Mathematics for Economics and Business

Chapter 4: Partial differentiation and applications

Faculty of Economic Mathematics, University of Economics and Law

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 1 / 46

Key terms: see Chapter 5 in Jacques’ book

Function of two variables Marginal propensity to consume

Cross-price/income elasticity of demand multiplier
Marginal product of capital Method of substitution
Autonomous consumption multiplier
Objective function
Balanced budget multiplier
Comparative statics Lagrange multiplier
Investment multiplier Lagrangian

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 2 / 46

 Partial differentiation

Chapter 4: Partial differentiation and applications

1 Partial differentiation
Multivariate functions
Partial derivatives
Unconstrained optimization
Constrained optimization
2 Applications in Economics: Partial elasticity and marginal functions
Elasticity of demand
Utility
Production
Comparative statics
3 Applications in Economics: Optimization
Maximizing the profit
Maximizing the output subject to a cost constraint
Maximizing the utility subject to a budgetary constraint
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 3 / 46
 Partial differentiation Multivariate functions

Multivariate functions
Definition
A function f of two variables is a rule that assigns to each incoming pair of numbers (x, y) a
unique defined outgoing number z.
Example.
1 f(x, y) = xy + 2y,

2 z = x2 + y2 ,
√
3 f(x, y) = 2x − y2 ,
y
4 g(x, y) = x .

In general, a function of n variables has the form

y = f(x1 , x2 , . . . , xn ).
Example. √
1 f(x, y, z) = 4 − x2 − y2 − z2 .
2 u = ax + by + cz.

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 4 / 46

 Partial differentiation Multivariate functions

Multivariate functions
Graph
The graph of a function f with the two variables x and y is the surface z = f(x, y) formed by
the points (x, y, z) in Oxyz-space with (x, y) in the domain of the function and z = f(x, y).

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 5 / 46

 Partial differentiation Partial derivatives

Partial derivatives

Definition
The partial derivative of f(x, y) with respect to x is found by differentiating f with respect
to x, with y held constant. The partial derivative of f with respect to x is denoted as
∂f
either ∂x or f′x and is defined as

f(x, y0 ) − f(x0 , y0 )
f′x (x0 , y0 ) = lim .
x→x0 x − x0

The partial derivative of f(x, y) with respect to y is found by differentiating f with respect
to y, with x held constant. The partial derivative of f with respect to y is denoted as
∂f
either ∂y or f′y and is defined as

f(x0 , y) − f(x0 , y0 )
f′y (x0 , y0 ) = lim .
y→y0 y − y0
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 6 / 46
 Partial differentiation Partial derivatives

Partial derivatives

In general, a function f of n variables x1 , . . . , xn has n partial derivatives, which is denoted by

f′x1 , . . . , f′xn .

Properties
1 (αf)′x = αf′x ,
2 (f ± g)′x = f′x ± g′x ,
3 (fg)′x = f′x g + fg′x ,
( )′
f gf′ − fg′
4 = x 2 x.
g x g

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 7 / 46

 Partial differentiation Partial derivatives

Partial derivatives
Example.
1 If f(x, y) = x2 + y3 , then
f′x = 2x, f′y = 3y2 .
2 If f(x, y) = xy2 − (x + y3 )2 , then

f′x = y2 − 2(x + y3 ), f′y = 2xy − 6(x + y3 )y2 .

Practice. Find all partial derivatives of the following functions

1 f(x, y) = xy ,
2 f(x, y) = ln(x2 + 2y2 ),
3 f(x, y, z) = x2 y − 5y2 z3 ,
√
4 f(x, y, z) = x2 + y2 + z2 ,
Calculate the partial derivatives of the second function at (1, 2).
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 8 / 46
 Partial differentiation Partial derivatives

Partial derivatives
The second order partial derivatives of f(x, y):
∂2f
(x, y) = f′′xx (x, y) := (f′x (x, y))′x ,
∂x2
∂2f
(x, y) = f′′xy (x, y) := (f′x (x, y))′y ,
∂x∂y
∂2f
(x, y) = f′′yx (x, y) := (f′y (x, y))′x ,
∂y∂x
∂2f
(x, y) = f′′yy (x, y) := (f′y (x, y))′y .
∂y2
A function f of n variables has n2 second order partial derivatives.

