Ees 200 Revised Lecture Notes (Complete) Courtesy of Michelle Owino

EES 200: MATHEMATICS FOR ECONOMISTS II
FACILITATOR: DOROTHY NGINA
LECTURE NOTES
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LECTURE ONE: EQUILIBRIUM ANALYSIS
1.1 Introduction.
Welcome to our first lesson of Mathematics for Economist II. In this lesson we start by discussing
equilibrium analysis. The general objective of this lesson is to understand how to compute market
equilibrium and the national income equilibrium. In this lecture the learner will learn how to get
equilibrium values in simultaneous equations. Knowledge of solving simultaneous equations will
be very useful in this course especially when dealing with the general equilibrium.
1.2 Lesson Learning Outcomes
By the end of this lesson, you will be able to:
1.2.1 Compute the equilibrium price and quantity in the partial market model.
1.2.2 Compute the equilibrium price and quantity in the general market model.
1.2.3 Compute the equilibrium in the national income model
1.2.1 Equilibrium in the partial market model
Equilibrium: A constellation of selected interrelated variables so adjusted to one another that
no inherent tendency to change prevails in the model which they constitute. It is important to
explain some few terms that are in this definition
i) Selected variables: - There could be other variables that have not been included. If the
model is enlarged to include more variables, the equilibrium may no longer hold.
ii) Interrelated: - All the variables included must be simultaneously be in a state of rest.
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iii) Inherent – when defining the equilibrium, the state of rest is based only on the
balancing of internal forces of the model. The external forces are therefore assumed to
be constant.
For example: Assume a demand function is given as: 𝑃 = 50 − 2𝑄,
50 𝑎𝑛𝑑 2 are parameters of the equation and are assumed to be exogenous, hence they do not
change. If any of the external factors change, a new equilibrium will prevail.
Equilibrium therefore can be simply defined as a situation characterized by lack of tendency to
change.
An equilibrium does not imply an ideal state of affairs. For example, the market price for a bag of
wheat could be Kshs. 4,000 which may be low to some of the farmers or is too high to the millers
who are buying it. But at this price, the total supply of wheat to the market is equal to the total
demand of wheat in that market.
We will analyze the partial market equilibrium using both a linear model and a non-linear model.
a) Partial market equilibrium - Linear model
This is a model of price determination in an isolated market/ single market. Only one
commodity is considered. Equilibrium in the market for a single commodity occurs when the
quantity demanded (Qd) is equal to the quantity supplied (Qs) in the market. For equilibrium to
occur, the price that the consumers are willing to pay is equal to the price that the sellers are willing
to accept.
Conditions for equilibrium
No excess demand in the market i.e
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𝑄𝑠 − 𝑄𝑑 = 0 𝑡ℎ𝑖𝑠 𝑤𝑖𝑙𝑙 𝑖𝑚𝑝𝑙𝑦 𝑡ℎ𝑎𝑡
𝑄𝑠 = 𝑄𝑑
The quantity demanded function and quantity supplied function are functions of price. If price is
below the specified level nothing will be supplied. The demand function can be given as:
𝑄𝑑 = 𝑓(𝑃) 𝑤ℎ𝑖𝑐ℎ 𝑐𝑎𝑛 𝑏𝑒 𝑔𝑖𝑣𝑒𝑛 𝑎𝑠:
𝑄𝑑 = 𝑎 − 𝑏𝑃
This indicates that the demand function is negatively sloped. While the supply function will be
given as:
𝑄𝑠 = 𝑓(𝑃) 𝑎𝑛𝑑 𝑐𝑎𝑛 𝑏𝑒 𝑔𝑖𝑣𝑒𝑛 𝑎𝑠:
𝑄𝑠 = −𝑐 + 𝑑𝑃
In the demand and supply functions, a, b, c and d are positive constants. The supply function is
positively sloped. At equilibrium: quantity demanded is equal to quantity supplied, that is:
𝑄𝑑 = 𝑄𝑠
The equilibrium price and quantity can be determined graphically by drawing both the demand
and supply function on the same graph. Both the quantity demanded and quantity supplied will be
plotted on the Y-axis while the price will be plotted on the X-axis.
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The equilibrium price and quantity are P* and Q* respectively. It will be the price and quantity
when the supply curve intersects with the demand curve.
Determination of the equilibrium price and quantity algebraically
If we have the demand and supply functions of the commodity we can determine the equilibrium
values of P and Q algebraically.
The demand function is given as:
𝑄𝑑 = 𝑓(𝑃)
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𝑄𝑑 = 𝑎 − 𝑏𝑃
While the supply function will be given as:
𝑄𝑠 = 𝑓(𝑃)
𝑄𝑠 = −𝑐 + 𝑑𝑃
At equilibrium:
𝑄𝑑 = 𝑄𝑠
If we equate the demand and supply functions, we get:
𝑎 − 𝑏𝑃 = −𝑐 + 𝑑𝑃
𝑎 + 𝑐 = 𝑑𝑃 + 𝑏𝑃
𝑃(𝑑 + 𝑏) = 𝑎 + 𝑐
𝑎+𝑐
𝑃∗ = 𝑑+𝑏
𝑃∗ should be greater than zero since all the constants a, b, c and d are positive.
To get the equilibrium quantity, we can replace the value of 𝑃∗ either in the demand or supply
function.
Let’s replace it in the demand function.
𝑄𝑑 = 𝑎 − 𝑏𝑃 ∗
𝑎+𝑐
= 𝑎−𝑏[ ]
𝑑+𝑏
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𝑎𝑑 + 𝑎𝑏 − 𝑎𝑏 − 𝑐𝑏
=
𝑑+𝑏
𝑎𝑑 − 𝑐𝑏
𝑄∗ = 𝑓𝑜𝑟 𝑄 ∗ 𝑡𝑜 𝑏𝑒 𝑝𝑜𝑠𝑖𝑡𝑖𝑣𝑒, 𝑎𝑑 𝑠ℎ𝑜𝑢𝑙𝑑 𝑏𝑒 𝑔𝑟𝑒𝑎𝑡𝑒𝑟 𝑡ℎ𝑎𝑛 𝑐𝑏 𝑖. 𝑒
𝑑+𝑏
𝑎𝑑 > 𝑐𝑏
Intersection between demand and supply function should occur above the X-axis for
𝑃∗ 𝑎𝑛𝑑 𝑄 ∗ 𝑡𝑜 𝑏𝑒 𝑝𝑜𝑠𝑖𝑡𝑖𝑣𝑒.
Example
The demand and the supply function for a good are given as:
𝑄𝑑 = 200 − 2𝑃
While the supply function will be given as:
𝑄𝑠 = −20 + 2𝑃
Required:
Determine the equilibrium price and quantity
At equilibrium, 𝑄𝑑 = 𝑄𝑠
If we equate the demand and supply functions, we get:
200 − 2𝑃 = −20 + 2𝑃
220 = 2𝑃 + 2𝑃
4𝑃 = 220
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220
𝑃∗ = = 55
4
𝑄 ∗ = 200 − 2[55]
= 200 − 110
𝑄 ∗ = 90
Exercise
The demand function is given as:
𝑃 = 100 − 2𝑄𝑑
While the supply function is given as:
𝑃 = 10 + 7𝑄𝑠
Determine the equilibrium price and quantity
b) Partial market equilibrium – Non-linear model
The demand and supply functions for a commodity are given as:
𝑄𝑑 = 6 − 𝑃2
𝑄𝑠 = 10𝑃 − 5
For equilibrium
𝑄𝑑 = 𝑄𝑠
6 − 𝑃2 = 10𝑃 − 5
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𝑃2 + 10𝑃 − 11 = 0
Since the resulting equation is a quadratic equation, then we can use any one of the methods that
are available for solving such equations: Factorization, the quadratic formula, completing the
square method, and so on.
For instance, if we use the factorization method, we obtain:
𝑃(𝑃 + 11) − 1(𝑃 + 11) = 0
(𝑝 − 1)(𝑝 + 11) = 0
𝑃 = 1 𝑜𝑟 𝑃 = −11
We can only deal with positive prices hence equilibrium price is 1 while the equilibrium
quantity will be:𝑄𝑑 = 6 − (1)2 = 5
Self-test question
Determine the equilibrium prices and quantities in the following two problems:
i) 𝑄𝑑 = 3 – 𝑃2 , 𝑄𝑠 = 6𝑃 – 4
ii) 𝑄𝑑 = 8 − 𝑃2 , 𝑄𝑠 = 𝑃2 − 2
General Market Equilibrium
Rarely will the demand for a product be a function of own price alone. Prices of other related
commodities such as complements and substitutes will affect its. General market equilibrium deals
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with a case whereby demand or supply of a commodity is a function of its own price and also
prices of related commodities.
Numerical Example
The demand and supply functions of 2 commodities are given as:
𝑄𝑑1 = 18 − 3𝑃1 + 𝑃2 𝑄𝑑2 = 12 − 𝑃1 − 2𝑃2
𝑄𝑠1 = −2 + 4𝑃1 𝑄𝑠2 = −2 + 3𝑃2
At equilibrium:
Qd1 = 𝑄𝑠1 𝑎𝑛𝑑
Qd2 = 𝑄𝑠2
18 − 3𝑃1 + 𝑃2 = −2 + 4𝑃1 ⇒ 7𝑃1 − 𝑃2 = 20
12 − 𝑃1 − 2𝑃2 = −2 + 3𝑃2 ⇒ 𝑃1 + 5𝑃2 = 14
This gives us two simultaneous equations that can be solved simultaneously to obtain:
116 78
𝑃1 = 𝑎𝑛𝑑 𝑃2 = 𝑇ℎ𝑒 𝑒𝑞𝑢𝑖𝑙𝑖𝑏𝑟𝑖𝑢𝑚 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑖𝑒𝑠 𝑓𝑜𝑟 𝑔𝑜𝑜𝑑 1 𝑎𝑛𝑑 2 𝑤𝑖𝑙𝑙 𝑏𝑒
36 36
98
𝑄1 = 𝑎𝑛𝑑 𝑄2 = 4.5
9
In the general market, equilibrium requires that all the markets be in equilibrium simultaneously.
For each market i, equilibrium requires that:
𝑄𝑑𝑖 − 𝑄𝑠𝑖 = 0
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Or
𝑄𝑑𝑖 = 𝑄𝑠𝑖
We will get a set of prices, Pi and Qi for each market that will ensure the market is in equilibrium.
𝟐 𝒄𝒐𝒎𝒎𝒐𝒅𝒊𝒕𝒚 𝒄𝒂𝒔𝒆
𝑄𝑑1 = 𝑄𝑠1
𝑄𝑑1 = 𝑎0 + 𝑎1 𝑃1 + 𝑎2 𝑃2
𝑄𝑠1 = 𝑏0 + 𝑏1 𝑃1 + 𝑏2 𝑃2
𝑄𝑑2 = 𝑐0 + 𝑐1 𝑃1 + 𝑐2 𝑃2
𝑄𝑠2 = 𝑑0 + 𝑑1 𝑃1 + 𝑑2 𝑃2
Solving the 1st set of equations:
𝑎0 + 𝑎1 𝑃1 + 𝑎2 𝑃2 = 𝑏0 + 𝑏1 𝑃1 + 𝑏2 𝑃2
(𝑎0 − 𝑏0 ) + (𝑎1 − 𝑏1 )𝑃1 + (𝑎2 − 𝑏2 )𝑃2 = 0 − − − − − − − −(𝑖)
(𝑎𝑖 − 𝑏𝑖 ) = 𝛼𝑖
From the second set we get:
(𝑐0 − 𝑑0 ) + (𝑐1 − 𝑑1 )𝑃1 + (𝑐2 − 𝑑2 )𝑃2 = 0 − − − − − − − (𝑖𝑖)
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(𝑐𝑖 − 𝑑𝑖 ) = 𝛾𝑖
If we replace each (𝑎𝑖 − 𝑏𝑖 ) in equation (i) with αi and each (𝑐𝑖 − 𝑑𝑖 ) in equation (ii) with
𝛾𝑖 we get 2 simultaneous equations:
𝛼1 𝑃1 + 𝛼2 𝑃2 = −𝛼0
𝛾1 𝑃1 + 𝛾2 𝑃2 = −𝛾0
The two equations are then solved simultaneously to get equilibrium price and quantities.
𝛼2 𝛾0 − 𝛼0 𝛾2
𝑃1∗ = − − − − − − − −𝑒𝑞𝑢𝑖𝑙𝑖𝑏𝑟𝑖𝑢𝑚 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑔𝑜𝑜𝑑 1
𝛼1 𝛾2 − 𝛼2 𝛾1
𝛼0 𝛾1 − 𝛼1 𝛾0
𝑃2∗ = − − − − − − − −𝑒𝑞𝑢𝑖𝑙𝑖𝑏𝑟𝑖𝑢𝑚 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑔𝑜𝑜𝑑 2
𝛼1 𝛾2 − 𝛼2 𝛾1
For the price to be meaningful, 𝛼1 𝛾2 − 𝛼2 𝛾1 ≠ 0. In addition, the numerator should have the same
sign as the denominator.
The equilibrium quantities will be obtained by replacing these values of equilibrium prices in the
demand or supply equations of the relevant commodities.
Equilibrium conditions for an n-commodity market
If the quantity demanded of good i is given as:
𝑄𝑑𝑖 = (𝑃1 , 𝑃2 , 𝑃3 , . . 𝑃𝑛 )𝑤ℎ𝑒𝑟𝑒 𝑖 = 1,2 … . . 𝑛
𝑄𝑠𝑖 = (𝑃1 , 𝑃2 , 𝑃3 , . . 𝑃𝑛 ) 𝑤ℎ𝑒𝑟𝑒 𝑖 = 1,2 … . . 𝑛
Equilibrium requires that for the n-markets to be in equilibrium simultaneously,
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𝑄𝑑𝑖 = 𝑄𝑠𝑖
Equilibrium in National – Income Analysis (for a closed economy)
𝑌 = 𝐶 + 𝐼0 + 𝐺0 𝐶 = 𝑎 + 𝑏𝑌 𝑎 > 00< 𝑏 < 1
Y, C are endogenous variables while I0 and G0 are exogenous variables. In order to get the
equilibrium national income, we substitute the expression for C in the model
𝑌 = 𝑎 + 𝑏𝑌 + 𝐼0 + 𝐺0
𝑌 − 𝑏𝑌 = 𝑎 + 𝐼0 + 𝐺0
𝑌(1 − 𝑏) = 𝑎 + 𝐼0 + 𝐺0
a+ I0 + G0
Y* =
(1- b)
This is the expression for the equilibrium national income.
We can get the equilibrium level of consumption by replacing the equilibrium value of national
income in the consumption function.
a+ I0 + G0
𝐶 = 𝑎 + 𝑏[ ]
(1- b)
𝑎(1 − 𝑏) + 𝑏(a+ I0 + G0 )
=
1−𝑏
𝑎 − 𝑎𝑏 + 𝑏a+ bI0 +bG0 )

