MATHEMATICAL ECONOMICS

❖ Syllabus: -

Differential Calculus

• Calculation of MC, MR, etc…

• Calculation of profit maximizing output
• Cost Minimizing inputs

Integral Calculus

• Consumer surplus and Producer Surplus

Linear Algebra

• Matrix Operations
• Types of Matrices
• Practical Examples for Matrices

Linear Programming Problem

• Optimization Problems
• Transportation Problems
• Methods to solve LPP
• Input Output Model

➢ Calculus:

Calculus in Mathematics is generally used in mathematical models to

obtain optimal solutions and thus helps in understanding the changes
between the values related by a function.

Application of calculus

• To understand whether the function is increasing or decreasing

 • To understand the concavity and convexity
• To find extreme points
• To find the inflection points

Increasing function

• Slope should be positive

• f’ > 0

Decreasing function

• Slope should be negative

• f’ < 0

Constant function

• Slope should be ZERO

• f’ = 0

Concavity and convexity of the curve

A convex function has an increasing first derivative, making it

appear to bend upwards. Contrarily, a concave function has a decreasing
first derivative making it bend downwards. It is important to understand
the distinction between the first derivative, which informs us of the slope
of the tangent of a function, and the second derivative, which shows us
how it is curved
Concave Downward:

• As we move from left to right, sign of the slope changes from

positive to negative
• Thus ,we can say that slope is decreasing

Conditions

• f’<0
• f ’’ < 0

Concave Upward (convex):

• As we move from left to right, sign of the slope changes from

negative to positive
• Thus, we can say that slope is increasing

Conditions

• f’>0
• f ’’ > 0

➢ Extreme points

Extreme points, also called extrema, are places where a function

takes on an extreme value—that is, a value that is especially small or
especially large in comparison to other nearby values of the function.
 Only two Extreme Points are there maxima and minima; Maxima and
minima of a function are the largest and smallest value of the function
respectively either within a given range or on the entire domain

1. Maxima

Conditions

• f’=0
• f ’’ < 0

2. Minima

Conditions

• f’=0
• f ’’ > 0

Inflection point

An inflection point is a point on a curve at which the sign of the

curvature (i.e., the concavity) changes. Inflection points may be stationary
points, but are not local maxima or local minima. In other words, the point
in which the rate of change of slope from increasing to decreasing manner
or vice versa.

Conditions

• f ’’ = 0
Application of calculus in economics:

In economics, we can apply the concept of calculus for the following

purposes.

• To find marginal concepts

• For optimization

1. Profit/utility/revenue maximization

2. Cost minimization

• To find elasticity

Marginal concepts:

• In economics, the concept of margin has a great importance. The

marginal unit of anything is the unit whose small addition or
subtraction is under consideration. In the language of Mayers, “The
marginal unit of any factor of production, of any stock of goods and
of any output of goods, is one extra unit of the same.”In economics
the term ‘margin’ always refers to anything extra. In economics we
have many marginal concepts to look into. We have mainly,

1. Marginal utility
 2. Marginal product

3. Marginal cost

4. Marginal revenue

5. Marginal propensity to consume

6. Marginal propensity to save

7. Marginal rate of substitution

8. Marginal rate of technical substitution

➢ Marginal utility:

Marginal utility is the added satisfaction that a consumer gets from

having one more unit of a good or service. The concept of marginal utility
is used by economists to determine how much of an item consumers are
willing to purchase.

U = f(X,Y)
𝑑𝑈 𝑑𝑈
Then, MUx = 𝑑𝑋 , MUy = 𝑑𝑌

➢ Marginal product

Marginal product, also called marginal physical product, is the

change in total output as one additional unit of input is added to
production. In other words, it measures the how many additional units will
be produced by adding one unit of input like materials, labor, and
overhead.

