being on a
saddle where the shape is traced from the left to the right of the saddle. Now, turn
90 degrees. You are still at a point where the slope is zero, but the shape running
from the back to the front of the saddle is now a valley and you are at the
minimum.
For this type of a shape, the first order derivatives of x and y are zero, but the
second order derivatives have different signs, meaning a relative maximum in one
direction and a relative minimum in the other.
The third condition is rather technical. When evaluated at the critical point(s), the
product of the second order partials must exceed the product of the cross partials.
This condition rules out critical points that are neither points of maximum or
minimum, but are points of inflection. A point of inflection is a point on a shape
where certain conditions of optima are met, but the function does not actually take
on the shape of a maximum or minimum.
To sum up, the points of optimum must have all of the following characteristics:
Relative maximum Relative minimum
Let's try an example. Given the following function, start by setting first derivatives
equal to zero:
Using the technique of solving simultaneous equations, find the values of x and y
that constitute the critical points.
Now, take the second order direct partial derivatives, and evaluate them at the
critical points.
Both second order derivatives are positive, so we can tentatively consider the
function evaluated at the critical point (x=1, y=1) to be a relative minimum. Now
we take cross partials and check the final condition:
Note that it wasn't necessary to take both cross partials. Recall that in a previous
section we noted that continuous functions will have identical cross partials.
Therefore, either cross partial could have been used in the last condition, but taking
both is a good way to check your work.
Constrained optimization with Lagrange multipliers
Constrained optimization is the technique of optimizing a function while adding an

additional limit or constraint to the process. Typically, this constraint will be a
budget (a monetary constraint) or process limitation (a physical constraint). Up to
this point, all optimization problems have implicitly assumed that we could spend
any amount of money on resources, and also use physically any amount of
resources in order to optimize. This in one of the most unrealistic assumptions it is
possible to make, and so the last technique we will review is a technique that
allows constraints to be added to optimization processes.
The Lagrangian multiplier method incorporates a constraint into the body of the
function being optimized in such a way that only if the constraint is met will the
function reach its optimal point.
Let's illustrate this with an example.
Suppose our goal is to optimize Z, subject to the requirement that x and y equal 60:
Now, we can take derivatives of L, with respect to x, y, and our new variable λ.
The result of forming this new function is that we have added the condition that in
order for the derivative of L with respect to the variable λ to be equal to zero (a
condition of optimization), the coefficient on the new variable must be equal to
zero. Given the way the constraint is rearranged, the coefficient is zero only when
the constraint is met. Therefore, the process of optimization now includes meeting
the constraint as a condition of optimization.
Once the Lagrangian is formed, optimization is a very straightforward process.

Take first derivatives, set equal to zero, and use the three equations to solve for the
two choice variables:
The last step is to test whether the critical point is a maximum or minimum, using
standard second order conditions where second derivatives greater than zero
implies a minimum, less than zero a maximum.
Problem Set
SHOW SOLUTIONS
Practice problems
The following is a quiz on your understanding of multivariate rates of change and

optimization techniques. After you work through the problems, you can link to a
step by step solution to each problem.
1a.
b.
c.
d.
2a.
b.
c.
d.
3a.
b.
c.
d.
Problem Set
HIDE SOLUTIONS
Practice problems
The following is a quiz on your understanding of multivariate rates of change and

optimization techniques. After you work through the problems, you can link to a
step by step solution to each problem.
1a. correct
b. incorrect
c. incorrect
d. incorrect
2a. correct
b. incorrect
c. incorrect
d. incorrect
3a. correct
b. incorrect
c. incorrect
d. incorrect

Functions Variables

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Variables, Functions and Equations

Economists are interested in examining types of relationships. For example an

A function tries to define these relationships. It tries to give the relationship a

A variable represents a concept or an item whose magnitude can be represented by

An expression such as 4x3 is a variable. It can assume different values because x

A monomial is an algebraic expression that is either a numeral, a variable, or the

The following are examples of monomials:

One or more monomials can be combined by addition or subtraction to form what

The expression 4x3y2 - 2xy2 +3 is a polynomial with three terms.

Independent variables are those which do not depend on other variables.

Definition: A function is a mathematical relationship in which the values of a

A goal of economic analysis is to determine the independent variable(s) which

We say y is a function of x. This means y depends on or is determined by x.

Mathematically we write y = f(x)

It means that mathematically y depends on x. If we know the value of x, then we

It is not necessary to use the letter f. For example we could say

We may look at functions algebraically or graphically. If we use algebra we look at

A simple example of functional notation

Qd = the number of pizzas (quantity) demanded

Pp = the price of a pizza

Pt = the price of tomato sauce

Pc = the price of cheese

Pd = the price of pizza dough

N = the number of potential pizza eaters

Pp = f(Pt, Pc, Pd)

A common economic example of functional notation

C = consumption, the amount spent on goods and services

Y = income, the amount available to spend

This is an example of a function that says the amount spent on consumption

This is a function which says that consumption is 25 regardless of the level of

The use of functional notation: some examples

This is a function that says that, y, a dependent variable, depends on x, an

Find f(0). This means find the value of y when x equals 0.

f(0) = 3 times 0 plus 4

Find f(1). This means find the value of y when x equals 1.

f(1) = 3 times 1 plus 4

d(p) = p2 -20p + 125

Find the demand when one item costs $2.

d(2) = 22 - 20(2) + 125 = 89

Find the demand when one item costs $5.

d(5) = 52 - 20(5) + 125 = 50

Two or more functions can be added, subtracted, multiplied or divided.

Find g(0) + h(0)

Find g(1) h(2)

g(1) h(2) = (-2) ( 6) = -12

f(0) = (0)2 + 5(0) –24 = -24

f(-1) = (-1)2 + 5(-1) –24 = -28

f(3) = (3)2 + 5(3) –24 = 0

f(.5) = = (.5)2 –4 = -3.25

3. Consider the following demand function:

d(p) = p2 –20p + 125

d(2) = 22 –20(2) + 125 = 89

d(5) = 52 –20(5) + 125 = 50

d(8) = 82 –20(8) + 125 = 29

d(10) = 102 –20(10) + 125 = 25

5. f(x) = x – 3 and g(x) = x2 + 2

a. find f(0) + g(0)

f(0) + g(0) = (1-3) + (02 + 2) = -1

b. find [f(1)] [g(2)]