Mathematics for Economists (CAEC 502)

Jema Haji (Associate Professor)

Haramaya University
 Objectives of the Course
• To equip the students with knowledge and skills
to enable them apply mathematics in economic
analyses;
• To enable students use mathematics to
understand the structure of economics;
• To facilitate the student to carry out quantitative
analysis of economic systems;
• To provide a framework for enabling the student
to see the application of mathematical techniques
to economics through examples.

2
Topics
• 1. Linear Algebra
• 2. Differential and integral calculus
• 3. Optimization
• 4. Differential and difference equations
• 5. Linear and non-linear programming
Mathematics? Economics?

Several questions:
What does the indifference curve look like? Why?
How to get demand functions from the utility
functions?
Is there a utility function?
Does the maximum exist?
Is it unique?
How do we obtain the solution?
What properties does a well-behaved demand
function possess?
Chapter 1. Linear Algebra
• Matrix
• System of equations
• Applications
• Vectors
• Orthonormal Basis
• Operation of matrices
• Determinants of a matrix
• Inverse of a matrix
• Applications
 1.1. Matrix
• A matrix is a set of elements, organized into rows and columns
rows

 a b
columns
c d
 
• a and d are the diagonal elements.
• b and c are the off-diagonal elements.
• Matrices are like plain numbers in many ways: they can be added,
subtracted, and, in some cases, multiplied and inverted (divided).
 1.1. Matrix
• Examples:

1 b 
A   ; b   
1  d 
• Dimensions of a matrix: numbers of rows by numbers of
columns. The Matrix A is a 2x2 matrix, b is a 1x3 matrix.
• A matrix with only one column or only one row is called a
vector.
• If a matrix has an equal numbers of rows and columns, it is
called a square matrix. Matrix A, above, is a square matrix.
• Usual Notation: Upper case letters => matrices
Lower case => vectors

7
 Basic Operations of Matrices

• Addition, Subtraction, Multiplication

 a b  e f   a e b f 
c d   g h 
c  g d  h  Just add elements
     
 a b  e f  a e b f  Just subtract elements
c d   g h 
c  g d  h 
     
 a b  e f   ae  bg af  bh  Multiply each
c d  g  
  h   ce  dg cf  dh  row by each
column
 a b   ka kb  Multiply each
k   
 c d   kc kd  element by the
scalar
Vector multiplication: Geometric interpretation

• Think of a vector as a x2

directed line segment in 6

N-dimensions! (has 5
“length” and “direction”)
4
• Scalar multiplication  6 4  2 U
3
(“scales” the vector –i.e.,
changes length) 2
 3 2 U
1
x1

-4 -3 -2 -1 1 2 3 4 5 6


 1 U   3  2  -2

9
 Matrix multiplication: Details
• Multiplication of matrices requires a conformability
condition
• The conformability condition for multiplication is that the
column dimensions of the lead matrix A must be equal to
the row dimension of the lag matrix B.
• What are the dimensions of the vector, matrix, and result?

 b11 b12 b13 

aB a11 a12   c 
 b21 b23 
22 
c11 c12 c13 
a11b11  a12b21 a11b12  a12b22 a11b13  a12b23 
• Dimensions: a(1x2), B(2x3), c(1x3) 10
Basic Matrix Operations: Examples
 2 1  3 1   5 2 
• Matrix addition  7 9   0 2  7 11
     
A2 x 2 B2 x 2 C2 x 2

• Matrix subtraction  2 1  1 0  1 1 
 7 9    2 3   5 6 
     

• Matrix multiplication  2 1  1 0  4 3 
 7 9 x  2 3  26 27
     
A 2 x 2 xB2 x 2 C 2 x 2

• Scalar multiplication 1  2 4  1 4 1 2
   11 
8  6 1  3 4 1 8
Vector Addition: Geometric interpretation

x2
• v' = [2 3]
5
• u' = [3 2]
• w’= v'+u' = [5 5] 4 u
• Note that two vectors 3
plus the concepts of v w
addition and 2

multiplication can create u

1
a two-dimensional space. x1

1 2 3 4 5

A vector space is a mathematical structure formed by a

collection of vectors, which may be added together and
multiplied by scalars. (It’s closed under multiplication
12 and
 Transpose Matrix
• The transpose of a matrix A is another matrix AT (also written
A′) created by any one of the following equivalent actions:
- write the rows (columns) of A as the columns (rows) of AT
- reflect A by its main diagonal to obtain AT
• Formally, the (i,j) element of AT is the (j,i) element of A:
[AT]ij = [A]ji
• If A is a m × n matrix => AT is a n × m matrix.
• (A')' = A
• Conformability changes unless the matrix is square.

