UNIT 3: DIFFERENTIATION

3.1. Unit Introduction

Economists use models to study complex phenomena in the real world. To construct an economic model,
one needs to know which variables are endogenous and which ones are exogenous to the model.
Endogenous variables are those whose values are determined within the economic system being studied
while exogenous variables are those whose values are taken as given in the analysis of an economic
system.

Now, to be able to analyze economic models, economists rely on three analytical tools: optimization,
equilibrium analysis and comparative statics. Optimization is the analytical framework used to assess
economic agents’ optimal decision-making subject to any possible limitations or restrictions on the
choices. Equilibrium analysis essentially involves analyzing the state or condition of an economic system
when exogenous factors remain unchanged. Comparative statics analysis examines how a change in
some exogenous variable affects the level of some endogenous variable and the economic system’s
equilibrium.

In this unit, we focus on mathematical tools that are relevant for comparative statics analysis. First, we
examine the concept of limits used to define derivatives. Second, we describe what a derivative is and
then move on to explain differentiation and the rules associated with differentiating functions. Third, we
demonstrate how to take higher order derivatives and conclude the unit with a closer look at partial
derivatives.

3.2. Unit Aim and Objectives

The aim of this unit is to expose students to basic calculus rules that are extensively used by economists
for comparative statics analysis. By the end of this unit, students should be able to do the following:
1. Find the limit, if it exists, of any given function
2. Explain the concept of derivatives
3. Apply the key rules of differentiation
4. Derive higher-order derivatives
5. Demonstrate the calculus of multivariable functions

3.3. Limits

Consider a function 𝑓(𝑥) where 𝑥 is the independent (exogenous) variable. We define the limit of the
function as the finite real number that the dependent (endogenous) variable, let us call it 𝑦, approaches
as the independent variable approaches a constant, say 𝑎. Mathematically, this is written as follows:

1
 lim 𝑓(𝑥 ) = 𝐿
+→-

The expression above simply states that as 𝑥 approaches 𝑎, 𝑓(𝑥) approaches 𝐿, which in this case is the
limit. When finding the limit of a function, our presentation might suggest that 𝑥 = 𝑎. In truth, 𝑥 is not
equal to 𝑎. The correct way to put it is to say that the difference between 𝑥 and 𝑎 is so small such that
𝑥 is close to 𝑎 but not necessarily equal to 𝑎. Mathematically, this is stated as follows:

𝑥−𝑎 =𝜀

where 𝜀 is the Greek letter epsilon, which signifies a very small number. Graphing functions is one
approach that is used to find limits of functions. You are encouraged to check the Khan academy website
or any relevant mathematics text to see how graphs are used to find limits. To save on time in class, we
shall only look at the rules of limits that are useful when finding limits in the absence of graphs. These
are:

1. lim 𝑘 = 𝑘 (𝑘 = a constant)
𝑥→𝑎

2. lim 𝑥𝑛 = 𝑎𝑛 (𝑛 = a positive integer)

𝑥→𝑎

3. lim 𝑘𝑓(𝑥) = 𝑘 lim 𝑓(𝑥) (𝑘 = a constant)

𝑥→𝑎 +→-

4. lim [𝑓 (𝑥) + 𝑔(𝑥)] = lim 𝑓 (𝑥) + lim 𝑔(𝑥)

+→- +→- +→-

5. lim [𝑓 (𝑥) − 𝑔(𝑥)] = lim 𝑓 (𝑥) − lim 𝑔(𝑥)

+→- +→- +→-

6. lim [𝑓 (𝑥) ∙ 𝑔(𝑥)] = lim 𝑓 (𝑥) ∙ lim 𝑔(𝑥)

+→- +→- +→-

7. lim [𝑓 (𝑥) ÷ 𝑔(𝑥)] = lim 𝑓 (𝑥) ÷ lim 𝑔(𝑥) lim 𝑔(𝑥) ≠ 0

+→- +→- +→- +→-

<
8. lim [𝑓 (𝑥)]< = =lim 𝑓(𝑥)> (𝑛 = a positive integer)
+→- +→-

3.3.1. In-class Exercise 3.1

Find the limits of the following functions:

1. lim[𝑥 @ (𝑥 + 4)]
+→?

