INTRODUCTION

Why Study Mathematics?

Economics is a social science. It does not just describe what goes on in the economy. It attempts to
explain how the economy operates and to make predictions about what may happen to specified
economic variables if certain changes take place, e.g. what effect a crop failure will have on crop
prices, what effect a given increase in sales tax will have on the price of finished goods, what will
happen to unemployment if government expenditure is increased. It also suggests some guidelines
that firms, governments or other economic agents might follow if they wished to allocate resources
efficiently. Mathematics is fundamental to any serious application of economics to these areas.

Quantification
In introductory economic analysis predictions are often explained with the aid of sketch diagrams.
For example, supply and demand analysis predicts that in a competitive market if supply is restricted
then the price of a good will rise. However, this is really only common sense, as any market trader
will tell you. An economist also needs to be able to say by how much price is expected to rise if
supply contracts by a specified amount. This quantification of economic predictions requires the use
of mathematics. Although non-mathematical economic analysis may sometimes be useful for
making qualitative predictions (i.e. predicting the direction of any expected changes), it cannot by
itself provide the quantification that users of economic predictions require. A firm needs to know
how much quantity sold is expected to change in response to a price increase. The government wants
to know how much consumer demand will change if it increases a sales tax.

Simplification
Sometimes students believe that mathematics makes economics more complicated. Algebraic
notation, which is essentially a form of shorthand, can, however, make certain concepts much clearer
to understand than if they were set out in words. It can also save a great deal of time and effort in
writing out tedious verbal explanations. For example, the relationship between the quantity of apples
consumers wish to buy and the price of apples might be expressed as: ‘the quantity of apples
demanded in a given time period is 1,200 kg when price is zero and then decreases by 10 kg for
every 1p rise in the price of a kilo of apples’. It is much easier, however, to express this
mathematically as:
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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
q = 1,200−10p where q is the quantity of apples demanded in kilograms and p is the price in pence
per kilogram of apples. This is a very simple example. The relationships between economic variables
can be much more complex and mathematical formulation then becomes the only feasible method
for dealing with the analysis.

Scarcity and choice

Many problems dealt with in economics are concerned with the most efficient way of allocating
limited resources. These are known as ‘optimization’ problems. For example, a firm may wish to
maximize the output it can produce within a fixed budget for expenditure on inputs. Mathematics
must be used to obtain answers to these problems. Many economics graduates will enter
employment in industry, commerce or the public sector where very real resource allocation decisions
have to be made. Mathematical methods are used as a basis for many of these decisions. Even if
students do not go on to specialize in subjects such as managerial economics or operational research
where the applications of these decision-making techniques are studied in more depth, it is essential
that they gain an understanding of the sort of resource allocation problems that can be tackled and
the information that is needed to enable them to be solved.

Economic statistics and estimating relationships

As well as using mathematics to work out predictions from economic models where the relationships
are already quantified, one also needs mathematics in order to estimate the parameters of the models
in the first place. For example, if the demand relationship in an actual market is described by the
economic model q = 1,200 − 10p then this would mean that the parameters (i.e. the numbers 1,200
and 10) had been estimated from statistical data. The study of how the parameters of economic
models can be estimated from statistical data is known as econometrics. Although this is not one of
the topics covered in this book, you will find that a knowledge of several of the mathematical
techniques that are covered is necessary to understand the methods used in econometrics. Students
using this book will probably also study an introductory statistics course as a prerequisite for
econometrics, and here again certain basic mathematical tools will come in useful.

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
 1. APPLICATION OF LINEAR EQUATIONS

1.1 Single Linear Equations

A function of a real variable x (with domain D) is a rule that assigns a unique real number to each
number x in the domain D. Functions are often given letter names such as f, g, or F. We often call x
the independent variable or the argument of the function f. If g is the function and x is a number in
D, then g(x) denotes the number that the function g assigns to x. We often use a variable name to
represent the value of the function f. For example, we might write y = f(x) where x represents a
number in the domain of f. Or we might right p = g(q) where q represents a number in the domain of
g.
Examples of functions
Let f(x) = 3x + 2.
First consider the case where x = 4.
If x = 4, then f(x) = (3)(4) + 2 = 14
Now, let x = -2. If x = -2, then f(x) = (3)(-2) + 2 = -4
The domain of a function is the set of all values that can be substituted for x in the function f(x). If
a function f is defined using an algebraic formula, we normally adopt the convention that the domain
consists of all values of the independent variable for which the function gives a meaningful value.

Examples
1. y = f(x) = 6x2 + 2
Because f(x) is defined for all real numbers, we say that the domain of f is the real line or all
numbers between -∞ and ∞.
1
2. z = g(w) = w2 +
w
Because g(w) is not defined at w = 0, but is defined for all other real numbers, we say that the
domain of g is all numbers between -∞ and ∞ except for zero.

3. p = f(q) = q + 2q
Because f(q) is not defined if q is a negative number (the square root of a negative number yields an
imaginary number), but is defined for all non-negative real numbers, we say that the domain of f is
all non-negative real numbers.

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
The Graph of a Function in Two Dimensions
When the function g(x) is given by an equation of y and x, the graph of g is the graph of the
equation, that is the set of points (x, y) in the xy-plane that satisfies the equation (makes the equation
true.) In other words, the graph of the function g(x) is the set of all points [x, g(x)], where x is in the
domain of g.

When graphing a function f(x) in two dimensions, it is customary to represent values in the domain
of the function on the horizontal axis and corresponding values f(x) on the vertical axis. That is, the
independent variable (x) is normally graphed on the horizontal and the dependent variable (y) on the
vertical axis. While this representation is customary, it is also acceptable to represent the domain on
the vertical axis as long as the relationship is clear.

Example

f(x) = 8 - 2x

20

15

10

5 f(x)

0
-6 -4 -2 0 2 4 6 8 10
-5

-10

When x = 0, then f(x) = 8. When x = 4, f(x) = 0. When x = -2, f(x) = 12.

A linear function of a real variable x is given by, y = f(x) = ax + b, where a and b are constant real
numbers.
The graph of a linear equation is a straight line. The number a is called the slope of the function and
the number b is called the y-intercept. The y-intercept is the value of the function when x = 0. For
illustration consider the following consumption and saving linear functions.
C  a  bY
S     Y
Note: Y = C + S and hence MPC +MPS = 1

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
 1.2 Simultaneous Linear Equations
Example 1: Rhoda bought a fruit cake and two chocolate cakes at a cost of Sh.2, 000.On the
following day her brother Luther visited the same shop and bought two fruit cakes and three
chocolate cakes at a cost of Sh.3500.What was the cost of each cake?
To find the value of two unknowns in a problem, two different equations must be given that relate
the unknowns to each other. These two equations are called simultaneous equations.
A) Substitution method
From the situation above, let the cost of the fruit and chocolate cakes be x and y respectively.
x + 2y = 2000 (i)
2x + 3y = 3500 (ii)
Step 1: Write one variable in terms of the other using one of the equations. E.g from (i) x = 2000 -
2y.
Step 2: Substitute this expression for x in equation (ii) and solve to find y.
2(2000 – 2y) + 3y = 3500.
4000 – 4y +3y = 3500.
4000 – y = 3500.
y = 4000 – 3500
y = 500.
Step 3: Find x from any of the two equations using this value of y.
x + 2(500) = 2000.
x + 1000 = 2000.
x = 2000 – 1000
x = 1000.
Therefore the fruit cake costs Sh.1000 and the chocolate cake costs Sh.500.
Exercise: Use the substitution method to solve the following.
1. 2x + y = 5 3. x + 2y = 8
X + 3y = 5 2x + 3y = 14
2. 3x + y = 10 4. 2x+ y = - 3
x–y=2 x – y = -3

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
 B) Elimination Method.
Example 2: The cost of one litre of petrol and two litres of diesel is Sh.5800.If you buy two litres of
petrol and three litres of diesel, the cost would be Sh.9800.Find the unit cost of petrol and diesel.
Let the cost of a litre of petrol be x and that of diesel y.
x + 2y = 5800 (i)
2x + 3y = 9800 (ii)
Step 1: Choose an unknown in one of the equations and multiply the equations by a factor or factors
so that this unknown has the same coefficient in both equations.
Step 2: Eliminate this unknown from the two equations by subtracting them, then solve for the
remaining unknown.
Step 3: Substitute in the first equation and solve for the eliminated unknown.
x + 2y =5800 …(i)
(1) x 2 2x + 4y = 11,600 …(ii)
2x + 3y = 9800…(ii)
Subtract (ii) from (iii)
y = 1800
Substituting in (i)
x + 2(1800) = 5800
x + 3600 = 5800
x = 5800 – 3600
x = 2200.
One litre of petrol costs Sh.2200 while diesel Sh.1800.

Exercise: Use the elimination method to solve the following:

1. 2x + 5y = 24 2. 5x + 2y = 13
4x +3y = 20 2x + 6y = 26

3. 4x +y = 11 4. x + 2y = 17
9x + 2y = 28 8x +3y = 45

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
 C) Solution by Matrix Method.

Example 3: The wage bill for five men and six women workers is Sh.670, 000, while the bill for
eight men and three women is Sh.610,000. Find the wage for a man and a woman.
Let the wage of a man be x and that of a woman y.
5x + 6y = 670,000. ….(i)
8x + 3y = 610,000. …..(ii)

Step 1: Re-write the equations in matrix form.