 3 1
 3 8  9
Example
: A    A  8 0 
1 0 4  
    9 4
13
 Inverse of a Matrix

• Identity matrix:
AI = A  1 0 0
• Some matrices have an 
I  0 1 0 
inverse, such that:
AA-1 = I
• Inversion is tricky:  0 0 1
(ABC)-1 = C-1B-1A-1
• More on this topic later
 1.2. System of Equations: Matrices and Vectors
• Assume an economic model as system of linear equations in
which
aij parameters, where i = 1.. n rows, j = 1.. m columns, and
n=m
di endogenous variables,
xi exogenous variables and constants
a11 x1  a12 x2   a1m xn d1
a21 x1  a22 x2   a2 m xn d 2
   
an1 x1  a n 2 x2   anm xn d n

15
1.2. System of equations: Matrices and Vectors
• A general form matrix of a system of linear
equations
Ax = d where
A = matrix of parameters
x = column vector of exogenous variables
d = column vector of endogenous variables and
constants
 a11 a12  a1m   x1   d1 
a a  a   x  d 
• Solve for x*  21 22 2m   2 
 2 
          
    
 an1 an 2  anm   xn   d n 
Ax d
x *  A  1d
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Solution of a General-equation System

• Assume the 2x2 model • Why?

2x + y = 12 4x + 2y =24
4x + 2y = 24 2(2x + y) = 2(12)
• one equation with two
Find x*, y*: unknowns
y = 12 – 2x 2x + y = 12
4x + 2(12 – 2x) = 24 x, y
4x +24 – 4x = 24 Conclusion:
not all simultaneous equation
0 = 0 ? indeterminant! models have solutions

17
 Linear Dependence
v1' 5 12
• A set of vectors is linearly v2' 10 24
dependent if any one of them can
 5 10   v1' 
be expressed as a linear 12 24  ' 
combination of the remaining    v2 
vectors; otherwise, it is linearly 2v1/  v2/ 0 /
independent.
• Dependence prevents solving a  2  1  4
system of equations. More v1   ; v2   ; v3  
unknowns than independent  7   8  5 
equations. 3v1  2v2

• The
6 21  2 16
number of linearly
independent rows or columns in a 4 5 v3
matrix is the rank of a matrix
(rank(A)). 3v1  2v2  v3 0
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Application 1: One Commodity Market Model
(2x2 matrix)
• Economic Model * a c
P 
1) Qd=Qs bd
2) Qd = a – bP (a,b >0) * ad  bc
Q 
3) Qs = -c + dP (c,d >0) bd
• Find P* and Q*
Scalar Algebra Matrix Algebra
4) 1Q + bP = a
1 b   Q   a 
5) 1Q – dP = -c  1  d   P    c 
    
Ax d
x *  A  1d
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General form of 3x3 linear matrix
Scalar algebra form
parameters & exogenous variables endog. vars
& const.
a11x + a12y + a13z = d1
a21x + a22y + a23z = d2
a31x + a32y + a33z = d3
Matrix algebra form
parameters exog. endog.
vars vars. &
constan
 a11 a12 a13   x  d1 
 ts
a a22 a23   y   d 2 
 21
 a31 a32 a33   z   d 3 
20
Application II: Three Equation National Income
Model (3x3 matrix)
• Let
Y = C + I 0 + G0
C = a + b(Y-T) (a > 0, 0<b<1)
T = d + tY (d > 0, 0<t<1)
• Endogenous variables?
• Exogenous variables?
• Constants?
• Parameters?
• Why restrictions on the parameters?

21
 Three Equation National Income Model
• Endogenous: Y, C, T: Income (GNP), Consumption,
and Taxes.
• Exogenous: I0 and G0: autonomous Investment &
Government spending.
• Constants a & d: autonomous consumption and
taxes.
• Parameter t is the marginal propensity to tax gross
income 0 < t < 1.
• Parameter b is the marginal propensity to consume
private goods and services from gross income 0 < b
< 1.

