CALCULUS FOR ECONOMISTS

Module III

Course Team: Ato Fredu Nega

Ato Torben Kenea

Mekelle University
Faculty of Business and Economics
Department of Economics
Mekelle
April 2004
 TABLE OF CONTENTS
IV.TECHNIQUES AND APPLICATIONS OF INTEGRAL CALCULUS ..... 83
4.1. INTRODUCTION ................................................................................ 83
4.2. ANTIDERIVATIVES AND THE INDEFINITE INTEGRAL ...................................... 83
4.3. TECHNIQUES OF INTEGRATION & THE GENERAL POWER RULE ....................... 84
4.4. DEFINITE INTEGRALS ......................................................................... 95
4.4.1. Properties of Definite Integrals.............................................................. 95
4.4.2. Area under a Curve.................................................................................. 97
4.4.3. The area of a region between two curves .............................................. 99
4.5. SOME ECONOMIC APPLICATIONS OF DEFINITE INTEGRALS:........................... 102
4.5.1 Consumers’ Surplus and producers’ Surplus ........................................ 102
4.5.2. Distribution of income ..................................................................... 106
4.5.3. Continuous Money Streams............................................................ 107
4.5.4. Continuous Money Streams within a Period............................... 108
4.6. IMPROPER INTEGRALS .................................................................. 109
4.8. DIFFERENTIAL EQUATIONS ........................................................... 111
4.8.1. First Order Differential Equations................................................. 111
4.8.1.1 First order linear differential equations with constant coefficient and term....................... 112
Application of the Non-Homogenous case: Dynamic model of the market price .... 115

82
 IV.TECHNIQUES AND APPLICATIONS OF INTEGRAL
CALCULUS
4.1. Introduction

In this section, you will be briefly introduced the tools of

mathematical economics required to handle dynamic analyses of
economic theories and empirics. In the first section, we will touch
on topics of anti-derivatives and the indefinite integral, techniques
of integration and the general power rule, definite integral,
fundamental theorem of calculus, and area of irregular shaped
bodies, and some economic applications of integrals like
consumer’s, producer’s surpluses and social welfare, Present value
of future income stream, income distribution and Gini-coefficient. In
the second section, you will be introduced with an introduction to
differential equations and their applications in the dynamics of
market price in a free enterprise economy.

4.2. Antiderivatives and the Indefinite Integral

Up to this time, we have been concerned with finding the derivative

of a function. However, there are some problems in economics that
require us to come up with the original function given its rate of
change. These problems are common in the area of social welfare,
distribution of income of a country etc. The technique of finding out
the original function based on its derivative is known as integration
or antiderivative. For introduction let’s begin with illustrations.

IF f ' ( x ) = 2 then f ( x ) = 2 x or f ( x ) = 2 x − 10 or in general for a constant

“C”, f (x ) = 2 x + C

Thus,

∫ f ′(x )dx = f (x ) + C
Where
• The sign ∫ is read as “Integration of…”
• The term f ' ( x ) is the integrand
• The term dx as usual is w. r. t. “X”
• The term C is Constant of integration/an element of indefinite
integral.
Antiderivative involves finding f ( x) + C from f ' ( x). That is

∫ f ' ( x)dx = f ( x) + c

83
The inverse relationship between differentiation and integration
helps us to set the formula for integration directly from
differentiation formula.

4.3. Techniques of Integration & the General Power Rule

In this section, I will briefly discuss the rules of integration which
shall refer to increasingly from time to time while we are dealing
with the techniques of integration.
a. The constant rule: Given constant K & C, ∫ Kdx = Kx + C

Example:
1. ∫ 2dx = 2 x + c

2. ∫ − 8dx = −8x + c
b) Constant Multiple Rule: for ∫ kf ( x )dx = k ∫ f ( x )dx

Example:
1. ∫ 2 x 7 dx = 2 ∫ x 7 dx
−10
∫ 10 x dx =10∫ x
−10
2. dx

C) Sum or Difference Rule: For ∫ ( f (x ) ± g (x ) )dx = ∫ f (x )dx ± ∫ g (x )dx

Example:
( )
1. ∫ 2 x 2 + 7 x − 10 dx = ∫ 2 x 2 dx + ∫ 7 xdx − ∫ 10dx

xn +1
D) Simple Power Rule: For ∫ x dx = + c for n ≠ -1
n

n +1
Examples:
1. Evaluate the indefinite integral of the following problems.
a) ∫ 3xdx
1
b) ∫x 3
dx

c) ∫ x dx

d) ∫ (x + 2)dx
e) ∫ (3x )
− 5 x 2 + x dx
4

x +1
f) ∫ x
dx

84
Solution
3x 1+1 3x 2
a) +c = +c
1+1 2
x −3+1 −1
b) +C = 2 +C
− 3 +1 2x
1
+1
x2 2
c) + C = x 3/ 2 + C
1 3
+1
2
1 2
d) x + 2x + C
2

∫( )
3 x 5 5 x 3 1x 2
3 x − 5 x + x dx =
4 2
− + +C
e) 5 3 2

3x 5 5 x 3 x 2
= − + +C
5 3 2
x +1  x 1  1
f) ∫ x
dx = ∫  x
+ dx =
x
∫ x dx + ∫
x
dx

2 x 1 / 2+1 x −1 / 2+1
= + C, + C2
3 − 1/ 2 + 1
2 2/3
= x + C ,+2 x 1 / 2 + C 2
3
2 3/ 2
= x + 2 x1 / 2 + C
3

Since all the functions that we have come up with after integration
have unknown C term, all the integrations that involve C are known
as indefinite integral. Some times, when initial conditions are
given, the particular solution can be calculated.