5 6 x = 670,000

8 3 y 610,000

This shows the matrices of coefficients, variables and constants in the order they appear.
Step 2: Find the inverse of the matrix of coefficients.
Note: In order to find an inverse of matrix requires us to find the determinant of the matrix first.
The determinant of 5 6 is (5 x 3 ) – ( 6x 8) = - 33.
8 3

Thus the inverse of the above matrix would then be:

1 3 -6
. -33 -8 5

Step 3: Pre-multiply through the matrix equation by this inverse.

1 3 -6 5 6 x = 1 3 -6 670000
-33 -8 5 8 3 y -33 -8 5 610000
When a matrix is multiplied by its inverse the result is an Identity matrix. Thus the left hand side
yields an identity matrix.
1 0 x = 1 -1650000
0 1 y -33 -2310000

x = 50000
y 70000

Therefore a man earns Sh.50,000 while a woman Sh.70,000.

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
Exercise: Formulate a pair of simultaneous equations and solve using the matrix method.
1. Find two numbers with a sum of 28 and a difference of 2.
2. Twice one number added to three times another gives 26. Find the number, if the
difference between them is 3.
3. The average of two numbers is 9, and three times the difference between them is 18.
Find the numbers.

D) Graphical Solution of Simultaneous Equations.

Example 4: Solve graphically 3x + 2y = 8
x – 4y = -2 .
The equations above are equations of straight lines. Hence we can draw the two lines on the same
graph page and find their point of intersection. The co-ordinates of this point of intersection will
provide the solutions to the simultaneous equations.
For the line 3x + 2y = 8
x 0 2 4

y 4 1 -2

For the line x – 4y = -2.

x 2 6 10

y 1 2 3

Exercise: Draw the two lines on the same pair of axes and find the point of intersection. State the x
and y co-ordinates as the solution.

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
1.3 Demand and Supply Analysis
Market Equilibrium is attained at a point where Quantity Demanded = Quantity Supplied
In general,
Demand Function: QD = a + bP
Supply Function: QS = c + dP
 Set QD = QS and solve simultaneously for Pe = (a - c)/(d - b)
 Knowing Pe, find Qe given the demand/supply functions
 Qe = (ad - bc)/(d - b)
Example 1:
QD = 50 – P (i)
QS = 20 + 2P (ii)
 Set QD = QS
50 – P = 20 + 2P
3P = 30
P = 10
 Knowing P, find Q
Q = 50 – P
= 50 - 10 = 40
 Check the solution
i) 40 = 50 – 10 and (ii) 40 =20 + (2*10)
In both equations if P=10 then Q=40
Changes in Demand or Supply…
Shift the curves and results in a new equilibrium price and quantity

Market Equilibrium + Excise Tax

Impose a tax t on suppliers per unit sold……
Shifts the supply curve to the left
QD = a + bP
QS = d + eP with no tax
QS = d + e(P-t) with tax t on suppliers

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
QD = 50 – P, and QS = 20 + 2P becomes
QS = 20 + 2(P-t)
Write Equilibrium P and Q as functions of t
 Set QD = QS
50 – P = 20 + 2(P-t)
30 = 3P – 2t
3P = 30 + 2t
P = 10 + 2/3t
 Knowing P, find Q  Q = 50 – P
= 50 – (10+2/3t)
= 40 – 2/3t

Example 2: Consider the following demand and supply equations

QD = 132 – 8P
QS = 6 + 4P
(i) Find the equilibrium P and Q.
(ii) What is the equilibrium P and Q if unit tax t = 4.5?
Solution…..
(i) Equilibrium values
 Set QD = QS
132 – 8P = 6 +4P
12P = 126
P = 10.5
 Knowing P, find Q  Q = 6 +4P
= 6 + 4(10.5) = 48
Equilibrium values: P = 10.5 and Q=48
(ii) If per unit t = 4.5, recall Pd = Ps + t which implies Pd = Ps + 4.5
8(Ps + 4.5) =132 – Q and 4Ps = -6 + Q
8(Ps + 4.5) =132 – (4Ps + 6) which implies Ps = 7.5 and Pd = 12
From either demand or supply equation we obtain new quantity traded in the market after tax
Q* = 36

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
Example 3: Consider a competitive market with demand given by Pd = 100-2Q and supply given by
Ps = 10+Q, with the aid of a diagram:
i. Find competitive equilibrium price and quantity.
Pd = Ps, 100-2Q = 10 +Q, Q* = 30 and P* = 40
ii. Suppose government introduce per unit tax of T = 15 on producers. Find the quantity traded
in the market after tax. Find the price paid by the consumer (Pd) and the price received by the
supplier (Ps) after tax.
With go government per unit tax (T) of 15, setting Qd = Qs implies, 50-0.5(Ps + 15) = Ps –
10. That means Ps = 35 and Pd = 50, hence quantity traded after tax is Q = 25 units.
Price paid by the consumer after tax is Pd = 50 and price received by producer after tax is Ps
= 35.

Example 4: A match box in Tanzania is sold at Tshs. 200 each. Assuming that supply curve is
perfectly elastic and demand function for match box is P = 325 – 1.25Qd. Calculate the effect on
price and quantity demanded of the introduction of VAT at a rate of 20%, and determine the
resulting deadweight loss and tax revenue collected.
Note: Supply curve is perfect elastic (horizontal placed)
Equating Qd = Qs, from given information 200 = 325 – 1.25Q implies Q* = 100
P1 = P0 + (P0*20%) = 200 + (200*0.2) = 240, Equating again Qd = Qs to determine impact of
introduced tax
240 = 325 – 1.25Q implies Q* = 68

Price

240 S1

200 S0

100 68 Qty

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
1.4 National Income Determination
In its simplest form an economy consists of firms and households (a two -sector economy).
Households own factors of production which they provide to firms. In return for land,
labour, capital and enterprise to firms they receive income in the form of rent, wages,
interest and profit. These incomes are spent in buying the output of goods and services
made by firms and this expenditure becomes incomes for firms which in turn are used to
pay incomes to households and so on. Thus a circular flow of income is created. Therefore
the total value of output should equal the total expenditure on goods and services and
should equal the total income of households.
Y=C+I

Recall that C = a + bY and also MPC + MPS = 1, derived from consumption and saving functions in
linear forms.
Example 1: For a given general consumption function determines the corresponding saving
function.
S = Y – C substitute value of C given above
S = Y – (a + bY)  S = -a + (1-b)Y and recall that 1 – b = MPS
Given C = 0.8Y +25 Determine the savings function that corresponds to this consumption.
Example 2: For above given general consumption function in a two sector model determine the
equilibrium level of national income.
Recall Y = C + I but C = a + bY combine those two equations we obtain
aI
Y = a + bY + I  Y * 
1 b
Find the equilibrium level of income if the consumption function is C = 0.8Y + 25 and planned
investment I = 17.

There are two schools of thought about how national income is determined. Some
economists believe that aggregate demand is the main determinant whilst others believe
that it is aggregate supply. Others believe that both aggregate demand and supply are
relevant. Economists who believe in the demand side of the economy as being the more
important are called Keynesians, named after the economist John Maynard Keynes who
developed the theory in the 1930s.

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
Equilibrium national income in an open economy
In a two-sector economy it is assumed that the economy is closed and that there is no
government activity. In an open economy, there is government activity and international
trade. This means that, as well as savings withdrawing income from the circular flow there
will also be taxation and spending on imports. Government spending and the selling of
exports will, in addition to investment, inject income into the circular flow. Ag gregate
demand in an open economy is therefore:
Y = C + I + G + (X – M)
Example 3: consider the following given information
G = 40, I = 55, C = 0.8Yd + 25 and T = 0.1Y + 10
You are required to calculate the equilibrium level of national income. (Hint: Yd = Y – T)

Example 4: In a Keynesian macroeconomic model of an economy with no foreign trade it is

assumed that
Y=C+I+G
C = 0.75Yt
Yt = (1 − t)Y
Where the usual notation applies and the following are exogenously fixed: I = £600m, G = £900m, t
= 0.2 is the tax rate. Find the equilibrium value of National Income (Y).

Example 5: In an economy which engages in foreign trade, it is assumed that Y = C + I + G + X −M

C = 0.9Yt; Yt = (1 − t)Y and imports M = 0.15Yt
The usual notation applies and the following values are given: I = £200m, G = £270m, X = £180m
and t = 0.2 What is the equilibrium value of Y? What is the balance of payments surplus/deficit at
this value?

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
 2. APPLICATION OF NON-LINEAR EQUATIONS
Definition: A quadratic function can be expressed in the form: y  f ( x)  ax 2  bx  c where
a  0 , a, b, and c are real numbers. The graph of a quadratic function is a called parabola.
Example 1: Investigate the effects of various values for a, b, and c on the graph of the function,
y  f ( x)  ax 2  bx  c . If available, you can use a graphing calculator, but in the absence of a
calculator, much can be learned by starting with a few special quadratic functions, using a table, and
carefully changing the values for a, b, and c. Be prepared to describe the functions you graphed and
your conjectures based on the graphs you studied.
Example 2: The equation y  0.05x 2  0.7 x  5 describes the path of a basketball after it is tossed.
a) What do the variables x and y represent in
Path of BB
the equation?
8

b) What was the approximate maximum 6

Height (ft)

height the ball reached? 4

2
c) When it hit the floor, about how far was 0
the ball from the person who tossed it? 0 5 10 15 20
horizontal distance (ft)

Example 3: A quadratic function can also be written in the form y  f ( x)  a( x  h)2  k , which
sometimes is more useful. Investigated the effects of various values for a, h, and k in the equation
y  f ( x)  a( x  h)2  k . How does your analysis of this form differ from what you learned with
Example 1?
Example 4: Different ways of thinking about a problem can lead to different methods for solving it.
For example, finding the x-intercepts of the graph of y  ax 2  bx  c is the same as solving the

equation ax 2  bx  c  0 . The solutions to ax 2  bx  c  0 are called the roots of the

equation y  ax 2  bx  c .

