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Application of Functions in Business and Economics

Functions:
Functions can be applied in situations when a variable (e.g. cost) depends upon another variable (e.g.
quantity of output produced).

The symbol of a function, 𝒚 = 𝒇 ( 𝒙 ) contains two important information:

1) ‘𝒚’ depends upon ‘𝒙’ , here ‘𝒚’ is the dependent variable and ‘𝒙’ is the independent variable
2) For every value of 𝑥 there is only one corresponding value of y. For example, 𝑦 = 𝑥 + 1 is a function and
it tells us: if 𝑥 = 7 , then there is only one corresponding value of 𝑦 = 8.
Note: Here, the function has only one independent variable and hence is an univariate function
Note: In the symbol of a function, the independent variable always occurs inside the bracket

Application in business and economics:

A business firm produces only one product and Q is the amount of that product and C is the total cost of
production, then we can apply the concept of univariate functions, that is 𝑪 = 𝒇 (𝑸)
Which tells us that the total cost (C) of the business firm depends upon the amount of output (Q)
produced (Q).
Business Example: A particular business has the following total cost function: 𝐶 = 𝑓(𝑄) = 150 + 7𝑄
If the business produces 100 units, then Q = 100, and 𝐶 = 𝑓(100) = 150 + 7(100) = 220
So, we may conclude (interpret) that the total cost of producing 100 units is BDT 220.

Similarly, if the revenue (R) of the business firm depends only upon the output (Q) then we may write:
R = f (Q)
Business Example: If the revenue function of the same business is: 𝑅 = 20𝑄
then the profit function of the business can be derived: 𝝅 = 𝑹 − 𝑪 = 20𝑄 − 150 − 7𝑄
Now, if the business produces and sells 500 units, then, 𝜋 = 20(500) − 150 − 7(500) = 6350
So, we may conclude (interpret) from the last line that if the business produces and sells 500 units then it will
make a profit of BDT 6350.

Deriving other functions from given functions:

1) Given, the above information we may derive the profit (𝝅) function using Profit = Revenue – Cost
𝝅=𝑹−𝑪

𝑡𝑜𝑡𝑎𝑙 …
2) Remember in business situations: 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 … =
𝑄
𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 𝑓𝑢𝑐𝑛𝑡𝑖𝑜𝑛
Therefore: 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 𝑓𝑢𝑛𝑐𝑡𝑖𝑜𝑛 =
𝑄
150+7𝑄
If, 𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡: 𝐶 = 150 + 7𝑄 then 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡: 𝐴𝑇𝐶 = .
𝑄
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So far, we have looked at only univariate functions. Now, let us look at multivariate functions – which
contains more than one independent variable.

Multivariate Functions:
If a business firm produces two products (A and B) and the amount of these two products are QA and QB
respectively, then the total cost of production (C) depends upon the amount of product A and B.
Hence, we can write: C = f (QA , QB) note: there are two independent variables here

E.g. 𝐶 = 𝑓(𝑄𝐴 , 𝑄𝐵 ) = 3𝑄𝐴2 + 𝑄𝐵2

Here, if the business produces 2 units of product A and 3 units of product B,
Then, 𝐶 = 𝑓(2, 3) = 3(2)2 + 32 = 21
So we may conclude (interpret) that the total cost of producing 2 units of product A and 3 units of product B
is BDT 21.

E.g. In a factory the amount of product or output (Q) produced depends upon the number of labor or
workers (L) and the number of machines or capital (K)
Hence: 𝑸 = 𝒇(𝑳, 𝑲) note: this function is the production function
Let’s assume, 𝑄 = 𝑓(𝐿, 𝐾) = 10𝐿0.5 𝐾 0.5
If the business employs 16 workers and 4 machines, then 𝑄 = 𝑓(16, 4) = 10(16)0.5 (4)0.5 = 80 𝑢𝑛𝑖𝑡𝑠
So, we may conclude (interpret) that if the business employs 16 workers and 4 machines, then it can produce
80 units of product or output.

