CHAPTER TWO

DERIVATIVES
Introduction
This part deals with the techniques and applications of differential calculus. It deals with
concepts and techniques of mathematical economics, which is commonly used in comparative
statics analyses of economic variables. It mainly deals with the concept of instantaneous rate of
change-namely the derivative. In economics, we are interested in instantaneous rates of changes
of various economic variables. For instance, we deal with marginal utility, marginal product,
marginal revenue, value of marginal product, and other marginal values, which are the
instantaneous rate of change of their respective total functions.
The Concept of the Derivative

dy f  x  x   f  x 
 im
dx x 0 x
f  x  x   f  x 
The term , is simply slope of the functions which is an equivalent expression to
x
y
, and it represents average rate of change of a function .But the derivative approximates the
x
rate of change of the positive function when x is infinitesimal i.e. slope of a function at a point
or instantaneous rate of change.
As you might remember from the previous discussion, the derivative is also the slope of the
tangent line to f (x) at a point.
Example:

1. Given

2. Given

3. Given

Solution:
1. For f(x)=3x+7
JU, Department of Economics Calculus for Economists page 1
2.

3. For

Thus,

JU, Department of Economics Calculus for Economists page 2

 2. Geometric Interpretation of Derivatives: slope of a curve
Geometrical meaning of derivative. Consider a graph of a function y = f ( x ) :

From Fig.1 we see, that for any two points A and B of the function graph:

where - a slope angle of the secant AB.

Therefore, the difference quotient is equal to a secant slope. If to fix the point A and to move the
point B towards A, then will unboundedly decrease and approach 0, and the secant line AB
will approach to the tangent line AC. Hence, a limit of the difference quotient is equal to a slope
of a tangent at point A.
The slope of the secant line that passes through point A(x0, f(x)) and point B(x+ΔX, f(x+Δx)) is

given by …Average rate of change

Thus, the slope of the secant line is the average rate of change of y with respect to x.
As tends to be 0, the secant line approaches to the tangent line. Thus, the slope of the tangent
line becomes:

M= …instantaneous rate of change

Thus, the slope of tangent line is the instantaneous rate of change of y with respect to x.
Hence, it follows: a derivative of a function at a point is a slope of a tangent of this function
graph at this point.

JU, Department of Economics Calculus for Economists page 3

Generally, the slope of the curve at a point can be found by the slope of a tangent line drawn at
that point.

Slope of a curve at x1, …derivative

Slope of a curve = or

M=

Example: find the slope of at x=-1, 0, 1.

Solution:

The slope of the curve = it is not constant.

Continuity and Differentiability of a Function

If the derivative of a function, say f x , exists at point ‘c’ then f  x  is said to be differentiable at
‘c’.
To say a function f  x  is differentiable at ‘c’ the following conditions should be fulfilled
1. f  x  should be continuous at ‘c’
2. f  x  should have a unique (only one) slope at ‘c’
st
The 1 condition requires the fulfillment of continuity conditions i.e. a given function is said to
be continuous over a given rage [at a point] if it is defined for all real numbers within that range
[at that point]. Graphically speaking, continuity occurs if we cannot draw graph of a function
JU, Department of Economics Calculus for Economists page 4
without lifting our pen/pencil. Any function is said to be continuous at a point such as X=C if the
following conditions are satisfied. That is
1. im f x  & im f x  Should exist, i.e the limit L must be a finite number
x c x c

2. im f x   im f x   im f x 

x c x c x c

3. im f x   f c  and f(x) is defined at x = c i.e. f(c) exists

x c
From this, we can understand that continuity does not necessarily mean differentiability.
The 2nd condition is sufficient condition for differentiability:

The left-hand derivative of f at X=c is given by , provided this limit exists.

This left-hand derivative is the slope of the line in the limiting position.

Similarly, the right –hand derivative of f at x=c is given by , provided this

limit exits. The left-hand derivative is the slope of the line in the limiting position.
Continuality rules out jumps and gaps at a point while differentiability condition requires
smoothness of the curve at the given point in addition to continuity conditions. In other words,
differentiability rules out jumps, gaps, sharps & cusp corners, while continuity rules out only the
first two
Example show the function f x   x  2 is not differentiable at x = 2.

Steps 1 Testing continuity of the function

1. im x  2  0
x 2

2. im x  2  0
x 2

3. im f x   f 2  0., so, f  x  is continuous at x  2

x 2

Step 2 in this step we will see whether the limit of the difference quotient exist or not.
Since f  x  is an absolute value functions, it can be redefined as follows:

 x  2, for.x  2
f x   
2  x, for.x  2
To see the existence of the limit of the difference quotient, we find its left & right side limits .i.e.
f x  h   f x  x  h   2  x  2  1
im  im
h 0 h h 0 h
f x  h   f x  (2  x  h   2  x   1
im  im
h 0 h h 0  h
JU, Department of Economics Calculus for Economists page 5
From the above result, we can see that the left & right side limits are not equal. Therefore the
limit of the difference quotient does not exist which intern means that the function f ( x)  x  2

is not differentiable at x=2.