Examples,
1
1. Given f (x ) = & f (1) = 2, find f ( x )
x2

Solution

85
 1
f (x ) = ∫ dx
x2
= ∫ x − 2 dx
x − 2+1
= +C
− 2 +1
1
=− +C
x
But f (1) = −1 + C = 2
C = 2 +1 = 3
−1
Thus f ( x ) = +3
x

2. Given the marginal cost MC= 32.0.004x and it costs $50 to

produce the first unit of output, find the total cost of
producing 200 units of output.

Solution
2
0.04 X
TC = ∫ MCdx = ∫ (32 − 0.04 x )dx = 32 x − 2
+C

=32X -0.02X2 +C
But, TC (1) = 50
TC (1) = 32 − 0.02(1) + C = 50

C= 50.02-32
C=18.02 which is Fixed Cost
Thus, TC = 32x-0.02x2+18.02
2
TC (200) = 32(200)- x 200 2 + 18.02
100
= 6400-800+18.02
= 5600+18.02
= 5618.02
e) The General Power Rule:

Before describing this rule, let us begin with an example.

If (
f (X ) = x2 + 6 )
12

f ' ( x ) = 12( x 2 + 6)11 (2 x) = 24 x( x 2 + 6)11

Thus, ∫ 24 x( x + 6)11 dx = ( x 2 + 6)12 + C

2

86
Consider also
∫ 2 x( x + 1) 3 dx =
2

du
Let x2+1 = U and = 2x
dx
du u4 1
Thus, ∫ U 3 dx = + C = ( x 2 + 1) 4 + C
dx 4 4

In general, we can say du U n +1

∫U .dx = + C ,n ≠ − 1
n

dx n +1

By the same analogy we can reduce in to ∫U ⋅ dx = ∫ U n du using

n du
dx

Leibniz Rule

Example:
Evaluate the following problems

1..∫ 3(3 x − 1) 4
Solution
du
let (3x − 1) = U , Thus =3
dx
 du 
= ∫ U  ⋅ dx
4

dx 
U 4+1
= U 4 du = +C
4 +1
1
= (3x − 1) 5 + C
5

2. ∫ (2 x + 1)( x2 + x)dx
Solution
du
let ( x 2 + x) = U and = 2x + 1
dx
 du 
= ∫ U ⋅ dx
 dx 
= ∫ udu
1
= U2 +C
2
1
(
2
= x2 + x + C
2
)

87
3. ∫ 3x x 3 − 2 dx
2

Solution

du
let ( x 3 − 2) = U and = 3x 2
dx
 du 
= ∫ U
1/ 2
dx
dx 
∫U
1/ 2
du
U 1 / 2+1
= = +C
1
+1
2
2
= x3 − 2
3
( 3/ 2
+3 )

∫ x(− 4x )2
4. 2
+ 3 dx

Solution
dU 1 dU
Let 3-4x2 = U and = −8 X and (− )( )=X
dx 8 dx
 − 1 du 
= ∫ U 2 (  dx
 8 dx 
−1 du
8 ∫ U2
dx
⋅ dx
=
−1U 3 
 +C
8  3 
−1
= (3 − 4 x 2 ) 3 + C
24

7 x2
5. ∫ 4x3 − 5
dx

Solution
dU 1 du
Let 4x3-5=U and = 12X 2 as a result we have = x 2 and
dx 12 dx
7 du
= 7 x2
12 dx
Thus,
7 x2
∫ 4x3 − 5
dx is,

= ∫ 7 x 2U −1 / 2 dx

88
 7 du
=∫ ⋅ U −1 / 2 dx
12 dx
7
∫U
−1 / 2
du =
= 12
1/2
7 U
( )( ) + C
12 1
2
7
= (4 x 3 − 5) + C
6

6. ∫ 1 − 3 x dx

Solution
du
Let U= 1-3x and = −3 as a result, we have
dx
−1
du = -3dx and dx = du
3
= ∫ U 1 / 2 dx
 −1
∫U
1/ 2
 du
=  3 
− 1 1/ 2
3 ∫
U du

1 U 1 / 2+1
= − +C
3 1
+1
2
−1 U 3/ 2
= +C
3 3
2

=
−2
9
( 1 − 3x ) + C 3

89
 F. Integration of Logarithmic & Exponential Functions
Like what we have done in relation to the derivative of non-
algebraic functions, here we will present the integration of the
logarithmic functions first accompanied by the integration of
exponential functions. Concerning the integration of logarithmic
functions, let’s begin with example. The general power rule of
integration applies only when n ≠ -1; i.e.
du U n +1
∫U ⋅ dx = + C iff n ≠ -1.
n

dx n +1
But, the following formula applies when n = -1. That is

du
∫U
−1
⋅ dx = ln |u| + C
dx

We use absolute value to protect it from being negative & the whole
logarithm undefined. This formula is a direct result of the fact that
d ln x 1
=
dx x
Thus,
1
∫ x dx = ∫ x
−1
dx = ln | x | +C

d ln u du 1
Similarly, when U is a function of X, = ⋅
dx dx u
1 du
∴∫ ⋅ dx = ln | u | +C
u dx

Example: Evaluate the indefinite integral of the following.