Find the x-intercepts of the graph of y  x 2  9 x i.e., solve x 2  9 x  0 .

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
2.1 Solving Quadratic Equations
Equations such as x2 = 64, x2 -5x = 0, and x2 + 4x = 5 are called quadratic equations as we have seen
earlier. This is because in each of these equations the greatest exponent of any variable is 2.
Standard Form of Quadratic Equations: ax2 + bx + c = 0
Before you select the method that you will use to solve a quadratic, you must use inverse operations
to get the equation to equal zero (if necessary).

When solving quadratic equations, we can use two main methods:

1) Factoring
2) Quadratic Formula

2.1.1 Solving Quadratic Equations Using Factoring:

To Solve a Quadratic Using Factoring:
1) Put the quadratic equation into standard form (above).
2) Factor the quadratic expression.
3) Set each factor equal to zero.
4) Solve each equation.
5) Check each root in the original equation.
For example: x2 + 4x = 5
-5 -5
x2 + 4x – 5 = 0
(x + 5)(x – 1) = 0
x+5=0 x–1=0
-5 -5 +1 +1
x = -5 or x=1 Now, check in the original.

Exercises: Solve each quadratic equation using factoring:

1) x2 – 3x + 2 = 0 2) z2 – 5z + 4 = 0 3) x2 – 8x + 16 = 0
4) r2 – 12r + 35 = 0 5) c2 + 6c + 5 = 0 6) m2 + 10m + 9 = 0

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
2.1.2 Solving Quadratics Using the Quadratic Formula:
Not every quadratic equation can be solved by factoring. In this case, we need to use the quadratic
formula.
Quadratic Formula: x = - (b) ± √b2 – 4ac
2a
To Solve a Quadratic Using the Quadratic Formula:
1) Put the quadratic equation into standard form (above).
2) Write out the formula and what a, b, & c stand for.
3) Substitute for each variable.
4) Split into two separate equations (setting each equal to zero) and solve.
5) Check each root in the original equation.
For example: 2x2 + x = 6
-6 -6
2x2 + x – 6 = 0 ***Can’t be factored, use the formula.

x = - (b) ± √b2 – 4ac

2a
a = 2, b = 1, c = -6 x = - (1) ± √(1)2 – 4(2)(-6)
2(2)
= -1 ± √1 +48
4
x = -1 ± √49
4
x = -1 ± 7
4
x = -1 + 7 x = -1 – 7
4 4
x= 6 x = -8
4 4
x=3 x = -2 *** Now check in original equation
2

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
Exercises: Solve each equation using the quadratic formula:
1) x2 - 7x + 6 = 0 2) x2 + 4x – 5 = 0 3) x2 + 3x + 2 = 0
4) 2x2 + x – 1 = 0 5) 3x2 + 5x + 2 = 0 6) 3x2 + 5x + 2 = 0
7) x2 + 6x + 9 = 0 8) 4x2 – 4x + 1 = 0 9) x2 + 10x = -25
10) x2 + x = 12 11) x2 + 2x = 24 12) x2 = x + 2
13) x2 + 8 = 6x 14) 2x2 – 10 = x 15) x2 – 9 = 0
16) 5x2 = 20 17) x2 – 3x + 1 = 1 18) x2 = 5x
19) x2 – 2x – 2 = 0 20) x2 – 10x + 4 = 0 21) x2 + 2x – 4 = 0
22) x2 – 2 = 4x 23) 2x2 – 8x + 7 = 0 24) 4x2 = 2x + 1

2.1.3 Solving Quadratics Equation Using the Graph

Example: Use the graph below to solve the quadratic equation x 2  x  2  0 .

The graph of y  x 2  x  2 .

Solution: Since we are given the graph of y  x 2  x  2 and we are asked to solve

x 2  x  2  0 , we need to look for any places on the graph where y  0 , i.e., we need to find the
x-intercepts of the graph. Since the x-intercepts are (2, 0) and (1, 0) , we can conclude that the

solutions are x   2 or x  1 , so the solution set is 2, 1 .

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
 2.2 Application of Quadratic Equations in Economics
Worked Example 1: Given the quadratic supply and demand functions
P  Qs  2Qs  12
2

P  Qd  4Qd  68
2

Determine the equilibrium price and quantity.

Worked Example 2: Given the supply and demand functions

P  Qs  2Qs  7
2

P  Qd  25
Determine the equilibrium price and quantity.

Worked Example 3: Sketch on the same diagram, graphs of the total revenue and total cost
functions TR  2Q 2  14Q and TC  2Q  10
a) Use your graph to estimate the values of Q for which the firm maximizes profit.
b) Confirm your answer to part (a) using algebra.

Worked Example 4: Find an expression for the profit function given the demand function
32
2Q  P  25 and the average cost function AC  5.
Q
Find the value of Q for which the firm
a) Breaks even (profit = 0)
b) Makes a loss of 432 units
c) Maximizes profit

18
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
 3. MATHEMATICS OF FINANCE
3.1 Interest
Borrowing money is a necessary transaction for most people and businesses. Whenever money is
borrowed or goods are bought on credit, the customer pays interest on the amount due.
 The amount of money on which interest is paid is called the initial value (P).
 The interest charged on the borrowed money is expressed as a percentage. This percentage is
called the interest rate (i).
 When money is borrowed, the borrower agrees to pay back the initial value and the interest
within a specified period of time (n).

3.1.1 Simple interest

Simple interest calculations are used to determine the approximate interest gained once money has
been invested. Suppose you invest an amount of money at a certain bank and you are informed that
you will earn simple interest on the invested amount. This means that when the interest is calculated,
only the initial invested value will be considered. You will not earn interest on the interest that you
have earned on the initial invested amount. It is assumed in each case that the interest rate remains
constant. Simple interest is therefore the cost of borrowing money, computed on the original
principal only.
The interest due depends on 3 things:
 the initial value (P), the interest rate (i) and the number of years, or time (n)
The relationship is expressed as follows:
Formula for simple interest:
SI  P  i  n
where SI is the simple interest earned
P is the initial value
i is the interest rate written as a decimal and
n is the time in years

The amount to be repaid in the end is equal to the initial value plus the interest:
Amount to be repaid  P  SI

19
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
The time period is always quoted in years, so convert months to years before applying the time in the
formula. Remember that:
1
1 month = years
12
2 1
2 months =  years
12 6
9 3
9 months =  years
12 4
73 1
73 days =  years
365 5
292 4
292 days =  years
365 5
1
Example 1: Determine the simple interest when £200 is invested for 1 years at an interest rate of
2
9.5% per year.
Solution: P = £200
9,5
i  0,095 and n=1.5 years  SI  P * i * n  200 * 0.095 *1.5  £28.50
100
The interest earned is £28.50.
Example 2: John borrows £5,000 for 5 years at a simple interest rate of 19% per year. How much
interest must he pay? What is the total amount that must be repaid?
Solution: P = £5,000
19
i  0,19 n  5 years  SI  P * i * n  5000 * 0.19 * 5  £4,750
100
John has to pay £4,750 interest.
Amount to be repaid  P  SI = £5000 + £4750 = £9,750
The total amount that John must repay is £9,750.
Example 3:
How much interest will £3,000 earn in 9 months at a simple interest rate of 12% per year?
Example 4:
Your friend lends you £600 and states that you must pay him back £645 at the end of the month.
What is the simple interest rate that he is charging you?

20
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
3.1.2 Compound interest
When the interest due at the end of a certain period is added to the initial investment amount and the
sum of the two earns interest for the next period, then the interest earned is called compound interest.
The interest for each succeeding period will be greater than the interest for the previous one, as the
amount on which interest is calculated keeps on increasing.
Example 1: Find the total interest when £300 is invested for 3 years at an interest rate of 11%
compounded annually.
11
Solution: P = 300 i   0.11 n = 3
100
Year Instalment Interest earned New instalment
1 £300 £33 £333
2 £333 £36.63 £369.63
3 £369.63 £40.66 £410.29

So the total interest earned is £410.29 - £300 = £110.29

Example 2: Find the interest when £1,000 is invested for 3 years at an interest rate of 10%
compounded annually.

Example 3: Suppose your sister opened an account to the amount of £3,500 on 1 June 2015. If the
account earned interest at a rate of 6.5% compounded annually, how much money would be in the
account on 1 March 2017?