Is f differentiable at ?
LHD=

RHD=

Rules of Differentiation

In this section, we formally state the different rules of derivatives that are important in several
problems of getting the derivative. These are the constant rule, the simple power rule, the
coefficient rule, sum/difference rule, product rule, quotient rule, chain rule, and others.
Rule 1: The constant rule
If c is constant and the function is given by f(x) =c, then f’(x) =0
Proof of rule 1: we apply the definition of derivative to the function whose outputs
have the constant value C. At every value of x, we find that:

y lim 7  7
Example 1. If f(x) =7; lim
x  0  x  0 0
x x

JU, Department of Economics Calculus for Economists page 6

Rule 2: Power Function Rule
The derivative of the function y=f(x) = xn, where n is any real number is equal to nxn-1
dy
Example 1. y  5 x 3 ,  f ' ( x)  y '  3(5 x 31 )  15 x 2
ax
1 6
1. f(x)= 6 , f ' ( x)  6 x 61  6 x 7  7
x x

Note. A constant factor may be taken outside the derivative sign, i.e., if where
C is a constant, then
[( x  x) 2  ( x) 2 ]
Example: f(x) = 6x2; f’(x) = 6 lim
x 0  12 x
x

JU, Department of Economics Calculus for Economists page 7

Rule 4: Sum/ Difference Rule
The derivative of the sum/difference of differentiable functions is equal to the corresponding
sum/difference of the derivatives of these functions.
i.e. Let f(x) and g(x) are two differentiable functions, then
d df ( x) dg ( x)
( f ( x)  g ( x))    f ' ( x)  g ' ( x).
dx dx dx
Example 1) f(x) = 9x2 + 3x + 7
d (9 x 2  3x  7) d (9 x 2 ) d (3x) d (7)
f’(x)=   
dx dx dx dx

=18x +3 + 0 = 18x + 3
2) f(x) = 9 x  3x
2

d (9 x 2  3x) d (9 x 2 ) d (3x)
f’(x) =    18 x  3
dx dx dx

Rule 5: the product rule

The derivation of a product of two differentiable functions is equal to the product of the
derivative of the first function by the second function plus the product of the first function by the
derivative of the second function; i.e. given f(x) and g(x) are two differentiable functions, then
d
[f(x) . g(x)] =f’(x). g(x) + f(x) . g’(x)
dx

3. Given AR = 25 –Q2, find MR?

The solution for the above problem can be found by using the relationship between the marginal, average
and total revenue functions

JU, Department of Economics Calculus for Economists page 8

 TR dTR dAR.Q using the product rule of differentiation we
AR   TR  AR.Q , MR  
Q dQ dQ
get

dAR dQ
MR  Q  AR
dQ dQ



d 25  Q 2 Q 
 25  Q 2 
dQ
 2Q 2  25  Q 2
 25  3Q 2

4. Given, y=5x3(2x-5) find

 Let f(x) = 5 x , f’(x) =15x2

3

g(x)=2x-5,g’(x)=2
Y’=f’(x) g(x) +f(x).g’(x) =15 x2 (2x-5) +5 x3 (2) =30 x3-75 x2+10 x3
Corollary:-This rule can be extended for differentiating the product of any number of functions.
Thus, if we have a product of three functions
d
[ f ( x).g ( x), h( x)]  f ' ( x), g ( x), h( x)  f ( x) g ' ( x).h( x)  f ( x), g ( x), h ' ( x)
dx
= 40x3-75x2
Rule 6: Quotient Rule
The derivative of a fraction (quotient) is equal to a fraction whose denominator is square of the
denominator of the given fraction, and the numerator is the difference between the product of the
denominator by the derivative of the numerator and the product of the numerator by the
derivative of the denominator;
i.e., if f(x) and g(x) are two functions, g(x)  0, and h(x) is the quotient
f ( x) d f x  f ' ( x)  f ( x).g ' ( x)
,then ( )
g ( x) dx g ( x) [ g ( x)]2
Example: differentiate with respect to x.
2
x 2 x.(1  x)  x 2 (1) x 2  2 x
f ( x)  ; f ' ( x)  
1 x (1  x) 2 (1  x) 2
Example
1. Given f ( x)  ax  b , find f (x) ?
2

cx
Since f (x) is a quotient of two functions, let g ( x)  ax  b , and h( x)  cx .
2