∫ (4 x + 1) 4dx
−1
a)

∫ ( x − 3)( x − 6 x + 1)
−1
b) 2
dx

Solution

a) Let 4x + 1 = U
du
=4
dx

du
Thus, ∫ U −1 ⋅ dx = ln | 4 x + 1 | +C
dx

90
 b) Let u(x) = x2 – 6x + 1
du ( x)
= 2 x − 6 =2(x-3)
dx
1 du
(X-3)=
2 dx
Thus,
 du 
∫ ( x − 3)( x − 6 x + 1) −1 dx = ∫ U −1 ( 1
2
2 dx 
) dx

1 du 1
= ∫ U −1 dx = (ln | u |) + C
2 dx 2
1
= ln | x 2 − 6 x + 1 | +C
2
= ln x 2 − 6x + 1 + C

x 4 − 2x3 + 4x 2 − 7x − 1
c) ∫ x 2 − 2x
dx

 x −1 
= ∫  ( x + 4) + dx …Using division of rational functions
2

x − 2x 
2

 x −1 
= ∫ (X + 4)dx + ∫  x
2
dx
2
− 2X 

1 3  1 
= x + 4 X + ∫  ( x 2 − 2 x) −1 ( )(2)( x − 1) dx
3  2 

=
1 3
3
1
(
x + 4 x + ln | x 2 − 2 x | + C
2
)
1 3
= x + 4 x + ln x 2 − 2 x + C
3

The second type of non-algebraic function we saw was exponential

functions. In relation to exponential function, we have seen that
de x
⇒ = e x , Thus, ∫e dx = e x + C
x

dx

Moreover, we have seen that when U is a function of X, that is,

de u de u
, give U = f ( x), = u ' ( x)e u , thus, ∫ e u u ' ( x)dx = e u + C
dx dx

91
Example
Evaluate the indefinite integral of the following

∫ 2 xe
x2
a) dx

Solution
du
Let x2=U and = 2X
dx

∫ U ' ( x )e
u
dx
Thus, = e u + C
2
= ex + C

∫x
3
b) 2
e x dx
Solution
1
Let x3 = U, U’(x) = 3x2 and manipulating it little, we get x2 = U ' ( x)
3
1 u du 1 x3
3 ∫ dx
= e ⋅ dx = e + C = 1 e x3 + C
3 3

C) Suppose the marginal revenue from the sale of a product is

MR = 6 e0.01x. What is the revenue from the sale of 100 units of the
product?

Solution

TR = ∫ MRdx = ∫ 6e
0.01 x
dx

= ∫ 600u ' ( x)e dx ♠

u( x)

= 600e0.01 +C

♠
Let 0.01 x = U(x)
U’(x) = 0.01
1
U’(x) =
100
100u’(x) = 1
600 u’(x) = 6

92
 But Revenue= 0, when output x = 0, thus 0 = 600 + C
C = -600

TR = 600e0.01x – 600
TR (100) = 600 (e0.01 x 100 –1)
= 1030.97
G. Integration by Parts
Although the previous rules of integration are important elements in
the day to day mathematical toolkits of economists when dealing
with integration problems, there are problems which require us
more. Some of these problems are solved using the concept of
integration by parts.
We know that
d
(u ( x)m( x)) = u' m + m' u
dx
d 
∫  dx (um) dx = ∫ u' mdx + ∫ m' udx
um = ∫ um' dx + ∫ mu ' dx

dm du
um = ∫ u dx + ∫ m dx
dx dx
um = ∫ udm + ∫ mdu

∴ ∫ udm = um − ∫ mdu.

This is the formula which helps us solving integration problems by

dividing them in to two parts. In fact, that is why it is called
integration by parts. Hence, in applying this method, you have to
divide the integrand in to two parts namely “U” and “dm”.
Experience has thought us that the success in using this method
strongly depends up on our choice of the two parts. From
experience we have learnt that there is more chance of arriving at
the solution easily if you choose the “U” part, a part which is easily
differentiable and “dm” part, a part which should be easily

93
integrable. If you confront with a dilemma give priority to the easily
integrable part. Any way, let’s see examples for they make ideas
simple and clearer.