+CB
2. lim + D CEF
+→B

2
3.4. The Derivative

Suppose we want to find the rate of change between two points on a function, the mathematical
approach would be to get the difference quotient. Consider Figure 3.1 that shows a cubic function (a
kind of polynomial function). If the independent variable (variable on the x-axis) increases by ℎ from 𝑥
to 𝑥 + ℎ, the average increase in the dependent variable (variable on the y-axis) is computed using the
difference quotient depicted below:

𝑓 (𝑥 + ℎ) − 𝑓(𝑥) 𝑓 (𝑥 + ℎ) − 𝑓(𝑥)
=>
(𝑥 + ℎ ) − 𝑥 ℎ

Figure 3.1: Rate of change of a cubic function

Thus, for the function 𝑦 = 𝑓(𝑥), and assuming the limit exits, the derivative of the function 𝑓 𝑎𝑡 𝑥,
written 𝑓′(𝑥) or 𝑑𝑦/𝑑𝑥, is defined as

𝑓(𝑥 + ℎ) − 𝑓(𝑥)
𝑓 M (𝑥 ) = lim
N→O ℎ

This definition simply states that as ℎ gets smaller and smaller, the point (𝑥 + ℎ, 𝑓(𝑥 + ℎ) − 𝑓(𝑥)) will
get closer and closer to the point (𝑥, 𝑓(𝑥)), and the green line will get closer and closer to the tangent
line of 𝑓 at 𝑥. So, when ℎ → 0, the difference quotient becomes the slope of the tangent line, which
leads to the following interpretation of the derivative: The derivative 𝑓′(𝑥) is the slope of the tangent
line of𝑓 at 𝑥. 𝑓 M (𝑥) is read “the derivative of 𝑓 with respect to 𝑥” or “𝑓 prime of 𝑥.” The derivative

3
measures the rate of change of a function. In calculus language, finding the derivative of a function is
also referred to as “taking the derivative.”

The formula that we have derived above can be used to find derivatives for relatively simple functions
as we shall see during in-class exercise 3.2.

3.4.1. In-class Exercise 3.2

Find the derivatives of the following functions using the derivative formula:

1. 𝑥 ?

2. 4𝑥 ? + 9

3.5. Rules of differentiation

Differentiation is the process of finding the derivative of a function. Instead of using the derivative
formula in section 3.5, some rules have been developed for taking derivatives. Below are some rules of
differentiation for the single independent variable case.

Rule 1: Constant function rule: If 𝑦 = 𝑏, where b is a constant:

𝑑𝑦
=0
𝑑𝑥

Rule 2: Linear function rule: If 𝑦 = 𝑎𝑥 + 𝑏, where 𝑎 is the coefficient of 𝑥 and 𝑏 is a constant;

𝑑𝑦
=𝑎
𝑑𝑥

Rule 3: Power function rule: If 𝑦 = 𝐴𝑥 T , where 𝐴 is a constant and 𝛼 is any real number;
𝑑𝑦
= 𝛼𝐴TCV
𝑑𝑥

Rule 4: Sum rule: If 𝑦 = 𝑔(𝑥) + ℎ(𝑥), where 𝑔(𝑥) and ℎ(𝑥) are both differentiable functions;
𝑑𝑦
= 𝑔′(𝑥) + ℎ′(𝑥)
𝑑𝑥

Rule 5: Difference rule: If 𝑦 = 𝑔(𝑥 ) − ℎ(𝑥 ), where 𝑔(𝑥) and ℎ(𝑥) are both differentiable functions;
𝑑𝑦
= 𝑔M (𝑥) − ℎ′(𝑥)
𝑑𝑥

4
Rule 6: Product rule: If 𝑦 = 𝑓 (𝑥 )𝑔(𝑥), where 𝑔(𝑥) and ℎ(𝑥) are both differentiable functions;
𝑑𝑦 𝑑𝑓 𝑑𝑔
= 𝑔 (𝑥 ) + 𝑓 (𝑥 )
𝑑𝑥 𝑑𝑥 𝑑𝑥
f(+)
Rule 7: Quotient rule: If 𝑦 = g(+), where 𝑔(𝑥) and ℎ(𝑥) are both differentiable functions;

𝑑𝑓 𝑑𝑔
𝑑𝑦 𝑑𝑥 𝑔(𝑥 ) − 𝑑𝑥 𝑓(𝑥 )
=
𝑑𝑥 [𝑔(𝑥 )]?