JU, Department of Economics Calculus for Economists page 9

 g x  g ' h  h' g
 f ( x)   f ' x  
h x  h2
g '  x   2ax, h'  x   c

 f ' x  

2ax.cx  c ax 2  b 
cx 2
ax 2  b

cx 2

Rule 7: Composite Function/chain rule/

If a function Z =f(y) has a derivative at some point Y, such as Z y
= f’(y), and the function y =

S x  has a derivative at some point in x, such as y  S ' x  , then the composite function
x

Z  f S x  at the given point x also has a derivative, which is equal to:

dz dz dy
Z x  f y ( y ) Sx( x) Or  .
dx dy dx
Thus, for instance, if y=f(x), where x = S (u) , and z= z (v) and v= x(t), then the derivative y’(t)
dy dy dx du dv
is given by: y’(t)= f’(x) . S ’ (u) z’ (v) x’ (t) or  . . .
dt dx du dv dt
Example: - 1) Differentiate the following composite functions.
i) if y = 5x2, z = 7y + 3,
dz dz dy
:.  .  7 10 x  70 x
dx dy dx
ii) x = 10p – p2, p = 0.7y -2
dx dp dx
:.  .  0.7(10  2 p)
dy dy dp
Corollary: If y = [f(x)] n, y’ = n [f(x)] n-1. f’(x)

JU, Department of Economics Calculus for Economists page 10

 1 6x  5
 (3x 2  5 x  7) 2 .6 x  5 
1 dy 1
Example: y= (3x2 + 5x + 7) 2 ;
dx 2 2 3x 2  5 x  7

4. The total physical output P of workers is a function of the

number of workers “x”. The function f(x) =p is called physical
productivity function and is given by
find the marginal physical productivity.
5. Suppose the revenue function for a certain product is given by
where x is in thousands units and R
is in thousands.
1. Find the MR when 200 units are sold
2. How is revenue changing when 2000 units are sold

Rule 8: Inverse Function

If a function has a derivative  at the point x0, then it’s inverse

Also has derivative at the corresponding point y0= f(x0), and then, g 1
f ' ( x0 )
1 dg 1
, or g ’(y0) = or 
f ' ( g ( y 0 ) dy dy
( )
dx
Example 1: Find the derivative of the inverse function for the following given function.
y  1 dy 1 1 1 ( y  1) 2
a. x= ;    
y  1 dx dx ( y  1)  ( y  1) 2 2
[ ]
dy ( y  1) 2
( y  1) 2

JU, Department of Economics Calculus for Economists page 11

 dy 1 1 1 1
b. x=y2;     ,since
dx dx 2y 2y 2 x
( )
dy 1
Rule 9: Implicit Function
So far we have said that an explicit function is one in which the dependent variable is to one side
of the equality sign (say to the let of) and the independent variable and parameters are to the
other (say to the right).
But, implicit function is one in which both variables are on the same side of the equality sign.
Therefore, it may sometimes be difficult to solve an equation explicitly for a dependent variable
in terms of independent variable(s). Hence, given the implicit function f(x, y) =0, we may
differentiate it term by term and then solve the equation for the derivative.
Suppose we have an implicit function given by
We have use two different approaches
1. Total derivative approach
2. Chain rule approaches (technical approach)
Total derivative approach
Then, totally differentiating the equation we get

Rearrange terms and gives us:

Examples:
dy
1. Find by implicit differentiation.
dx
A) 6x2 + y3 = 0
12x dx + 3y2dy=0
3y2dy=12xdx

B) x y 3
1 1 1 1
 ( x 2 )dx  ( y 2 )dy  0
2 2

JU, Department of Economics Calculus for Economists page 12

 1
dy x 2  y
= - 1 
dx y 2 x

C) 4x3 + x2y – 3xy2 – 5y3 = 9

 12x2dx + 2xydx + x2dy – 3y2dx – 6xydy – 15y2dy = 0
(12x2 + 2xy – 3y2) dx + (x2 – 6xy – 15y2) dy = 0
12 x 2  2 xy  3 y 2 dy

15 y 2  6 xy  x 2 dx
2. Find for the following implicit functions
a.
b.
Solutions

Solution b.

, bu t , then by substitution

Chain rule (technical approach)

1st. differentiate both sides with respect to x, and when you differentiate a y term with respect to
y multiply by dy/dx.
2nd. solve for dy/dx.
Example
JU, Department of Economics Calculus for Economists page 13
 A.
B.
Solution (A)

Rule 10: Derivatives of logarithmic functions

A. A function, which is given by is equivalent to that its first order derivate
can be specified as .
B. If the function is stated to any base than e, which is given by then the
derivative of this function is specified as .
Examples:
Find for each of the functions below
1. 6.
2. 7.
3.
8.
4.
5.