TP = f(K,L)
𝑑𝑇𝑃 𝑑𝑇𝑃
Then, 𝑀𝑃𝐾 = , 𝑀𝑃𝐿 =
𝑑𝐾 𝑑𝐿

➢ Marginal cost

In economics, the marginal cost of production is the change in total

production cost that comes from making or producing one additional unit.
To calculate marginal cost, divide the change in production costs by the
change in quantity.
𝑑𝑇𝐶
MC = 𝑑𝑄

TC = TVC + TFC

AC = AVC + AFC
𝑇𝐶
AC = 𝑄

➢ Marginal revenue

Marginal revenue (MR) is the increase in revenue that results from

the sale of one additional unit of output
𝑑𝑇𝑅
MR = 𝑑𝑄

➢ Marginal propensity to consume

In economics, the marginal propensity to consume (MPC) is defined

as the proportion of an aggregate raise in pay that a consumer spends on
the consumption of goods and services, as opposed to saving it.

Marginal propensity to consume is a component of Keynesian

macroeconomic theory and is calculated as the change in consumption
divided by the change in income. It is the slope of the consumption
function
𝑑𝐶
MPC = 𝑑𝑌

➢ Marginal propensity to save

Marginal propensity to save is the proportion of each added dollar of

income that is saved rather than spent. MPS is a component of Keynesian
macroeconomic theory and is calculated as the change in savings divided
by the change in income, or as the complement of the marginal propensity
to consume (MPC). It is the slope of the saving function.
 𝑑𝑆
MPS = 𝑑𝑌

Relation between MPC and MPS

• The sum of MPC and MPS is equal to unity (MPC + MPS = 1). For
eg, suppose a man’s income Increases by Rs 1. If out of it, he spends
70 paise on consumption (i.e., MPC = 0.7) and saves 30 paise (i.e.,
MPS = 0 3) then MPC + MPS = 0.7 + 0.3 = 1.

• MPC =1-MPS

• MPS =1-MPC

➢ Average propensity to consume

The average propensity to consume (APC) measures the percentage of

income that is spent rather than saved. This may be calculated by a single
individual who wants to know where the money is going or by an
economist who wants to track the spending and saving habits of an entire
nation.
𝐶
APC = 𝑌

➢ Average propensity to save

The average propensity to save (APS) is a macroeconomic term that refers

to the proportion of income that is saved rather than spent on current
goods and services. Also known as the savings ratio, it is usually expressed
as a percentage of total household disposable income (income minus
taxes).
𝑆
APC = 𝑌

Relation between APC and APS

 We know that Y = C + S

APC = APS = C/Y + S/Y = C+S/Y = Y/Y = 1

Hence APC + APS = 1

➢ Marginal rate of substitution

In economics, the marginal rate of substitution (MRS) is the amount of a

good that a consumer is willing to consume compared to another good,
as long as the new good is equally satisfying. MRS is used in indifference
theory to analyze consumer behavior.
𝑑𝑌 𝑀𝑈𝑥
∣MRSxy∣ = - = 𝑀𝑈𝑦
𝑑𝑥

➢ Marginal rate of technical substitution

The MRTS reflects the give-and-take between factors, such as capital and
labor, that allow a firm to maintain a constant output. MRTS differs from
the marginal rate of substitution (MRS) because MRTS is focused on
producer equilibrium and MRS is focused on consumer equilibrium.
𝑑𝐾 𝑀𝑃
∣𝑀𝑅𝑇𝑆𝐿𝐾 ∣ = - 𝑑𝐿
= 𝑀𝑃 𝐿
𝐾

➢ Elasticity

Degree of responsiveness of change in dependent variable due to change

in independent variable is elasticity

Three types of elasticity:

1. Price Elasticity Of Demand

2. Cross Elasticity Of Demand

3. Income Elasticity Of Demand

Price Elasticity Of Demand

Price elasticity of demand is a measurement of the change in

consumption of a product in relation to a change in its price. Expressed
mathematically, it is:
%𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝐷𝑒𝑚𝑎𝑛𝑑𝑒𝑑
Price Elasticity of Demand =
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒

Economists use price elasticity to understand how supply and demand

for a product changes when its price changes.
𝑑𝑄 𝑃
𝐸𝑃 = 𝑑𝑃 * 𝑄

Cross elasticity of demand

The cross elasticity of demand is an economic concept that

measures the responsiveness in the quantity demanded of one good when
the price for another good changes. Also called cross-price elasticity of
demand, this measurement is calculated by taking the percentage change
in the quantity demanded of one good and dividing it by the percentage
change in the price of the other good.

𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑋

Cross Elasticity of Demand =
𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑌
𝑑𝑄𝑥 𝑃𝑦
𝐸𝑃 = *
𝑑𝑃𝑦 𝑄𝑥

If 𝐸𝑥𝑦 = ∞, goods are perfect substitutes

If 𝐸𝑥𝑦 > 1, goods are close substitutes

If 𝐸𝑥𝑦 < 1, goods are poor substitutes

If 𝐸𝑥𝑦 = 0, goods are unrelated to each other

If 𝐸𝑥𝑦 = -ve, goods are complementary

Income elasticity of demand

Income elasticity of demand is an economic measure of how

responsive the quantity demand for a good or service is to a change in
income. The formula for calculating income elasticity of demand is the
percent change in quantity demanded divided by the percent change in
income. Businesses use the measure to help predict the impact of a
business cycle on sales.
𝑑𝑄 𝑌
𝐸𝑃 = 𝑑𝑌 * 𝑄

Relationship between MR , AR and elasticity

1
• MR = P(1- 𝑒 )
𝐴𝑅
• e = 𝐴𝑅−𝑀𝑅

Cobb Douglas Production Function

The Cobb-Douglas production function is based on the empirical

study of the American manufacturing industry made by Paul H. Douglas
and C.W. Cobb. It is a linear homogeneous production function of degree
one which takes into account two inputs, labour and capital, for the entire
output of the manufacturing industry.

Q= A𝐿𝛼 𝐾𝛽

• where Q = output
• L and K are inputs of labour and capital respectively.
• A, 𝛼 and β are positive parameters where = a > O, β > O.

Properties
 1. C-D production function (8.100) is a homogeneous function, the
degree of homogeneity of the function being α + β.
2. Sum of exponents gives returns to scale
• α + β = 1, constant returns to scale
• α + β > 1, increasing returns to scale
• α + β < 1, decreasing returns to scale

3. Marginal product of a factor depends on its amount used in

production
𝑄
• 𝑀𝑃𝐿 = α 𝐿
𝑄
• 𝑀𝑃𝐾 = β 𝐾

4. Exponents measure the output elasticity

• α measures the output elasticity of labour

𝑑𝑄 𝐿
α= 𝑑𝐿 𝑄

• β measures the output elasticity of capital

𝑑𝑄 𝑘
β=
𝑑𝑘 𝑄

5. Elasticity of substitution between L and K is one

➢ Consumer surplus:

Consumer surplus is an economic measurement of consumer

benefits. A consumer surplus happens when the price that consumers pay
for a product or service is less than the price, they're willing to pay. It's a
measure of the additional benefit that consumers receive because they're
paying less for something than what they were willing to pay.
 b
• ∫a f(x)dx = F (b) − F(a)

Consumer surplus
𝑞0
• CS = ∫𝑎0 𝑓(𝑞)𝑑𝑞 − 𝑝𝑜 𝑞0

Formula

𝑥 𝑛+1
• ∫ 𝑥 dx =
𝑛
𝑛+1

➢ Linear programming

Linear programming is a simple technique where we depict complex

relationships through linear functions and then find the optimum points.
The important word in the previous sentence is depicted. The real
relationships might be much more complex – but we can simplify them to
linear relationships.

• Developed by L.Kantrowich , Russian

• Re-introduced by T.C.Koopman, Dutch-American

• Both shared Nobel Prize in economics in 1975

 • Simplex method was developed by G.B.Dantzig

Common terminologies used in Linear Programming

Let us define some terminologies used in Linear Programming using the

above example.

• Decision Variables: The decision variables are the variables that will
decide my output. They represent my ultimate solution. To solve any
problem, we first need to identify the decision variables.
• Objective Function: It is defined as the objective of making decisions.
It has two parts
1. Primal: LP Problem given in original format
2. Dual: Transpose of primal
• Constraints: The constraints are the restrictions or limitations on the
decision variables. They usually limit the value of the decision
variables.
• Non-negativity restriction: For all linear programs, the decision
variables should always take non-negative values. This means the
values for decision variables should be greater than or equal to 0.