Rule 8: Chain rule: Given a composite function, also called a function of a function, in which 𝑦 is a
function of 𝑢 and 𝑢 in turn is a function of 𝑥, that is, 𝑦 = 𝑓(𝑢) and 𝑢 = 𝑔(𝑥 ), then 𝑦 = 𝑓[𝑔(𝑥)] and
the derivative of 𝑦 with respect to 𝑥 is equal to the derivative of the first function with respect to 𝑢
times the derivative of the second function with respect to 𝑥:

𝑑𝑦 𝑑𝑦 𝑑𝑢
=
𝑑𝑥 𝑑𝑢 𝑑𝑥

3.5.1. In-class Exercise 3.3

Find the derivatives of the following functions with respect to 𝑥:

1. 𝑦 = −9𝑥 CE

2. 𝑦 = 8𝑥 ? + 5𝑥 − 6

3. 𝑦 = 5𝑥 E (3𝑥 − 7)

3.6. Higher-order derivatives

Once you have the derivative of a function, also known as the first-order derivative, you can find the
second-order derivative by computing the rate of change of the first derivative. Further, it is possible to
get higher-orders (third, fourth and so on) of derivatives as long as the function remains differentiable.
In economics, the concept of second or higher-order derivatives is particularly useful in optimization
problems such as profit maximization. The approach enables the analyst to ascertain whether the profit
maximization solution computed is indeed at the maximum level. The in-class exercise 3.4 will enable
you to practice how to take higher order derivatives.

3.6.1. In-class Exercise 3.4

Use the functions in Exercise 3.3 to find the second order derivatives for each one of them.

5
3.7. Partial derivatives

If a function has two or more independent variables, the rate of change of the dependent variable is
analyzed using partial derivatives. Given a function 𝑓(𝑥, 𝑦), the partial derivative of 𝑓 with respect to 𝑥
measures the instantaneous rate of change of 𝑓 with respect to 𝑥 while 𝑦 is held constant. The partial
nf
derivative in this case would be denoted as n+, 𝑓+ (𝑥, 𝑦), or 𝑓+ . Similarly, the partial derivative of 𝑓 with
respect to 𝑦 measures the instantaneous rate of change of 𝑓 with respect to 𝑦 while 𝑥 is held constant.
nf
The partial derivative in this case would be denoted as no, 𝑓o (𝑥, 𝑦), or 𝑓o . The in-class exercise 3.5 will
give you some practice on how to take partial derivatives.

3.7.1. In-class Exercise 3.5

Find the first order partial derivatives for the following functions:
1. 𝑧 = 8𝑥 ? + 14𝑥𝑦 + 5𝑦 ?

2. 𝑧 = 3𝑥 ? (5𝑥 + 7𝑦)

6
3.8. Unit 3 Tutorial Exercise

1. Find the limits of the following:

@+ D Cr+
a. lim +st
+→E

+CB
b. lim
+→CB + D CEF

2. Find the derivatives of the following and state the rule that you have used:

VO+ uCt+ v
a. 𝑦 = ?+

b. 𝑦 = (3𝑥 E + 5)t

3. Find the successive derivatives of the following (from the first to the highest order derivative):

a. 𝑦 = 𝑥 @ + 3𝑥 ? + 9𝑥 − 7

b. 𝑦 = (5 − 𝑥)E

4. Find the partial derivatives of the following:

a. 𝑧 = (𝑤 − 𝑥 − 𝑦)(3𝑤 + 2𝑥 − 4𝑦)

b. 𝑧 = (7𝑥 ? + 4𝑦 @ )r