Solutions:

1.

2.

3.

4. Let,

JU, Department of Economics Calculus for Economists page 14

 Or

Let, , then

5. Use the implicit function rule:

Divided by dx both sides

6. taking the natural logarithm of both sides:

, then taking the derivative of both sides using implicit function rule, we
get

7. apply natural logarthim for both sides, then

use the implicit function rule

, since , we left

Apply product rule

Divided by dx and multiply by y, then

JU, Department of Economics Calculus for Economists page 15

 8. apply natural logarithm in both case
, but =1, so that we have .
Apply implicit function rule

…..use product rule only for x terms

Rule 11: Derivative of exponential function

an be easily be found by changing it to the
logarithmic function.

diveded by dx, and multiply by y

 In general, if the function is given, using the chain rule, the derivative of this fuction
w.r.t to x is stated as:
 The exponential function is a unique function with special behaviour. That is.
However, in case we have , we can use the chain rule to evaluate its derivative. That is left
and we will have .
If :
. thus . But imples that

Example: Find dy/dx in each of the functions given below

1. 4. 7.
2. 5.
3. 6.
Solutions
1.

JU, Department of Economics Calculus for Economists page 16

 2.

3.

4.

5. Let ,so that . then,

6. , so that

7. Let, ,and , , so that

Self-test exercise
1. check the differentiability of f x   x  1, for x  2
ax  5 , for x  2 at x=2

2. Find the first order derivatives of the following functions

a). y  x 2 log 3x
b). g x   e
5 x  4 

c). f x   2 x  15 x  36 x  4
3 2

3. Evaluate the 2nd order derivatives of the function g  x   4 x  x

Higher Order Derivatives
The concept of a derivative of order n
The derivative of a function f(x) leads to another function f’(x). We call f’(x) the first order
derivative of the function f(x). The derivative of the derivative of a function is the second order
derivative (or the second derivative) of the function. The derivative of the second derivative is
the third-order derivative (or the third derivative) and so on. Starting with the second derivative;
the derivatives are called derivatives of higher orders and are denoted by y”, y”’, y (4), y (5)…

y(n)…(instead of y” and y”’ we sometimes write y(2) and y(3), or f ''x  , f '''x  ,

th
The derivative of order n (or the n derivative) is the derivative of the derivative of order (n-1),

i.e. y (n) =(y (n-1))’.

JU, Department of Economics Calculus for Economists page 17

 The derivatives of higher orders have a variety of applications in Economics and other different
disciplines. For this, we will see in its roles in this chapter as well as in the next chapter.
Note: Higher order derivatives are found by applying the rules of differentiation to the derivative
of the previous order.
Examples 1) compute the derivative of the 1st, 2nd, 3nd and 4th order derivatives of the functions;
a.

2x
, 1
x 1

1st order y'  f ' x   2 x 12

y' '  f ' ' x    4x 1

3
2nd order

y' ' '  f ' ' ' x   12x 1

4
3rd order

f x  f x   48x 1

4  4  5
4th order …etc.

Exercise:
Find the first five derivatives of the following functions
1. 4.
2. 5.
3. 6.

Formulas for the nth derivatives of some functions

1. Let us generate the nth derivative of the power function
, hence
i. If n = m; f(n)(x)= ;//  m=n
f(n+1)(x) =0
f (n)(x .

JU, Department of Economics Calculus for Economists page 18

2. For an exponential function: , where 0  a  1 generate the nth derivative of this
function.

f ' ( x)  a ln a
x

f ' ' ( x)  a ln a  x 2

f ' ' ' ( x)  a ln a 

x 3

f x  ln a 
n  n
a
x

f x 
n 
In particular, if y  e , then we have for any nth derivatives,
x
e .
x
3.

4. For the función which is given by, find the nth derivative.

Solution
f ' x   a e …
ax

f '' a
2 ax
e
...

f x 
n 
a
n ax
e
The sign of the Derivative
What does the first order derivative says about graph? There is different importance of the sign
of first and second order derivatives.
1. Test for either a function is increasing /decreasing
2. Test for a concavity or convexity of a function
3. Test for either a function is at maximum /minimum at a critical value
Increasing /decreasing function
It is possible to decide whether the given function is an increasing or decreasing by observing
the sign of the derivative of the given function.
To see how the derivative of a function can tell us where a function is increasing or decreasing,
look the following figure. Between point A and B, and point C and D, the tangent lines have
positive slope and so
Between point B and C, the tangent lines have negative slope and so . Thus, it appears
that f increases when is positive and decreases when is negative.