Formula for compound interest:

A  P1  i 
n

where A is the future value of the investment

P is the present value of the investment
i is the interest rate written as a decimal, and
n is the number of years
A  P  interest earned

21
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
In the preceding section the interest was compounded annually. In many instances the interest may
be compounded over other time periods such as a quarter, month, week or day. This rate, when it is
expressed as a rate per annum, is known as a nominal rate of interest.
Example 4: Find the interest when £200 is invested for 1.5 years at a nominal annual rate of 9.5%,
compounded half-yearly.
Solution
Months Instalment Interest earned New instalment
6 £200.00 £9.50 £209.50
12 £209.50 £9.95 £219.45
18 £219.45 £10.42 £229.87

When dealing with nominal rates of interest, we need to consider a few things before using the
formula. To determine the correct interest rate (i), the nominal rate must be divided by the number of
periods per year for which the interest is compounded. Furthermore, the time (n) now consists of the
total number of time periods involved.
Formula for calculating compound interest:
A  P1  i 
n

where A is the future value of the investment

P is the present value of the investment (initial investment)
i is the rate of interest per period written as a decimal
n is the number of periods that the interest is compounded for

Example 5: Find the interest when £200 is invested for 1.5 years at a nominal annual rate of 9.5%
compounded half-yearly.
Solution: The period is six months and the number of six months in 1.5 years (18 months) is
18
n  3 . Since the interest is compounded half-yearly, the interest rate per six months is
6
9,5%
 4,75%  0,0475 . We divide by 2, because there are two six-month periods in a year.
2
A  P1  i   2001  0.0475  £229.88
n 3

Total interest earned is £229.88  £200.00  £29.88 .

22
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
Example 6: An amount of £2,000 is deposited in a bank paying an annual interest rate of 8.6%,
compounded quarterly. Find the balance after 3 years.
Solution: Here the period is a quarter year (3 months), and the number of quarters in 3 years is
n  3  4  12 . Since the interest rate is compounded quarterly, the interest rate
8.6%
per quarter is  = 2.15% = 0.0215.
4
We are trying to find the future value of £2,000 in 12 periods of three months each at a quarterly rate
of 2.15% = 0.0215. Let us substitute all our given numbers in the formula.
A  P1  i   20001  0,0215  £2581.61
n 12

The balance in the bank is £2,581.61 after three years.

Example 7: Joe made a deposit of £1,200. Two years later he made a second deposit of £800. How
much is in Joe’s account five years after the first deposit, at a nominal annual rate of 9%
compounded quarterly.
Solution: Here the period is a quarter year (3 months), and the number of quarters in 5 years is
n  5  4  20 . Since the interest rate is compounded quarterly, the interest rate per quarter is
9%
  2.25% = 0.0225.
4
In this case there are two payments at different points in time. The solution is straightforward when
it is realised that the accumulated values of the payments can be considered separately and then
simply added together.
The first payment was £1200, which will earn interest for five years, or 20 periods. The second
payment was £800, which will earn interest for three years, or 12 periods.
Interest earn for the first payment:
A  P1  i   12001  0.0225  £1872.61
n 20

Interest earn for the second payment:

A  P1  i   8001  0.0225  £1044.84
n 12

Interest earn over the five years = Interest earn for the first payment + Interest earn for the second
payment.
Interest earn over the five years = £1872.61  £1044.84  £2917.45 .

23
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
3.2 Annuity
An annuity is a finite series of payments made at equal intervals of time. The payments may be of
constant amount or they may vary.
Examples of annuity payments are mortgage payments, loan repayments, rent payments and
insurance premiums.
There are two types of annuities. We will only work with simple ordinary annuities. A simple
annuity is where interest is compounded at the same time as the annuity payments and ordinary
means that constant level of payments is made at the end of each period.

3.2.1 Future value of an annuity

The future value of an annuity is the amount due at the end of the term.
Let us illustrate the idea below:
Example 1: If you deposit £500 at the end of each year for the next three years at a nominal annual
rate of 8% compounded yearly, how much will you have at the end of three years in your bank
account?
Year Balance at Interest earn Payment at the Total at the end of
beginning of end of the year the year
year
1 0 0 500 500
2 500 40 500 1040
3 1040 83.20 500 1623.20

At the end of three years you will have £1,623.20 in your bank account.
Formula for future value of an annuity

Fv  R 
1  i n  1 where:
i
Fv = future value of the annuity (total payments plus the interest earn)
R = amount of the annuity payments made per period
n = the total number of payments
i = the interest rate per payment period written as a decimal

24
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
Example 2: If you deposit £500 at the end of each year for the next three years at a nominal annual
rate of 8% compounded yearly, how much will you have at the end of three years in your bank
account?
Solution:

Fv  R
1  i  1
n

Fv  500 
1  0,08  1
3

0,08
Fv  £1623.20
At the end of three years you will have £1,623.20 in your bank account.

Example 3: Suppose you want to be a millionaire by the time you are 65. You can deposit £500 at
the end of every three months and earn interest at a nominal annual rate of 11% compounded
monthly. Give reasons whether you will be a millionaire at 65 if you are now 25 years of age.
Solution:
The period is every three months, and the number of three months in 40 years is: n  40  4  160 .
Since the interest is compounded monthly, the interest rate
11%
per month is   0.917% = 0.00917.
12
R = £500
n = 160
i = 0.00917

Fv  R 
1  i n  1
i

Fv  500 
1  0.00917   1
160

0.00917
Fv  £180380.16
You will only have £180380.16 by the time that you are 65 years old. That is not a lot of money. So
you are definitely not a millionaire.

25
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
3.2.2 Present value of an annuity
The present value of an annuity is its value at the beginning of the initial rent period.

Formula for present value of an annuity

1  1  i 
n
Pv  R  where:
i
Pv = present value of the annuity (total payments plus the interest paid)
R = amount of the annuity payments made per period
n = the total number of payments
i = the interest rate per payment period written as a decimal

Example 1: Stuart bought himself a little house and made monthly payments of £4,000 for twelve
years. The nominal annual rate is 12.5% compound monthly. He would like to know the equivalent
cash price of the house.
Solution: The period is every month, and the number of months in 12 years is n  12 12  144 .
Since the interest is compounded monthly, the interest rate
12.5%
per month is   1.042% = 0.01042.
12

1  1  i 
n
Pv  R 
i

1  1  0.01042
144
Pv  4000 
0.01042
Pv  £297596.43
The equivalent cash price of the house is £297,596.43

Example 2: Your dad owes the bank £40,000 and wants to make equal monthly payments that will
have the total paid off at the end of two years. What will the size of the payments be if the bank is
charging a nominal annual rate of 13% compounded monthly?
Solution: The period is every month, and the number of months in 2 years is n  2 12  24 .
Since the interest is compounded monthly, the interest rate

26
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
 13%
per month is   1.083% = 0,01083.
12
R we need to find

1  1  i 
n
Pv  R 
i

1  1  0.01083
24
40000  R 
0.01083
1  1,01083
24
R  40000 
0,01083
R  £1901,60
The size of the payments must be £1901.60

Example 3: As you run low on cash during the holiday you put £2,000 of expenses on your credit
card. You can only afford to make the minimum payment of £300 per month. If the nominal annual
rate is 16%, compounded daily, how long will you need to pay off the £2,000?
Solution: Since the interest is compounded daily, the interest rate
16%
per day is   0.0438% = 0.000438.
365
n we need to find

1  1  0.000438
n
2000  300 
0.000438
2000  0.000438
 1  1  0.000438
n

300
1  0,00292  1  0,000438
n
the equation is of the form a  b n we have to use
the Log rule to find the solution
log( 1  0,00292)  log 1  0,000438
n

log(1  0,00292)  n log 1  0,000438

log( 0,99708)
n
log( 1,000438)
n  6,68
It will take you almost 7 months to pay off your debt.

27
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
3.3 Project Appraisal
Project appraisal or capital budgeting is a required managerial tool. One duty of a financial manager
is to choose investments with satisfactory cash flows and rates of return. Therefore, a financial
manager must be able to decide whether an investment is worth undertaking and be able to choose
intelligently between two or more alternatives. To do this, a sound procedure to evaluate, compare,
and select projects is needed. This procedure is called capital budgeting. Investment decision
involve a systematic process for calculating and comparing benefits and costs of a project for two purposes:
(1) to determine if it is a sound investment (justification/feasibility), (2) to see how it compares with alternate
projects (ranking/priority assignment). It involves comparing the total expected cost of each option against the
total expected benefits, to see whether the benefits outweigh the costs, and by how much.

I. Basic Steps of Capital Budgeting

1. Estimate the cash flows
2. Assess the riskiness of the cash flows.
3. Determine the appropriate discount rate.
4. Find the PV of the expected cash flows.
5. Accept the project if PV of inflows > costs. IRR > Hurdle Rate and/or payback < policy

Consider the following hypothetical data to be used in computation

Expected Net Cash Flow

Project L Project S
Year
0 ($100) ($100)
1 10 70
2 60 50
3 80 20

Definitions:
Project is independent: A project is independent if the decision to accept or reject the project does
not affect the decision to accept or reject any other project.
Mutually exclusive projects: If taking one project means another project is not taken, the projects
are mutually exclusive. The one with the highest IRR may not be the one with the highest NPV.
28
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
II. Evaluation Techniques
A. Net present value (NPV)
B. Internal rate of return (IRR)

A. Net Present Value (NPV)

The net present value is the difference between the market value of an investment and its cost.

NPV is a measure of the amount of market value created by undertaking an investment project.

The interest rate, r, will reflect the risk of the cash flows.