Examples
1. ∫ xe
x
dx

Solution
Dividing it into X part and exdx part let U= x and
dm = exdx so that m = ∫ dm = ∫ e dx = e x and du = dx
x

∫ udm = um − ∫ mdu Directly inserting in to the formula, we obtain

∫ xe dx =xe x − ∫ e x dx + C
x

∫ xe dx =xe x − ∫ e x dx + C
x

= xex - ex+C

2. ∫X
2
ln xdx

Solution
Dividing it into X part and exdx part let U=ln x and dm = X2dx, we
1 1
have m = ∫ dm = ∫ x 2 dx = x 3 and du= dx
3 x
Using the formula ∫ udm = um − ∫ mdu and directly inserting the values

into it we come up with,

1 3 1 1
= x ln x − ∫ x 3 ⋅ dx
3 3 x
1 1
= x 3 ln x − ∫ x 2 dx
3 3
1 2+1
X
1 3 3
= x ln x − +C
3 2 +1
1 1
= x 3 ln x − x 3 + C
3 9

94
4.4. Definite Integrals

Let f(x) be a function and “a” and “b” be real numbers. The definite
integral of f(x) over the interval from X=a to X=b denoted by
b

∫ f ( x)dx
a is the net change of an anti-derivative of f(x) over the
interval. Thus, if F(x) is an antiderivative of f(x), then we have
b

∫ f ( x)dx = F ( x)
b
a
= F (b) − F (a )
a

Note that it is used to find definite integral and not antiderivative of

a function.
b b

∫
a
f ( x)dx = F (b) − F ( x) = F (b) − F (a )
a

Now it is time to look at some examples so that the idea of definite

integral and fundamental theorem of calculus will be well planted in
your mind.

Example:
Evaluate the defnite integrals of the following
3

∫ x dx
3
1.
1

 x 3+1 3
= + C
3 + 1 1
1 3
=  x4 + C
4 1
1  1 
=  ⋅ 3 4 + C  −  ⋅ 14 + C 
4  4 
81 1
= −
4 4
= 20

4.4.1. Properties of Definite Integrals

Here are the basic properties of definite integrals which we often
refer to in dealing with analytical and empirical problems involving
definite integrals and related issues. The properties are intuitively
attracting and seem convincing though their proof is overlooked for
advanced courses or your investigation through further readings.
Let us present them!
For functions of f(x) & g(x), and constants of a, b, c, and k we have
the following properties.

95
 b b
1. ∫ Kf ( x)dx = K ∫ f ( x)dx,
a a
b b b
2. ∫ [ f ( x) ± g ( x)]dx = ∫ f ( x)dx ± ∫ g ( x)dx
a a a
b c b
3. ∫ f ( x)dx = ∫ f ( x)dx + ∫ f ( x)dx,
a a c
for a < c < b

a
4. ∫ f ( x)dx = 0
a
b a
5. ∫
a
f ( x)dx = − ∫ f ( x)dx
b

Example: Evaluate the definite integral of the following problems

5
1. ∫ 3x
2
dx
2
2
2. ∫e
3x
dx
−1
1 2
3. The marginal cost function for a company is MC= x − 2 x + 120
100
birr per unit, where X is output produced. Find the net increase in
cost when output increases from 100 units to 105 units.

Solution

∫ 3x dx =
2

2
1.
 3 x 2+1 5
= + C
 2 +1 2
=5 −2
3 3

= 125 – 8
= 117
2.
2

∫e dx =
3x

−1

1 2
=  e3x + C 
3  −1
1 1
= e 6 − e −3
3 3
1 1 
=  e6 − 3 
3 3e 

96
 1  e9 − 1
=  
3  e 3 
= 134.46

3.
105

∫ MCdxdx
100
105
 1 
= ∫  100 x − 2 x + 120 dx
2

100 
 1 3  105
= x − x 2 + 120 x 
 300  100
= 100.42

Exercise
Try the following problems.
1. Suppose that the marginal profit for a company is
MP=100+50X-3X2. Find the total profit earned from the sale of
three additional units if 5 units are currently being produced.
2. For a number of years the annual worldwide rate of oil
consumption was growing exponentially with a growth
constant of about 0.07. At the beginning 1970, the rate was
about 16.1 million barrels of oil/year. Let R(t) denote the rate
of oil consumption at time (t) where t is the number of years
since the beginning of 1970. Then a reasonable model of R(t)
is given by
R (t) =16.1e0.07t
How much oil was consumed between 1975 and 1980?

The answers are $888 and 0.465 for the first and second questions
respectively.

4.4.2. Area under a Curve

One of the most important applications of defnite integral is the

calculation of area under a curve.

Y Y=f(x)

a b X

97
Let f(x) be a function that is continuous and non-negative for all X
between “a” and “b” where a<b, determine the area of the shaded
region lying beneath the curve Y=f(x) and above the X-axis from
X=a to X=b. The area of the shaded region is calculated using the
fundamental theorem of calculus stated above. It is given by
b b

∫ f ( x)dx = F (b) − F ( x)
a a
= F (b) − F (a )

Examples

1. Find the area bounded by f(x) = x2 – 1 with in the internal

1<x<2

Solution
Area
2
= ∫ f ( x)dx
1
2
= ∫ ( x 2 − 1)dx
1
2
1 
=  x 3 − x
3 1
8  1 
=  − 2 −  − 1
3  3 
= 4/3

2. Find the area bounded by f (t) = (4t+1)2 within the interval

0<t<1

Solution
Area
1
= ∫ (4t + 1) dt
2

3 1
1  4t + 1  
=   
4  3   0
1  5 3 13 
=  − 
4 3 3
31
=
3

3. Find the area of the region under the carve Y = X from X = x to

X=2

98
 Solution

Y=X
2
1

1 2

Area=
2

∫ xdx
1
2
1 
=  x2 + C 
2 1
1
= 2−
2
3
=
2

Why don’t you try this problem? Try it!