JU, Department of Economics Calculus for Economists page 19

 Conditions:-
A. First order derivative
If f(x) is a differentiable function at any point and/ or interval, then:
1. The function tends to increase or the function is an increasing function at a given point or an
interval, and the rate of change of f(x) with respect to x is positive,
2. The function tends to decrease or the function is a decreasing function at a given point or an
interval, and the rate of change of f(x) with respect to x is negative,
3.
Example:
1. Given
A. The ranges of x over which f(x) is decreasing and increasing
B. The point at which f(x) attains its relative extreme value
Solution
, i.e

If , i.e

Thus, the function f(x) is increasing for the value of It is decreasing in

the range

JU, Department of Economics Calculus for Economists page 20

Example 2: For the following functions identify whether they are increasing or decreasing at a
given points.

A. f(x) = x  6 x  17 ,at
2

 The function is decreasing.

When  the function is increasing.
B.

 The function is decreasing.

When  the function is increasing.
When  , the slope of the curve is horizontal and stationary.

Relative maximum or minimum

First-order derivative test for relative extremum
, then the value of the function at ,f( will be:
1. A relative maximum if f’(x) changes its sign from positive to negative from the immediate
left of the point to its immediate right.
2. A relative minimum if f’(x) changes its sign from negative to positive from the immediate
left of the point to its immediate right.
3. No extreme points if f’(x) has the same sign on some neighborhood
Example
Let
Is the function is at its relative maximum or minimum at a critical point?
1st find the critical value of the function
, then the critical points of f are , and

JU, Department of Economics Calculus for Economists page 21

Then, what will be the value of f’(x) at the critical points?

The value of f’(x) changes its sign from negative to positive value at x= -3 which means that the
function changes from decreasing to an increasing, and changes from positive to negative value at
x=3, which means that the function changes from increasing to decreasing. Therefore, it is a
relative minimum.
To find out relative minima or maxima:

Solution
A. , then solve the value of x using quadratic formula

JU, Department of Economics Calculus for Economists page 22

 B. , then solve the value of x using quadratic formula


.

JU, Department of Economics Calculus for Economists page 23

B. Second order derivative test for relative maximum or minimum
Suppose is a function of x that is twice differentiable at a stationary point
1. If , then f has a local /relative minimum at
2. If , then f has a local /relative maximum at
3. , test in conclusive (maximum, minimum or inflection.)
Example:

Solution

JU, Department of Economics Calculus for Economists page 24

In Summary: Condition Relative max Relative min
First order necessary condition f ( x0 )  0 f ( x0 )  0
Second order sufficient condition f ( x0 )  0 f ( x0 )  0
Note that: For f n ( x 0 )  0, where n is higher derivative or order n;
1. If f n ( x0 )  0 and n is even, the point is an extremum point

f x <0.
 
n
I. A relative maximum, if n is even and 0

f x >0.
 
n
II. A relative minimum, if n is even and 0

2. If f n ( x0 )  0 and n is odd, the point is an inflection point

I. A point of inflection, if n is odd number
Concavity Test
I. If for all x in an interval, then the graph of f is concave upward (convex) on an
interval. The graph is bending up on an interval
II. If for all x in an interval, then the graph of f is concave downward (concave)
on an interval. The graph is bending down in an interval.
III. then the graph of the function changes from bending up to bending down
or vice versa is called the infliction point, and the value of the function is either maximum
or minimum value
Example:
1. Given find
A. The ranges of x over which is concave up and concave down
B. The point of inflection
Solution: concavity and convexity

Solution: point of inflection

JU, Department of Economics Calculus for Economists page 25

 2. For the following function identify whether they are concave, convex or has point of
inflection at its respective critical values.
a) f(x)=2x2-4x

then the curve is convex downward.

b.

– Point of inflection is where f”(x) =0, hence it will be at

Exercise
1. Identify whether the following function is either at relative maximum, minimum or inflection
point.
A.
B.
C.
Economic Application of Derivatives

Here we will consider the application of derivatives on different Economic issues. Since the
relation between economic variables can be expressed by means of functions and curves, the
derivatives obtained from these functions give us the marginal in economics. Most economic
decision problems make use of the concept of marginal. Thus, this chapter will focus on the
application of derivatives on marginal and average values of economic issues.
Objectives
At the end of this chapter, you will be able to:
- Understand the marginal and average concepts of some economic variables.
- Calculate the elasticity of demand and supply.
- Calculate the marginal and average revenue and cost.
- Understand the price and income elasticity coefficients.