=
1−𝑏
𝑎 + 𝑏( I0 + G0 )
𝐶∗ =
1−𝑏
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This is the expression for the equilibrium consumption.
Example
The national income model for a closed economy is given as:
𝑌 = 𝐶 + 𝐼0 + 𝐺0 𝑤ℎ𝑒𝑟𝑒 𝐶 = 40 + 0.8𝑌 𝐼0 = 50 𝐺0 = 100
Determine the equilibrium values of the endogenous variables within the model.
The Endogenous variables are: Y and C
To solve for the equilibrium values of Y we substitute for C in to national income equation
𝑌 = 40 + 0.8𝑌 + 50 + 100
𝑌 = 190 + 0.8𝑌
𝑌 − 0.8𝑌 = 190
0.2𝑌 = 190
𝑌 ∗ = 950
To obtain the value of equilibrium consumption, we substitute for the value of Y* into the
consumption function
𝐶 ∗ = 40 + 0.8(950)
𝐶 ∗ = 40 + 0.8(950)
𝐶 ∗ = 800
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1.3 Self-Assessment Questions
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1.4 E-references
1. Chiang Alpha, Wainwright K. (2005), Fundamental methods of Mathematical Economics,

4th edition, McGraw Hill, Singapore
2. Holden K., Pearson A.W. (1985), Introductory Mathematics for Economists, Macmillan
press, London
3. Mukras M.S. (1986), Elements of Mathematical Economics, Kenya Literature bureau
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LECTURE TWO: DIFFERENTIATION OF NON-ALGEBRAIC FUNCTIONS
2.1 Introduction
This lecture will guide the learner on how to differentiate exponential and logarithmic functions.
In addition, economic applications will be explored.
By the end of this lecture the learner should be able to:
2.2.1 Differentiate exponential functions.
2.2.2 Differentiate logarithmic functions.
2.2.3 Understand the economic applications of non-algebraic functions.
2.2.1/2.2.2 Differentiation of Non-Algebraic Functions (Exponential Functions and
Logarithmic Functions)
An algebraic function is any function that can be expressed in terms of polynomials or roots of
polynomials. For example:
4𝑋 2 +5𝑋−2
𝑌= is an algebraic function.
3𝑋+2
A non-algebraic function is any function where the independent variable appears in the power,
as a logarithm or a trigonometric function.
The following are examples of non-algebraic functions:
Y = sin 𝑋
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𝑌 = 𝑙𝑜𝑔5 𝑋
2 −7𝑋
𝑌 = 𝑒 2𝑋
In this course we will concentrate on the exponential and logarithmic functions because they
have more applications in economics.
Rule of differentiating Non-Algebraic Functions
a) The Natural Exponential Function rule
𝐼𝑓 𝑦 = 𝑒 𝑥
𝑑𝑦
= 𝑦 = 𝑒𝑥
𝑑𝑥
If 𝑦 = 𝑒 𝑓(𝑥)
𝑑𝑦
= 𝑓′(𝑥). 𝑒 𝑓(𝑥) - Chain Rule
𝑑𝑥
Examples
i) 𝑦 = 𝑒 4𝑥
𝑑𝑦
= 4𝑒 4𝑥
𝑑𝑥
ii) 𝑦 = 𝑒 −𝑥
𝑑𝑦
= −𝑒 −𝑥
𝑑𝑥
3 −7𝑥 2
iii) 𝑦 = 5𝑒 2𝑥
𝑑𝑦 3 2
= 5 (𝑒 2𝑥 −7𝑥 ) ∗ (6𝑥 2 − 14𝑥)
𝑑𝑥
𝑑𝑦 3 2
= 5 (6𝑥 2 − 14𝑥)(𝑒 2𝑥 −7𝑥 )
𝑑𝑥
b) Exponential function Rule with Arbitrary Bases
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𝑦 = 𝑎𝑥
𝑑𝑦
The easiest way of finding the derivative of such a function with respect to x (𝑑𝑥 ) is presented in
the following steps:
1. Take the logarithm of the function to the base “e”
Ln 𝑦 = 𝑥 𝐿𝑛 𝑎
2. Find the derivative of both sides with respect to x
1 𝑑𝑦
= (1) Ln a
𝑦 𝑑𝑥
𝑑𝑦
3. Making 𝑑𝑥 the subject of the formula, we have:
𝑑𝑦
= y Ln a = 𝑎 𝑥 𝐿𝑛 𝑎
𝑑𝑥
Examples
Find the derivatives of the following with respect to x
i) 𝑦 = 3𝑥
1. 𝐿𝑛 𝑦 = 𝑥 𝐿𝑛 3
1 𝑑𝑦
2. = (1) Ln 3
𝑦 𝑑𝑥
𝑑𝑦
3. = 𝑦 𝐿𝑛 3 = 3𝑥 𝐿𝑛 3
𝑑𝑥
3 −𝑥 2
ii) 𝑦 = 53𝑥
4. 𝐿𝑛 𝑦 = (3𝑥 3 − 𝑥 2 )𝐿𝑛 5
1 𝑑𝑦
5. = (9𝑥 2 − 2𝑥) Ln 5
𝑦 𝑑𝑥
𝑑𝑦 3 −𝑥 2
6. = 𝑦 (9𝑥 2 − 2𝑥) 𝐿𝑛 5 = 53𝑥 (9𝑥 2 − 2𝑥)𝐿𝑛 5
𝑑𝑥
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c) The Natural Logarithmic function rule
𝑦 = 𝐿𝑛𝑥
𝑑𝑦 1
=
𝑑𝑥 𝑥
In general, the rule becomes:
𝑌 = 𝐿𝑛 𝑓(𝑥)
𝑑𝑦 𝑓′ 𝑥
= 𝑓(𝑥)
𝑑𝑥
Examples
i) 𝑦 = 𝐿𝑛(𝑎𝑥)
𝑑𝑦 𝑎 1
= 𝑎𝑥 = 𝑥
𝑑𝑥
ii) 𝑦 = 𝐾 𝐿𝑛𝑥
𝑑𝑦 𝐾
=
𝑑𝑥 𝑥
iii) 𝑦 = 𝐿𝑛 𝑥 2
𝑑𝑦 𝑓′(𝑥) 2𝑥 2−1 2
= = =
𝑑𝑥 𝑓(𝑥) 𝑥2 𝑥
iv) 𝑦 = ln(3𝑥 3 − 2𝑥 2 )
𝑑𝑦 9𝑥 2 − 4𝑥
=
𝑑𝑥 3𝑥 3 − 2𝑥 2
𝑑𝑦 9𝑥 − 4
=
𝑑𝑥 3𝑥 2 − 2𝑥
v) 𝑦 = 𝑡 3 𝐿𝑛𝑡 2
Get the derivative of 𝑌 with respect to 𝑡
Use the product rule
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𝑑𝑦 2 (𝐿𝑛𝑡 2 )
𝑡 3 . 2𝑡
= 3𝑡 + 2
𝑑𝑡 𝑡
= 3𝑡 2 𝐿𝑛𝑡 2 + 2𝑡 3+1−2
= 3𝑡 2 𝐿𝑛𝑡 2 + 2𝑡 2
= 𝑡 2 (3𝐿𝑛𝑡 2 + 2)
d) Other logarithmic functions rule
If a function is given as:
𝑙𝑛𝑋
a) 𝑌 = 𝑙𝑜𝑔𝑎 𝑋 , 𝑖𝑛𝑡𝑜 𝑛𝑎𝑡𝑢𝑟𝑎𝑙 𝑙𝑜𝑔𝑎𝑟𝑖𝑡ℎ𝑚𝑠, 𝑡ℎ𝑒 𝑓𝑢𝑛𝑐𝑡𝑖𝑜𝑛 𝑏𝑒𝑐𝑜𝑚𝑒𝑠: 𝑌= 𝑙𝑛𝑎
𝑑𝑦 1 1
= 𝑙𝑛𝑎 𝑋
𝑑𝑥
Example
i) 𝑌 = 𝑙𝑜𝑔10 𝑋
𝑑𝑌 1 1
= 𝑙𝑛10 . 𝑋
𝑑𝑋
ln 𝑓(𝑋) 𝑑𝑦 𝑓 ′ (𝑋)
b) If 𝑌 = 𝑙𝑜𝑔𝑎 𝑓(𝑋) 𝑌= = 𝑙𝑛𝑎 𝑓(𝑥
𝑙𝑛𝑎 𝑑𝑋
Example
i) 𝑌 = 𝑙𝑜𝑔5 (2𝑋 3 + 3𝑋)
ln(2𝑋 3 +3𝑋)
𝑌= 𝑓 ′ (𝑋) = 6𝑋 2 + 3
𝑙𝑛5
𝑑𝑦 6𝑋 2 +3 6𝑋 2 +3
= =
𝑑𝑋 𝑙𝑛5(2𝑋 3 +3𝑋) 1.61(2𝑋 3 +3𝑋)
e) Differentiation of complex products and quotients
Sometimes we may encounter products and quotients of functions whose derivatives may turn out
to be difficult to compute by means of the product and quotient rules. One efficient approach of
dealing with such functions is to make use of logarithms.
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We demonstrate how to do this using the following examples:
Examples
Find the derivatives of the following:
(1+𝑥 3 )
1. 𝑦 = (𝑥+5)(3𝑥−2)
Obtain the natural log of each term
𝐿𝑛 𝑦 = 𝐿𝑛 (1 + 𝑥 3 ) − 𝐿𝑛 (𝑥 + 5) − 𝐿𝑛 (3𝑥 − 2)
Obtaining the derivatives of both sides we get
1 𝑑𝑦 3𝑥 2 1 3
= (1+𝑥 3 ) − (𝑥+5) − 3𝑥−2
𝑦 𝑑𝑥
Multiply both sides by y to obtain
𝑑𝑦 3𝑥 2 1 3
= {(1+𝑥 3 ) − (𝑥+5) − 3𝑥−2}*y
𝑑𝑥
Substitute for y
𝑑𝑦 3𝑥 2 1 3 (1+𝑥 3 )
= {(1+𝑥 3 ) − (𝑥+5) − 3𝑥−2}*((𝑥+5)(3𝑥−2) )
𝑑𝑥
2. 𝑦 = 𝑎3𝑥+5 𝑒 5𝑥+9
𝐿𝑛 𝑦 = (3𝑥 + 5)𝐿𝑛 𝑎 + (5𝑥 + 9)𝐿𝑛 𝑒
𝐿𝑛 𝑒 = 1
Rewrite as follows:
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𝐿𝑛 𝑦 = (3𝑥 + 5)𝐿𝑛 𝑎 + (5𝑥 + 9)
1 𝑑𝑦
= 3 𝐿𝑛 𝑎 + 5
𝑦 𝑑𝑥
𝑑𝑦
= {3 𝐿𝑛 𝑎 + 5} ∗ 𝑦
𝑑𝑥
𝑑𝑦
= {3 𝐿𝑛 𝑎 + 5} ∗ (𝑎3𝑥+5 𝑒 5𝑥+9 )
𝑑𝑥
2.2.3 Economic applications of non-algebraic functions.
a) Growth Rate of Economic Variables
i) Growth Rate of Single Functions
If Y is a function of time given as:
𝑌 = 𝑓(𝑡)
Method 1: The rate of growth of Y with time is given as
𝑑𝑌/𝑑𝑡 𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑓𝑢𝑛𝑐𝑡𝑖𝑜𝑛 𝑓 ′ (𝑡)