7. Compute the area under the curve Y = x2-3x+5 from
a) X = 3 to x = 4
b) X = 1 to x = 4

4.4.3. The area of a region between two curves

For any two functions f(x) and g(x), if Y = f (x) lies above Y = g (x)
from x=a to x=b, the area of the region between f(x) and g(x) from
x=a to x=b is given by

∫ [ f ( x) − g ( x)]dx
a

99
Example
1. Find the area of the region between Y= 2x2–4x + 6 and
Y = -X2 +2X+1 from X=1 to X=2

Solution
Over the range of values X=1 to X=2, the function Y= 2x2–4x + 6
lays above the function Y = -X2 +2X+1. To check which function is
greater, let’s sketch the graph with in the interval [1, 2].

Y = 2x2 – 4x + 6

6
R

-1
1 2
Y = x2 + 2x + 1
Hence, the area of the shaded region is

∫ [(2 x )]
2
R= 2
) (
− 4 x + 6 − − x 2 + 2 x + 1 dx
1

2
= ∫ (2 x − 4 x + 6 + x 2 − 2 x − 1 dx )
2

2
= ∫ (3x − 6 x + 5 dx)
2

2
= x3 − 3 x 2 + 5 x 1

[
= 2 − 3( 2) + 5( 2) − 1 − 3(1) + 5(1)
3 2
] [ 3 3
]
= [8 − 12 + 10] − [1 − 3 + 5] = 6 − 3 = 3
2. Find the area of the region between Y=X2 and Y=X2-4x+4
from X=0 to X=3
Solution
If we sketch both functions, we get

Y=X2 Y=X2-4x+4

0 1 3

100
To find the point of inter section X2 = x2-4x+4
0 =-4x + 4
X=1
Since no line completely lies above the other over the shaded
region, we need to calculate the area from X=0 to X=1 and from
X=1 to X=3.
Thus, area is given by

∫ ( f ( x) − g ( x )dx = ∫ [( x − 4 x + 4) − ( x )]dx + ∫ ( x − x + 4 x + 4)dx

3 1 3
= 2 2 2 2

0 0 1
1 3
= ∫ (−4 x + 4)dx + ∫ (4 x − 4)dx
0 1
1 3
= − 2x 2 + 4x + 2x 2 − 4x
0 1

[ ]
= 2 + 18 − 2 − [2 − 4] = 2 + 6 + 2 = 10

3. Calculate the area between Y=x2 and Y= -ex from X= -1 to

X=2
Solution
Area=
2

∫ (x )
− (−e x ) dx
2

−1
2
= ∫ (x )
+ e x dx
2

−1
2
1 3
= x + ex
3 −1

8  −1 
=  + e 2  −  + e −x 
3  3 
2 -1
=3+e –e

4. Find the area bounded by Y = x2 + 2x + 3 and Y = 2x+4

Solution
In this case let’s check for points of intersection get the interval
Thus, x2 + 2x + 3 = 2x + 4
x2 = 1
x = ±1

f(x) 3 3 11
X -2 -1 0 1 2
g(x)
0 4 8

Within –1 < x < 1

101
 Y = 2x + 4 > Y = x2 + 2x + 3
g(x)>f(x)
1
Area = ∫ (2 x + 4 − x )
− 2 x − 3 dx
2

−1
1

∫ (− x + 1)dx
2

−1

−1 3 1
=∫ x +x
3 −1
 − 1  1 
=  + 1 −  − 1
3  3 
−1 1 2 4
= + 1 − + 1= 2 − =
3 3 3 5

4.5. Some economic applications of definite integrals:

4.5.1 Consumers’ Surplus and producers’ Surplus

In policy evaluation and welfare economics, economists make use of
the idea of consumers’ surplus, producers’ surplus, social utility,
and social welfare. In this section we will briefly touch on the
mathematical aspect of these concepts and finally we will see the
total income for a continuous income stream and its present value.

Consumer’s surplus: is the excess of money that the consumer is

willing and able to pay for a commodity over what he is actually
paid. Let’s take example. If price is Birr 3, the consumer is willing
to buy 5 units with Birr 25 but she is actually required to pay
3x5=Birr 15. The surplus of the consumer is then = 25 – 15 = Birr
10 when the relationship between price and quantity demanded is
assumed to be discrete.