Example. Let f(x, y) = x2 y3 − 10x2 , then

f′x = 2xy3 − 20x, f′y = 3x2 y2 ,
f′′xx = 2y3 − 20, f′′xy = 6xy2 , f′′yx = 6xy2 , f′′yy = 6x2 y.
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 9 / 46
 Partial differentiation Partial derivatives

Partial derivatives

In general, it is not true that f′′xy = f′′yx . However, this is true for most functions in applications.

Schwarz’s theorem
If f(x, y) has continuous partial derivatives f′′xy and f′′yx , then

f′′xy = f′′yx .

Practice. Find the second-order partial derivatives of the following functions:

1 f(x, y) = exy ,
x2 y
2 f(x, y, z) = z + yz2 .

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 10 / 46

 Partial differentiation Partial derivatives

Partial derivatives
Implicit differentiation
If y = y(x) is a function of one variable x defined by F(x, y) = 0 then y(x) is an implicit
function. Its derivative is given by
dy F′
= − ′x .
dx Fy

Example. Let y = y(x) be an implicit function defined by the equation

y3 + 2yx2 − x − 5 = 0.

Let us denote by F(x, y) the function on the left-hand side of the above equation. Then
F′x 4yx − 1
y′ = − ′
=− 2 .
Fy 3y + 2x2

Practice. Find the implicit differentiation of y(x) given by ex = ln y + y.

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 11 / 46
 Partial differentiation Unconstrained optimization

Unconstrained optimization

Let z = f(x, y) be a function of two independent variables x, y. The stationary points of z is

the solution of the system of equations
{
z′x (x, y) = 0,
z′y (x, y) = 0.

There are three types of stationary points: minimum points, maximum points, and saddle
points.

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 12 / 46

 Partial differentiation Unconstrained optimization

Unconstrained optimization
For a stationary point (a, b), we define
( )2
∆ := z′′xx (a, b)z′′yy (a, b) − z′′xy (a, b) and A := z′′xx (a, b).

The following is a criterion for a point to be classified as maximum, minimum or saddle:

A stationary point (a, b) is a minimum point if

∆>0 and A > 0.

A stationary point (a, b) is a maximum point if

∆>0 and A < 0.

A stationary point (a, b) is a saddle point if

∆ < 0.
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 13 / 46
 Partial differentiation Unconstrained optimization

Unconstrained optimization
Example. Let f(x, y) = x2 + xy + y2 − 2x − y be a function of two independent variables x and
y. Then { ′ { {
fx = 0 2x + y − 2 = 0 x=1
⇐⇒ ⇐⇒
f′y = 0 x + 2y − 1 = 0 y=0
At the stationary point (1, 0):
f′′xx (1, 0) = 2, f′′yy (1, 0) = 2, f′′xy (1, 0) = 1.
Hence ∆ = 2 · 2 − 12 = 3 > 0 and A = 2 > 0.
By applying the criterion, we conclude that the point (1, 0) minimizes the function.

Practice. Find all minimum and maximum points of the functions

1 U = 96x + 33y − 0.8x2 − 0.3y2 ,
√
2 f(x, y) = x2 + y2 + 1,
1 1
3 z = x + y + + , where x, y > 0.
x y
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 14 / 46
 Partial differentiation Constrained optimization

Constrained optimization

Problem. We want to optimize a function z = f(x, y) subject to a constraint g(x, y) = M.

The function z = f(x, y) is called the objective function, M is a known constant. There are two
methods to solve the problem: the method of substitution and the method of Lagrange
multipliers.

Method of substitution:
find an expression of a variable (either x or y) from the constraint g(x, y) = M,
substitute that expression to the objective function z = f(x, y) to convert the constrained
optimization with two variables to the unconstrained optimization with one variable.
A disadvantage of this method is that sometimes we can not find out an expression from the
constraint.

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 15 / 46

 Partial differentiation Constrained optimization

Constrained optimization

Method of Lagrange multipliers:

1 Define a new function of three variables, called the Lagrangian function (of the problem)

L(x, y, λ) = f(x, y) + λ(M − g(x, y)).

2 Find all stationary points of the Lagrangian function by solving


 ′
Lx (x, y, λ) = 0,
L′y (x, y, λ) = 0,

 ′
Lλ (x, y, λ) = 0.

3 Compare the values of the objective function at all the stationary points to find the
solution for the optimization problem.