E.g. A consumer consumes only two products apples and oranges. Therefore, the utility or satisfaction (U)
of the consumer depends upon the amount of apples (𝒙) and the amount of oranges (𝒚) consumed.
Hence: 𝑈 = 𝑓(𝑥, 𝑦) = 2𝑥 + 3𝑦
𝑈 = 𝑓(3, 2) = 2(3) + 3(2) = 12 𝑢𝑡𝑖𝑙𝑠
The above statement tells us that if the consumes 3 apples and 2 oranges, then the consumer receives 12 utils
of satisfaction.
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Derivatives and Partial Derivatives:

We may be able to find the derivative of a univariate function (containing one independent variable)
𝑑𝑦
E.g. if, 𝒚 = 𝒇( 𝒙 ) then the symbol of the first derivative is 𝑓′(x) or (the derivative of 𝑦 with
𝑑𝑥
respect to 𝑥)
The derivatives of multivariate functions (more than one independent variables) are called partial
derivatives
E.g. From 𝒛 = 𝒇( 𝒙, 𝒚 ) the following partial derivatives can be found
𝜕𝑧
𝑓𝑥 or 𝜕𝑥
is the symbol of the first partial derivative with respect to 𝑥 (which implies 𝑥 is the variable 𝑦 is
constant)
𝜕𝑧
𝑓𝑦 or 𝜕𝑦
is the symbol of the first partial derivative with respect to 𝑦 (which implies 𝑦 is the variable and
𝑥 is constant)

Rules of Derivatives or Differentiation:

To find derivatives or partial derivatives we must apply one or more rule(s) of derivatives or differentiation.

Rule 1: if, 𝑦 = 𝑓 (𝑥) = 𝑘 , where k is a constant, then the first derivative, 𝑓 ′ (𝑥) = 0

E.g. Given, 𝑦 = 𝑓(𝑥) = 10. Then the first derivative, 𝑓 ′ (𝑥) = 0 (using Rule 1)
E.g. Given, 𝑧 = 𝑓(𝑥, 𝑦) = 30. Then the first partial derivatives, 𝑓𝑥 = 0 and 𝑓𝑦 = 0 (using Rule 1)
Note: Rule 1 is applied only when there are only constant(s). If a constant is attached with a variable e.g. 2𝑥,
then Rule 1 cannot be applied and Rule 2 has to be applied.

Rule 2: if, 𝑦 = 𝑓(𝑥) = 𝑐𝑥 𝑛 where, 𝑥 is the variable and 𝑐 and 𝑛 are constants.
Then the first derivative, 𝑓 ′ (𝑥) = 𝑐𝑛𝑥 𝑛−1

E.g. Given, 𝑦 = 𝑓(𝑥) = 2𝑥 3. Then the first derivative, 𝑓 ′ (𝑥) = 2(3)𝑥 3−1 = 6𝑥 2
E.g. Given, 𝑧 = 𝑓(𝑥, 𝑦) = 𝑥 2 + 3𝑦 2 . Then the first partial derivatives, 𝑓𝑥 = 2𝑥 2−1 + 0 = 2𝑥 (here,
x is the variable and hence Rule 2 is applied on the first term; y is constant and hence Rule 1 is
applied on the second term)
𝑓𝑦 = 0 + 3(2)𝑦 2−1 = 6𝑦 (here, y is the variable and x is the constant…)

Application of First Derivatives and First

Partial Derivatives
The first derivative(s) of a function gives us the
slope of a function:
E.g. 𝑦 = 𝑓(𝑥) = 𝑥 2 → 𝑓′(𝑥) = 2𝑥 →
𝑓 ′ (3) = 2(3) = 𝟔 > 𝟎
→ positive (upward) slope at 𝑥 = 3

𝑓 ′ (−2) = 2(−𝟐) = −𝟒 < 𝟎 → downward

slope x
at 𝒙 = −𝟐 -2 3

at 𝒙 = 𝟎 the graph is flat (neither upward nor

downward) and the slope is zero
i.e. 𝑓 ′ (𝟎) = 2(0) = 𝟎.
Therefore, at 𝑥 = 0 we have a stationary point.
Important: At stationary points, the slope (first derivative) is zero.
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In the last diagram, the stationary point is also the lowest point on the graph. Therefore, it is called a
minimum point. Moreover, it is also the lowest point in the entire graph and hence it is also called a
global minimum. This idea will become clearer in the next discussion.

In the following graph, we have two stationary (zero slope) points at 𝑥 = 2 and at 𝑥 = 6. At
𝑥 = 6 there is a minimum point, but there other points lower than this on the graph, for example the
green dot on the graph. Therefore, at 𝑥 = 6 we have a relative minimum. Similarly, at 𝑥 = 2
we have a relative maximum, since there other points higher than this on the graph, for example the
red dot below.