22
Three Equation National Income Model
Parameters & Exog
Endogenous .
• Given vars.
vars.
Y = C + I0 + G0 Y C T &con
s.
1Y -1C +0 = I0+G
C = a + b(Y-T) T 0
T = d + tY -bY +1 +b = a
 1 C1 0T Y   I 0  G0 
• Find Y*, C*, T*  b   C   a 
Ax d -tY
 1
+0 b+1
   = d 
  t 0
C 1T T   d 
x *  A  1d
24
Three Equation National Income Model

 1  1 0  Y   I 0  G0 
  b 1 b   C   a 
    
  t 0 1  T   d 
Ax d
1
 Y   1  1 0  I 0  G0 
*

 *    
 C    b 1 b   a 
 T *    t 0 1  d 
 
* 1
x A d
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Application III: Two Commodity Market
Equilibrium (4x4 matrix)
• Given • Scalar algebra
Qdi = Qsi, i=1, 2 1Q1 +0Q2 +2P1 - 1P2 = 10
Qd1 = 10 - 2P1 + P2
1Q1 +0Q2 - 3P1 +0P2= -2
Qs1 = -2 + 3P1
0Q1+ 1Q2 - 1P1 + 1P2= 15
Qd2 = 15 + P1 - P2
Qs2 = -1 + 2P2 0Q1+ 1Q2 +0P1 - 2P2= -1
1 0 2  1   Q1   10 
• Find Q1*, Q2*, P1*, P2*
1
 0  3 0   Q2    2

Ax d 0 1  1 1   P1   15 
    
x *  A  1d 0 1 0  2  P2    1 
26
Two Commodity Market Equilibrium
1 0 2  1   Q1   10 
1 0
  3 0   Q2    2

0 1  1 1   P1   15 
    
0 1 0  2  P2    1 
Ax d
1
 Q1*   1 0 2  1  10 
 * 
 Q 2   1 0  3 0    2
 
 P*   0 1 1 1   15 
 1*     
 P2   0 1 0  2   1
x *  A  1d 27
1.3. Vector Operations
An [m x 1] column vector u and a
 3
u   [1 x n] row vector v, yield a
2 x1
 2 product matrix uv of dimension
[m x n].
v 1 4 5
1x 3

 3  31215
uv     1 4 5   
2 x3  2  2 8 10 

28
1.3. Vector multiplication: Dot (inner), and
cross product

y c1 z1  c 2 z 2  c3 z 3  c 4 z 4
4
y  c i z i
i 1
 z1 
z 
y c 1 c2 c3 c4  2
c' z
 z3 
 
 z4 

• The dot product produces a scalar! c’z =1x1=1x4 4x1= z’c

29
 1.3. Vectors: Dot Product
d Think of the dot product
   T a b c  e  ad  be  cf as a matrix multiplication
 f 
T 1/ 2
The magnitude (length) is
 [ ]  aa  bb  cc the square root of the dot
product of a vector with
itself.
The dot product is also
     cos( ) related to the angle between
the two vectors – but it
doesn’t tell us the angle.
Note: As the cos(90) is zero, the dot product of two orthogonal
vectors is zero.
1.3. Vectors: Magnitude and Phase (direction)
T
v ( x , x ,  , x )
1 2 n
n
v   x 2 (Magnitude or “2-norm”)
i
i 1
If v 1, v is a unit vector

(unit vector => pure direction)

Alternate representations:
Polar coords: (||v||, )
Complex numbers: ||v||ej
y

||v||
 “phase”
x
1.3. Vectors: Cross Product

• The cross product of vectors A and B is a vector C

which is perpendicular to A and B
• The magnitude of C is proportional to the sine of the
angle between A and B
• The direction of C follows the right hand rule – this
why we call it a “right-handed coordinate system”

a b  a b sin( )
1.3. Vectors: Cross Product: Right hand rule
1.3. Vectors: Norm
• Given a vector space V, the function g: V→ R is called a norm if
and only if:
1) g(x)≥ 0, for all xεV
2) g(x)=0 iff x=θ (empty set)
3) g(αx) = |α|g(x) for all αεR, xεV
4) g(x+y)=g(x)+g(y) (“triangle inequality”) for all x,yεV

•The norm is a generalization of the notion of size or length of a

vector.
• An infinite number of functions can be shown to qualify as
norms. For vectors in Rn, we have the following examples:
g(x)=maxi (xi), g(x)=∑i |xi|, g(x)=[∑i (xi)4 ] ¼
• Given a norm on a vector space, we can define a measure of
“how far apart” two vectors are using the concept of a metric.
1.3. Vectors: Metric
• Given a vector space V, the function d: VxV→ R is called a metric
if and only if:
1) d(x,y)≥ 0, for all x,yεV
2) d(x,y)=0 iff x=y
3) d(x,y) = d(y,x) for all x,yεV
4) d(x+y)≤d(x,z) + d(z,y) (“triangle inequality”) for all x,y,zεV

•Given a norm g(.), we can define a metric by the equation:

d(x,y) = g(x-y).