𝑔= = =
𝑌 𝑡𝑜𝑡𝑎𝑙 𝑓𝑢𝑛𝑐𝑡𝑖𝑜𝑛 𝑓(𝑡)
As long as the function f(t) is continuous and differentiable.
Method 2: The growth rate of Y can also be obtained through making use of logarithms
This is computed by the following steps:
1. Take logarithms of the function of both sides
𝐿𝑛 𝑌 = 𝐿𝑛 𝑓(𝑡)
2. Differentiate the function with respect to t to obtain
𝑑𝑦 𝑓 ′ (𝑡)
(𝐿𝑛 𝑓(𝑡)) =
𝑑𝑡 𝑓(𝑡)
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Example One
The population size in a country denoted as N is defined by the following function:
𝑁 = 𝑁0 𝑒 𝑎𝑡
Determine the rate of growth in population size.
Using Method 1
𝑑𝑁⁄𝑑𝑡
𝑔=
𝑁
𝑑𝑁
= 𝑎𝑁0 𝑒 𝑎𝑡
𝑑𝑡
𝑎𝑁0 𝑒 𝑎𝑡
𝑔= =𝑎
𝑁0 𝑒 𝑎𝑡
Example Two
The growing value (V) of an asset is given by the exponential function. Find the rate of growth
of the value of the asset.
𝑉 = 𝐵𝑒 𝑟𝑡
Where: B = Constant
r = rate of growth
t = time
Solution
Using Method 2
Taking the natural logs of the function:
𝐿𝑛 𝑉 = 𝐿𝑛 𝐵 + 𝑟𝑡 𝐿𝑛 𝑒
Computing the derivative of the function with respect to t we obtain:
Page 24 of 167
Growth rate = r
ii) Growth rate of product of functions
Consider two functions 𝑝(𝑡) and 𝑞(𝑡), where both functions are known to be growing with
time. The product of the two functions is given by:
𝑦 = 𝑝. 𝑞
Where: 𝑝 = 𝑝(𝑡) and 𝑞 = 𝑞(𝑡) and 𝑦 = 𝑦(𝑡)
All these functions are functions of time. The growth rate of y (𝐺𝑦 ) is obtained by the following
two step procedure.
Step 1:
Take logarithms of the equation to the base e (Ln)
𝐿𝑛𝑦 = 𝐿𝑛 𝑝 + 𝐿𝑛 𝑞
To obtain the growth rate of y, we obtain the derivative of Ln y with respect to time ‘t’
𝑑 𝑑 𝑑
𝐺𝑦 = {𝐿𝑛 𝑦} = {𝐿𝑛 𝑝} + {𝐿𝑛 𝑞} = 𝐺𝑝 + 𝐺𝑞
𝑑𝑡 𝑑𝑡 𝑑𝑡
The results tell us that the growth rate of the product of two functions is equal to the sum of
the growth rates of the individual functions.
Example
The price (P) of tea harvested from a plantation is growing at 3% per annum, while the quantity
(Q) supplied is growing at 1.8% per annum. Calculate the annual growth rate of the total
revenue (R) from the sale of the tea.
Solution
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𝑅 = 𝑃. 𝑄
Where: 𝑃 = 𝑃(𝑡), 𝑄 = 𝑄(𝑡), 𝑅 = 𝑅(𝑡)
𝐿𝑛 𝑅 = 𝐿𝑛 𝑃 + 𝐿𝑛 𝑄
𝑑 𝑑 𝑑
𝐺𝑅 = {𝐿𝑛 𝑅} = {𝐿𝑛 𝑃} + {𝐿𝑛 𝑄} = 𝐺𝑃 + 𝐺𝑄
𝐺𝑅 = 3% + 1.8% = 4.8%
iii) Growth rate of quotient of functions
We shall consider two functions of time: u and v whose quotient is given by:
𝑢
𝑦=
𝑣
Where 𝑢 = 𝑢(𝑡); 𝑣 = 𝑣(𝑡); 𝑦 = 𝑦(𝑡)
All the three functions are functions of time. The growth rate of y is derived by applying the
following procedure:
Step 1
Take Logarithms of y to obtain:
𝐿𝑛 𝑦 = 𝐿𝑛 𝑢 − 𝐿𝑛 𝑣
Step 2
Find the growth rate of y by finding the derivative of 𝐿𝑛 𝑦 with respect to time.
𝑑 𝑑 𝑑
𝐺𝑦 = {𝐿𝑛 𝑦} = {𝐿𝑛 𝑢} − {𝐿𝑛 𝑣} = 𝐺𝑢 − 𝐺𝑣
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The results tell us that the growth rate of the quotient of two functions is equal to the difference
of the growth rates of the individual functions i.e the growth rate of the numerator minus the
growth rate of the denominator.
Example
The national income (Y) of a developing country is growing at an annual rate of 1.3% while
the population (P) is growing at the rate 2.5% per annum. Find the growth rate of the per capita
income (PCY)
Solution
𝑌
𝑃𝐶𝑌 =
𝑃
Where: 𝑌 = 𝑌(𝑡); 𝑃 = 𝑃(𝑡); 𝑃𝐶𝑌 = 𝑃𝐶𝑌(𝑡)
The growth rate of PCY is obtained by the following procedure:
Step 1
Find the logarithm of both sides of the function
𝐿𝑛 𝑃𝐶𝑌 = 𝐿𝑛 𝑌 − 𝐿𝑛 𝑃
Step 2
Find the growth rate of PCY by finding the derivative of 𝐿𝑛 𝑃𝐶𝑌 with respect to time.
𝑑 𝑑 𝑑
𝐺𝑃𝐶𝑌 = {𝐿𝑛 𝑃𝐶𝑌} = {𝐿𝑛 𝑌} − {𝐿𝑛 𝑃} = 𝐺𝑌 − 𝐺𝑃
= 1.3% − 2.5% = 1.2%
b) Elasticity of Economic Functions:
Consider the univariate function
𝑦 = 𝑓(𝑥)
Page 27 of 167
Using the concept of logarithms, the elasticity of y with respect to x is obtained using the following formula:
𝑑(𝐿𝑛 𝑦)
𝜀𝑦,𝑥 =
𝑑(𝐿𝑛 𝑥)
Example
Find the elasticity of demand for the following hyperbolic demand function
𝑄 = 𝑎𝑃−𝑏
Solution
Taking logarithms on both sides we obtain:
𝐿𝑛 𝑄 = 𝐿𝑛 𝑎 − 𝑏 𝐿𝑛 𝑃
To obtain the elasticity of Q with respect to P by finding the derivative of 𝐿𝑛 𝑄 with respect to
𝐿𝑛 𝑃
𝑑(𝐿𝑛 𝑄)
𝜀𝑄,𝑃 = = −𝑏
𝑑(𝐿𝑛 𝑃)
a) The initial value of wine is W0 = 100, the rate of growth is 3%, and the growing value of
wine is given by the following equation.
Wt = W0er√t
Required: Calculate the value of wine at the end of 9th year.
b) Suppose that the population of Nairobi County is growing according to the function
N(t) = 2,400,000e0.03t, where N(t) is population size at time t; t is the number of years.
What time is required for the population to double?
2.4 E-references
Page 28 of 167
1. Chiang Alpha, Wainwright K. (2005), Fundamental methods of Mathematical
Economics, 4th edition, McGraw Hill, Singapore
press, London
Page 29 of 167
LECTURE THREE: PARTIAL DIFFERENTIATION
3.1 Introduction
This lecture will guide the learner on how to differentiate multivariate functions and its
applications in economics especially in consumer and producer theories.
3.2.1 Get the total differential of a multivariate function.
3.2.2 Understand the rules of partial derivatives to multivariate functions.
3.2.3 Understand the concept of second order partial derivatives
3.2.4 Understand the economic applications of partial derivatives in economics
3.2.1 The concept of total differential of a multivariate function
A function of two or more independent variables is called a multivariate function. The total change
of the dependent variable will be as a result of the changes resulting from a change of each of the
independent variable.
For example, when we consider the change of utility of a household which consumes two types of
food, ugali and rice, we can represent it as:
U = f (X1, X2)
Where U = total utility derived
X1 = units of ugali consumed
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X2 = units of rice consumed
When analyzing the total change in the utility of the household, due to change in number of units
of each food item consumed, it will be composed of two parts.
i) Change in utility due to change in units of ugali consumed
ii) Change in utility due to change in units of rice consumed
Symbolically: the total change in utility is given as:
𝜕𝑈 𝜕𝑈
𝑑𝑈 = 𝑑𝑋1 + 𝑑𝑋
𝜕𝑋1 𝜕𝑋2 2
The sum of the two parts is called the total differential of the utility function. i.e
𝑑𝑈 = Total differential of utility. It is the total change in utility as a result of change in number of
units of ugali and number of units in rice consumed.
Each of the parts is called a partial differential of the utility function with respect to gods 1 and 2
respectively.
𝜕𝑈
𝑑𝑋1 = Partial differential of utility function with respect to X1
𝜕𝑋1
. It measures the change in utility due to amount of good 1(Ugali) consumed
𝜕𝑈
𝑑𝑋2 = Partial differential of utility function with respect to X2. It measures the change in utility
𝜕𝑋2
due to the amount of good 2 (rice) consumed.
In general, if a function is given as:
𝑌 = 𝑓(𝑋1 , 𝑋2 , 𝑋3 , … … … … . . 𝑋𝑛 )
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The total differential is given as:
𝜕𝑌 𝜕𝑌 𝜕𝑌 𝜕𝑌
𝑑𝑌 = 𝑑𝑋1 + 𝑑𝑋2 + 𝑑𝑋3 … … … … … … . . + 𝑑𝑋
𝜕𝑋1 𝜕𝑋2 𝜕𝑋3 𝜕𝑋𝑛 𝑛
𝜕𝑌
Where 𝜕𝑋 𝑑𝑋𝑖 represents the change in dependent variable Y due to change in variable i
𝑖
If we are interested in knowing how Y changes when Xi changes, the other variables are assumed
to be constant.
Example1
𝑌 = 4𝑋1 + 10𝑋2 𝑋12 + 3𝑋23
Find the total differential of the function
𝜕𝑌 𝜕𝑌
𝑑𝑌 = 𝑑𝑋1 + 𝑑𝑋
𝜕𝑋1 𝜕𝑋2 2
𝜕𝑌
= Partial derivative of Y with respect to X1 when X2 is held constant.
𝜕𝑋1
𝜕𝑌
= Partial derivative of Y with respect to X2 when X1 is held constant.
𝜕𝑋2
𝑑𝑌 = (4 + 20𝑋2 𝑋1 ) 𝑑𝑋1 + (10𝑋12 + 9𝑋22 )𝑑𝑋2
Example 2
Get the total differential of the function below:
𝑍 = 5𝑋𝑌 + 2𝑋 2 𝑌 – 8𝑌 2 𝑋
Solution
Page 32 of 167
𝑑𝑍 = (5𝑌 + 4𝑋𝑌 – 8𝑌 2 )𝑑𝑋 + (5𝑋 + 2𝑋 2 – 16𝑌𝑋)𝑑𝑌
Partial differentiation
This is applied to multivariable functions when we are analyzing the change in the dependent
variables as a result of change in one of the independent variables when the other independent
variables are held constant.
For example, a firm produces 2 goods 1 and 2. If we want to know the change in the total cost of
the firm when the production of good1 is increased when production of good 2 is held constant,
partial derivatives of the cost function with respect to change in good 1 will be useful.
3.2.2 Rules of partial differentiation
Whenever we differentiate multivariate function with respect to one of the independent variable,
the other variables are treated as constants.
Example
Y = 15X1 + 8X22
𝜕𝑌
= 15 (8x22 behaves like a constant hence its derivative with respect to X1 is 0)
𝜕𝑋1
𝜕𝑌
= 16𝑋2 (15x1 is a constant. Its derivative with respect to X2 is 0)
𝜕𝑋2
If:
Y = 2X1 X2 + 3X12 + 12X22
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𝜕𝑌
= 2𝑋2 + 6𝑋1 (12X22 behaves as constant hence its derivative with respect to
𝜕𝑋1
X1 is 0, but in 2X1X2, X2 is in a multiplicative function, hence its retained as a constant)
𝜕𝑌
= 2𝑋1 + 24𝑋2
𝜕𝑋2
1. Sum and difference rule.
If Y = f(X1 ,X2) ± g (X1,X2)
Then:
𝜕𝑌
= 𝑓 ′ (𝑋1 ) + 𝑔′ (𝑋1 )
𝜕𝑋1
𝑆𝑖𝑚𝑖𝑙𝑎𝑟𝑙𝑦
𝜕𝑌
= 𝑓 ′ (𝑋2 ) + 𝑔′ (𝑋2 )
𝜕𝑋2
Example
𝜕𝑦 𝜕𝑦
Get 𝜕𝑥 𝑎𝑛𝑑 in the following function
1 𝜕𝑥2
i. Y = 8X1 + 5X12 X2
𝜕𝑌
= 8 + 10𝑋1 𝑋2
𝜕𝑋1
𝜕𝑌
= 5𝑋1 2
𝜕𝑋2
ii. Y = 15X22 X13 – 2X12 X2
Page 34 of 167
𝜕𝑌
= 45X22 X12 – 4X1 X2
𝜕𝑋1
𝜕𝑌
= 30X2 X13 – 2X12
𝜕𝑋2
Practice question
Y = 5X12 + 3X1 X2 – 4X13 X22
𝜕𝑦 𝜕𝑦
Get 𝜕𝑥 𝑎𝑛𝑑
1 𝜕𝑥2
2. Product rule
If we have a function Y given as:
Y= f(X1 ,X2) . g (X1,X2)
The partial derivatives will be given as:
𝜕𝑌 𝑑𝑓 𝑑𝑔
= 𝑑𝑋 . 𝑔(𝑋1 , 𝑋2 ) + 𝑑𝑋 𝑓(𝑋1 , 𝑋2 )
𝜕𝑋1 1 1
𝑆𝑖𝑚𝑖𝑙𝑎𝑟𝑙𝑦
𝜕𝑌 𝑑𝑓 𝑑𝑔
= 𝑑𝑋 . 𝑔(𝑋1 , 𝑋2 ) + 𝑑𝑋 𝑓(𝑋1 , 𝑋2 )
𝜕𝑋2 2 2
Example:
𝑌 = (8𝑋 12 + 2𝑋2 ). (4𝑋23 + 3𝑋1 𝑋2 )
𝜕𝑌
= 16𝑋1 (4𝑋23 + 3𝑋1 𝑋2 ) + 3𝑋2 (8𝑋 12 + 2𝑋2 )
𝜕𝑋1
= 64X1X23 + 48X12 X2 + 24X2 X12 + 6X22
Page 35 of 167
= 64X1 X23 + 72X12 X2 + 6X22
𝜕𝑌
= 2(4𝑋23 + 3𝑋1 𝑋2 ) + (12𝑋2 2 + 3𝑋1 )(8𝑋 12 + 2𝑋2 )
𝜕𝑋2
= 8X23 + 6X1 X2 + 96X22 X12 + 24X23 + 24X13 + 6X1 X2
= 32X23 + 12X1 X2 + 96X22 X12 +24X13
3. Quotient rule
𝑓(𝑋 ,𝑋 )
𝑌 = 𝑔(𝑋1 ,𝑋2 )
1 2
𝑑𝑓 𝑑𝑔
𝜕𝑌 . 𝑔(𝑋1 , 𝑋2 ) − 𝑓(𝑋1 , 𝑋2
𝑑𝑋1 𝑑𝑋1
=
𝜕𝑋1 (𝑔(𝑋1 , 𝑋2 )2 )
𝑑𝑓 𝑑𝑔
𝜕𝑌 . 𝑔(𝑋1 , 𝑋2 ) − 𝑓(𝑋1 , 𝑋2
𝑑𝑋2 𝑑𝑋2
=
𝜕𝑋2 (𝑔(𝑋1 , 𝑋2 )2 )
Example:
8𝑋 21 .𝑋2
𝑌 = 4𝑋 2
1 + 3𝑋2
𝑓(𝑋1 ) = 64𝑋1 2 𝑋2 𝑔(𝑋1 ) = 4
𝑓(𝑋2 ) = 8𝑋 12 𝑔(𝑋2 ) = 6𝑋2
𝜕𝑌 16𝑋1 𝑋2 . (4𝑋1 + 3𝑋2 2 ) − 4(8𝑋 12 . 𝑋2 )

= 2
𝜕𝑋1 (4𝑋 + 3𝑋 2 )
1 2
𝜕𝑌 64𝑋1 2 𝑋2 + 48𝑋1 𝑋2 3 − 32𝑋 12 . 𝑋2 )

= 2
𝜕𝑋1 (4𝑋 + 3𝑋 2 )
1 2
Page 36 of 167
𝜕𝑌 32𝑋1 2 𝑋2 + 48𝑋1 𝑋2 3
= 2
𝜕𝑋1 (4𝑋 + 3𝑋 2 )
1 2
𝜕𝑌 8𝑋 12 . (4𝑋1 + 3𝑋2 2 ) − 6𝑋2 (8𝑋 12 . 𝑋2 )