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 16 / 46

 Partial differentiation Constrained optimization

Constrained optimization
Example. Let the utility function √ √
U= x+ y.
Find (x, y) which maximizes U subject to the general budgetary constraint P1 x + P2 y = M.

Solution 1. It follows from the constraint that y = M−P 1x

P2 . Hence, the problem reduces to
finding the maximum point of the 1-variable function
√
√ M − P1 x
U(x) = x + .
P2
We have
1 P1
U′ (x) = √ − √ .
2 x 2 P2 (M − P1 x)
1 3 P2 3
U′′ (x) = − x− 2 − √1 (M − P1 x)− 2 .
4 4 P2
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 17 / 46
 Partial differentiation Constrained optimization

Constrained optimization
Hence,
1 P21 P2 M
U′ (x) = 0 ⇔ = ⇔x= 2 .
x P2 (M − P1 x) P1 + P1 P2
Moreover, U′′ (x) < 0 for every x. Therefore, U(x) maximizes at
P2 M
x= .
P21 + P1 P2
The corresponding y is
P1 M
y= .
P22 + P1 P2
We conclude that U(x, y) is maximized at
( )
P2 M P1 M
(x, y) = , .
P21 + P1 P2 P22 + P1 P2
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 18 / 46
 Partial differentiation Constrained optimization

Constrained optimization
√ √
Solution 2. The Lagrangian function is L(x, y, λ) = x + y + λ(M − P1 x − P2 y).
Find all stationary points of the Lagrangian function by solving
  
 L ′ = 0, 

1
√ − λP = 0, 
 x = 4λ12 P2 ,
 x 2 x 1  1
L′y = 0, ⇔ 2√ 1
− λP 2 = 0, ⇔ y = 1
,

 ′ 

y 
 4λ2 P22
Lλ = 0. P x + P y = M. 
1 2 P1 x + P2 y = M.

By substituting the first two equations

√ ( directly into the constraint (the third equation), we get
)
1
4λ2 P
+ 4λ12 P = M ⇒ λ = ± 4M 1 1 1
P1 + P2 .
1 2

Hence, the Lagrange function has 2 stationary points, which yields the same x, y. Hence
U(x, y) is maximized at ( )
P2 M P1 M
(x, y) = , .
P21 + P1 P2 P22 + P1 P2
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 19 / 46
 Partial differentiation Constrained optimization

Constrained optimization
Practice 1. Minimize function z = x2 + y2 subject to the constraint x + y = 2.
Practice 2. Maximize function z = 2x + 3y subject to the constraint x2 + y2 = 13.
Practice 3. Optimize function f(x, y) = 6 − 5x − 4y subject to the constraint x2 − y2 = 9.

Practice 4. Assume that a milk can is a

cylinder with height h and radius r. Moreover,
assume that the same material is used to
cover milk cans’ bases and lateral surfaces.
What is the ratio h/r milk companies should
choose to save the cost most?

(Hint. The surface area of the cylinder is

2πr2 + 2πrh, while its volume is πr2 h.)

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 20 / 46

 Applications in Economics: Partial elasticity and marginal functions

Chapter 4: Partial differentiation and applications

1 Partial differentiation
Multivariate functions
Partial derivatives
Unconstrained optimization
Constrained optimization
2 Applications in Economics: Partial elasticity and marginal functions
Elasticity of demand
Utility
Production
Comparative statics
3 Applications in Economics: Optimization
Maximizing the profit
Maximizing the output subject to a cost constraint
Maximizing the utility subject to a budgetary constraint
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 21 / 46
 Applications in Economics: Partial elasticity and marginal functions Elasticity of demand

Elasticity of demand
Suppose that the demand Q for a certain good depends on its price P, the price of an
alternative good PA , and the income of consumers Y:

Q = f(P, PA , Y)

The price, cross-price and income elasticity of demands, denoted by EP and EPA and EY
(respectively), are defined by
percentage change in Q P ∂Q
EP = = × ,
percentage change in P Q ∂P
percentage change in Q PA ∂Q
EPA = = × ,
percentage change in PA Q ∂PA
percentage change in Q Y ∂Q
EY = = × .
percentage change in Y Q ∂Y
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 22 / 46
 Applications in Economics: Partial elasticity and marginal functions Elasticity of demand

Elasticity of demand
EP < 0 because the demand decreases whenever P increases.