Px = 8 – x
P X
O 8
1 7 Graphically
2 6
3 5 Px
8 Consumer’s Surplus
5 4
5 3
6 2
7 1 P=3
8 0 3
Px=8-x
5 8 x

102
 Using integral calculus assuming the relationship between price and
quantity demanded is continuous,
5 5 5
 1 
CS = ∫ [(8 − x ) − 3]dx = ∫ (5 − x)d = 5 x − x 2 
0 0  2 0

= [25 − 12.5]
= 12.5
Area of the shaded region using the law of triangle is given as
= (8-3) (5-0)X0.5
1
Shaded region = (8-3) (5-2) x = 12.5
2

In general, consumers’ surplus at price P and corresponding

quantity demanded x and demand function DX (written as a
function of price) is given by
X
CS = ∫ ( D X − P)dx
0

Examples:
1. Find the consumer’s surplus at price of $8 if the demand
1
function is given by P = 20 - x
2
Solution
To find point of intersection, find x at P =8. That is,
1
8 = 20 − x
20
1
x = 12
20
x = 240
Hence, the consumers’ surplus is given by
240
1
CS = ∫ (20 − x − 8)dx
0
20
240
 1 
= 12 x − x 2
 40  0
 1 
= 12(240) − (240 x 240)
 40 
= [12(240) − 6(240)]

= 6 (2(240) – 240) = 6x240

= $ 1440

103
Producer’s surplus: is the excess of money that the producer
actually receives over what she is willing to accept/receive. If
supply function, written as a function of price, is given by S (x) and
we want to obtain producers’ surplus at price P and corresponding
quantity supplied x , we can use the general formula specified below:

x
PS = = ∫ P − S ( x)dx That is
0

S(x) = P

PS
p
Y =P

Example

1. Find the producer’s surplus at price level of $ 20 if the supply

1 2
function is given by P = 2 + x
500
Solution

To find the value x (quantity of intersection), let’s insert p in the

supply function.
1 2
20 = 2 + x
500
1 2
18 = x
500
x2=18x5000=90000
x = ±300

X =300… since producers will not supply at negative quantities.

Now, by just inculcating the values of x and p in the above formula,
we obtain
300
 1 
PS = ∫  20 − 2 − 500 x
2
dx
0 

104
 300
 1 
= ∫ 18 − 500 x
2
dx
0 
300
 1 
= 18 x − x3 
 15000  0

 300 x300 x300 

= 18 x300 −  − [0]
 15000 
=5400 – 1800
= $3600
2. If demand and supply functions are given below, find

a) Consumers’ surplus
b) Producers’ surplus
c) Social welfare assuming the economy is two-sector
Warlasian economy.

1
P x
= 20 −
20
x

1 2
P x
= 2+
500
x

Solution
To find the market price and quantity,
1 1
⇒ 20 − x = 2+ x2
20 5000
1 1
⇒ x2 + x − 18 = 0
5000 20
⇒ x 2 + 250 x − 90,000 = 0
⇒ X2 + 250X+ 15575 = 10575

− 250 ± 2502 + 360,000

⇒
2
− 250 ± 62,500 + 360,000
⇒
2
⇒ X = 200 or –450. We drop the negative value for quantity demanded can’t be negative.
1
P = 20 − x 200 = 10
20

Now, it is easy to deal with the problem. Insert the values in the
formulae so that you will come up with the answers.

105
 200
 1 
CS = ∫  20 − 20 x − 10 dx = 1000
0

200
 1
PS = ∫ 10 − 2 − 5000 x
dx = 1067
2

0 
Social welfare is the sum of total consumers’ surplus and producers’
surplus.
SW = CS + PS = 2067

4.5.2. Distribution of income

While no country has been able to achieve equal distribution of
income, a desirable goal in the eyes of many political scientists is to
reduce the in-qualities that exist. The table and corresponding
graph indicate how incomes in the United States were distributed in
1973 (source: Paul Samuelson, Economics (10th ED.), New York:
McGraw-Hill, q976). The left column of the table assumes that
people have been ranked according to income.

Note in the table that the lowest paid 40% of the population
receives only 18% of the income, whereas if income were
absolutely equally distributed, they would get 40% of the income.
In fact, if income were equally distributed, the data would lie along
the 45-degree line. In actuality, the data always lie along a curve
below the line, a curve called a Lorenz curve. The further this curve
moves from the 45 degree line, the more unequal the income
distribution.

100
Cumulative Cumulative 80
Percent of Income

percentage percentage
of people of income 60

2 0
20 6 40

40 18
20
60 35
80 59
100 100 20 40 60 80 100

Percent of people
As a measure of inequality, we use the so-called Gini coefficient of
inequality “g” defined by
g = Area between the Lorenz curve and the line y = x
Area under the line y = x

106
The numerator is a definite integral whose value is between 0 and
½; the denominator has a value of exactly ½. Thus, g is between 0
(absolute equality) and 1 (absolute inequality). If y = f(x) is the
equation of the Lorenz curve, the formula for g takes the simple
form

1
g = 2∫ [x − f ( x)]dx
0

Example
Sketch the Lorenz curves y = x 2 and y = x 5 on the same graph and
determine the corresponding Gini coefficients.

Solution
The graphs are shown in Figure below. The required Gini coefficients
are
 x2 x3  1 1
[ ]
1
g = 2∫ x − x 2 dx = 2  −  ∫ =
0 2 3 0 3
and
 x2 x6  1 2
[ ]
1
g = 2∫ x − x dx = 2  −  ∫ =
5

0 2 3 0 3

Y
100

.80

.60 Y=x

.40 Y = x2

.20
Y = x5
x
.20 .40 .60 .80

4.5.3. Continuous Money Streams

You will formally be introduced with the notion of continuous
compounding of interest in monetary economics. If P dollars is
invested at annual rate r compounded continuously, then its value F
at the end of t years is given by F = Pe rt . Solving this equation for P
in terms of F gives the equation

P = fe − rt

107
Written in this from, the equation tells us the present value P of F
dollars that will be received t years from now, assuming that
interest is compounded continuously at the annual rate r.