The process to formulate a Linear Programming problem

1. Identify the decision variables

2. Write the objective function
3. Mention the constraints
4. Explicitly state the non-negativity restriction

➢ Matrix
• Rectangular array of numbers in rows and columns is called matrix.
• The numbers are called elements/ entries of the matrix.
• The number of rows and columns that a matrix has is called its
order or dimension.
• A matrix having ‘m’ rows and ‘n’ columns is called a matrix of order
m*n or simply m* n
Types of matrix

Row Matrix

A matrix having only one row is called a row matrix. Thus A = [aij]
m × n is a row matrix if m = 1. So, a row matrix can be represented as A
= [aij] 1×n. It is called so because it has only one row and the order of a
row matrix will hence be 1 × n. For example, A = [1 2 4 5] is row matrix
of order 1 x 4. Another example of the row matrix is P = [ -4 -21 -17 ]
which is of the order 1×3

Column Matrix

A matrix having only one column is called a column matrix. Thus, A

= [aij] mxn is a column matrix if n = 1. Thus, the value of for a column
matrix will be 1. Hence, the order is m × 1.An example of a column
matrix is:

Zero or Null Matrix

 If in a matrix all the elements are zero then it is called a zero matrix
and it is generally denoted by 0. Thus, A = [aij]m x n is a zero-matrix if aij
= 0 for all i and j

Square Matrix

If the number of rows and the number of columns in a matrix are

equal, then it is called a square matrix. Thus, A = [aij] m x n is a square
matrix if m = n

Diagonal Matrix

If all the elements, except the principal diagonal, in a square matrix,

are zero, it is called a diagonal matrix. Thus, a square matrix A = [aij] is a
diagonal matrix if aij = 0,i ≠ j
Scalar Matrix
If all the elements in the diagonal of a diagonal matrix are equal, it
is called a scalar matrix.

Equal Matrices

Equal matrices are those matrices which are equal in terms of their
elements

Triangular Matrix

A square matrix is said to be a triangular matrix if the elements

above or below the principal diagonal are zero. There are two types:

Upper Triangular Matrix

A square matrix [aij] is called an upper triangular matrix, if aij = 0, when i

> j.
Lower Triangular Matrix

A square matrix is called a lower triangular matrix, if aij = 0 when i < j.

Transpose of a matrix

The transpose of a matrix is found by interchanging its rows into

columns or columns into rows. The transpose of the matrix is denoted by
using the letter “T” in the superscript of the given matrix. For example, if
“A” is the given matrix, then the transpose of the matrix is represented by
A’ or AT.

Symmetric matrix
A square matrix A = [aij] is called a symmetric matrix if aij = aji, for all i,j
values;

Skew-Symmetric Matrix:

A square matrix A = [aij] is a skew-symmetric matrix if aij = aji, for all

values of i,j.[putting j = i] aii = 0

Matrix operations

Addition, subtraction and multiplication are the basic operations on the

matrix. To add or subtract matrices, these must be of identical order and
for multiplication, the number of columns in the first matrix equals the
number of rows in the second matrix.

• Addition of Matrices
 • Subtraction of Matrices
• Scalar Multiplication of Matrices
• Multiplication of Matrices

Addition of Matrices

If A[aij]mxn and B[bij]mxn are two matrices of the same order then
their sum A + B is a matrix, and each element of that matrix is the sum of
the corresponding elements. i.e. A + B = [aij + bij]mxn

Properties of Matrix Addition:

If A, B and C are matrices of same order, then

(a) Commutative Law: A + B = B + A

(b) Associative Law: (A + B) + C = A + (B + C)

(c) Identity of the Matrix: A + O = O + A = A, where O is zero matrix
which is additive identity of the matrix,

(d) Additive Inverse: A + (-A) = 0 = (-A) + A, where (-A) is obtained by

changing the sign of every element of A which is additive inverse of the
matrix,

Subtraction of matrices
 If A and B are two matrices of the same order, then we define
A−B=A+(−B). We can subtract the matrices by subtracting each element
of one matrix from the corresponding element of the second matrix. i.e. A
– B = [aij – bij] mxn

Scalar multiplication of matrices

If A=[aij]m×n is a matrix and k any number, then the matrix which

is obtained by multiplying the elements of A by k is called the scalar
multiplication of A by k and it is denoted by k A thus if A=[aij]m×n

Multiplication of Matrices
If A and B be any two matrices, then their product AB will be defined
only when the number of columns in A is equal to the number of rows in
B.
If A=[aij] m×n and B=[bij] n×p then their product AB=C=[cij]m×p