= 2
𝜕𝑋2 (4𝑋 + 3𝑋 2 )
1 2
2
𝜕𝑌 32𝑋 13 . − 24𝑋 12 𝑋2
= 2
𝜕𝑋2 (4𝑋1 + 3𝑋2 2 )
4. Chain rule - derivative of a function of 2two independent variables raised to power
𝑌 = [𝑓(𝑋1 , 𝑋2 )]𝑛
𝜕𝑌
= 𝑛. [𝑓(𝑋1 , 𝑋2 )]𝑛−1 . 𝑓′𝑋1
𝜕𝑋1
𝜕𝑌
= 𝑛. [𝑓(𝑋1 , 𝑋2 )]𝑛−1 . 𝑓′𝑋2
𝜕𝑋2
Example
Y = (8X22 + 3X1 X2)4
𝜕𝑌
= 4. [8𝑋22 + 3𝑋1 𝑋2 ]3 .( 3𝑋2 )
𝜕𝑋1
𝜕𝑌
= 4. [8𝑋22 + 3𝑋1 𝑋2 ]3 .( 16𝑋2 + 3𝑋1 )
𝜕𝑋2
3.2.3 First order and second order partial derivative
i) First order partial derivative
If we have a multivariate function given as:
Page 37 of 167
𝑌 = 𝑓(𝑋1 , 𝑋2 )
Then:
𝜕𝑌 𝜕𝑌
𝑎𝑛𝑑 are called the first order partial derivatives with respect to X1 and X2 respectively.
𝜕𝑋1 𝑑𝑋2
When the first order partial derivatives are differentiated again with respect to X1 and X2 we get
the second order partial derivatives and the cross partial derivatives.
ii) Second order partial derivatives:
Given : 𝑌 = 𝑓(𝑋1 , 𝑋2 )
Then:
𝜕𝑌 𝜕𝑌 𝜕𝑌
𝑐𝑎𝑛 𝑏𝑒 𝑤𝑟𝑖𝑡𝑡𝑒𝑛 𝑎𝑠: = 𝑓𝑋1 while 𝜕𝑋 = 𝑓𝑋2
𝜕𝑋1 𝜕𝑋1 2
The second order partial derivative of Y with respect to X1 is given as:
𝜕 2𝑌
= 𝑓𝑋1 𝑋1
𝜕𝑋1 2
While the second order partial derivative of Y with respect to X2 is given as:
𝜕 2𝑌
= 𝑓𝑋2 𝑋2
𝜕𝑋2 2
𝜕𝑌 𝜕𝑌
In addition we get the partial derivatives of with respect to 𝑋2 𝑎𝑛𝑑 with respect to 𝑋1.
𝜕𝑋1 𝜕𝑋2
These are given as:
𝜕2 𝑌
= 𝑓𝑋1 𝑋2 This tells us how 𝑓𝑋1 changes when X2 changes.
𝜕𝑋1 𝜕𝑋2
Page 38 of 167
And
𝜕2 𝑌
= 𝑓𝑋2 𝑋1 tells us how 𝑓𝑋2 changes when X1 changes.
𝜕𝑋2 𝜕𝑋1
These two second order partial derivatives are known as the cross partial derivatives.
According to the young’s theorem, the cross partial derivatives should be equal. i.e.
𝑓𝑋1 𝑋2 = 𝑓𝑋2 𝑋1
Example:
Given a function
Y = 3X12 + 2X23 + 6X1 X2
Get the first and the second order partial derivatives with respect to X1 and X2.
𝜕𝑌 𝜕𝑌
= 6𝑋1 + 6𝑋2 while = 6𝑋22 + 6𝑋1
𝜕𝑋1 𝜕𝑋2
𝜕 2𝑌
= 𝑓𝑋1 𝑋1 = 6
𝜕𝑋1 2
𝜕 2𝑌
= 𝑓𝑋2 𝑋2 = 12𝑋2
𝜕𝑋2 2
𝜕 2𝑌
= 𝑓𝑋1 𝑋2 = 6
𝜕𝑋1 𝜕𝑋2
𝜕 2𝑌
𝑎𝑛𝑑 = 𝑓𝑋2 𝑋1 = 6
𝜕𝑋2 𝜕𝑋1
The young’s theorem is proved:
Page 39 of 167
𝑓𝑋1 𝑋2 = 𝑓𝑋2 𝑋1 = 6
a) Get the partial derivatives of the following functions:
i) Y =f (X1 X2) = [18X12 + 3X2 X1 – X22]4
8𝑋12
ii) 𝑦 = (2𝑋1 +3𝑋2 𝑋1 )3 )
iii) Y = (4X1+ 8X22)2 (9X22 + 2X1 X2)
b) Get the first order, second order and cross partial derivatives of the following functions.
i) Y = 8X1 + 15X12 X2 + 3X23
ii) Y = 2X2 + 3XW + 7W3
3.4 E-references
(i) Chiang Alpha, Wainwright K. (2005), Fundamental methods of Mathematical Economics, 4th
edition, McGraw Hill, Singapore
(ii) Holden K., Pearson A.W. (1985), Introductory Mathematics for Economists, Macmillan
press, London
(iii)Mukras M.S. (1986), Elements of Mathematical Economics, Kenya Literature bureau
Page 40 of 167
LECTURE FOUR: ECONOMIC APPLICATIONS OF PARTIAL DERIVATIVES
4.1 Introduction
In this lecture we shall learn how partial derivatives and the second order partial derivatives are
applied in Economics.
4.2.1 Get the marginal functions and their nature in multivariate economic functions
4.2.2 Compute the price and income elasticity of demand.
4.2.1 Marginal functions and their nature in multivariate economic functions
In Economics, most functions are multivariate. We therefore need to look at how these functions
change due to change in one of the independent variable when others are held constant.
a) Utility function and the marginal utility
Assume a consumer derives satisfaction from consuming 2 goods 1 and 2. The utility function
can be given as
U =f (Q1, Q2)
Where U = Total utility
Q1 = Amount of good 1 consumed
Q2 = Amount of good 2 consumed.
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We assume that this utility function is continuous, differentiable and 2nd order partial derivatives
can be obtained.
If each of the 2 goods has positive marginal utility, then
𝜕𝑈 𝜕𝑈
>0 >0
𝜕𝑄1 𝜕𝑄2
𝜕𝑈
= marginal utility of good 1
𝜕𝑄1
𝜕𝑈
= marginal utility of good 2
𝜕𝑄2
Total differential of the utility function
𝜕𝑈 𝜕𝑈
𝑑𝑈 = 𝑑𝑋1 + 𝑑𝑋
𝜕𝑋1 𝜕𝑋2 2
𝑑𝑈 = 𝑀𝑈𝑋1 𝑑𝑋1 + 𝑀𝑈𝑋2 𝑑𝑋2
If you recall what you learnt in micro economics I, an indifference comes is convex to be origin
and its downward sloping. Along an indifference curve, the utility level is constant and does not
change. Hence, 𝑑𝑈 = 0
0 = 𝑀𝑈𝑋1 𝑑𝑋1 + 𝑀𝑈𝑋2 𝑑𝑋2
The slope of an indifference curve is given as:
𝑑𝑋2 −𝑀𝑈𝑋2
=
𝑑𝑋1 𝑀𝑈𝑋2
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Q2
Indifference map
Q1
If the slope of the marginal utility with respect to a good is positive, the utility function displays
decreasing marginal utility with respect to that good and if negative, it displays diminishing
marginal utility. Most normal goods display decreasing marginal utility hence;
𝜕𝑀𝑈(𝑄1 )
is expected to be less than 0.
𝜕𝑄1
𝜕𝑀𝑈(𝑄1 ) 𝜕 2 𝑈
=
𝜕𝑄1 𝜕𝑄1 2
Example one
A utility function is given as:
U=Q½ Q4/3
i)
Determine the marginal utility of good 1 and 2
ii)
Determine the nature of marginal utility for each of the goods.
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Solution
𝜕𝑈 4/3
i) = 0.5𝑄1−0.5 𝑄2 = marginal utility of good 1
𝜕𝑄1
𝜕𝑈 4 1/3
= 3 𝑄10.5 𝑄2 marginal utility of good 2
𝜕𝑄2
𝜕(𝑀𝑈𝑄 ) 4/3
4/3 −0.25𝑄2
ii) 1
= −0.25𝑄1−1.5 𝑄2 = Given that 𝑄1 𝑎𝑛𝑑 𝑄2 are non-negative, it
𝜕𝑄1 𝑄11.5
means the entire expression will be negative, hence good 1 displays
decreasing marginal utility.
𝜕(𝑀𝑈𝑄 ) 4 −1/3 4 𝑄10.5

iii) 2
= 9 𝑄10.5 𝑄2 =9 1/3 Given that 𝑄1 𝑎𝑛𝑑 𝑄2 are non-negative, it means the
𝜕𝑄2 𝑄2
entire expression will be positive, hence good 2 displays increasing marginal utility.
b) Cost function and Marginal cost function
We have been assuming that a firm produces 1 product only. But in some cases, a firm is likely to
produce several products. There is need to find out how the total cost of a firm changes when the
production one of the products change when the production of other products is held constant. The
total cost of the firm will be a function of production level of each of the products. If we have 𝑛
products then
𝑇𝐶 = 𝑓(𝑄1 , 𝑄2 , … … . 𝑄𝑛 )
Assuming we have 2 products only then
𝑇𝐶 = 𝑓(𝑄1 , 𝑄2 )
The marginal costs of good 1 is given as:
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and 2 are
𝑑𝑇𝐶 𝑑𝑇𝐶
𝑀𝐶1 = 𝑑𝑄 While marginal cost of good 2 is given as: 𝑀𝐶2 = 𝑑𝑄
1 2
Example
𝐶 = 8𝑄13 + 6𝑄22 + 4𝑄1 𝑄2 − 10
𝑑𝑇𝐶
𝑀𝐶1 = = 24𝑄1 2 + 4𝑄2
𝑑𝑄1
𝑑𝑇𝐶
𝑀𝐶2 = = 12𝑄2 + 4𝑄1
𝑑𝑄2
The firm is also interested in knowing if marginal costs are increasing or decreasing with output
change. This is computed by getting the derivatives of partial marginal cost functions with respect
to that good.
In our previous example:
𝑑𝑇𝐶
𝑀𝐶1 = = 24𝑄1 2 + 4𝑄2
𝑑𝑄1
To determine if MC1 increases or decreases with output we differentiate it with respect to Q1
𝑑𝑀𝐶1
= 48𝑄1 > 0 since Q1 is positive, the whole expression will be positive, hence good 1
𝑑𝑄1
displays increasing marginal cost.
Similarly, to determine if MC2 increases or decreases with output we differentiate it with respect
to Q2.
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𝑑𝑀𝐶2
= 12 > 0, hence good 2displays increasing marginal cost.
𝑑𝑄2
c) Total Product and Marginal Product
In mathematics for economics 1, you learnt about the production function. The production function
describes the output level (total product) as a function of the level of inputs employed by the firm.
If we assume we have only two factors of production, capital and labour, we can denote the
production function as:
𝑄 = 𝑓(𝐿, 𝐾)
If we want to know how the level of output changes when one of the inputs is changed while the
other one is held constant, we use the partial derivatives. The marginal product of labour is the
partial derivative of the production function with respect to labour when capital is held constant.
i.e.
𝜕𝑄
𝑀𝑃𝐿 =
𝜕𝐿
On the other hand, the marginal product of capital is the partial derivative of the production
function with respect to capital when the labour is held constant
𝜕𝑄
𝑀𝑃𝐾 =
𝜕𝐾
Slope of an isoquant
It we get the total differential of a production function; it will be given as:
𝜕𝑄 𝜕𝑄
𝑑𝑄 = 𝑑𝐿 + 𝑑𝐾
𝜕𝐿 𝜕𝐾
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Along an isoquant the output level does not change, hence the total differential, dQ=0
If we equate the total differential to 0, we get:
𝜕𝑄 𝜕𝑄
𝑑𝑄 = 𝑑𝐿 + 𝑑𝐾 = 0
𝜕𝐿 𝜕𝐾
𝑀𝑃𝐿 𝑑𝐿 + 𝑀𝑃 𝐾 𝑑𝐾 = 0
𝑀𝑃𝐾 𝑑𝐾 = 𝑀𝑃𝐿 𝑑𝐿
Assuming that K is on the Y axis and L is on the X axis, the slope will be given as:
𝑑𝐾 𝑀𝑃𝐿
=−
𝑑𝐿 𝑀𝑃𝐾
This is the marginal rate of technical substitution (MRTS).
If the derivative of the marginal product of labour with respect to labour is positive, the marginal
product is said to be increasing as labour use increases. On the other hand, if it is negative, there
is diminishing marginal product. If it is 0, it has constant marginal product.
If the derivative of the marginal product of capital with respect to capital is positive, the marginal
product is said to be increasing as capital use increases. On the other hand, if it is negative, there
is diminishing marginal product. If it is 0, it has constant marginal product.
Example
A production function (total product) is given as:
𝑄 = 80𝐾 0.2 𝐿0.5
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Determine the marginal product of labour, marginal product of capital, the slope of the isoquant
and whether the marginal products are increasing or decreasing.
Solution
𝜕𝑄 40𝐾 0.2
𝑀𝑃𝐿 = = 40𝐾 0.2 𝐿−0.5 = 0.5
𝜕𝐿 𝐿
𝜕𝑄 −0.8 0.5
16𝐿0.5
𝑀𝑃𝐾 = = 16𝐾 𝐿 = 0.8
𝜕𝐾 𝐾
𝑑𝐾 𝑀𝑃𝐿 40𝐾 0.2 16𝐿0.5 2.5𝐾

𝑆𝑙𝑜𝑝𝑒 = =− = 0.5 ÷ 0.8 =
𝑑𝐿 𝑀𝑃𝐾 𝐿 𝐾 𝐿
Nature of the Marginal products:
𝜕𝑀𝑃𝐿 𝜕 2 𝑄 −20𝐾 0.2

= 2 = −20𝐾 0.2 𝐿−1.5 = <0
𝜕𝐿 𝜕𝐿 𝐿1.5
Since K and L are positive, the partial derivative of MPL with respect to L will be negative. Hence
marginal product of labour decreases as more labour is employed (Diminishing / Decreasing MPL).
𝜕𝑀𝑃𝑘 𝜕 2 𝑄 −1.8 0.5