EPA may be positive or negative depending on the nature of the alternative good.
If the alternative good is substitutable, then Q increases as PA rises, because consumers
buy more of the given good as it becomes relatively less expensive. Consequently,

∂Q
>0 i.e., EPA > 0.
∂PA
If the alternative good is complementary, then Q decreases as PA rises, because the
bundle of goods as a whole becomes more expensive. Consequently,

∂Q
<0 i.e., EPA < 0.
∂PA

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 23 / 46

 Applications in Economics: Partial elasticity and marginal functions Elasticity of demand

Elasticity of demand

EY can be positive or negative depending on the quality of goods.

If a good is inferior, then demand falls as income rises and EY < 0. Examples: canned
vegetables, a supermarket’s own-brand white bread and bus transportation.
If a good is normal, then demand rises as income rises and EY > 0.
For some normal goods, we have EY > 0. These goods are called superior. For these
goods, the percentage rise in consumption is greater than the percentage increase in
income. Examples: sports cars, caviar, and quality wine.

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 24 / 46

 Applications in Economics: Partial elasticity and marginal functions Elasticity of demand

Elasticity of demand
Example. Given the demand function
Q = 500 − 3P − 2PA + 0.01Y.
Then
P P
× Q′P =
EP = × (−3),
Q 500 − 3P − 2PA + 0.01Y
PA PA
EPA = × Q′PA = × (−2),
Q 500 − 3P − 2PA + 0.01Y
Y Y
EY = × Q′Y = × 0.01.
Q 500 − 3P − 2PA + 0.01Y
For example, at P = 20, PA = 40, Y = 5000, EP = −0.146, EPA = −0.195, EY = 0.122.
Hence,
the alternative good is complimentary,
if income rises 5%, the demand rises 5 × 0.12% = 0.61%,
this good is classified as normal.
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 25 / 46
 Applications in Economics: Partial elasticity and marginal functions Elasticity of demand

Elasticity of demand

Practice. Given the demand function

√
Q = 1000 − 2P − PA − 0.01P2A + 0.01Y2 + 0.05 Y.

Find the price, cross-price, and income elasticity of demand.

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 26 / 46

 Applications in Economics: Partial elasticity and marginal functions Utility

Utility

To analyze the behavior of consumers quantitatively, we associate with each set of options a
number U called utility, which indicates the level of satisfaction.

Suppose that there are two goods, G1 and G2, and that the consumer buys x1 items of G1 and
x2 items of G2. Then utility U is a function of x1 and x2 :

U = U(x1 , x2 ).

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 27 / 46

 Applications in Economics: Partial elasticity and marginal functions Utility

Utility

Marginal utility of xi is the rate of U with respect to xi and is determined by

∂U
.
∂xi
Marginal rate of commodity substitution is the increase in the quantity of a good
necessary to maintain a constant value of utility when the quantities of one or more other
goods decrease
dx2 U′x
MRCS = − = ′1 .
dx1 Ux2
Notes. If x1 and x2 both change, then the net change in U can be found from the small
increments formula
∂U ∂U
∆U ≈ ∆x1 + ∆x2 .
∂x1 ∂x2

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 28 / 46

 Applications in Economics: Partial elasticity and marginal functions Utility

Utility

In the figure:
At the same level of satisfaction (i.e. U = U0 ,
which is constant), a decrease of x1 causes an
increase of x2 . Hence, the indifference curve,
which is the graph of points (x1 , x2 ) satisfying
the equation U(x1 , x2 ) = U0 , is usually
downward-sloping.

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 29 / 46

 Applications in Economics: Partial elasticity and marginal functions Utility

Utility
Example. An individual’s utility function is given by
U = 1000x1 + 450x2 + 5x1 x2 − 2x21 − x22 ,
where x1 is the amount of leisure measured in hours per week, and x2 is earned income
measured in dollars per week. Then the marginal utilities are
U′x1 = 1000 + 5x2 − 4x1 ,
U′x2 = 450 + 5x1 − 2x2 .
When x1 = 138 and x2 = 500, the value of the marginal utilities are U′x1 = 2948, U′x2 = 140. If
the individual works for an extra hour, his earned income rises by $15 per week and his leisure
decreases by 1 hour. Hence, the change in utility if the individual works for an extra hour,
which increases earned income by $15 per week, is
U′x1 × (−1) + U′x2 × 15 = −848.
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 30 / 46
 Applications in Economics: Partial elasticity and marginal functions Utility

Utility

Now, assume that the individual wants to determine how much income per week he should
earn for an extra hour working to maintain his utility. Let’s denote that value by P. Then he
need to find P (in dollars) so that

U′x1 × (−1) + U′x2 × P = 0.