JU, Department of Economics Calculus for Economists page 26

Demand, Supply and Market equilibrium
a) Point Elasticity of demand
From microeconomics I, we can remember that elasticity is the relative change in demand in
 Q
Q
response to a relative change in price. Thus, price elasticity at a point is: ed = .
p
p
If the changes are small and the demand function Q=f(p) is continuous at price P, we can express
elasticity of demand as:
 Q
Q dQ p
ed = =-  . Since
p dp Q
p
p dQ
In fact, the ratio  gives us the average elasticity of demand over the price range of p.
Q dp
According to the law of demand, if price increases demand falls (the change is negative). Thus,
p dQ p dQ dQ
ed = (-) = . Observe that is the derivative of the given demand
Q dp Q dp dp
function with respect to price. For each price, the expression will give the elasticity of demand.
Example: 1) Find if the demand function is Q=7-2p
i) At P=1 ii) At p=2
dQ p p 2p
ed = . -2 × =
dp Q 7  2p 72p
 2(1) 2
i) At p=1, ed = = - , hence demand is inelastic at p = 1.
7  2(1) 5
 2( 2)  4
ii) At p=2, ed = = , demand is elastic at p = 2.
7  2( 2) 3
b) Point elasticity of supply
It is the relative change in supply in response to a relative change in price. If Q stands for supply
and the supply function is written as Q = g (p), then elasticity of supply when a price change by
p dQ
infinitesimal value is given by:
Q dp
Note:-The slop of the demand curve is negative and hence is negative. However,
conventionally we use the absolute value. Similarly, the slope of supply curve is generally
positive and hence es is positive.
Example: 1) Find , for the supply function Qs = 5+2p2

JU, Department of Economics Calculus for Economists page 27

 i) At ii) At
dQ p 4 p
es = .
dp Q 5  2 p2
4( 2) 16
i) At p = 2, es = = , supply is elastic
5  2( 2) 2
13
4(3) 36
ii) At p =3, es = = , supply is elastic.
5  2(3) 2
23
dQ p
Note: /ed/ = . , is a formula for Point price elasticity of demand.
dp Q
a) If /ed/ >1, demand is said to be elastic
b) If 0< /ed/< 1, demand is said to be inelastic
c) If /ed/ = 1, demand is unitary elastic
d) If /ed/=0, demand is said to be perfectly inelastic
e) If /ed/=  , demand is said to be perfectly elastic
c) The relationship between average revenue, marginal revenue and price elasticity
Given total revenue function. (TR)
R = P.Q = Price × quantity sold, and Q = f (p)
d (TR) d ( PQ)
Then, marginal revenue (MR) = =
dQ dQ
dP dQ
= .Q  p
dQ dQ
dp dp Q 1
= .Q  p  p( .  1)  p(  1)
dQ dq p ed

1 1
MR = P (1- ) = AR (1- )
ed ed

ed
Or AR= MR ( )
ed  1

Then, it follows that when:

ed = 1, TR remains constant with a fall in price, MR = 0( or TR constant, P , MR = 0)
ed > 1, MR > 0, TR rises, when Q  or P
ed < 1, MR< 0, TR falls when Q  or P

JU, Department of Economics Calculus for Economists page 28

4.2 Price and income Elasticties
Given the Engle curve equation Q = f(y), where y-is income. Then the point income elasticity
dq y
can be expressed as ey = . .From the above expression, we note that:
dy Q
a) If ey > 1, then it is a luxury good.
b) If ey < 0, then it is an inferior good.
c) If 0 < ey < 1, then it is necessity good.
Example: 1) Find the income elasticity of demand, if the Engle curve equation is 40Q = 20+5y,
at y= 8000, what can you say about the nature of the good?
1 4
The given function can be re-expressed as Q =  y .
2 8
dQ y
ey = .
dy Q
1 8000
=  , but y= 8000
8 (  y)
1
2 8
1 8000 1000
= [ ]=
1
8 (  8000 1000 .5
)
2 8
0 < ey < 1, hence it is necessity good.
4.3 Cost Functions
For producing a given level of output, there is a corresponding outlay of money expenditure,
called costs of production.
Let us now generalize the total cost function:
TC = f (Q) + K, (K is fixed cost); f (Q) is variable cost)
TC f (Q)  K
Then average total cost = ATC =  ,
Q Q
f (Q )
Average variable cost = AVC =
Q
K
Average fixed cost = AFC = .
Q

JU, Department of Economics Calculus for Economists page 29

 f (Q)  K
Therefore, ATC = AVC + AFC =
Q
d (TC )
Marginal Cost = MC =
dQ
Relationship between AC and MC
d (TC ) d AC  Q  d ( AC) dQ
MC = = = .Q  AC   Product rule.
dQ dQ dQ dQ

d ( AC )
, Thus,
dQ

The rate of change of AC with respect to Q (the slope of AC) is:

1  d (TC ) TC 
= MC  AC  
d ( AC ) 1
 
dQ Q Q  dQ Q

Characteristics of the Slope of AC Curve:

i. When AC curve slopes downward [ i.e., if the slope of AC is negative.],then
d ( AC ) 1
= ( MC  AC ) < 0.
dQ Q
MC –AC< 0.
MC < AC; (MC lies below the AC curve.)
ii. When AC curve is rising [i.e., if the slope of AC is positive.], then
d ( AC) 1
 ( MC  AC) > 0.
dQ Q
MC –AC > 0
MC > AC (MC curve is above AC curve.)
iii. At the minimum point of AC curve, the slope is zero.
d ( AC) 1
 ( MC  AC) = 0
dQ Q
MC = AC (MC crosses the AC curve at the minimum point of AC
curve.)
Example: - 1) If TC (Q) = 0.5Q3- 0.7Q2 -30Q + 300, find
i) AC and its slope

JU, Department of Economics Calculus for Economists page 30

 ii) MC and its slope
iii) The values for which MC = AVC
3 2
TC 0.5 Q - 0.7 Q - 30Q  300
i) AC = 
Q Q

300
= 0.5Q2- 0.7Q -30+
Q
d ( AC ) 300
= Q – 0.7 - 2
dQ Q
d (TC )
ii) MC = = 1.5Q2 – 1.4Q – 30
dQ
d ( MC )
= 3Q – 1.4
dQ
iii) MC = AVC
1.5Q2 – 1.4Q – 30 = 0.5Q2 – 0.7Q – 30
Q2 - 0.7Q = 0
Q (Q - 0.7) = 0
Q = 0 or Q = 0.7, hence if the production process is running, then Q = 0.7 units.
The profit equation
Profit (π) = Total revenue – Total cost.
–

If the TR of a firm equals its TC; then we can say that the firm is at its breaks even point.
I.e. TR = TC TR – TC = 0.
Marginal profit: It’s the incremental profit obtained when a unit of output is produced and sold.
d ( ) d (TR) d (TC )
Hence Mπ = =   M  MR  MC
dQ dQ dQ
Q3
Example: 1) A firm assumed a cost function C (Q) =  210Q , where Q is the monthly
10
output. And its revenue function is given by R (Q) = 1500Q -1.5Q2
1. If the firm decides to produce with a marginal cost of 330, find the level of output per month
and the cost to the firm?
2. Find the level of output that maximizes the firm’s profit.
3. Calculate MR and MC at profit maximizing level of output?
4. Calculate the profit or loss at optimum condition?
JU, Department of Economics Calculus for Economists page 31
 Q3
Solution: - Given TC =  210Q ; TR = 1500Q – 1.5 Q2; MC = 330
10
1. Required: The level of output (Q) and total cost TC at MC=330.
TC =?
Q3
d[  210Q]
d (TC ) 10 3
MC =   Q 2  210 , but MC = 330
dQ dQ 10

3Q 2
Thus,  210  330  Q  20, therefore the level of output is 20 units per month.
10
Q3 (20) 3
And TC =  210Q , but Q=20 Total cost =  210(20)  5000
10 10
2. Find the level of output that maximizes the firm’s profit.
Profit can be reaches at maximum when
Mπ = 0
But profit –
Q3 Q3
= (1500Q -1.5Q2) – (  210Q) = 1290Q – 1.5 Q2 -
10 10
d ( ) 3 2
Mπ = = 1290 -3Q - Q
dQ 10

 3Q 3
- 3Q + 1290 = 0
10
3Q2 + 30Q – 12900 = 0
Q2 + 10Q – 4300 = 0, using general quadratic formula
Q = -70.76 or Q = 60.76473
Q ≈ 60.76473 unit
3. Calculate the MR and MC at this level of output (60.76) and comment on the result.
At Q = 60.76
3 2
MC = Q  210
10
3
MC (60.76) = (60.76473) 2  210
10
= 1107.7057 + 210 = 1317.7057≈ 1317.71

JU, Department of Economics Calculus for Economists page 32

MR (60.76) = 1500 – 3(60.76473)
= 1500 – 182.29419
= 1317.7059
≈ 1317.71
Since, R (Q) = 1500Q – 1.5 Q2 and MR = 1500 – 3Q.
Therefore, MR = MC at the level of output that makes
4. Calculate profit or loss at optimum condition
Q3
1290Q – 1.5 Q2 - , at
10

1290 (60.76) – 1.5 –

Optimization Problems
Profit Maximization and Cost Minimization

Conditions for Profit Maximization

So far we have seen how to estimate an output level that maximizes total revenue from the

demand function irrespective of total cost function of the firm. Now in order to maximize profit,

a firm must choose the output level such that its MC = MR.