From the graph above we can also see that at both minimum and maximum points, the slope (or
first derivative) is zero. Therefore, both minimum and maximum are stationary points.

The equation of the above graph is: 𝑦 = 𝑓(𝑥) = 𝑥 3 − 12𝑥 2 + 36𝑥 + 8.

Question: Now, let us imagine we have only the equation and not the graph and we want to find at
what values of 𝑥 the function (or graph) is stationary.

We know at a stationary point the slope (the first derivative) is zero.

The symbol of slope or first derivative is: 𝑓′(𝑥)
Therefore, at staionary points: 𝒇′ (𝒙) = 𝟎 (this is called the first order condition)

Here, 𝑓 ′ (𝑥) = 3𝑥 2 − 24𝑥 + 36 = 0

𝐷𝑖𝑣𝑖𝑑𝑖𝑛𝑔 𝑏𝑦 3: 𝑥 2 − 8𝑥 + 12 = 0
𝑀𝑖𝑑𝑑𝑙𝑒 𝑡𝑒𝑟𝑚 𝑓𝑎𝑐𝑡𝑜𝑟𝑖𝑠𝑎𝑡𝑖𝑜𝑛: 𝑥 2 − 6𝑥 − 2𝑥 + 12 = 0 → 𝑥(𝑥 − 6) − 2(𝑥 − 6) = 0
→ (𝑥 − 6)(𝑥 − 2) = 0 → 𝑥 = 6, 2
Therefore at 𝑥 = 2 and 𝑥 = 6 we have stationary points (where the slope is zero). However,
without graph we cannot be sure whether the stationary points are maximum or mimum because
both of them has zero slopes1. To understand whether a stationary point is a maximum or
minimum, we can take the help of second derivatives.

Important: We can use the first order condition 𝑓 ′ (𝑥) = 0 to find at what values of 𝑥 the function
is stationary (has a zero slope).

1
The first order condition is true (derivative is zero) for both maximum and minimum points. We found the solution
𝑥 = 2 , 6 from the first order condition, therefore at 𝑥 = 2 , 6 there can be either a maximum or minimum.
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Second derivatives [ symbol2: 𝑓′′(𝑥) ] are simply the derivatives of 𝑓′(𝑥) – the first derivative.

Here, 𝑓 ′ (𝑥) = 3𝑥 2 − 24𝑥 + 36

Therefore, 𝑓 ′′ (𝑥) = 3(2)𝑥 2−1 − 24(1)𝑥1−1 + 0 = 6𝑥 − 24
The second derivative tells us how the slope changes as we move (slightly) right. If second
derivative is negative, then it means the slope decreses as we move right. If it is positive, it means
the slope increases as we move right. These ideas will become clearer in the following discussions.

Now we want to check, whether at 𝑥 = 2 we have minimum or maximum.

Putting the value of 𝑥 = 2 in the second derivative:
𝑓 ′′ (2) = 6(2) − 24 = −12 < 0
Since the second derivative at 𝒙 = 𝟐 is negative, it means as we move right from 𝑥 = 2 the slope
decreases. In figure below, at 𝑥 = 2 the slope is zero, but if you move right the slope becomes
negative (downward sloping); so the slope is decreasing and at 𝑥 = 2 we have a maximum.

0
−

+
0

(same diagram as last page)

At 𝑥 = 6 , 𝑓 ′′ (6) = 6(6) − 24 = 12 > 0

Since the second derivative is positive at 𝑥 = 6 it means as we move right from 𝑥 = 6 the slope
increases. At 𝑥 = 6 the slope is zero, but as we move right the slope becomes positive (upward
sloping) and therefore we have a minimum point at 𝑥 = 6.

Question: What should be the first derivative and second derivative at 𝑥 = 1 (above). At 𝑥 = 1, we
have a upward slope. Therefore, the first derivative at 𝑥 = 1 should be positive, that is 𝑓 ′ (1) > 0

As we move right from 𝑥 = 1 the slope decreases. At 𝑥 = 1 the slope was positive, but as we move
right let’s say to 𝑥 = 2 the slope becomes zero. So the slope is decreasing as we move right from
𝑥 = 1. Therefore at 𝑥 = 1 , the second derivate should be negative, that is 𝑓 ′′ (1) < 1.