−12.8𝐿0.5
= = −12.8𝐾 𝐿 = <0
𝜕𝐾 𝜕𝐾 2 𝐾 1.8
There is diminishing marginal product of capital as capital use increases.
Page 48 of 167
4.2.2 Partial Elasticity of Demand
In partial market equilibrium, the demand for a product is assumed to be a function of its own price
when other factors are held constant.
𝑄𝑑𝑥 = 𝑓(𝑃𝑥) ceteris paribus
𝑄𝑑𝑦 = 𝑓(𝑃𝑦)
This is a very simplified market model. In most cases, the demand of a product will be affected
by its own price, and also the prices of other related commodities such as its substitutes and
complements, the income among other variables.
Assuming we have a product A, its demand function can be given as:
𝑄𝐴 = 𝑓(𝑃𝐴 , 𝑃𝐵 , 𝑌)
Where:
𝑄𝐴 = 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 𝑜𝑓 𝑔𝑜𝑜𝑑 𝐴
𝑃𝐴 = 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑔𝑜𝑜𝑑 𝐴
𝑃𝐵 = 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑔𝑜𝑜𝑑 𝐵
𝑌 = 𝑐𝑜𝑛𝑠𝑢𝑚𝑒𝑟 𝑖𝑛𝑐𝑜𝑚𝑒
We will now look at how we compute the responsiveness of the quantity demanded of good A
with respect to price of good A, price of good B and the income.
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i) Own Price elasticity of demand
It measures the percentage change in the quantity demanded of good A when its own price changes
keeping the price of good B (PB) and the income (Y) constant.
𝜕𝑄𝐴 . 𝑃𝐴
𝑃𝑟𝑖𝑐𝑒 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 =
𝜕𝑃𝐴 . 𝑄𝐴
ii) Cross price elasticity of demand
It measures the percentage change in quantity demanded of good A when price of good B changes
when the price of good A (PA) and other factors such as the income (Y) are held constant.
𝜕𝑄 .𝑃
𝐶𝑟𝑜𝑠𝑠 𝑝𝑟𝑖𝑐𝑒 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 = 𝜕𝑃 𝐴.𝑄𝐵
𝐵 𝐴
You can know whether two goods are substitutes or complements by looking at the sign of the
partial derivatives of their demand functions will respect to price of the other good e.g.
∂QA
> 0 the two goods are substitutes i.e. As price of good B increase, the demand of good A
∂PB
increase. If demand for a good goes down due to an increase in its own price and consumers
substitute it by buying more its substitute.
For complementary commodities
∂QA
<0
∂PB
As price of good B increase quantity of demanded of good A decrease. The decrease in demand
for good B due to an increase in its price causes the demand of good A to decrease since the two
goods are used together.
Page 50 of 167
iii) Income elasticity of demand
It measures the percentage change in the quantity demanded of good A when income changes
when the price of good A and the price of good B are held constant.
𝐴 𝜕𝑄 .𝑌
𝐼𝑛𝑐𝑜𝑚𝑒 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 = 𝜕𝑌.𝑄
𝐴
The income elasticity is positive for normal goods and negative for inferior and giffen goods.
Example
A demand function is given as:
𝑄𝐴 = 90 − 2𝑃𝐴 + 0.4𝑃𝐵 + 0.1𝑌
Find the own price, income and cross price elasticities of demand when:
𝑃𝐴 = 6 𝑃𝐵 = 10 𝑌 = 100
𝑄𝐴 = 90 − 2(6) + 0.4(10) + 0.1(100) = 90 − 12 + 4 + 10 = 92
Own price elasticity of demand
𝜕𝑄𝐴
= −2
𝜕𝑃𝐴
𝜕𝑄𝐴 . 𝑃𝐴 6
= = −2 ∗ = −0.13
𝜕𝑃𝐴 . 𝑄𝐴 92
A 1% change in the price of good A, holding PB and Y constant leads to a 0.13% decrease in the
quantity demanded of good A. It is inelastic to price change.
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Cross-Price elasticity of demand
𝜕𝑄𝐴
= 0.4
𝜕𝑃𝐵
𝜕𝑄𝐴 . 𝑃𝐵 10
= = 0.4 ∗ = 0.04
𝜕𝑃𝐵 . 𝑄𝐴 92
A 1% change in the price of good B, holding P A and Y constant leads to a 0.04% increase in the
quantity demanded of good A. It is inelastic to price change. Since the cross elasticity is positive
the two goods are substitutes.
Income elasticity of demand
𝜕𝑄𝐴
= 0.1
𝜕𝑌
𝜕𝑄𝐴 . 𝑌 100
= = 0.1 ∗ = 0.11
𝜕𝑌. 𝑄𝐴 92
A 1% change in the income holding PB and PA constant leads to a 0.11% increase in the quantity
demanded of good A. It is inelastic to income change. Since the income elasticity is positive, good
A is a normal good.
a) Determine whether these 2 goods are substitutes or complements.
𝑄𝑑𝑥 = 20 − 3𝑃𝑥 + 4𝑃𝑦 + 0.2𝑌
𝑃𝑥 = 1 𝑃𝑦 = 2 𝑌 = 500
b) A total cost function is given by:
Page 52 of 167
𝐶 = 𝑄23 + 𝑄1 𝑄2 − 6𝑄23 + 40
Find: MC1, MC2 and if function displays increasing or decreasing MC with respect to each of the
goods.
4.4 E-references

press, London
Page 53 of 167
LECTURE FIVE: HOMOGENEITY OF A FUNCTION AND RETURNS TO SCALE
5.1 Introduction
In this lesson, we will discuss the concepts of homogeneity of a function, returns to scale and the
Euler’s Theorem. We will also perform some comparative statics.
By the end of this lesson, the learner should be able to:
5.2.1 Understand how to compute the homogeneity of a function
5.2.2 Understand how to calculate the returns to scale of a function
5.2.3 Understand the Euler’s Theorem
5.2.4 Perform comparative statics
5.2.1 Homogeneity of a function
Given a function 𝑌 = 𝑓(𝑋1 , 𝑋2 )
We say it is homogenous of degree r if by multiplying all the independent variables by a constant
K, the dependent variable (Y) changes by a multiple 𝐾 𝑟
Example 1
𝑌 = 𝑓(𝑋1 , 𝑋2 ) = 4𝑋1 + 𝑋2
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New Y= 4𝑘𝑋1 + 𝑘𝑋2 = 𝑘(4𝑋1 + 𝑋2 ) = 𝑘1 𝑌 The function is homogenous of degree 1. Functions
which are homogenous of degree 1 are said to be linearly homogenous.
Example 2
Determine the homogeneity of the function given as:
𝑌 = 𝑋 2 + 5𝑋𝑊 + 𝑊 2
𝑌 = (𝑘𝑋)2 + 5(𝑘𝑋)(𝑘𝑊) + (𝑘𝑊)2
𝑁𝑒𝑤 𝑌 = 𝑘 2 (𝑋 2 + 5𝑋𝑊 + 𝑊 2 ) = 𝑘 2 (𝑌)
It’s homogenous of degree 2
Example 3
Determine the homogeneity of the function given as: 𝑄 = 80𝐾 0.2 𝐿0.5
𝑄 = 80(𝐶𝐾)0.2 (𝐶𝐿)0.5
𝑄 = 𝐶 0.2+0.5 80𝐾 0.2 𝐿0.5
𝑄 = 𝐶 0.7 80𝐾 0.2 𝐿0.5
5.2.2 Returns to scale
This refers to the proportion by which output changes when all inputs are multiplied by the same
multiple. For example, assume that a farmer has been using 2 employees and 1 tractor and the
resultant output produced is 1000bags of maize.
Page 55 of 167
If the farmer doubles the inputs/factors such that he employs 4 employees and 2 tractors, it can
result in three scenarios:
i) Using 4 employees and 2 tractor production is 2000 bags
This is a case of constant returns to scale. When inputs are doubled, output doubles. The
output changes by the same multiple by which inputs where multiplied by
ii) 4 employees 2 tractors produce 1500 bags
The output has increased by less than double i.e. By 1.5 times. This is a case of decreasing
returns to scale. The output increases by less than the multiple by which the inputs were
multiplied by.
iii) 4 Employees - 2 tractors - 3000 bags
The output has increased by more than double i.e. by three times. This is increasing returns to
scale. The output increases by more than the multiple by which the inputs were multiplied by.
A function is said to display:
i) Constant returns to scale if its degree of homogeneity is of degree 1.
ii) Decreasing returns to scale if its degree of homogeneity is less than 1.
iii) Increasing returns to scale if its degree of homogeneity is more than 1.
Example
Determine the nature of returns to scale for the following functions:
i) 𝑄 = 80𝐾 0.2 𝐿0.5
𝑄 = 80(𝐶𝐾)0.2 (𝐶𝐿)0.5
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𝑄 = 𝐶 0.2+0.5 80𝐾 0.2 𝐿0.5
𝑄 = 𝐶 0.7 80𝐾 0.2 𝐿0.5
This function is homogenous of degree 0.7. Hence it displays decreasing returns to scale.
1 3
ii) 𝑄 = 𝐴𝐿2𝐾4
𝑁𝑒𝑤𝑄 = 80(𝐶𝐿)0.5 (𝐶𝐾)0.75
𝑛𝑒𝑤𝑄 = 𝐶 1.25 𝐴𝐾 0.75 𝐿0.5
The function is homogenous of degree 1.25. Hence displays increasing returns to scale.
1 1
iii) 𝑄 = 𝐴𝐿2𝐾2
𝑁𝑒𝑤𝑄 = 80(𝐶𝐿)0.5 (𝐶𝐾)0.5
𝑛𝑒𝑤𝑄 = 𝐶 1 𝐴𝐾 0.5 𝐿0.5
The function is homogenous of degree 1. Hence displays constant returns to scale.
5.2.3 Euler’s Theorem
According to this theorem, if a production function displays characteristics of constant returns to
scale, the sum of marginal product of labour multiplied by labour units (L) and marginal product
of capital multiplied by capital units (K) is equal to the total output.
i.e. if Q = A K L
Such that  +  = 1
Then: 𝑀𝑃𝐿 . 𝐿 + 𝑀𝑃𝐾 . 𝐾 = 𝑄 − − − − − − − − − − − − − −1
From the production function:
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𝑄 = 𝐴𝐾 𝛼 𝐿𝛽
𝛽𝐴𝐾𝛼 𝐿 𝛽 𝛽𝑄
𝑀𝑃𝐿 = 𝛽𝐴𝐾 𝛼 𝐿𝛽−1 = = :
𝐿 𝐿
Similarly
𝛼𝐴𝐾𝛼 𝐿 𝛽 𝛼𝑄
𝑀𝑃𝐾 = 𝛼𝐴𝐾 𝛼−1 𝐿𝛽 = =
𝐾 𝐾
If we plug in the MPL and MPK
Into equation 1, we get:
𝛽𝑄 𝛼𝑄
.𝐿 + . 𝐾 = 𝛽𝑄 + 𝛼𝑄 = 𝑄(𝛽 + 𝛼)
𝐿 𝐾
Since 𝐵 +  = 1
𝑄(𝛽 + 𝛼) = 𝑄
This is a proof of the theorem.
If the production function is homogenous of degree 𝑛, then Euler’s theorem becomes
𝑀𝑃𝐿 . 𝐿 + 𝑀𝑃𝐾 . 𝐾 = 𝑛𝑄 − − − − − − − − − − − − − −2
Example
Proof Euler’s theorem for the production function.
Q = 3K3 – 5KL2 – L3
MPL = 10KL – 3L2
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MPK = 9K2 – 5L2
Degree of homogeneity
=3(Kd)3 – 5Kd (Ld)2 – (dL)3
= d3 (3K3 – 5KL2 – L3)
 Homogenous of degree 3
We want to proof the Euler’s theorem
MPL L + MPK K = nQ = 3Q
(-10KL – 3L2)L + (9K2 – 5L2)K = 3Q
-10KL2 – 3L3 + 9K3 – 5L2K = 3Q
Can be written as
3(3K3) -2(5KL2) -3(L3) – 5KL2 = 3Q
9K3 – 15KL2 – 3L3 = 3Q
3(3K3 - 5KL2 – L3) =3Q Q = (3K3 - 5KL2 – L3)
3Q = 3Q
5.2.4 Comparative statics
This section deals with how the equilibrium value of on endogenous variable changes when there
is a change in any of the exogenous variables or parameters.
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a) Market Model
Consider the simple one commodity market model given as:
𝑄 = 𝑎 − 𝑏𝑃 (𝑎, 𝑏) > 0
𝑄 = −𝑐 + 𝑑𝑃 (𝑐, 𝑑) > 0
𝑎 + 𝑐
𝑃∗ =
𝑏+𝑑
𝑎𝑑 – 𝑏𝑐
𝑄∗ =
𝑏+𝑑
P* and Q* are the endogenous variables and they have been purely expressed as a function of the
parameters a, b, c, and d.
We would want to analyze how P* changes due to change in any of the parameters. This is done
by partially differentiating P* with respect to any of the parameters, by making use of the quotient
rule: e.g
𝜕𝑃 ∗ 1 𝜕𝑃 ∗ 1
= >0 = >0
𝜕𝑎 𝑏+𝑑 𝜕𝑐 𝑏+𝑑
𝜕𝑃 ∗ −1 (𝑎 + 𝑐) 𝜕𝑃 ∗ −1 (𝑎 + 𝑐)
= <0 = <0
𝜕𝑏 (𝑏 + 𝑑)2 𝜕𝑑 (𝑏 + 𝑑)2
Since a, b, c and d are greater than 0, the expressions
𝜕𝑃 ∗ 𝜕𝑃 ∗ 1
𝑎𝑛𝑑 = >0
𝜕𝑎 𝜕𝑐 𝑏+𝑑
And
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𝜕𝑃 ∗ 𝜕𝑃 ∗ −1 (𝑎 + 𝑐)
𝑎𝑛𝑑 = <0
𝜕𝑏 𝜕𝑑 (𝑏 + 𝑑)2
How does the equilibrium Q* change as parameters change. This is done by getting the partial
derivatives of Q* with respect to a, b, c and d.
𝜕𝑄 ∗ 𝑑 𝜕𝑄 ∗ −𝑏
= >0 = <0
𝜕𝑎 𝑏+𝑑 𝜕𝑐 𝑏+𝑑
𝜕𝑄 ∗ −𝑑 (𝑎 + 𝑐) 𝜕𝑄 ∗ 𝑏(𝑎 + 𝑐)
= <0 = >0
𝜕𝑏 (𝑏 + 𝑑)2 𝜕𝑑 (𝑏 + 𝑑)2
b) National income model
Simple national income model (closed economy)
𝑌 = 𝐶 + 𝐼0 + 𝐺0
𝐶 = 𝑐0 + 𝑐1 (𝑌 𝑑 ) 𝑤ℎ𝑒𝑟𝑒 𝑐0 > 0 0 < 𝑐1 < 1
𝑇 = 𝑡0 + 𝑡1 𝑌 𝑡0 > 0 0 < 𝑡1 < 1
𝑌𝑑 = 𝑌 − 𝑇
𝑌 = 𝑐0 + 𝑐1 (𝑌 𝑑 ) + 𝐼0 + 𝐺0
𝑌 = 𝑐0 + 𝑐1 (𝑌 − 𝑇) + 𝐼0 + 𝐺0
𝑌 = 𝑐0 + 𝑐1 (𝑌 − 𝑡0 − 𝑡1 𝑌 ) + 𝐼0 + 𝐺0
𝑌 = 𝑐0 + 𝑐1 𝑌 − 𝑐1 𝑡0 − 𝑐1 𝑡1 𝑌 + 𝐼0 + 𝐺0
𝑌 − 𝑐1 𝑌 + 𝑐1 𝑡1 𝑌 = 𝑐0 − 𝑐1 𝑡0 + 𝐼0 + 𝐺0
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𝑌(1 − 𝑐1 + 𝑐1 𝑡1 ) = 𝑐0 − 𝑐1 𝑡0 + 𝐼0 + 𝐺0
𝑐0 − 𝑐1 𝑡0 + 𝐼0 + 𝐺0
𝑌∗ =
(1 − 𝑐1 + 𝑐1 𝑡1 )
𝑌 ∗ is the equilibrium value of national income.
How does Y* change as exogenous variables change.
𝜕𝑌 ∗ 1
= 𝑇ℎ𝑖𝑠 𝑖𝑠 𝑡ℎ𝑒 𝑎𝑢𝑡𝑜𝑛𝑜𝑚𝑜𝑢𝑠 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡𝑠 𝑚𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟.
𝜕𝐼0 (1 − 𝑐1 + 𝑐1 𝑡1 )
Given that
𝑐1 𝑎𝑛𝑑 𝑐1 𝑡1 are positive and less than 1, the autonomous investment multiplier is positive,
meaning an increase in the autonomous investments will lead to an increase in the equilibrium
value of the national income.
Using partial differentiation, we can also get the autonomous tax multiplier.
𝜕𝑌 ∗ −𝑐1
=
𝜕𝐼0 (1 − 𝑐1 + 𝑐1 𝑡1 )
The autonomous tax multiplier is negative. This means that an increase in taxes will lead to a
decrease in the national income.
Similarly, we can get the tax rate multiplier. It tells us how the national income changes due to a
unit change in the tax rate.
𝜕𝑌 ∗ −(𝑐1 )(𝑐0 − 𝑐1 𝑡0 + 𝐼0 + 𝐺0 )
=
𝜕𝑡1 (1 − 𝑐1 + 𝑐1 𝑡1 )2
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−(𝑐1 )𝑌 ∗
=
(1 − 𝑐1 + 𝑐1 𝑡1 )
An increase in the tax rate reduces the value of the national income and vice versa.
National income model for an open economy
𝑌 = 𝐶 + 𝐼0 + 𝐺0 + 𝑋0 − 𝑀
𝐶 = 𝑐0 + 𝑐1 (𝑌 𝑑 ) 𝑤ℎ𝑒𝑟𝑒 𝑐0 > 0 0 < 𝑐1 < 1
𝑇 = 𝑡0 + 𝑡1 𝑌 𝑡0 > 0 0 < 𝑡1 < 1
𝑀 = 𝑚0 + 𝑚1 𝑌
𝑌 = 𝑐0 + 𝑐1 (𝑌 𝑑 ) + 𝐼0 + 𝐺0 + 𝑋0 − (𝑚0 + 𝑚1 𝑌)
𝑌 = 𝑐0 + 𝑐1 (𝑌 − 𝑇) + 𝐼0 + 𝐺0 −𝑋0 − 𝑚0 − 𝑚1 𝑌
𝑌 = 𝑐0 + 𝑐1 (𝑌 − 𝑡0 − 𝑡1 𝑌 ) + 𝐼0 + 𝐺0 −𝑋0 − 𝑚0 − 𝑚1 𝑌
𝑌 = 𝑐0 + 𝑐1 𝑌 − 𝑐1 𝑡0 − 𝑐1 𝑡1 𝑌 + 𝐼0 + 𝐺0 −𝑋0 − 𝑚0 − 𝑚1 𝑌
𝑌 − 𝑐1 𝑌 + 𝑐1 𝑡1 𝑌 + 𝑚1 𝑌 = 𝑐0 − 𝑐1 𝑡0 + 𝐼0 + 𝐺0 −𝑋0 − 𝑚0
𝑌(1 − 𝑐1 + 𝑐1 𝑡1 + 𝑚1 ) = 𝑐0 − 𝑐1 𝑡0 + 𝐼0 + 𝐺0 − 𝑚0
𝑐0 − 𝑐1 𝑡0 + 𝐼0 + 𝐺0 − 𝑚0
𝑌∗ =
(1 − 𝑐1 + 𝑐1 𝑡1 + 𝑚1 )
We can get a number of multipliers.
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𝜕𝑌 ∗ 1
=
𝜕𝐺0 (1 − 𝑐1 + 𝑐1 𝑡1 + 𝑚1 )
This is the government multiplier. An increase in government expenditure causes the national
income to increase.
𝜕𝑌 ∗ 1
=
𝜕𝐼0 (1 − 𝑐1 + 𝑐1 𝑡1 + 𝑚1 )
𝜕𝑌 ∗ −1
=
𝜕𝑀0 (1 − 𝑐1 + 𝑐1 𝑡1 + 𝑚1 )
a) From the national income model for an open economy,
𝜕𝑌 ∗ 𝜕𝑌 ∗ 𝜕𝑌 ∗
Compute: 𝜕𝑐 , 𝜕𝑚 𝑎𝑛𝑑
1 1 𝜕𝑡1
b) Find the degree of homogeneity and nature of returns to scale for the following function. Prove
Euler’s Theorem using the same function
Q = 10 K¼ L¾
5.4 E-references