Let us see the above argument graphically using the total and marginal approaches.

 In the total approach, profit reaches at maximum when the difference /gap between TR and

TC reach at maximum

 In the marginal approach, profit reaches at maximum when the additional revenue that the

firm earns from producing and selling an extra unit of output is exactly equal to additional

cost that the firm incurred to produce additional unit of output.

JU, Department of Economics Calculus for Economists page 33

 Mathematical illustration.
1. The necessary condition for profit (π) to be a maximum.

Π (Q) = TR (Q) – TC (Q) total profit function, then derive marginal function
d d (TR) d (TC )
   Marginal profit function, then
dQ dQ dQ
–
MR – MC = 0
MR = MC this is called the first order condition (necessary condition). Thus the first order
condition for profit maximization gives us the level of output where
2. The sufficient condition for profit (Π) to be maximum i.e., MC is rising.
d 2 d 2 d 2 (TR ) d 2 (TC )
< 0, but =  <0
dQ 2 dQ 2 dQ 2 dQ 2

d ( MR) d ( MC )
=  <0
dQ dQ

JU, Department of Economics Calculus for Economists page 34

 d ( MR) d ( MC )
<
dQ dQ

Slope of MR< slope of MC

This is called the second order condition (sufficient
condition)
d 2 (TR) d 2 (TC )
That is 
dQ 2 dQ 2

Example 1: Given and

1. Maximize the total revenue and total profit function by:
a. Finding the critical value
b. Testing the second order condition
c. Calculate the maximum profit.
Solution:-
a) TR = 24Q – Q2
d (TR)
=0 MR = 24-2Q = 0 Q = 12 is critical value.
dQ
Q3 2
b) π = 240Q - -Q - 91
6
d ( ) Q2
=0 Mπ = 240 - - 2Q = 0 (multiply by 2 and by (-)
dQ 2
Q2 +4Q – 480 = 0 using general quadratic formula, we get Q = 20 or Q = -24
d 2 (  ) d ( M )
  Q  2
dQ 2 dQ
At Q = 20 π “(20) = - (20) – 2 = -22 it is relative maximum. Hence, the maximum
( 20)3
profit is π = 240(20) - - (20)2 – 91
6
8000
= 4800 - - 400 – 91
6
= 20309 units
Example 2: A company determines that the cost of manufacturing Q units of a commodity may
be approximated by:
C (Q) = 100 + 6Q2 + Q3
How many units should be produced in order to minimize the cost?
d (C )
Solution: - I. =0, 12Q + 3Q2=0
dQ

JU, Department of Economics Calculus for Economists page 35

 12Q +3Q2 = 0 Q (Q – 4) = 0
Q = 4 is the critical value.
d 2 (C ) d ( MC )
II.   12  6Q , but Q = 4
dQ 2 dQ
12 +6 (4) = 12 + 24 = 36 > 0 is relative minimum.
Thus, the company should produce 4 units of a commodity in order to minimize the cost.

EXERCISE
1. Calculate the price elasticity of demand of the equation Qp3 = 50
2. Given Qx = 50 – 0.2 Px + 0.1Py – 0.8Pz – 0.5I, calculate the cross elasticity between good
x and y at Px = 5, Py = 10, I = 40 and Pz = 20, what can you say about the two goods?
1 2
3. Given u(x,y) = 100x - x  50 y  5 to 2x + 5y = 600
2
i. Find the optimal choice?
ii. Find the max (profit)?
4. A factory determines that the cost of manufacturing Q units of a commodity may be
10 Q 2
approximated by c(Q) = 100 -  . How many units should be produced in order to
Q 100
minimize the cost?
5. Find the elasticity of demand for the following function at P = 4, 8Q + 2P = 56.
6. Compute the income elasticity, own price elasticity and cross price Elasticties for the
following demand function on good X as given by
where px is price of good x, py is price of good y and I is the consumer’s income. (Given:
Px= 400 Birr, Py =100 birr and I=10,000). Identify whether the demand is elastic or
inelastic, whether the two goods are related or unrelated, and whether good x is inferior
or normal good.
7. Suppose, there are two commodities in the market and their respective demand functions
are given as, and Find:
A. Direct price elasticity of demand for good Q1 and good Q2 (I; e ?
B. Cross- partial price elasticity of demands ( , if the price of Q1 and Q2
are Birr four and Birr five respectively?

JU, Department of Economics Calculus for Economists page 36