• The dot product is called the Euclidian distance metric.

1.3. Orthonormal Basis
• Basis: A space is totally defined by a set of vectors – any point
is a linear combination of the basis
• Orthonormal: orthogonal + normal
• Orthogonal: dot product is zero
• Normal: magnitude is one
• Example: X, Y, Z (but don’t have to be!)

x 1 0 0
T
x y 0
y 0 1 0
T
x z 0
z 0 0 1
T
y z 0
• X, Y, Z is an orthonormal basis. We can describe any 3D point as
a linear combination of these vectors.
1.3. Orthonormal Basis
• How do we express any point as a combination of a new basis
U, V, N, given X, Y, Z?

 a 0 0  u1 v1 n1   a u  b u  c u 
 0 b 0  u v2 n2   a v  b v  c v 
  2
 0 0 c   u3 v3 n3   a n  b n  c n 

(not an actual formula – just a way of thinking about it)

• To change a point from one coordinate system to another,

compute the dot product of each coordinate row with each
of the basis vectors.
1.4. Laws of Matrix Addition & Multiplication

• Commutative law: A + B = B + A

 a11 a12   b11 b12   a11  b11 b12  a12 

A  B      
 a 21 a 22   b21 b22   a 21  a 21 b22  a 22 

 b11 b12   a11 a12   b11  a11 b12  a12 

B  A      
b b b b b
 21 22   21 22   21 21 22 a b  a 22 

38
 1.4. Matrix Multiplication

• Matrix multiplication is generally not commutative. That is,

AB  BA even if BA is conformable
(because diff. dot product of rows or col. of A&B)

 1 2  0  1
A   ,B  
 3 4   6 7 
 10   26  1 1  27   12 13 
AB     
 30   46  3 1  47   24 25

 01   13 02   14   3  4

BA    
 6 
1   7 3 62   7 4   27 40 
39
1.4. Matrix multiplication

• Exceptions to non-commutative law:

AB=BA iff
B = a scalar,
B = identity matrix I, or
B = the inverse of A -i.e., A-1

40
 1.5. Identity and Null Matrices
1 0
• Identity matrix is a square matrix 0  or
and also it is a diagonal matrix with  1
1 along the diagonals. Similar to 1 0 0
scalar “1” 0
 1 0 etc.
• Null matrix is one in which all  0 0 1 
elements are zero. Similar to scalar
“0” 0 0 0
0 0 0

• Both are diagonal matrices  0 0 0
• Both are symmetric and
idempotent matrices:
A = AT and
A = A 2 = A3 = … 41
1.6. Inverse matrix

• AA-1 = I • Ax=d
• A-1A=I • A-1A x = A-1 d
• Necessary for matrix to • Ix = A-1 d
be square to have • x = A-1 d
unique inverse • Solution depends on
• If an inverse exists for a A-1
square matrix, it is • Linear independence
unique • Determinant test!
• (A')-1=(A-1)'

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1.6. Inverse of a Matrix

1. Append the identity matrix

to A
a b c 1 0 0 2. Subtract multiples of the
other rows from the first
d e 
f | 0 1 0 row to reduce the diagonal
 element to 1
 g h i 0 0 1 3. Transform the identity
matrix as you go
4. When the original matrix is
the identity, the identity has
become the inverse!
1.6. Determination of the Inverse
(Gauss-Jordan Elimination)

all A, X and I are (nxn) X = A-1

AX = I square matrices

1)Augmented 2) Transform
matrix augmented matrix
[A I ] [U H] [I K] further row
operations
Gauss elimination Gauss-Jordan
U: upper triangular elimination
IX=K
I X = X = A-1 K = A-1
1.6. Determinant of a Matrix