NPV = -Cost + PV(Future Flows)

n CFt
NPV  Cost  
t  1 (1  k) t

n CFt
NPV  
t  0 (1  k) t
Project L:
0 1 2 3

100.00 10 60 80
9.09
49.59
60.11
NPVL = $18.79 NPVS = $19.98
If the projects are independent, accept both.
If the projects are mutually exclusive, accept Project S since NPVS > NPVL.
Note: NPV declines as k increases, and NPV rises as k decreases. 10% discount rate applied

29
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
B. Internal Rate of Return (IRR)
Internal rate of return: The discount rate that makes the present value of future cash flows equal to
the initial cost of the investment. Equivalently, the discount rate that gives a project a zero NPV.
IRR Rule: An investment is accepted if its IRR is greater than the required rate of return. An
investment should be rejected otherwise.
Calculating IRR: Like the Yield To Maturity, trial and error, financial calculators and financial
spreadsheets are used to calculate the IRR.
n CFt
IRR :   $0  NPV .
t  0 1  IRR t

Project L:
0 1 2 3

100.00 10 60 80
8.47 18.1%
43.02 18.1%
48.57 18.1%

$ 0.06  $0
IRRL = 18.1%, IRRS = 23.6%

If the projects are independent, accept both because IRR > k.

If the projects are mutually exclusive, accept Project S since IRRS > IRRL.

Example 2: Braun Industries is considering an investment project with the following cash flows:

Year Cash Flow

0 -$1,000
1 400
2 300
3 500
4 400
The company's discount rate is 10 percent. Using internal rate of return (IRR) and net present value
(NPV) decide whether the company should invest in the project or not.

30
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
 4. APPLICATIONS OF DIFFERENTIATION
4.1 Rules of Differentiation
1. The Constant Rule
dy
If y = c where c is a constant, 0
dx
dy
e.g. y = 10 then 0
dx
2. The Linear Function Rule
If y = a + bx
dy
b
dx
dy
e.g. y = 10 + 6x then 6
dx

3. The Power Function Rule

If y = aXn, a & n are constants

dy
 n.a.x n1
dx
dy
i) y = 4x =>  4 x0  4
dx
dy
ii) y = 4x2 =>  8x
dx
dy
iii) y = 4x3 =>  12x 2
dx
dy
iv) y = 4x-2 =>  8 x 3
dx

31
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
4. The Sum-Difference Rule
If y = f(x)  g(x)

dy d [ f ( x )] d [ g( x )]
 
dx dx dx
If y is the sum/difference of two or more functions of x: differentiate the 2 (or more) terms
separately, then add/subtract
(i) y = 2x2 + 3x then

dy
 4x  3
dx
dy
2 3
(ii) y = 4x - x - 4x then  8 x  3x 2  4
dx
dy
(iii) y = 5x + 4 then 5
dx

5. The Product Rule

If y = U.V where u and v are functions of x
dy dv du
Then u v
dx dx dx
i) y = (x+2)(ax2+bx)

 x  22ax  b  ax2  bx 
dy
dx
ii)y = (4x3-3x+2)(2x2+4x)
dy
dx
 
 4 x 3  3 x  2 4 x  4  

 
2 x 2  4 x 12 x 2  3 

32
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
6. The Quotient Rule
If y = u/v where u and v are functions of x
du dv
v u
Then dy  dx dx
2
dx v
i) y = (x+2)/(x+4)

dy   x  4   x  2 
   
2
dx  x  4 2
 
 x  4 2
 
   

ii) y = (3x+2)/(x2+4)
 x2  4 3  3x  22 x 
dy  

dx  x2
2
  4 
 

dy  3x 2  4 x  12

dx  x2  4
2
 
 

7. The Chain Rule

If y is a function of v, and v is a function of x, then y is a function of x and
dy dy dv
 .
dx dv dx
i) y = (ax2 + bx)½
let v = (ax2 + bx) , so y = v½

  .2ax  b
1
dy 1 
 ax 2  bx 2
dx 2
ii) y = (4x3 + 3x – 7 )4
let v = (4x3 + 3x – 7 ), so y = v4
dy
dx
 3
 4 4 x 3  3x  7 . 12 x 2  3  

33
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
8. The Inverse Function Rule

If x = f(y) then dy 1

dx dx
dy
The derivative of the inverse of the function x = f(y), is the inverse of the derivative of the function

i) x = 3y2 then
dx dy 1
 6y so 
dy dx 6 y
ii) y = 4x3 then
dy dx 1
 12x 2 so 
dx dy 12 x 2

4.2 Marginal Functions

Example 1: A firm faces the demand curve P = 17 - 3Q
(i) Find an expression for TR in terms of Q
(ii) Find an expression for MR in terms of Q
Solution:
TR = P.Q = 17Q – 3Q2

d TR  d TC 
MR   17  6Q MC 
dQ dQ
Example 2:
If a firms Total Cost Curve is:
TC = Q3 – 4Q2 + 12Q
(i) Find an expression for AC in terms of Q
AC = TC / Q = Q2 – 4Q + 12
(ii) Find an expression for MC in terms of Q
d TC 
 3Q 2  8Q  12
dQ
(iii) When does AC=MC?
Q2 – 4Q + 12 = 3Q2 – 8Q + 12

34
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
  2Q2 – 4Q = 0
 2Q = 4
Q =2
Thus, AC = MC curves when Q = 2
(iv) When does the slope of AC=0?
Differentiate AC = Q2 – 4Q + 12 to find slope……
d  AC 
 2Q  4
dQ
then set it equal to 0
2Q – 4 = 0
 Q = 2 when slope AC = 0
(v) Plot MC and AC curves and comment on the economic significance of their relationship
MC curve cuts the AC curve at its minimum point…….(draw both curves)
MC cuts AC curve at minimum point…
3 2
(vi) Suppose now TC = Q - 4Q +12Q +10. Draw new curves and comment….
3 2
TC=Q - 4Q +12Q +10

 no impact on the MC function,

 shift up AC function by FC/q

4.3 Elasticity
Price Elasticity of Demand: It measures degrees of responsiveness of change in demand due to
change in price of a commodity.
proportional change in demand
d 
proportional change in price

= Q P = Q P
/ .
Q P P Q
To calculate the point elasticity of demand then,

dQ P
d  x
dP Q
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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
 e.g. Find elasticity of demand of the function Q = aP-b
P
 d  baP b 1 .
aP b
b
=  baP .
P
 b
P aP b
Inelastic demand: if ed < 1
Unit elastic demand: if ed = 1
Elastic demand: if ed > 1

Example 1: Consider the following demand function for chapatti: Q = 102-2P - 10Pc + 15Pac
Where P = the price of chapati, Pc = the price of coffee, and Pac = the price of sambusa.
a. Suppose that the price of coffee is $1 and that the price of sambusa is $2. Calculate the
inverse demand curve (e.g., express price as a function of quantity).
b. Suppose further that price of chapatti is $3, calculate the price elasticity of demand and
interpret the results.
c. Calculate the cross elasticity of demand for chapati with respect to the price of coffee. How
is coffee related to chapati? Why?

Example 2: The demand for Maxwell ZIP disks is given by the following equation
Q = 10P-3PH1.5I2.
Where P is the price of the ZIP disks, PH is the price of Hard disk drive space, and I is income (in
thousands of dollars)
a. What is the price elasticity of demand?
b. What is the income elasticity of demand? What does the income elasticity of demand suggest
about the kind of good Maxwell disks are?
c. Suppose that due to a recession in the market, income of ZIP disk users is projected to fall by
4% next year. How will sales be affected?

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
4.4 Optimization Techniques
To study the process of optimization by the firm, we begin by examining the relationship between
total revenue, average revenue, and marginal revenue on the one hand, and total cost, average cost,
and marginal cost on the other. In the cost analysis section, we will bring together the revenue and
cost concepts and curves presented in this section to examine the process of optimization by the
firm.
4.4.1 Methods of Expressing Economic Relationships
The first step in presenting optimisation techniques is to examine ways to express economic
relationships. Economic relationship can be expressed in the form of equation, tables, or graphs.
When the relationship is simple, a table and/ or graph may be sufficient. However, if the relationship
is complex, expressing the relationship in equational form may be necessary.

Expressing an economic relationship in equational form is also useful because it allows us to use the
powerful techniques of differential calculus in determining the optimal solution of the problem.
More importantly, in many cases calculus can be used to solve such problems more easily and with
greater insight into the economic principles underlying the solution. This is the most efficient way
for the firm or other organization to achieve its objectives or reach its goal.
 Suppose that the relationship between the total revenue (TR) of a firm and the quantity (Q) of
the good and services that firm sells over a given period of time, say, one year, is given by
TR= 100Q-10Q2
(Recall: TR= The price per unit of commodity times the quantity sold; TR=f(Q), total revenue is a
function of units sold; or TR= P x Q).

By substituting into equation 1 various hypothetical values for the quantity sold, we generate the
total revenue schedule of the firm, shown in Table 1. Plotting the TR schedule of table 1, we get the
TR curve as in graph 1. In this graph, note that the TR curve rises up to Q=5 and declines thereafter.

Illustration of different ways of expressing economic relationship:

Equation: TR= 100Q-10Q2

Table:

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
 Q 0 1 2 3 4 5 6

TR 0 90 160 210 240 250 240

Graph:

TR
300

250

200

150

100

50

0
0 1 2 3 4 5 6 7

4.4.2 Optimization Problems in Economics

Distinguish between Constrained and Unconstrained Optimization.
Optimization has three (3) elements:
1) Choice Variables: These are variables whose optimal values have to be determined;
quantities of commodities to be produced say output levels, and inputs.
2) Objective Function: specify mathematically relationship between the choice variables and
some variables that we wish to maximize. E.g profit to the amount of commodities that can
be produced say   PY WX
3) Feasible Set (Constraint): set of alternatives available to producers when they are making
decisions. Technology choices to producers say Y  f ( X )
Unconstrained Optimization: This involves finding optimal value (maximum or minimum) of any
given objective function without having any constraint to fulfill. This is normally being solved by
obtaining first derivative and second derivative if more than one critical value is obtained.
Example 1: Suppose that the relationship between the profit and output for each good of a certain
company is   20  113.75Q1  80Q2  10Q 21  10Q 2 2  5Q1Q2 find the level of output that will
maximize profit.