Equivalently,
U′x1
P= = 21.06.
U′x2
Hence, to increase the utility, he needs to earn at least $21 per week for an extra hour of
working.

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 31 / 46

 Applications in Economics: Partial elasticity and marginal functions Production

Production
Assume that output Q depends on capital K and labour L:

Q = f(K, L).

The marginal product of capital and the marginal product of labor are defined by

∂Q ∂Q
MPK = , MPL = .
∂K ∂L
The marginal rate of technical substitution concerns with the change of K to maintain the
same level of output when the labor L decreases

dK Q′ MPL
MRTS = − = ′L = .
dL QK MPK

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 32 / 46

 Applications in Economics: Partial elasticity and marginal functions Production

Production

Example. Given the production function

Q = K2 + 2L2 .

Then
Q′L = 4L, Q′K = 2K.
Therefore,
4L 2L
= . MRTS =
2K K
This means that at level K = K0 , L = L0 , for example, when the labor reduces by 1 unit, the
capital must increase by 2L
K0 to keep the output unchanged.
0

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 33 / 46

 Applications in Economics: Partial elasticity and marginal functions Comparative statics

Comparative statics

Assumes that there are two sectors, households and firms, and that household consumption C
is modeled by a linear relationship of the form

C = aY + b,

where Y denotes national income and a and b are parameters.

The parameter a is the marginal propensity to consume and lies in the range 0 < a < 1.
The parameter b is the autonomous consumption and satisfies b> 0.
In equilibrium
Y = C + I,
where I denotes investment, which is assumed to be given by I = I∗ = constant.

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 34 / 46

 Applications in Economics: Partial elasticity and marginal functions Comparative statics

Comparative statics

We deduce
b + I∗
. Y=
1−a
This shows that Y is a function of three variables a, b and I∗ . The partial derivatives
∂Y ∂Y ∂Y
, ,
∂a ∂b ∂I∗
are called the marginal propensity to consumer multiplier, the autonomous consumption
multiplier, and the investment multiplier, respectively. These multipliers enable us to explain
the behavior of the model both qualitatively (the signs of the multipliers) and quantitatively
(the values of the multipliers).

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 35 / 46

 Applications in Economics: Partial elasticity and marginal functions Comparative statics

Comparative statics

Example.
∂Y b + I∗
=
∂a (1 − a)2
is positive for every a, b, I∗ . Hence, the national income rises whenever the parameter a rises.
At a = 0.5, b = 10, I∗ = 30, the marginal propensity to consume multiplier is

b + I∗ 10 + 30
= = 160.
(1 − a) 2 (1 − 0.5)2

This means when the marginal propensity to consume (i.e. a) rises from
a = 0.5, b = 10, I∗ = 30 by x units, the change in national income is 160 · x.

Remark. The same approach can be used in most economics models, for example, the
equilibrium price and quantity in supply and demand theory.
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 36 / 46
 Applications in Economics: Optimization

Chapter 4: Partial differentiation and applications

1 Partial differentiation
Multivariate functions
Partial derivatives
Unconstrained optimization
Constrained optimization
2 Applications in Economics: Partial elasticity and marginal functions
Elasticity of demand
Utility
Production
Comparative statics
3 Applications in Economics: Optimization
Maximizing the profit
Maximizing the output subject to a cost constraint
Maximizing the utility subject to a budgetary constraint
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 37 / 46
 Applications in Economics: Optimization Maximizing the profit

Maximizing the profit

Let Q = f(K, L) be a firm’s production function. The fixed prices of each unit of output, capital
and labor are denoted by PQ , PK and PL , respectively. Then the profit function is given by
π(K, L) = PQ f(K, L) − PK K − PL L.
Problem. Maximize this profit function
π(K, L) → max .
Solution. This problem is an unconstrained optimization problem. By using the theory
constructed in previous sections, we can show that at a stationary point, we have
∂f PK ∂f PL
= , = .
∂K PQ ∂L PQ
Remark. When the profit is maximized, the marginal productivity of capital and labor is equal
to the ratio of the price of each unit of capital and labor, respectively, to the price of each unit
of output.
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 38 / 46
 Applications in Economics: Optimization Maximizing the output subject to a cost constraint

Maximizing the output subject to a cost constraint

The cost of using as input K units of capital and L units of labor is PK K + PL L. If the firm has
a fixed amount M to spend on these inputs, then

PK K + PL L = M.