press, London
Page 64 of 167
LECTURE SIX: CONSTRAINED OPTIMIZATION
6.1 Introduction
In this lesson we shall learn how we can maximize or minimize functions when we are faced with
a constraint.
6.2.1 Formulate optimization problems and the Lagrangian function.
6.2.2 Understand the first order conditions (f.o.c) for optimization.
6.2.3 Determine the optimal values of optimization problems.
6.2.4 Understand the second order condition (s.o.c) for maximum and minimum.
6.2.1 Formulation of optimization problems and the Lagrangian function
The structure of constrained optimization problem
In a constrained optimization problem, the decision maker would want to optimize but is faced
with a constraint. The problem is composed of two parts: -
a) Objective function – what is to be maximized or minimized.
b) Constraints or constraining equation – defines the limiting conditions
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Example
The Lagrangian function

Since the constrained optimization problem consists of two functions (the objective function and
the constraint), before the conducting the optimization problem, a Lagrangian function also known
as the augmented objective function is constructed from the two functions.
The construction of the Lagrangian function is illustrated using the following example:
Example
Optimize 𝑍 = 𝑓(𝑥, 𝑦)
Subject to 𝑎𝑥 + 𝑏𝑦 = 𝐵
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The Lagrangian function is constructed as follows:
Step 1:
Set the constraint equal to zero
𝐵 − 𝑎𝑥 − 𝑏𝑦 = 0
Step 2:
Multiply the resulting constraint by 𝜆, the Lagrangian multiplier.
𝜆(𝐵 − 𝑎𝑥 − 𝑏𝑦) = 0
Step 3:
Form the Lagrangian function L by adding the equation obtained in step 2 to the objective function
𝑓(𝑥, 𝑦). The Lagrangian function is given by:
𝐿 = 𝑓(𝑥, 𝑦) + 𝜆(𝐵 − 𝑎𝑥 − 𝑏𝑦)
The Lagrangian function has three choice variables, namely, 𝑥, 𝑦 and 𝜆. Hence we can rewrite the
Lagrangian function as follows:
𝐿 = 𝑓(𝑥, 𝑦, 𝜆 ) + 𝜆(𝐵 − 𝑎𝑥 − 𝑏𝑦)
After formulating the Lagrangian function, the next step is to obtain the first order conditions.
6.2.2 The first order conditions (f.o.c) for optimization
Consider the following constrained optimization problem in which the objective function and the
constraint are all presented in the general form:
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Subject to 𝑔(𝑥, 𝑦) = 𝐵
In order to determine the critical values of 𝑥, 𝑦 and λ we apply the first order condition.
The first order condition involves the computation of the first partial derivatives of the Lagrangian
function with respect to 𝑥, 𝑦 and λ, setting them equal to zero and solving the resulting system of
simultaneous equations for 𝑥, 𝑦 and λ.
The process is presented here in three steps:
Step 1:
Construct the corresponding Lagrangian function from the two functions.
𝐿(𝑥, 𝑦, 𝜆 ) = 𝑓(𝑥, 𝑦) + 𝜆{𝐵 − 𝑔(𝑥, 𝑦)}
Step 2:
Find the first partial derivatives of 𝐿(𝑥, 𝑦, 𝜆 ) with respect to the three choice variables 𝑥, 𝑦 and λ
and equating them to zero.
𝐿𝑥 = 𝑓𝑥 − 𝜆𝑔𝑥 = 0
𝐿𝑦 = 𝑓𝑦 − 𝜆𝑔𝑦 = 0
𝐿𝜆 = 𝐵 − 𝑔(𝑥, 𝑦) = 0
Step 3:
Solve the resulting system of three simultaneous equations from step 2 for the critical values
𝑥̅ , 𝑦̅ 𝑎𝑛𝑑 𝜆̅.
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6.2.3 Optimal values of optimization problems
Let’s illustrate the process of obtaining the critical values of optimization problems using the
following numerical examples.
Example 1
Consider the following constrained maximization problem:
Maximize 𝑍 = 12𝑥 + 4𝑦 − 6𝑥 2
Subject to −𝑥 2 + 𝑦 = 4
i. Construct the corresponding Lagrangian function
ii. Determine the critical values of 𝑥, 𝑦 and λ
iii. What is the stationary value of Z?
Solution
i. The Lagrangian function:
𝐿(𝑥, 𝑦, 𝜆 ) = 12𝑥 + 4𝑦 − 6𝑥 2 + λ (4 + 𝑥 2 − 𝑦)
ii. The critical values of 𝑥, 𝑦 and λ are obtained by applying the first order condition
𝐿𝑥 = 12 − 12𝑥 + 2λ𝑥 = 0 ………………………………….1
𝐿𝑦 = 4 − λ = 0 …………………………………………………2
𝐿𝜆 = 4 + 𝑥 2 − 𝑦 = 0 ……………………………………………3
Solve the system of three simultaneous equations for 𝑥, 𝑦 and λ
From equation 2:
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λ=4
Substituting for λ into equation 1
12 − 12𝑥 + 2λ𝑥 = 0
12 − 12𝑥 + 2(4)𝑥 = 0
12 − 12𝑥 + 8𝑥 = 0
12 − 4𝑥 = 0
𝑥̅ = 3
From equation 3:
4 + 𝑥2 − 𝑦 = 0
Substituting the value of x we have;
4 + (3)2 − 𝑦 = 0
𝑦̅ = 13
From equation (2):
𝜆̅ = 4
The critical values are: 𝑥̅ = 3; 𝑦̅ = 13; λ̅ = 4
iii. The stationary value of z is obtaining by substituting the critical values of x and y into the
objective function:
𝑍̅ = 12(3) + 4(13) − 6(32 ) = 34

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Example 2
Given the following constrained minimization problem:
Minimize 𝑍 = 4𝑥 2 + 2𝑥𝑦 + 𝑦 2
Subject to 𝑥 + 𝑦 = 8
Required:
i. Construct the corresponding Lagrangian function
ii. Determine the critical values of 𝑥, 𝑦 and λ
iii. What is the stationary value of Z?
Solution
i. The lagrangian function
𝐿(𝑥, 𝑦, 𝜆 ) = 4𝑥 2 + 2𝑥𝑦 + 𝑦 2 + 𝜆(8 − 𝑥 − 𝑦)
ii. The critical values of 𝑥, 𝑦 and λ
𝐿𝑥 = 8𝑥 + 2𝑦 − λ = 0 ………………………………………….1
𝐿𝑦 = 2𝑥 + 2𝑦 − λ = 0 …………………………………………………2
𝐿𝜆 = 8 − 𝑥 − 𝑦 = 0 ……………………………………………………3
Solve the system of three simultaneous equations for 𝑥, 𝑦 and λ
From 1;
8𝑥 + 2𝑦 = λ …………………………………….(a)
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2𝑥 + 2𝑦 = λ………………………………………(b)
Since (a) and (b) give the same value λ, we equate them to obtain:
8𝑥 + 2𝑦 = 2𝑥 + 2𝑦
6𝑥 = 2𝑦 − 2𝑦
6𝑥 = 0
𝑥̅ = 0
From (3)
8 − 𝑥 − 𝑦 = 0 since 𝑥̅ = 0
8−0−𝑦 = 0
𝑦̅ = 8
From (a)
8𝑥 + 2𝑦 = λ
λ̅ = 8(0) + 2(8) = 16
The critical values are: 𝑥̅ = 0; 𝑦̅ = 8; λ̅ = 16
iii. The stationary value of Z is obtained by substituting the critical values of x and y into the
objective function
𝑍̅ = 4(0)2 + 2(0)(8) + 82 = 64
6.2.4 The second order condition (s.o.c) for maximum and minimum
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The second order condition (s.o.c) for constrained optimization makes use of the Bordered Hessian
matrix determinant.
As the name suggests, a Bordered Hessian is a Hessian that has borders. The border elements or
the elements on the borders of the Bordered Hessian are obtained from the constraint while the
rest of the elements are obtained from the Lagrangian function.
We illustrate the process using the following example.
Consider the following constrained optimization problem in which both the objective function and
the constraint are presented in the general form.
Subject to 𝑔(𝑥, 𝑦) = 𝑘
The construction of the bordered Hessian is presented in the following steps:
Step 1: Construct the Lagrangian function
𝐿 = 𝑓(𝑥, 𝑦) + 𝜆{𝑘 − 𝑔(𝑥, 𝑦)}
Step 2: Determine the elements of the borders of the bordered Hessian
The elements of the borders of the bordered Hessian are made up of the first partial derivatives of
the constraint with respect to the arguments 𝑥 and 𝑦.
𝑔(𝑥, 𝑦) = 𝑘
The required partial derivatives are: 𝑔𝑥 𝑎𝑛𝑑 𝑔𝑦
Step 3: Determine the remaining elements of Bordered Hessian
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The rest of the elements of the Bordered Hessian are made up of the second partial derivatives of
the Lagrangian function with respect to 𝑥 and 𝑦.
𝐿 = 𝑓(𝑥, 𝑦) + 𝜆{𝑘 − 𝑔(𝑥, 𝑦)}
The required partial derivatives are:
𝐿𝑥𝑥 : The second partial derivative of the Lagrangian function with respect to 𝑥.
𝐿𝑦𝑦 : The second partial derivative of the Lagrangian function with respect to 𝑦.
𝐿𝑥𝑦 = 𝐿𝑦𝑥 : The cross partial derivative of the Lagrangian function with respect to 𝑥 and 𝑦.
Step 4: Form the required bordered Hessian
0 𝑔𝑥 𝑔𝑦
̅
𝐻 = (𝑔𝑥 𝐿𝑥𝑥 𝐿𝑥𝑦 )
𝑔𝑦 𝐿𝑦𝑥 𝐿𝑦𝑦
Step 5: Obtain the determinant of the bordered Hessian
0 𝑔𝑥 𝑔𝑦
̅
|𝐻 | = |𝑔𝑥 𝐿𝑥𝑥 𝐿𝑥𝑦 |
𝑔𝑦 𝐿𝑦𝑥 𝐿𝑦𝑦
̅ | > 0: The critical values yield a Maximum