38
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
 
 113.75  20Q1  5Q2  0
Q1

 80  20Q2  5Q1  0
Q2
Solving those two equations above simultaneously, we find that profit is maximized when Q1= 5
and Q2 = 2.75
Example 2: Let TR(Q)  1200Q  2Q2 and TC (Q)  Q3  61.25Q2  1528.5Q  2000

Then  (Q)  TR(Q)  TC (Q)  Q3  59.25Q2  328.5Q  2000

Where TR, TC and  are all in million Tshs and Q is in units (say tons per week). You are required
to find level of output that will maximize profit.
Step I: Obtain the first order necessary condition
d
 3Q 2  118.5Q  328.5  0
dQ
Step II: Solving above quadratic equation we obtain two critical values Q = 3 and Q = 36.5
Step III: Obtain second order sufficient condition
d 2
 6Q  118.5 {>0 when Q = 3 and <0 when Q = 36.5}
dQ 2
Therefore profit maximizing output is Q* = 36.5 (tons per week). By substituting Q* in the profit
function, we can find the maximized profit to be  * = 16,318.44 mill Tsh per week.
Constrained Optimization: Managers of firms and other organizations generally face constraints that
limit the option available to them. A production manager may want to minimize his or her firm’s
costs but may not be permitted to produce less than is required to meet the firm’s contracts with its
customers. The top managers of a firm may want to maximize profits, but in the short run, they may
be unable to change its product or augment its plant and equipment. Two main methods are going to
be used to solve optimization problems of this sort, Lagrange and Substitution methods.
1. Lagrange Method
TC  4Q 21  5Q 2 2  Q1Q2
Example 1. Minimize
S .TQ1  Q2  30

Step I: Formulate Lagrangian Function

L  4Q12  5Q2 2  Q1Q2   (Q1  Q2  30)

Step II: Obtain first order necessary condition

39
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
L
 8Q1  Q2    0 (i)
Q1

L
 10Q2  Q1    0 (ii)
Q2

L
 Q1  Q2  30  0 (iii)

Divide through eq (i) and (ii) to obtain eq (iv)
8Q1  Q2  11
  8Q1  Q2  10Q2  Q1 therefore Q1  Q2 (iv)
10Q2  Q1  9

Substitute eq (iv) into (iii) to obtain the optimal value of Q2 *

11
Q2  Q2  30  Q2 *  13.5
9
Substituting Q2 *  13.5 into the constraint we obtain the value of Q1*  16.5
Worked Example 2: Find the optimal value of inputs that will minimize the firm’s cost:
TC  X 21  X 2 2
Min
S .T  X 1  4 X 2  2

Step I: Formulate Lagrangian Function; L  X 12  X 2 2   ( X 1  4 X 2  2)

Step II: Obtain first order necessary condition
L
 2 X 1    0 (i)
X 1

L
 2 X 2  4  0 (ii)
X 2

L
 X 1  4 X 2  2  0 (iii)

Divide through eq (i) and (ii) to obtain eq (iv)
2 X1  1
  4 X 1  X 2 therefore X 1  X 2 (iv)
2 X 2 4 4

Substitute eq (iv) into (iii) to obtain the optimal value of X 2 *

1 8
X 2  4 X 2  2  X 2* 
4 17

40
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
 8 2
Substituting X 2 *  into the constraint we obtain the value of X 1* 
17 17

2. Substitution Method
TC  4Q 21  5Q 2 2  Q1Q2
Example 1. Minimize
S .TQ1  Q2  30

Step I: Substitute Q1  30  Q2 into objective function

TC  3600  270Q2  10Q 2 2

Step II: Obtain first order necessary condition

TC
 270  20Q2  0  Q2 *  13.5
Q2
Step III: To make sure that this is minimum, not maximum, we obtain the second derivatives
 2TC
 20 since its positive we have found the minimum
Q 2 2

Substitute into constraint to obtain the optimal value for Q1*  16.5
Example 2: Required to find the optimal value of the two inputs that will minimize the firm’s cost:
TC  X 21  X 2 2
Min
S .T  X 1  4 X 2  2

Step I: Substitute X 1  2  4 X 2 into objective function

TC  (2  4 X 2 ) 2  X 2 2  4  16 X 2  17 X 2 2

Step II: Obtain first order necessary condition

TC 8
 16  34 X 2  0  X 2 * 
X 2 17
Step III: To make sure that this is minimum, not maximum, we obtain the second derivatives
 2TC
 34 since its positive we have found the minimum
X 2 2

2
Substitute into constraint to obtain the optimal value for X 1* 
17
Example 3: A firm’s short-run production is given by Q  6L2  0.2L3 Where L denotes the number
of workers.
41
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
 a) Find the size of labour that maximizes output.
b) Find the size of labour that maximizes the average product of labour (AP L)
c) Find the marginal product of labour (MPL)

Example 4: The demand equation of a good is given by P  2Q  20 and the total cost function is

Q 3  8Q 2  20Q  2
a) Find the level of output that maximizes total revenue
b) Find the maximum profit and the value of Q at which it is achieved. Verify that at this value
of Q, MR = MC

Example 5: Find the level of output that minimize the total costs of Kahama Gold Mine, where the
total costs function of the company might be approximated by the following relationship (Q
represents output): TC  15  0.40Q  0.000080Q 2

Example 6: Mbuyuni Co Ltd. has determined through regression analysis that its sales (S) are a
function of the amount of advertising (measured in units) in two different media. This is given by the
following relationship (X = newspapers, Y = magazines):
S  200 X  100Y  10 X 2  20Y 2  20 XY
Assume the advertising budget is restricted to 20 units:
a) Determine (using Lagrangian multiplier techniques) the level of newspaper and magazine
advertising that maximizes sales subject to this budget constraint.
b) Calculate the firm’s sales at this constrained optimum level.

42
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
 5. APPLICATION OF MATRICES
5.1 Matrix Inversion
Square matrix: no. rows = no. columns
Identity Matrix I: AI = A and IA = A

1 0 
I = 0 1  (for 2 X 2 matrix)
 

Inverse Matrix A-1: A.A-1= I A-1.A= I

TO INVERT 2 X 2 MATRIX……

a b
If A =  c d 


 d  c
1) Get Cofactor Matrix:  b a 
 
d  b
Transpose Cofactor Matrix: 
2)
 c a 

1 1  d  b
 
3) multiply matrix by
|A|
so ad  bc  c a  (i.e. divide each element by ad– bc)
If |A|=0 then there is no inverse……(matrix is singular)

Determinant of a Matrix

 a11 a12  a b 
If A = a   c d 
 21 a 22   

Now we can find the determinant……

Multiply elements in any one row or any one column by corresponding co-factors, and sum…..
Select row 1….
|A| = a11.C11 + a12.C12 = ad – bc
Select column 2
|A| = a12.C12 + a22.C22 = b(-c)+da
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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
TO INVERT 3 X 3 MATRIX……
To find inverse of 3 X 3 matrix, first you need to calculate determinant

a11 a12 a13 

 
 a21 a 22 a 23 
A=
a31 a32 a33 

Corresponding to each aij is a co-factor Cij. 9 elements in 3X3  9 co-factors.

Co-factor Cij = determinant of 2X2 matrix obtained by deleting row i and column j of A, prefixed by
+ or – according to following pattern…

  
  
 

  

e.g. C23 is co-factor associated with a23, in row 2 and column 3
so delete row 2 and column 3 to give a 2X2 matrix

a11 a12 a13 

 
 a21 a 22 a 23 
a31 a32 a33 

co-factor C23 is – determinant of 2X2 matrix (negative sign in position a23)

a11 a12
C23 = – a = – (a11.a32 – a12.a31)
31 a 32

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
example find all co-factors of matrix

2 4 1 
4 3 7 
A=  
2 1 3 

C11 = (delete row 1 column 1, compute determinant of remaining 2X2 matrix, position a11 associated
with +)

2 4 1 
4 3 7  3 7
  and + 1 3 = + [3.3 – (7.1)] = 2
2 1 3 

C12 = (delete row 1 column 2, compute determinant of remaining 2X2 matrix, position a21 associated
with -)

2 4 1 
4 3 7  4 7
  and – = – [4.3 – (7.2)] = +2
2 1 3  2 3

45
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
Other co-factors compute as
4 3
C13 = + 2 1 = +[4.1 – (3.6)] = -2

4 1
C21 = – 1 3 = – [4.3 – (1.1)] = –11

2 1
C22= + 2 3 = +[2.3 – (1.2)] = 4

2 4
C23= – 2 1 = – [2.1 – (4.2)] = 6

4 1
C31 = + 3 7 = +[4.7 – (1.3)] = 25

2 1
C32= – 4 7 = – [2.7 – (1.4)] = -10

2 4
C33= + 4 3 = +[2.3 – (4.4)] = -10

 2 2 2
 11 4 6 
Co-factor Matrix =
 
 25  10  10 

46
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
Now we can find the determinant……
Multiply elements in any one row or any one column by corresponding co-factors, and sum…..