Example
Bethel knows that she will need to replace her car in 3 year How
much would she have to put in the bank today at 8% interest
compounded continually in order to have the $12,000 she expects
to need 3 years from now?

Solution
We apply the boxed formula, remembering that the interest rate of
8% must be written in its decimal form.

P = 12,000e −0.08( 3) = 12,000e −0.24 = $9439.53

4.5.4. Continuous Money Streams within a Period

There are many situations in business and industry where it is

useful to think of money as flowing continuously into an account.
For example, the ABC Company plans to buy an expensive machine
which it estimates will increase the company’s net income by
$10,000 per year. But this income won’t come at the end of each
year; it will come in dribbles throughout the year. As a model for
what will happen, it is convenient to think of the machine as if it will
produce income continuously. Our next example raises an
important question for the company to answer.

Suppose that the annual rate of income of an income stream is

R (t). Suppose further that this income stream will last over the
period 0 < t < T. If interest is at rate r compounded continuously,
then the present value PV of this income stream is given by

T
PV = ∫ R(t )e − rt dt
0

Example
Suppose the ABV Company takes a more optimistic view and
estimates that the new machine will produce income at the rate R
(t) = 10,000 + 200t. What is the present value of this income
stream, again assuming interest at 9% compounded continuously
and a lifetime of 8 years?

108
Solution

8
PV = ∫ (10,000 + 200t )e −0.09t dt
0

8 8
= ∫ 10,000e −0.09t dt + ∫ 200te −0.09t dt
0 0

Let us modify the problem in the above example in another way by

assuming that the machine will last indefinitely. More generally, let
us ask for the present value PV of a perpetual (meaning infinitely
long) income stream which produces income at an annual rate R(t),
assuming that interest is at an annual rate r compounded
continuously. The result in this case is

∞
PV = ∫ R (t )e − rt dt
0

Here, we face a new kind of integral, one with an infinite limit.

Such integrals are called improper integrals and must be given a
clear definition. We do this by defining

∞ T
R ( t ) e − rt dt
∫ R(t ) dt = Limr →∞ 0
e − rt ∫

This point leads us to the concept known as improper integrals

which we will handle right now!

4.6. Improper Integrals

With the counter-revolution of new classical macroeconomics, there
has been a shift by economists to consider an infinitely lived agent.
This agent is widely used in perfect foresight-model, rational
expectation model, Ricardian equivalence theorem, endogenous
economic growth models, among others. Hence, saving and
investment decision of households is governed by the utility
function agents maximize throughout, that is,

∞
 C 1−δ − 1 
U (c) = ∫ e − Bt  Ldx
0  1 − δ 

109
Where
• U(c) is the utility function the social planner maximizes,
• -B is the discount rate agents assign to future consumption,
• C is percapita consumption
• L is the size of population
• And δ is the inverse of the intertemporal elasticity of
substitution.
Now we have faced some what new, but definite integral, problem
in this function. Such type of integral is known as improper
integrals. An improper integral is an integral which is bounded by
either (− ∞, ∞ ) , (c, ∞ ) , or (− ∞, c ) where c is a constant. This limit of

integration is infinite. To find out the value of this integral use the
formula:

∞ b

∫
f ( x ) dx
a) For f ( x)dx = lim b→∞ a∫
a

This holds if f is continuous over the internal [a, ∞ ).

b) If f is continuous on the interval (- ∞, b], then

b b

∫
∫ f ( x ) dx
f ( x ) dx = lim a → −∞ a

−∞

c) If f is continuous on interval (− ∞, ∞ ) , then

∞ c ∞

∫ f ( x)dx = ∫ f ( x)dx + ∫ f ( x)dx

a −∞ c

c b
= Lim a →−∞ ∫ f ( x)dx + Limb→∞ ∫ f ( x)dx
a c

Note: In each three cases of above, if limit exists, then the

improper integral is said to converge; otherwise the improper
integral diverges.

Examples

110
 ∞
1
1. Find the value of ∫ x dx and
1
determine its status of

convergence.

Solution

∞ b

∫1 x dx = Limb→∞ ∫1 x dx = Limb→∞ [ ln x ]1 = Limb→∞ [ln b − ln 1]

1 1 b

Since limit does not exist, the integral diverges.

∞
1
2. Find ∫x
1
2
dx

Solution

∞ b b
1 1  − 1 −1 
∫1 x 2 dx = Limb→∞ ∫1 x 2 dx = Limb→∞  x  1 = Limb→∞  b + 1 = 1
Since limit does exist, the integral converges.

3. Now it is time for you to check whether you have grasped the
concept or not. To this end, why don’t you handle this problem? Use
0
dx
your paper and pen right now! ∫ 3
− ∞ (1 − 2 x ) 2

4.8. Differential Equations

Most of the dynamic problems in economic theory or empirics can

be handled with the tools we have developed earlier. However,
there is large body of the science which requires beyond what we
have covered earlier. To this end, let’s see the concept of
differential equations in a brief, precise and a sweet to swallow
manner.