Properties of matrix multiplication

1. Matrix multiplication is not commutative in general, i.e. in general

AB≠ BA.
2. Matrix multiplication is associative, i.e. (AB)C = A(BC).
3. Matrix multiplication is distributive over matrix addition,
i.e. A.(B + C) = A.B + A.C and (A + B)C = AC + BC
4. The product of two matrices can be a null matrix while neither of
them is null, i.e. if AB = 0, it is not necessary that either A = 0 or B =
0.
5. If AB = AC , B ≠ C (Cancellation Law is not applicable).
Determinant of a matrix

Determinants are calculated for square matrices only. If the

determinant of a matrix is zero, it is called a singular determinant and if it
is one, then it is known as unimodular. For the system of equations to have
a unique solution, the determinant of the matrix must be non-singular,
that is its value must be nonzero.

Determinant of a 2*2 matrix

The determinant of a 2 x 2 matrix is a scalar value that we get from

subtracting the product of top-right and bottom-left entry from the
product of top-left and bottom-right entry. Let’s calculate the determinant
of Matrix shown below:

Determinant of a 3*3 matrix

The determinant of a 3 x 3 matrix is calculated for a matrix having 3

rows and 3 columns. The symbol used to represent the determinant is
represented by vertical lines on either side, such as | |. The most popular
application is to find area of triangle using determinant, where the three
vertices of the triangle are considered as the coordinates in an XY plane.

Let A be the matrix, then the determinant of a matrix A is denoted

by |A|. To find any matrix such as determinant of 2×2 matrix, determinant
of 3×3 matrix, or n x n matrix, the matrix should be a square matrix. It
means that the matrix should have an equal number of rows and columns.
Finding determinants of a matrix are helpful in solving the inverse of a
matrix, a system of linear equations, and so on
 •

Properties of Determinant

1. The determinant remains unaltered if its rows are changed into

columns and the columns into rows. This is known as the property
of reflection.
2. If all the elements of a row (or column) are zero, then the
determinant is zero.
3. If the all elements of a row (or column) are proportional
(identical) to the elements of some other row (or column), then the
determinant is zero.
4. The interchange of any two rows (or columns) of the
determinant changes its sign
5. If all the elements of a determinant above or below the main
diagonal consist of zeros, then the determinant is equal to the
product of diagonal elements.

Inverse of a matrix
If A is a non-singular square matrix, there is an existence of n x n matrix
A-1, which is called the inverse matrix of A such that it satisfies the
property:

AA-1 = A-1A = I, where I is the Identity matrix

Input Output model

Input-output analysis (I-O) is a form of macroeconomic analysis

based on the interdependencies between different economic sectors or
industries. This method is commonly used for estimating the impacts of
positive or negative economic shocks and analyzing the ripple effects
throughout an economy. I-O economic analysis was originally developed
by Wassily Leontief (1906–1999), who later won the Nobel Memorial Prize
in Economic Sciences for his work in this area.

Assumptions:
(i) The whole economy is divided into two sectors—“inter-industry
sectors” and “final-demand sectors,” both being capable of sub-
sectoral division.
(ii) The total output of any inter-industry sector is generally capable
of being used as inputs by other inter-industry sectors, by itself and
by final demand sectors.

(iii) No two products are produced jointly. Each industry produces

only one homogeneous product.

(iv) Prices, consumer demands and factor supplies are given.

(v) There are constant returns to scale.

(vi) There are no external economies and diseconomies of

production.

(vii) The combinations of inputs are employed in rigidly fixed

proportions. The inputs remain in constant proportion to the level
of output. It implies that there is no substitution between different
materials and no technological progress. There are fixed input
coefficients of production.

X = (I-A)-1 Y

Define [I –A ] = B, where B = [bij] is an n x n matrix with bij ≤ 0, i ≠j

.Then the Hawkins–Simon theorem states that the following two
conditions are equivalent

(i) There exists an such that x ≥ 0, B.x > 0

(ii) All the successive leading principal minors of B are positive, that
is
 REFERENCE

 Mathematical Economics by R.G.D Allen

 Mathematics for Economics by Mehta and Madnani
 Basic Econometrics by Damodar N.Gujarati
 Econometrics by Koutsoyianni