Select row 1….

|A| = a11.C11 + a12.C12 + a13.C13

or equivalently select column 2

|A| = a12.C12 + a22.C22 + a32.C32

2 4 1 
4 3 7 
so the determinant of A=  
2 1 3 

(choose row 2 for example….)

|A| = a21.C21 + a22.C22 + a23.C23

= (4.-11) + (3.4) + (7.6) = 10

Now we can find the Inverse……

C11 C21 C31 

1  
C C C
A
12 22 32 
A-1 =
C13 C23 C33 

47
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
Step 1 : write matrix of co-factors

C11 C12 C13   2 2 2

C   
 21 C22 C23  =  11 4 6 
C31 C32 C33   25  10  10 
Step 2 : transpose that matrix (replace rows by columns), so

C11 C21 C31   2  11 25 

C C   
 12 22 C32 =  2 4  10 
C13 C23 C33   2 6  10 

1
Step 3: multiply each element by A

C11 C21 C31   2  11 25 

1   1  
C C C 
A  = 10 
12 22 32 2 4 10 
A-1 =
C13 C23 C33   2 6  10 

 1  10
11  5
 5  2
 15 2
5
 1
 1 
 5  1
So A-1 = 3
5 
Check : A.A-1 = I

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
Example 1: Find the inverse of matrix A

1 2
3 4
A=
 
|A| = ad – bc = (1.4) – (2.3) = –2(non-singular)

1  4  2  2 1 
    3  1
A –1 = 2  3 1  =
 2 2 

1 0 
0 1 
Check : A.A-1 = I =
 
Example 2: Find solution for the following simultaneous equation using matrix inversion.
5x + 6y = 670,000. ….(i)
8x + 3y = 610,000. …..(ii)
Step 1: Re-write the equations in matrix form.
5 6 x = 670,000

8 3 y 610,000
This shows the matrices of coefficients, variables and constants in the order they appear.
Step 2: Find the inverse of the matrix of coefficients.
Note: In order to find an inverse of matrix requires us to find the determinant of the matrix first.
The determinant of 5 6 is (5 x 3 ) – ( 6x 8) = - 33.
8 3

Thus the inverse of the above matrix would then be:

1 3 -6
. -33 -8 5

Step 3: Pre-multiply through the matrix equation by this inverse.

1 3 -6 5 6 x = 1 3 -6 670000
-33 -8 5 8 3 y -33 -8 5 610000

49
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
When a matrix is multiplied by its inverse the result is an Identity matrix. Thus the left hand side
yields an identity matrix.
1 0 x = 1 -1650000
0 1 y -33 -2310000
x = 50000
y 70000

5.2 Cramer’s Rule

Cramer’s rule is a method of solving a system of linear equations through the use of determinants.
Cramer’s rule is given by the equation

xi = Ai

A
where xi is the i th endogenous variable in a system of equations, A is the determinant of the original A
matrix, and Ai is the determinant a special matrix formed as part of Cramer’s rule.
To use Cramer’s rule, two (or more) linear equations are arranged in the matrix form
A x = D.

For a two equation model:

A x = D
a11 a12 x1 d1
a21 a22 x2 = d2

A is the matrix corresponding to the number of equations in a system (here, two equations), and the
number of endogenous variables in the system (here 2 variables). Remember that the matrix must be
square, so the number of equations must equal the same number of endogenous variables. Position x has
one column and corresponds to the number of endogenous variables in the system. Finally, position d
contains the exogenous terms of each linear equation.

50
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
Note: The determinant for a matrix must not equal 0 (A  0). If A = 0 then there is no solution, or
there are infinite solutions (from dividing by zero). Therefore, A  0. When A  0, then a unique
solution exists.
Example 1: Using Cramer’s rule to solve for the unknowns in the following linear equations:
2x1 + 6x2 = 22
-x1 + 5x2 = 53
Then, A x = D

2 6 x1 22

=
-1 5 x2 53
2 6
The primary determinant A = = 2 (5) - (-1) 6 = 16
-1 5
We need to construct xi = Ai, for i=1 and for i=2.
A

The first special determinant A1 is found by replacing the first column of the primary matrix with the
constant ‘D’ column. The new special matrix A1 now appears as:

22 6
A1 =
53 5
and solved as a regular matrix determinant,
A1 = 22 (5) - 53 (6) = -208
Likewise, the same procedure is done to find the second special determinant A2,

2 22
A2 =
-1 53
A2 = 2 (53) - (-1) (22) = 128
51
MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
We have now determined: A = 16
A1 = -208

A2 = 128
Using: xi = Ai
A
we get, A1 -208
x1 =  A = 16 = -13 (Solution)

A2 128

x2 = A = 16 = 8 (Solution)

Example 2: Expenditure Model of National Income

Y= Income, C = Consumption
I = Investment, G = Government expenditure
Y = C+I+G (1)
The consumption function is
C = a + bY (2)
Note C and Y are endogenous. I and G are exogenous.
Solve for values of endogenous variables Y and C using Cramers rule method

 Rewrite (1) and (2) with endogenous variables, C and Y, on left hand side

From eq. 1: Y- C =I+G

From eq. 2: -bY + C = a

 Now write this in matrix notation:

 1  1 Y   I  G 
 b 1  C    a 
    
or A.X = B

In the example above, where

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
  1  1 Y  I  G
A  X   B 
 b 1  C   a 
 Replace column 1 of A with the elements of vector B
I  G  1
A1   

 a 1 

Calculate the determinant of this as: |A1| = (I + G )(1) – ( –1)( a) = I + G + a

 The determinant of A is | A | = 1– b
 Therefore the solution using Cramers rule is:

| A1 | I  G  a
Y 
|A| 1 b

 Replace column 2 of A with the elements of vector b

 1 I  G
A2  
 b a 
 Calculate the determinant of this as: |A2|=(1)(a) – (I+G)(– b) = a+b(I+G)
 That the determinant of A is | A | = 1– b
 Therefore the solution using Cramers rule is:

| A2 | a  b( I  G )
C 
|A| 1 b
Practice Problems – Solve the system of equations using Cramer’s Rule.
x  2 y  9 3 x  2 y  1
1.  2. 
2 x  y  13  x  y  3

2 x  4 y  7 2 x  6 y  15
3.  4. 
2 x  4 y  1 4 x  12 y  30

2 x  y  z  3  x  y  2 z  9
 
5. 3x  z  5 6. 2 x  y  z  0
5 x  2 y  2 z  5  x  2 y  6 z  21
 

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
5.3 Input-Output Analysis
In economics, an input–output model is a quantitative economic model that represents the
interdependencies between different sectors of a national economy or different regional
economies. The model depicts inter-industry relationships within an economy, showing how output
from one industrial sector may become an input to another industrial sector. In the inter-industry
matrix, column entries typically represent inputs to an industrial sector, while row entries represent
outputs from a given sector. This format therefore shows how dependent each sector is on every
other sector, both as a customer of outputs from other sectors and as a supplier of inputs. Each
column of the input - output matrix shows the monetary value of inputs to each sector and each row
represents the value of each sector's outputs.
Say that we have an economy with n sectors. Each sector produces xi units of a single homogeneous

good. Assume that the j th sector, in order to produce 1 unit, must use a ij units from sector i.

Furthermore, assume that each sector sells some of its output to other sectors (intermediate output)
and some of its output to consumers (final output, or final demand). Call final demand in the ith
sector d i . Then we might write

xi  ai1 x1  ai 2 x2  ........  ain xn  d i

or total output equals intermediate output plus final output. If we let A be the matrix of
coefficients a ij , x be the vector of total output, and d be the vector of final demand, then our

expression for the economy becomes

x  Ax  d
which after re-writing becomes ( I  A) x  d . If the matrix ( I  A) is invertible then this is a linear
system of equations with a unique solution, and so given some final demand vector the required
output can be found. Furthermore, if the principal minors of the matrix I  A are all positive, the
required output vector x is non-negative.

Example 1: Consider an economy with two goods, A and B. The matrix of technological
coefficients and the final demand is given by

0.5 0.2 7 
A  and d  
0.4 0.2  4
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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
Intuitively, this corresponds to finding the amount of output each sector should produce given that
we want 7 units of good A and 4 units of good B. Then solving the system of linear equations
derived above gives us
19.19 
x  ( I  A) 1 d   
12.97 

Example 2: The output level of machinery, electricity and oil of a small country are 3000, 5000 and
2000 respectively.
 Each unit of machinery requires input of 0.3 units of electricity and 0.3 units of oil.
 Each unit of electricity requires inputs of 0.1 units of machinery and 0.2 units of oil.
 Each unit of oil requires inputs of 0.2 units of machinery and 0.1 units of electricity.
Determine the machinery, electricity and oil available for export.
Solution: Let us denote the total output of machinery, electricity and oil by X1, X2 and X3
respectively, so that X1 = 3000, X2 = 5000, X3 = 2000
The first bullet point of the problem statement provides details of the input requirements for
machinery. To produce 1 unit of machinery we use 0 unit of machinery, 0.3 units of oil. The first
column of the matrix of technical coefficient is therefore
0 
0.3
 
0.3

Likewise, the third and fourth sentences give the input requirements for electricity and oil, so the
complete matrix is

0 0.1 0.2 
 0.1
A = 0.3 0
0.3 0.2 0 
From the equation d = X – AX
We see that the final demand vector is

0 0.1 0.2 
 d 1  3000   3000  3000  900  2100 
 d  = 5000  - 0.3 0 0.1 5000  = 5000  - 1100 = 3900 
 2           
 d 3  2000  0.3
0.2 0  2000  2000  1900 100 

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
The country therefore has 2100, 3900 and 100 units of machinery, electricity and oil respectively,
available for export.