If |𝐻
̅ | < 0: The critical values yield a Minimum

If |𝐻
Example
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Test if the critical values of the following optimization problem yield a maximum or minimum
Optimize 𝑍 = 𝑥𝑦
Subject to 2𝑥 + 𝑦 = 9
𝐿 = 𝑥𝑦 + 𝜆(9 − 2𝑥 − 𝑦)
𝐿𝑥 = 𝑦 − 2𝜆 = 0 ………………………………………………………….1
𝐿𝑦 = 𝑥 − 𝜆 = 0…………………………………………………………….2
𝐿𝜆 = 9 − 2𝑥 − 𝑦 = 0……………………………………………………...3
From 1:
0.5𝑦 = 𝜆………………………………………………………………….(a)
From 2:
𝑥 = 𝜆…………………………………………………………………….(b)
From (a) and (b);
0.5𝑦 = 𝑥
Substituting for 𝑥 into equation 3;
9 − 2(0.5𝑦) − 𝑦 = 0
9 = 2𝑦
𝑦̅ = 4.5
0.5𝑦 = 𝑥
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𝑥̅ = 0.5 ∗ 4.5 = 2.25
To test if the critical values yield a maximum or minimum, we obtain the determinant of the
bordered Hessian.
From the constraint:
𝑔(𝑥, 𝑦) = 9 − 2𝑥 − 𝑦
The first partial derivatives of the constraint will form the border elements:
𝑔𝑥 = −2
𝑔𝑦 = −1
From the Lagrangian function: We obtain the remaining elements of the Hessian
𝐿 = 𝑥𝑦 + 𝜆(9 − 2𝑥 − 𝑦)
𝐿𝑥 = 𝑦 − 2𝜆
𝐿𝑥𝑥 = 0
𝐿𝑦 = 𝑥 − 𝜆
𝐿𝑦𝑦 = 0
𝐿𝑥𝑦 = 𝐿𝑦𝑥 = 1
The bordered Hessian will therefore be expressed as follows:
0 −2 −1
̅ = (−2 0
𝐻 1)
−1 1 0
Page 76 of 167
We obtain the determinant of the bordered Hessian as follows:
0 −2 −1
̅ | = |−2
|𝐻 0 1|
−1 1 0
̅ | = 0 |0
|𝐻 1
| − (−2) |
−2 1
| + (−1) |
−2 0
|=4
1 0 −1 0 −1 1
̅ | = 4 > 0: The critical values yield a maximum.

|𝐻
Given the following constrained optimization problem:
Optimize 𝑍 = 𝑥 2 + 𝑦 2
Subject to 5𝑥 + 2𝑦 = 25
Required:
i. The critical values of 𝑥, 𝑦 and 𝜆
ii. Test whether the critical values yield a maximum or minimum point
6.4 E-References

press, London
Page 77 of 167
LECTURE SEVEN: ECONOMIC APPLICATIONS OF CONSTRAINED
OPTIMIZATION
7.1: Introduction
Constrained optimization is very key in economic analysis. Most economic optimization problems
are subject to constraints.
In this Lesson we will discuss the economic applications of constrained optimization.
By the end of this Lesson, the learner should be able to understand the following constrained
optimization problems in economics:
7.2.1 Utility Maximization
7.2.2 Cost Minimization
7.2.3 Output Maximization
7.2.1 Utility Maximization
Maximize
𝑈 = 𝑢(𝑞1 , 𝑞2 )
Subject to
𝑀 = 𝑝1 𝑞1 + 𝑝2 𝑞2
𝑞1 𝑞2 > 0
Where:
M is the level of income, 𝑞1 and 𝑞2 are the amounts of goods 1 and 2 respectively, and P1 and
P2 are the prices of good 1 and 2 respectively.
Page 78 of 167
𝐿 = 𝑈(𝑞1 𝑞2 ) + 𝜆(𝑀 − 𝑝1 𝑞1 − 𝑝2 𝑞2 )
𝐿𝑞1 = 𝑈𝑞1 − 𝜆. 𝑝1 = 0
𝐿𝑞2 = 𝑈𝑞2 − 𝜆. 𝑝2 = 0 0
𝐿𝜆 = 𝑀 − 𝑝1 𝑞1 − 𝑝2 𝑞2 = 0
From the first equation,

𝑈𝑞1
𝑈𝑞1 = 𝜆. 𝑝1 → 𝜆 = 𝑝1
and from the second equation
𝑈𝑞2
𝑈𝑞2 = 𝜆𝑝2 𝜆=
𝑝2
𝑈𝑞1 𝑈𝑞2
𝜆= =
𝑃1 𝑃2
𝑆𝑖𝑛𝑐𝑒 𝑈𝑞1 = 𝑀𝑈𝑞1 𝑎𝑛𝑑 𝑈𝑞2 = 𝑀𝑈𝑞2

𝑀𝑈𝑞1 𝑀𝑈𝑞2
→ = This is the condition for utility maximization.
𝑃1 𝑃2
Ratio of 𝑀𝑈𝑞1 to price of 𝑃1 = Ratio of 𝑀𝑈𝑞2 to price of 𝑃2
If this is rearranged, it can be written as:
𝑀𝑈𝑞1 𝑃1
→ =
𝑀𝑈𝑞2 𝑃2
This condition states that, for utility maximization, the slope of the indifference curve should be
equal to the slope of the budget line.
Alternatively
If we get the total differential of the utility function
𝑈 = 𝑢(𝑞1 𝑞2 )
𝑑𝑢 = 𝑈𝑞1 . 𝜕𝑞1 + 𝑈𝑞2 . 𝜕𝑞2

Page 79 of 167
Along an indifference curve the utility does not change, hence du=0
𝑈𝑞1 𝜕𝑞1 = −𝑈𝑞2 𝜕𝑞2
𝜕𝑞2 𝑈𝑞
= − 𝑈𝑞1 This is the slope of the indifference curve
𝜕𝑞1 2
Slope of Budget Line
𝑀 − 𝑝1 𝑞1 + 𝑝2 𝑞2
𝑀 𝑝1
𝑞2 = − 𝑞
𝑝2 𝑝2 1
𝜕𝑞2 −𝑝1
= This is the slope of the budget line
𝜕𝑞1 𝑝2
𝑈𝑞1 𝑝1
− =−
𝑈𝑞2 𝑝2
𝑈𝑞 𝑝1
→ 𝑈𝑞1 = ⁄𝑝2……………. This is the condition for utility maximization
2
We use the determinant of the bordered Hessian to check whether the critical values yield a
maximum of minimum i.e.
̅ | > 0: The critical values yield a Maximum

If |𝐻
This means that the critical values maximize utility.
Example
Given a utility function U=5xy, and a budget constraint given as 5x+y=30, determine the levels of
x and y that will maximize the utility of the consumer.
Page 80 of 167
Solution
𝐿 = 5𝑥𝑦 + 𝜆(30 − 5𝑥 − 𝑦)
𝐿𝑥 = 5𝑦 − 5𝜆 = 0 → 𝜆 = 𝑦
𝐿𝑦 = 5𝑥 − 𝜆 = 0 → 𝜆 = 5𝑥
𝐿𝜆 = 30 − 5𝑥 − 𝑦 = 0
From the first equation and second equations,
𝜆 = 𝑦 = 5𝑥
If we replace 𝑦 in the third equation we get:
𝐿𝜆 = 30 − 5𝑥 − 𝑦 = 0
5𝑥 + 𝑦 = 30
5𝑥 + 5𝑥 = 30
10𝑥 = 30
𝑥=3
𝑦 = 5𝑥 = 15
𝜆 = 𝑦 = 15
Maximum utility will be given as:
𝑈 = 5𝑥𝑦 = 5 ∗ 3 ∗ 15 = 225
Do the critical values yield a maximum or a minimum?
We construct the bordered Hessian as follows:
From the constraint:
𝑔(𝑥, 𝑦) = 30 − 5𝑥 − 𝑦
Page 81 of 167
𝑔𝑥 = −5
𝑔𝑦 = −1
From the lagrangian function:
𝐿 = 5𝑥𝑦 + 𝜆(30 − 5𝑥 − 𝑦)
𝐿𝑥 = 5𝑦 − 5𝜆 = 0
𝐿𝑥𝑥 = 0
𝐿𝑦 = 5𝑥 − 𝜆 = 0
𝐿𝑦𝑦 = 0
𝐿𝑥𝑦 = 𝐿𝑦𝑥 = 5
0 −5 −1
̅ = (−5 0
𝐻 5)
−1 5 0
Obtain the determinant of the bordered Hessian
0 −5 −1
̅ | = |−5
|𝐻 0 5|
−1 5 0
̅ | = 0 |0
|𝐻 5
| − (−5) |
−5 5
| + (−1) |
−5 0
| = 50
5 0 −1 0 −1 5
̅ | = 50 > 0: The critical values maximize utility.

|𝐻
Page 82 of 167
7.2.2 Cost Minimization
If the firm wants to minimize the cost subject to a given output level, the problem can be written
as:
Minimize 𝐶 = 𝑟𝑘 + 𝑤𝑙
𝑆. 𝑡
𝑄 = 𝑓(𝑘 , 𝑙)
Where r and w are input prices of capital and labour respectively while K and L are the units of
capital and labour used respectively.
If we form the lagrangian function:
𝐿 = 𝑟𝑘 + 𝑤𝑙 + 𝜆 (𝑄 − 𝑓(𝑘 , 𝑙))
𝐿𝑘 = 𝑟 − 𝜆𝑓𝐾′ (𝑘 , 𝑙) = 0
𝐿𝑙 = 𝑤 − 𝜆𝑓𝐿′ (𝑘 , 𝑙) = 0
𝐿𝜆 = 𝑄 − 𝑓 (𝑘 , 𝑙) = 0
𝑟 = 𝜆𝑓𝑘 ′ (𝑘 , 𝑙) 𝑤 = 𝜆𝑓𝑙′ (𝑘 , 𝑙)
𝑟 𝑟 𝑤
𝜆 = 𝑓′ (𝑘𝑙)
= 𝜆 = 𝑚𝑝
𝑘 𝑚𝑝𝑘 𝑙
𝑟 𝑤
=
𝑚𝑝𝑘 𝑚𝑝𝑙
𝑟 𝑚𝑝𝑘
𝑤
= 𝑚𝑝𝑙
→ 𝐂𝐨𝐧𝐝𝐢𝐭𝐢𝐨𝐧 𝐟𝐨𝐫 𝐜𝐨𝐬𝐭 𝐦𝐢𝐧𝐢𝐦𝐢𝐳𝐚𝐭𝐢𝐨𝐧
Page 83 of 167
This condition states that, for cost minimization, the slope of the Isocost line is equal to the slope
of the isoquant.
Proof
From the Isocost equation: 𝐶 = 𝑟𝑘 + 𝑤𝑙
Slope of the Isocost
𝑘 = 𝐶 − 𝑤𝑙
𝑐 𝑤
𝑘= − 𝐿
𝑟 𝑟
𝜕𝑘 −𝑤
=
𝜕𝐿 𝑟
Slope of Isoquant
From the production function:
𝑄 = 𝑓 (𝑘, 𝑙)
Total differential
𝜕𝑄 = 𝑓𝑘′ (𝑘, 𝑙). 𝜕𝑘 + 𝑓𝐿′ (𝑘, 𝑙)𝜕𝑙
Along an isoquant, the output does not change, hence 𝑑𝑄 = 0
𝑂 = 𝑚𝑝𝑘 . 𝜕𝑘 + 𝑚𝑝𝑙 . 𝑑𝑙
𝑚𝑝𝑘 . 𝜕𝑘 = −𝑚𝑝𝑙 𝑑𝑙
𝑑𝑘 𝑚𝑝 +𝑤
= + 𝑚𝑝 𝑙 = ……. The slope of the isoquant is equal to the slope of the isocost line.
𝜕𝑙 𝑘 𝑟
Page 84 of 167
̅ | < 0: Cost is minimized
If |𝐻
Example
The production function for a firm is given as 𝑄 = 12𝐿0.5 𝐾 0.5. If the firm wants to produce an
output of 240 units, find the optimal values of labour and capital that will minimize the total cost
of production given that labour cost per unit is 25 dollars and capital cost per unit is 50 dollars
Solution
Minimize Cost: 𝐶 = 𝑤𝐿 + 𝑟𝐾 Since 𝑤 = 25 and 𝑟 = 50
𝐶 = 25𝐿 + 50𝐾
Subject to: 𝑄 = 12𝐿0.5 𝐾 0.5
𝐿 = 25𝐿 + 50𝐾 + 𝜆 (240 − 12𝐿0.5 𝐾 0.5 )
𝐿𝑙 = 25 − 𝜆6𝐿−0.5 𝐾 0.5 = 0
𝐿𝑘 = 50 − 𝜆6𝐿0.5 𝐾 −0.5 = 0
𝐿𝜆 = 240 − 12𝐿0.5 𝐾 0.5 = 0
If we solve for the first order conditions:
𝜆6𝐿−0.5 𝐾 0.5 = 25
𝜆6𝐿0.5 𝐾 −0.5 = 50
Dividing the two equations we have:
Page 85 of 167
25 𝜆6𝐿−0.5 𝐾 0.5 𝐾
= =
50 𝜆6𝐿0.5 𝐾 −0.5 𝐿
1
→ 𝐾= 𝐿
2
If we substitute this in the 3rd equation, we get:
𝐿𝜆 = 240 − 12𝐿0.5 𝐾 0.5 = 0
12𝐿0.5 𝐾 0.5 = 240
12𝐿0.5 (0.5𝐿)0.5 = 240
240
𝐿0.5 (0.5𝐿)0.5 = = 20
12
𝐿(0.5)0.5 = 20
20
𝐿̅ = = 28.28
0.50.5
1
̅ = 𝐿 = 14.14
𝐾
2
𝐶̅ = 25(28.28) + 50(14.14) = 1414
Page 86 of 167
7.2.3 Output Maximization
The firm may want to maximize output subject to cost constraint as shown below.
Maximize output: 𝑄 = 𝑓(𝑘, 𝑙)
Subject to: 𝐶 = 𝑟𝑘 + 𝑤𝑙
𝐿 = 𝑓(𝑘, 𝑙) + 𝜆 (𝐶 − 𝑟𝑘 − 𝑤𝑙)
𝐿𝑘 = 𝑓𝐾′ (𝑘 , 𝑙) − 𝜆𝑟 = 0
𝐿𝑙 = 𝑓𝐿′ (𝑘 , 𝑙) − 𝜆𝑤 = 0
𝐿𝜆 = 𝐶 − 𝑟𝑘 − 𝑤𝑙 = 0
From 𝐿𝑘 and 𝐿𝑙
𝜆𝑟 = 𝑓𝑘 ′ (𝑘 , 𝑙) 𝜆𝑤 = 𝑓𝑙′ (𝑘 , 𝑙)
𝑓 ′ 𝑘 (𝑘,𝑙) 𝑚𝑝𝑘 𝑚𝑝𝑙