Important: if at 𝑥 = 𝑎, 𝑓 ′ (𝑎) = 0 and 𝑓 ′′ (𝑎) > 0 , then we have a minimum at 𝑥 = 𝑎

if at 𝑥 = 𝑎, 𝑓 ′ (𝑎) = 0 and 𝑓′′(𝑎) < 0 , then we have a maximum at 𝑥 = 𝑎

Note: There is another kind of stationary points called inflection points where the first derivative
(slope) is also equal to zero. However, the second derivatives are also equal to zero at inflection
points. We will not be covering them here.

2 𝑑2𝑦
The ′′ signifies the second derivative. Another symbol is:
𝑑𝑥 2
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Business Application:
1
The profit function of a business firm is: 𝜋 = 𝑓(𝑄) = − 3 𝑄 3 + 6𝑄 2 − 11𝑄 − 50.
1) What output (Q) should the business firm produce to maximize the profit? 2) What is the maximum profit
the business firm can generate?

1) We know at the maximum profit point, the first derivative (slope) of the profit function is equal to zero
𝑓 ′ (𝑄) = 0
1
Here, 𝑓 ′ (𝑄) = − (3) (3)𝑄 3−1 + 6(2)𝑄 2−1 − 11(1)𝑄1−1 − 0
−𝑄 2 + 12𝑄 − 11 = 0
Multiplying by -1: 𝑄 2 − 12𝑄 + 11 = 0
Middle term factorization: 𝑄 2 − 11𝑄 − 𝑄 + 11 = 0
𝑄(𝑄 − 11) − 1(𝑄 − 11) = 0
(𝑄 − 11)(𝑄 − 1) = 0 → 𝑄 = 11, 1
At 𝑄 = 11, 1 we can have either a maximum or minimum. So, we need to check using second derivatives:
𝑓 ′′ (𝑄) = −2𝑄 2−1 + 12(1)𝑄1−1 − 0 = −2𝑄 + 12
At 𝑄 = 11, 𝑓 ′′ (𝑄) = −2(11) + 12 = −10 < 0
Therefore, at 𝑄 = 11 we have the maximum point (profit)
At 𝑄 = 1, 𝑓 ′′ (1) = −2(1) + 12 = 10 > 0
Therefore, at 𝑄 = 1 we have the minimum point (profit)

Conclusion: The business should produce 10 units of output to maximize the profit

2) What is the maximum profit?

Remember: Profit is given by the profit function (above) and maximum profit occurs at 𝑄 = 11
1
Therefore, maximum profit: 𝜋 = 𝑓(11) = − (11)3 + 6(11)2 − 11(11) − 50 = 111.3
3

Therefore, the maximum profit that the business firm can generate is BDT 111.3

Business application:
Given the total cost of a business firm is: 𝐶 = 𝑓(𝑄) = 𝑄 3 − 5𝑄 2 + 60𝑄
What output should be produced to minimize the average total cost (cost per unit)?
Here the objective is to minimize the average total cost. Therefore, we need the average total cost function3.
𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 𝑄 3 −5𝑄2 +60𝑄
We know, 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 = 𝑄
= 𝑄
= 𝑄 2 − 5𝑄 + 60

We know at the minimum average total cost: 𝑑𝑒𝑟𝑖𝑣𝑎𝑡𝑖𝑣𝑒 𝑜𝑓 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑐𝑜𝑠𝑡 𝑓𝑢𝑛𝑐𝑡𝑖𝑜𝑛 = 0
2𝑄 − 5 = 0 → 𝑄 = 2.5
𝑆𝑒𝑐𝑜𝑛𝑑 𝑑𝑒𝑟𝑖𝑣𝑎𝑡𝑖𝑣𝑒: 2 > 0 → at 𝑄 = 2.5 the average cost (cost per unit) is minimized
Conclusion: If the business produces 2.5 units of output then the cost per unit will be the lowest (minimized).

Note: These two examples are called optimization problems - where the main aim is to find the values of the
choice or decisions variables (independent variables) that will maximize or minimize the objective function
(the dependent variable). Read the foot note below for further clarification. (END OF QUIZ 1)

3
These two examples are called optimization problems. The first step of an optimization problem is to find the
objective function, if it is not given. Here, the objective is to minimize average total cost, therefore the average total
cost function is called the objective function which is not given and hence needs to be found.