Example 3: Determine the final demand vector for three firms given the matrix of technical
coefficients

0.2 0.4 0.2

  1000
A = 0.1 0.2 0.1  and the total output vector X = 300 
 
0.1 0.1 0  700 

a) How much total output is required to satisfy a given level of final demand?
Solution: In this case the vector d is assumed to be known and we need to calculate the unknown
vector X.
The matrix equation x =A x + d rearranges to give d = x – Ax or equivalent d = (I – A)x
This represents a system of linear equations in which the coefficients matrix I – A and the right hand
side vector is d. We can solve this by multiplying the inverse of the coefficient matrix by the right
hand side vector to get x = (I – A)-1d this is known as Leontief inverse

Example 4: Given the matrix of technical coefficient

0.3 0.1 0.1 

 
A = 0.2 0.2 0.2
0.4 0.2 0.3
For three industries, I1, I2 and I3, determine the total outputs required to satisfy final demands of 49,
106 and 17 respectively.
Solution: To solve this problem we need to find the inverse of I – A and then to multiply by the final
demand vector.
The matrix I – A is

1 0 0  0.3 0.1 0.1  0.7  0.1  0.1 

0 1 0 0.2 0.2 0.2  0.2 0.8  0.2
 - =
0 0 1  0.4 0.2 0.3  0.4  0.2 0.7 

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
 0.52 0.09 0.10
1 0.22 0.45 0.16 
Hence (I – A)-1 =
0.306
 
0.36 0.18 0.54

We are given that

49 
d = 106
 
17 

so the equation x = (I – A)-1d gives

0.52 0.09 0.10

 x1  0.22 0.45 0.16 49  120 
x  = 1 106 = 200 
 2  0.306      
 x 3  0.36 0.18 0.54 17  150 

Example 5: An economy consists of three industries, agriculture, mining and manufacturing.

 One unit of agriculture output requires 0.2 units of its own output, 0.3 units of mining output
and 0.4 units of manufacturing output.
 One unit of mining output requires 0.2 units of agricultural output, 0.4 units of its own output
and 0.2 units of manufacturing output.
 One unit of manufacturing output requires 0.3 units of agricultural output, 0.3 units of mining
output and 0.1 units of its own output.
a) Write down the matrix of technical coefficients and find the Leontief inverse
b) Determine the level of output needed to satisfy a final demand of 10,000 units of agricultural
output, 30,000 units of mining output and 40,000 units of manufacturing output.

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
 6. LINEAR PROGRAMMING
Linear programming (LP) is a mathematical method for determining a way to achieve the best
outcome (such as maximum profit or lowest cost) in a given mathematical model for some list of
requirements represented as linear relationships. More formally, linear programming is a technique
for the optimization of a linear objective function, subject to linear equality and linear inequality
constraints.

Example 1: Phoenix Bike is introducing two new bicycle frames, the Deluxe and the Professional,
to be made from special aluminum and steels. The anticipated unit profits are $10 for the Deluxe
and $15 for the Professional. The number of kg of aluminum and steel needed per frame is
summarized below. A supplier delivers 100 kg of the aluminum and 80 kg of the steel weekly.

Aluminum Steel
Deluxe 2 3
Professional 4 2
How many Deluxe and Professional frames should Phoenix produce each week?
Model Formulation: Definition of the Decision Variables
X1 = number of Deluxe frames produced weekly.

X 2 = number of Professional frames produced weekly.

Max 10 X 1  15 X 2 (Total Weekly Profit)

Subject to 2 X1  4 X 2  100 (Aluminum Available)

3 X1  2 X 2  80 (Steel Available) X1 , X 2  0
 Optimal Solution
X1 (Deluxe frames) = 15 Units

X 2 (Professional frames) = 17.5 Units

Objective function value = $412.50

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
Example 2: A business firm produces two line of product, I and II, with a plant consists of three
production departments: cutting, mixing, and packaging. The equipment in each department can be
used for 8 hours daily, thus you can regard 8 hours as the daily capacity in each department. The
process of production can be summarized as follows:

i. Product I is first cut, then packaged. Each ton of this product uses up 1 hour of the cutting
2

capacity and 1 hour of the packaging capacity.

3
ii. Product II is first mixed, then packaged. Each ton of this product uses up 1 hour of the

mixing capacity and 2 hour of the packaging capacity.

3
Finally, product I and II after deducting the variable costs incurred, they can be sold at prices of $40
and $30 per ton, respectively. What output combination should the firm choose in order to maximize
the total (gross) profit?

Optimal solution: X 1  16 , X 2  4 , and maximized gross profit   760

Example 3: To maintain good health, a person must fulfill certain minimum daily requirements for
several kinds of nutrients. Assume that only three kinds of these needs to be considered: calcium,
protein and vitamin A. Also assume that the person’s diet is to consist of only two food items, I and
II, whose price and nutrient contents are as shown in the table below. What combination of the two
food items will satisfy the daily requirements and entail the least cost?

Food I Food II Minimum daily

requirements
Price $0.60 $1.00

Calcium 10 4 20

Protein 5 5 20

Vitamin A 2 6 12

Optimal solution: X 1  3 , X 2  1 , and minimized cost of diet C  2.80

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
Example 4: A candy manufacturer has 130 kg of chocolate-covered cherries and 170 kg of
chocolate-covered mints in stock. He decides to sell them in the form of two different mixtures. One
mixture will contain half cherries and half mints by weight and will sell for $2.00 per kg. The other
mixture will contain one-third cherries and two-thirds mints by weight and will sell for $1.25 per kg.
How many kg of each mixture should the candy manufacturer prepare in order to maximize his sales
revenue?
Solution: For simplicity, let us call A the mixture of half cherries and half mints, and B the mixture
which is one-third cherries and two-thirds mints. Let x be the number of kg of A to be prepared and y
the number of kg of B to be prepared. The revenue function can then be written as
z  2x  1.25 y
Since each kg of A contains one-half kg of cherries and each kg of B contains one-third kg of
cherries, the total number of kg of cherries used in both mixtures is
1 1
x  y
2 3
Similarly, the total number of kg of mints used in both mixtures is:
1 2
x  y
2 3
Now, since the manufacturer can use at most 130 kg of cherries and kg pounds of mints, we have
the constraints:
1 1
x  y  130
2 3
1 2
x  y  170
2 3

Also, we must have x  0, y  0. Therefore, the above problem can be formulated as follows: find

x and y that maximize z  2x  1.25 y subject to the constraints:

1 1
x  y  130
2 3
1 2
x  y  170
2 3
x  0
y  0

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
To solve the problem, we will use the technique of linear programming described above. We start
by drawing the feasible region of the problem and locate our extreme points:

Since the feasible region is bounded in this case, we are sure that the optimal solution is attained at
one of the extreme points shown on the diagram above. So we evaluate the objective function at each
of these points:
Extreme point Value of z=2x+1.25y
(0, 0) 0
(0, 255) 318.75
(180, 120) 510.00
(260, 0) 520.00

The table shows that the largest value for z is 520.00 and the corresponding optimal solution is (260,
0). Thus the candy manufacturer attains maximum sales of $520 when he produces 260 kg of
mixture A and none of mixture B.

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
Example 5: Mbagala County refuse department runs two recycling centers. Center 1 costs $40 to
run for an eight hour day. In a typical day 140 kg of glass and 60 kg of aluminum are deposited at
Center 1. Center 2 costs $50 for an eight-hour day, with 100 kg of glass and 180 kg of aluminum
deposited per day. The county has a commitment to deliver at least 1540 kg of glass and 1440 kg of
aluminum per week to encourage a recycler to open up a plant in town. How many days per week
should the county open each center to minimize its cost and still meet the recycler’s needs?
Solution: Let x be the number of days per week Center 1 is open and y be the number of days per
week Center 2 is open. The linear programming problem associated with this question is as follows:
Minimize the function
z  40x  50 y (Cost of operating the two centers)
subject to the constraints:
140 x  100 y  1540 ( glass )
60 x  180 y  140 Alm.
x  0
y  0

The feasible region of the problem, together with the extreme points are shown in the following
diagram

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.
The region is unbounded, with three finite extreme points. Two are easy to obtain from the graph:
(0, 15.4) and (24, 0). The third is found algebraically to be: (6.94, 5.69). Also, we can assume that
there is other “infinite extreme points” since the region is unbounded. One can see that these infinite
extreme points are not going to be “optimal” since we are minimizing and not maximizing. So we
evaluate the objective function at each of the finite extreme points:
Extreme point Value of z = 40x + 50y
(0, 15.4) 770
(24, 0) 960
(6.94, 5.69) 562.10
So, the minimal cost is $562.10 and it is attainted when Center 1 is open for about 7 days a week
(eight-hours a day) and Center 2 is open for about 6 days a week (eight-hours a day).

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MATHEMATICS FOR ECONOMISTS (ECU_07103) LECTURE NOTES by Dr. Maganya, Mnaku H.