• The determinant is a number associated with any square

matrix.
• If A is an nxn matrix, the determinant is given by |A| or
det(A).
• Determinants are used to characterize invertible matrices.
A matrix is invertible (non-singular) if and only if it has a
non-zero determinant
• That is, if |A|≠0 → A is invertible.
• Determinants are used to describe the solution to a system
of linear equations with Cramer's rule.
• Can be found using factorials, pivots, and cofactors! More
on this later.
• Lots of interpretations
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 1.6. Determinant of a Matrix

• Used for inversion. Example: Inverse of a 2x2 matrix:

 a b
A   | A |det( A) ad  bc
 c d 

1 1  d  b
A  This matrix is called the
ad  bc   c a 
adjugate of A (or adj(A)).

A-1 = adj(A)/|A|
1.6. Determinant of a Matrix (3x3)

a b c
d e f aei  bfg  cdh  afh  bdi  ceg
g h i

a b c a b
d e f d e Sarrus’ Rule: Sum
from left to right.
g h i g h
Then, subtract from
right to left
Note: N! terms
1.6. Determinants: Laplace formula
• The determinant of a matrix of arbitrary size can
be defined by the Leibniz formula or the Laplace
formula.
• The Laplace formula (or expansion) expresses the
determinant |A| as a sum of n determinants of (n-
1) × (n-1) sub-matrices of A. There are n2 such
expressions, one for each row and column of A
• Define the i,j minor Mij (usually written as |Mij|) of
A as the determinant of the (n-1) × (n-1) matrix
that results from deleting the i-th row and the j-th
column of A.
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 1.6. Determinants: Laplace formula
• Define the Ci,j the cofactor of A as:
Ci , j ( 1) i  j | M i , j |
• The cofactor matrix of A -denoted by C-, is defined as
the nxn matrix whose (i,j) entry is the (i,j) cofactor of A.
The transpose of C is called the adjugate or adjoint of A
(adj(A)).

• Theorem (Determinant as a Laplace expansion)

Suppose A = [aij] is an nxn matrix and i,j= {1, 2, ...,n}.
Then the determinant
| A |ai1Ci1  ai 2Ci 2  ...  ainCin
a1 j C1 j  a2 j C2 j  ...  anj Cnj
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1.6. Determinants: Laplace formula

• Example:
 1 2 3

A  0  1 0  
 2 4 6
| A |1xC11  2xC12  3xC13 
1x ( 1x 6)  2x ( 1) x (0)  3x ( ( 1) x 2)) 0
 2x (0)  ( 1)(1x6 - 3x2)   4x (0) 0

|A| is zero => The matrix is singular. (Check!)

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1.6. Determinants: Properties

• Interchanging the rows and columns does not

affect |A|.
• |A| = |A’|.
• |kA| = kn |A|, where k is a scalar.
• |I| = 1, where I is the identity matrix.
• |AB| = |A||B|.
• |A-1|=1/|A|.

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 1.6. Matrix inversion

• It is not possible to divide one matrix by another. That

is, we can not write A/B. For two matrices A and B, the
quotient can be written as AB-1 or B-1A.
• In general, in matrix algebra AB-1  B-1A. Thus, writing
A/B does not clearly identify whether it represents AB-1
or B-1A. We’ll say B-1 post-multiplies A (for AB-1) and
B-1 pre-multiplies A (for B-1A)
• Matrix division is matrix inversion.

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Matrix Algebra: Summary

• Matrix algebra can be Ax d

used:
a. to express the system of *
x A d1
equations in a compact
notation;
1 adjA
b. to find out whether A 
solution to a system of det A
equations exist; and
c. to obtain the solution if it * adjA
exists. Need to invert the A x  d
matrix to find the solution A
for x*

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Notation and Definitions: Summary
• A (Upper case letters) = matrix
• b (Lower case letters) = vector
• nxm = n rows, m colums
• rank(A) = number of linearly independent vectors of A
• trace(A) = tr(A) = sum of diagonal elements of A
• Null matrix = all elements equal to zero.
• Diagonal matrix = all non-zero elements are in the diagonal.
• I = identity matrix (diagonal elements: 1, off-diagonal:0)
• |A| = det(A) = determinant of A
• A-1 = inverse of A
• A’=AT = Transpose of A
• A=AT Symmetric matrix
• A=A-1 Orthogonal matrix
• |Mij|= Minor of A

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