4.8.1. First Order Differential Equations

Differential equation is an equation that involves derivatives of
variables. If there is only one independent variable, then it is called
an ordinary differential equation. (ODE)

The order of the ODE is that of the highest derivative; that is, if the
highest derivative in an ODE is order of n, then it is an nth order
ODE. When the functional form of the equation is linear, then it is a
linear ODE.
Let have illustrations!

111
 •
a) a1 y (t ) + a 2 y (t ) + x(t ) = 0 This is 1st order linear ODE.
• dy
Where ⇒ y (t ) =
dt
⇒ a1 ,&a 2 are constants
⇒ x(t ) Known function of time

•• •
b) a1 y (t ) + a 2 y (t ) + a3 y (t ) + x(t ) = 0 This is 2nd order linear ODE
•• d2y
Where y (t ) =
dt 2

1
c) log y& (t ) + = 0 is non-linear first order ODE.
y (t )

4.8.1.1 First order linear differential equations with constant coefficient

and term

dy
Such an equation is + u (t ) y = w(t )
dt
When u (t) and w (t) are constants, it is first order linear differential
equations (LDE) with constant coefficient and constant term.
When w (t) = 0, it reduced to homogenous 1st order LDE
W (t) w(t ) ≠ 0, is it know as not-homogenous case

Let’s see how to solve each of them

The homogenous case

dy
This occurs when w (t) = 0. That is + ay = 0 which is reduced to
dt
the general solution of Yt = Ae − at

Let’s directly solve this equation

dy
= ay
dt
1
dy = − adt
y
1
∫ y dy = ∫ − adt = −∫ adt
ln Y == −(at ) + (c)

112
 Y = e − at + c
Y = e c ⋅ e − at

Y = Ae − at Where A = Y (0); i.e., when t = 0

From the solution, it can be seen that the objective and solution of
solving differential equation is not numeric value rather t is the time
path of y (t).

The Non-homogenous Case

dy
That is + ay = b . This occurs when w (t) is a constant “b” different
dt
from zero. The solution to such an equation is consists of sum of
two terms namely the complimentary function (Yc) and the
particular integral (YP). Each has its own economic interpretation as
will be clear latter.
Yc is the solution had “b” been Zero (the homogenous case)
YP is any particular Solutions

Thus, Yc = Ae − at
dy
By assuming Y to be constant = 0 and we’ll have ay = b and
dt
b
YP =
a
b
∴ The general solution will be Y (t ) = Yc + Yp = Ae − at +
a
But when t=0, our equation will be reduced to
b
Y (t ) = Ae − at +
a
b
Y (o) = A +
a
 b
A = Y( 0 ) − 
 a
Hence, we finally come up with

113
  b b
Yt = Y( 0 ) −  e − at +
 a a
When b = 0, Y (t) turns to the homogeneous case
Examples
dy
a) Solve + 4 y = 0. and Y (o) = 1
dt
Y (t ) = Ae − at

Y (o) = Ae 0
1=A
A=1

∴ Y (t ) = e −4t

dy
b) Solve + 2 y = 6 and Y (0) =10
dt
Solution
 b b
Yt = Y (o) −  e − at +
 a a

 6 6
Yt = 10 −  e −2t +
 2 2

Yt = 7e − 2t +3

114
Application of the Non-Homogenous case: Dynamic model of the market
price
The objective in this section is to see whether a free enterprise
economy without any form of government intervention can bring a
price which will satisfy both consumers and producers and whether
this price will be stable [ deviances from the equilibrium position will
not bring a sustained change in price and the equilibrium state will
be maintained again with some adjustments] or knife
edge[unstable] through fulfilling the economic interest of both
producers and consumers. Let’s begin with simple model of market.

For a given product,

Qd = α − β P.................(α ⋅ & β > 0) … Demand function

Qs = γ − δP.................(γ & δ > 0) … Supply function

Equation α − βρ = −γ + δρ
α + γ = (δ + β ) ρ
α +γ
P= ⇒ it is some positive constant
u+β

If P (0) ≠ P [there is a deviation from the equilibrium state], what is

the nature of adjustment of market price?

The rate of change in price is a function of excess supply. That is, if

supply is larger than what is required by consumers, market price
decrease and if it is lower than what is needed by consumers price
will increase. Hence, without any complexity, we can model the rate
of change in price as follows.

dp
= m(Qs − Qd ) Where m>0
dt
dp
= − m(γ + δρ − α + βP)
dt
= m(−γ + α ) + m(δ + β ) P
dp
+ − m(δ + β ) P = − m(γ + α ) Using the formula stated above, we get
dt

115
  − m(γ + α )  − m (δ + β ) t − m(γ + α )
⇒ P(t ) =  e + This is identical to the
 − m(δ + β  − m(δ + β )

 γ + α  − m (δ + β ) γ + α
expression P (t ) =  P(0) − e +
 γ + β  δ +β

[ ]
Pt = (0) − P e − m (δ + β ) t + P

P(0) − P
Pt = +P
e m (δ + β ) t

Thus, as time “t” approaches to infinity, t → ∞, P(t ) = P , the market

price “Pt”. This implies that the market (equilibrium) price and
concomitant quantity are stable.

116