Problem. Maximize the objective function

Q = f(K, L) → max

subject to the cost constraint

PK K + PL L = M.

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 39 / 46

 Applications in Economics: Optimization Maximizing the output subject to a cost constraint

Maximizing the output subject to a cost constraint

Solution. This is the problem of constrained optimization. We may use either the method of
substitution or the method of Lagrange multiplier to solve it. By applying those methods, the
output is maximized at points satisfying
PL MPL
= .
PK MPK
Remark. The output is maximized subject to a cost constraint if the ratio of marginal product
to price is the same for all inputs.

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 40 / 46

 Applications in Economics: Optimization Maximizing the utility subject to a budgetary constraint

Maximizing the utility subject to a budgetary constraint

An analogous situation arises when we maximize the utility function

U = U(x1 , x2 )

Where x1 , x2 denote the number of items of goods G1, G2 that an individual buys. If the
prices of these goods are denoted by P1 and P2 and the individual has a fixed budget, M, to
spend on these goods then, the corresponding constraint is

P1 x1 + P2 x2 = M.

Problem. Maximize the utility function

U = U(x1 , x2 ) → max

subject to the budget constraint

P1 x1 + P2 x2 = M.
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 41 / 46
 Applications in Economics: Optimization Maximizing the utility subject to a budgetary constraint

Maximizing the utility subject to a budgetary constraint

Solution. In the same manner, we can show that the utility is maximized subject to a
budgetary constraint if the ratio of marginal utility to price is the same for all goods consumed:
U′x1 U′x
= 2.
P1 P2
Remark. In general, firms and individuals don’t need to use all their budgetary. In the other
words, the equality constraints should be replaced by the inequality constraints. For example,
the cost constraint in item 2 above should be, in general,

PK K + PL L ≤ M.

However, one has proven that if the objective functions get optimization at a point (K0 , L0 )
then that point should satisfy the “=”, i.e.,

PK K0 + PL L0 = M.
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 42 / 46
 Applications in Economics: Optimization Maximizing the utility subject to a budgetary constraint

Maximizing the utility subject to a budgetary constraint

Example. A consumer’s utility function is given by
U(x1 , x2 ) = 2x1 x2 + 3x1 ,
where x1 and x2 denote the number of items of two goods G1 and G2 that are bought. Each
item costs $1 for G1 and $2 for G2. Assume that the consumer’s income is $83. Then the
problem of the consumer is to maximize U subject to the constraint x1 + 2x2 = 83. The
corresponding Lagrangian function is
L(x1 , x2 , λ) = 2x1 x2 + 3x1 + λ(83 − x1 − 2x2 ).
Find all stationary points of the Lagrangian function by solving
  
 ′  
Lx1 = 0, 2x2 + 3 − λ = 0, x1 = 43,
′
Lx2 = 0, ⇔ 2x1 − 2λ = 0, ⇔ x2 = 20,

 ′ 
 

Lλ = 0. x1 + 2x2 = 83. λ = 43.
Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 43 / 46
 Applications in Economics: Optimization Maximizing the utility subject to a budgetary constraint

Maximizing the utility subject to a budgetary constraint

Hence, U is maximized at x1 = 43, x2 = 20, and the maximum value of U is U(43, 20) = 1849.
Furthermore, if the consumer’s income rises by $1, then the new constraint should be
x1 + 2x2 = 84.

In the same manner, one can show that the maximum value of U subject to the new constraint
is U(43.5, 20.25) = 1892.25. The difference between this maximum value with the previous
maximum value of utility is 1892.5 − 1849 = 43.5 ≈ 43 = λ.

Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 44 / 46

 Applications in Economics: Optimization Maximizing the utility subject to a budgetary constraint

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Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 45 / 46

 Applications in Economics: Optimization Maximizing the utility subject to a budgetary constraint

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Faculty of Economic Mathematics (UEL) Chapter 4: Partial differentiation and applications 46 / 46