𝜆= = and 𝜆=
𝑟 𝑟 𝑤
𝑚𝑝𝑘 𝑚𝑝𝑙
=
𝑟 𝑤
𝑚𝑝𝑘 𝑟
= 𝑤 → 𝐂𝐨𝐧𝐝𝐢𝐭𝐢𝐨𝐧 𝐟𝐨𝐫 𝐨𝐮𝐭𝐩𝐮𝐭 𝐦𝐚𝐱𝐢𝐦𝐢𝐳𝐚𝐭𝐢𝐨𝐧
𝑚𝑝𝑙
Page 87 of 167
Example
The production function for garages which services cars and trucks is given as:
𝑄 = 15𝐿2/3 𝐾 1/3
If each unit of labour used costs $5 while each unit of capital cost $3, find the units of labour and
capital to be used so as to maximize the production given that the garage has only $450 dollars at
its disposal.
Solution
Set up the optimization problem:
Maximize output: 𝑄 = 15𝐿2/3 𝐾 1/3
Subject to: 𝑤𝐿 + 𝑟𝐾 = 𝐶
Since 𝑤 = 5; 𝑟 = 3 and 𝐶 = 450
Hence the isocost line is: 5𝐿 + 3𝐾 = 450
The augmented function will be given as:
𝐿 = 15𝐿2/3 𝐾 1/3 + 𝜆(450 − 5𝐿 − 3𝐾)
1
𝐿𝐿 = 10𝐿−3 𝐾 1/3 − 5𝜆 = 0
2 2
𝐿𝐾 = 5𝐿3 𝐾 −3 − 3𝜆 = 0
𝐿𝜆 = 450 − 5𝐿 − 3𝐾 = 0
If we solve the three first order conditions, we get:
Page 88 of 167
Dividing 𝐿𝐿 and 𝐿𝐾
2𝐾 5
=3
𝐿
6𝐾 = 5𝐿
5
𝐾 = 6𝐿
Substituting for K into 𝐿𝜆
𝐿𝜆 = 450 − 5𝐿 − 3𝐾 = 0
5𝐿 + 3𝐾 = 450
5
5𝐿 + 3 ∗ 𝐿 = 450
6
5𝐿 + 2.5𝐿 = 450
7.5𝐿 = 450
450
𝐿̅ = = 60 𝑻𝒉𝒊𝒔 𝒊𝒔 𝒕𝒉𝒆 𝒐𝒑𝒕𝒊𝒎𝒂𝒍 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇 𝑳𝒂𝒃𝒐𝒖𝒓 𝒖𝒏𝒊𝒕
7.5
5 5
̅=
𝐾 ∗ 𝐿̅ = ∗ 60 = 50 𝑻𝒉𝒊𝒔 𝒊𝒔 𝒕𝒉𝒆 𝒐𝒑𝒕𝒊𝒎𝒂𝒍 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇 𝒄𝒂𝒑𝒊𝒕𝒂𝒍 𝒖𝒏𝒊𝒕
6 6
2 1 2 1
𝑄̅ = 15𝐿̅3 𝐾
̅ 3 = 15(60)3 (50)3 = 15 ∗ 15.35 ∗ 3.68 = 847.32
a) The production function for a firm is given as : 𝑄 = 10𝐿1/2 𝐾 1/2
If each unit of labour used costs $5 while each unit of capital cost $3, find the units of labour and
capital to be used so as to minimize the production cost given that the firm wants to produce 250
units of output.
Page 89 of 167
b) A firm produces jam from two raw materials, strawberries and black berries. The
production function for the jam is given as: 𝑄 = 20𝑥 0.2 𝑦 0.8 where x is strawberries and y
is blackberries. If each unit of straw berries cost 20 shillings and each unit of blackberries
cost 2 shillings, and the firm has only 1450 shillings at its disposal:
i) Use the Lagrangian method to determine the optimal values of strawberries and
blackberries to be bought and the maximum amount of jam to be produced.
𝑀𝑃𝑥 𝑃𝑥
ii) Show that 𝑀𝑃𝑦 = 𝑃𝑦 at the maximum output
7.4 E-References
1. Allen R.G.D. Mathematical analysis for Economics

2. Bradley T. and Paul P. (1999) Essential Mathematics for Economics and Business, John
Willey and Sons Ltd, England.
press, London
6. Monga G.S. (2005) Mathematics and Statistics for Economics, second revised edition,
Vikas publishing press
Page 90 of 167
LECTURE EIGHT: MATRIX ALGEBRA I
8.1 Introduction
In this Lesson, we will discuss several concepts in matrices as well as matrix operations such as
addition, subtraction, multiplication and division.
By the end of the lesson, the learner should be able to.
8.2.1 Understand the meaning of matrices
8.2.2 Understand different types of matrices
8.2.3 Compute the determinant of a matrix
8.2.4 Understand matrix operations
8.2.1 The meaning of Matrices
A simple economic model consists of only one equation. The equation gives the relationship
between the dependent variables and the independent. Such a relationship can be given as
e.g. 𝑦 = 𝑎0 + 𝑎1 𝑥
𝑤ℎ𝑒𝑟𝑒 𝑦 = 𝐷𝑒𝑝𝑒𝑛𝑑𝑒𝑛𝑡 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒
𝑥 = 𝐼𝑛𝑑𝑒𝑝𝑒𝑛𝑑𝑒𝑛𝑡 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒
𝑎0 𝑎𝑛𝑑 𝑎1 𝑎𝑟𝑒 𝑝𝑎𝑟𝑎𝑚𝑒𝑡𝑒𝑟𝑠 𝑜𝑓 𝑡ℎ𝑒 𝑚𝑜𝑑𝑒𝑙
It is easy to get the values of such parameters.
Page 91 of 167
The economic model can contain several equations, which can be linear or non-linear.
Each of the equations would represent one aspect of the model. For example, it can be a
constraint on one of the resources.
Matrices can give a way of writing linear simultaneous equations and helps us to have a clear
way of getting a solution for each of the variables.
A matrix can therefore be defined as a rectangular / square array of numbers, parameters or
variables. The members of this array are called the elements of the matrix. A matrix is an
ordered set of numbers, parameters or variables.
The position and the magnitude of each element in a matrix matters. The examples below
illustrate this:
No. of Students MALE FEMALE
Machakos University 4,000 6,000
Kenyatta University 12,000 20,000
This can be represented as a matrix in the form
4,000 6,000
[ ]
12,000 20,000
4,000 in the 1st row 1st column represents the number of male students in Machakos University.
6,000 in the 1st row 2nd column represents the number of female students in Machakos
University.
12,000 in the 2nd row 1st column represent the number of male students in Kenyatta University.
20,000 in the 2nd row 2nd column represent the number of female students in Kenyatta
University.
Page 92 of 167
A matrix is represented by a capital letter while its elements are represented by small letters
with 2 subscripts on them.
The 1st subscript represents the row where the element is found while the 2nd one represents
the column where the element is found.
The above matrix can be given as:
4,000 6,000 𝑎11 𝑎12

𝐴=[ ] = [𝑎 𝑎22 ]
12,000 20,000 21
𝐴 = [𝑎𝑖𝑗 ] 𝑖 − 𝑟𝑜𝑤𝑠 𝑖𝑛 𝐴
𝑗 − 𝑐𝑜𝑙𝑢𝑚𝑛𝑠 𝑖𝑛 𝐴
𝑎11 − 𝐸𝑙𝑒𝑚𝑒𝑛𝑡 𝑖𝑛 1𝑠𝑡 𝑟𝑜𝑤 1𝑠𝑡 𝑐𝑜𝑙𝑢𝑚𝑛
𝑎12 − 𝐸𝑙𝑒𝑚𝑒𝑛𝑡 𝑖𝑛 1𝑠𝑡 𝑟𝑜𝑤 2𝑛𝑑 𝑐𝑜𝑙𝑢𝑚𝑛
𝑎21 − 𝐸𝑙𝑒𝑚𝑒𝑛𝑡 𝑖𝑛 2𝑛𝑑 𝑟𝑜𝑤 1𝑠𝑡 𝑐𝑜𝑙𝑢𝑚𝑛
𝑎22 − 𝐸𝑙𝑒𝑚𝑒𝑛𝑡 𝑖𝑛 2𝑛𝑑 𝑟𝑜𝑤 2𝑛𝑑 𝑐𝑜𝑙𝑢𝑚𝑛
The dimensions of a matrix are given by the number of rows and number of columns in the
matrix, in that particular order. Our previous matrix is a 2 x 2 matrix.
A matrix with 𝑚 rows and 𝑛 columns is said to be a 𝑚 by 𝑛 matrix.
In general, the element
𝑎𝑖𝑗 belongs to 𝑖 𝑡ℎ 𝑟𝑜𝑤 and 𝑗 𝑡ℎ 𝑐𝑜𝑙𝑢𝑚𝑛
Page 93 of 167
8.2.2 Types of Matrices
a) Column Vector – This is a matrix with only 1 column for example.
10
3
𝐴 = [15] A is 3 𝑥 1 𝐵 = [ ] B is a 2𝑥1 matrix
6
9
b) Row Vector
A matrix with only one row
𝐴 = [15 10 12] 𝐴 𝑖𝑠 𝑎 1 𝑥 3 𝑚𝑎𝑡𝑟𝑖𝑥
𝐵 = [7 15 20 9 11] 𝑇ℎ𝑖𝑠 𝑖𝑠 𝑎 1𝑥5 𝑚𝑎𝑡𝑟𝑖𝑥
c) Equal Matrices
Two matrices are equal if
i. They are of the same size.
ii. The elements in corresponding positions in the two matrices are the same.
For example
4 10 4 10
𝐴=[ ] 𝐵=[ ]
1 19 1 19
Matrix A’s elements can be represented by
𝑎11 𝑎12 𝑏11 𝑏12

𝐴 = [𝑎 𝑎22 ] 𝑤ℎ𝑖𝑙𝑒 𝐵 = [𝑏21 ]
21 𝑏22
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𝑎11 = 𝑏11 = 4 𝑒𝑙𝑒𝑚𝑒𝑛𝑡𝑠 𝑖𝑛 1𝑠𝑡 𝑟𝑜𝑤 1𝑠𝑡 𝑐𝑜𝑙𝑢𝑚𝑛
𝑎12 = 𝑏12 = 10 𝑒𝑙𝑒𝑚𝑒𝑛𝑡𝑠 𝑖𝑛 1𝑠𝑡 𝑟𝑜𝑤 2𝑛𝑑 𝑐𝑜𝑙𝑢𝑚𝑛
𝑎21 = 𝑏21 = 1 𝑒𝑙𝑒𝑚𝑒𝑛𝑡𝑠 𝑖𝑛 2𝑛𝑑 𝑟𝑜𝑤 1𝑠𝑡 𝑐𝑜𝑙𝑢𝑚𝑛
𝑎22 = 𝑏22 = 19 𝑒𝑙𝑒𝑚𝑒𝑛𝑡𝑠 𝑖𝑛 2𝑛𝑑 𝑟𝑜𝑤 2𝑛𝑑 𝑐𝑜𝑙𝑢𝑚𝑛
Hence Matrix A = Matrix B
Are the following two matrices C and D equal?
8 2 2 8
𝐷=[ ] 𝐶= [ ]
5 11 11 5
By rewrite
𝑑11 𝑑12 𝑐11 𝑐12

𝐷=[ ] 𝐶 = [𝑐 𝑐22 ]
𝑑21 𝑑22 21
𝑑11  𝑐11
𝑑21  𝑐21 Hence D and C are not equal
𝑑12  𝑐12
𝑑22  𝑐22
d) Transpose of a matrix
Page 95 of 167
This is a matrix formed when you interchange rows and columns so that a 𝑚𝑥𝑛 matrix become an
𝑛𝑥𝑚 matrix. For example
8 5 1
𝐴=[ ] 𝐴 𝑖𝑠 𝑎 2 𝑥 3 𝑚𝑎𝑡𝑟𝑖𝑥
2 3 9
8 2
𝐴𝑇 = [5 3] The transpose of A is a 3𝑥2 matrix
1 9
The transpose of a transpose is the original matrix i.e.
[𝐴𝑇 ]𝑇 = 𝐴
8 2
𝑇
𝐴 = [5 3]
1 9
[𝐴𝑇 ]𝑇 = [8 5 1
]
2 3 9
e) Square matrix
This is a matrix whose number of rows is equal to its number of columns.
E.g. 1 𝑥 1 2𝑥2 3𝑥3 4𝑥4 [𝑛 𝑥 𝑛]
Examples
2 8 10
10 20
𝐴=[ ] 𝐵 = [4 7 11]
15 40
9 5 6
Quick Test
Page 96 of 167
Are these matrices square.
8 1
𝐴=[ ] 𝐵 = [5]
2 5
5 8 1
9 2 0
𝐶=[ ]
1 4 10
7 3 15
f) A diagonal matrix
This is a square matrix whose elements are all zero except the elements in its principal diagonal
(the diagonal from up left to right down). At least one of the elements is principal diagonal should
be non-zero.
For Example
9 0 0 0
8 0 0
0 0 0 0
𝐷 = [0 2 0] 𝐹=[ ]
0 0 0 0
0 0 0
0 0 0 11
1 0
𝐸=[ ]
0 1
g) An Identity / Unit matrix
A diagonal matrix, whose elements of the principal diagonal are all 1.
1 0 0
1 0
e.g. 𝐸=[ ] 𝐴 = [0 1 0]
0 1
0 0 1
h) A null / zero matrix
Page 97 of 167
A matrix whose elements are all zero.
0 0
0 0 0
0 0
𝐵=[ ] 4𝑥2 𝑛𝑢𝑙𝑙 𝑚𝑎𝑡𝑟𝑖𝑥 𝐶 = [0 0 0] 3𝑥3 𝑛𝑢𝑙𝑙 𝑚𝑎𝑡𝑟𝑖𝑥
0 0
0 0 0
0 0
𝐸 = [0] 1𝑥1 𝑛𝑢𝑙𝑙 𝑚𝑎𝑡𝑟𝑖𝑥
i) Sub- matrix
This a matrix formed from another matrix by deleting some specified row/s and or column/s of the
matrix.
For Example
5 7 0
𝐴 = [9 4 2]
3 1 8
9 4 2
𝐴1 = [ ] − 𝐹𝑜𝑟𝑚𝑒𝑑 𝑏𝑦 𝑑𝑒𝑙𝑒𝑡𝑖𝑛𝑔 𝑡ℎ𝑒 1𝑠𝑡 𝑟𝑜𝑤 𝑜𝑓 𝑚𝑎𝑡𝑟𝑖𝑥 𝐴.
3 1 8
5 7
𝐴2 = [ ]
9 4
− 𝐹𝑜𝑟𝑚𝑒𝑑 𝑏𝑦 𝑑𝑒𝑙𝑒𝑡𝑖𝑛𝑔 𝑡ℎ𝑒 3𝑟𝑑 𝑟𝑜𝑤 𝑎𝑛𝑑 3𝑟𝑑 𝑐𝑜𝑙𝑢𝑚𝑛 𝑜𝑓 𝑚𝑎𝑡𝑟𝑖𝑥 𝐴.
In any matrix, we can form several sub matrices from it.
j) Principal Sub-matrix
If B is a square matrix, then any square sub matrix formed from B whose principal diagonal is part
of the principal diagonal of B is a principal sub matrix of A.
Page 98 of 167
5 10 2 4
9 1 6 9
e.g. 𝐵=[ ]
8 13 7 5
1 8 0 7
5 10 2 1 6 9
𝐵1 = [9 1 6] 𝐵3 = [13 7 5]
8 13 7 8 0 7
5 10 1 6
𝐵2 = [ ] 𝐵4 = [ ]
9 1 13 7
𝐵1 , 𝐵2 , 𝐵3 𝑎𝑛𝑑 𝐵4 𝑎𝑟𝑒 𝑎𝑙𝑙 𝑝𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙 𝑠𝑢𝑏 𝑚𝑎𝑡𝑟𝑖𝑐𝑒𝑠 𝑜𝑓 𝐵.
8.2.3 Determinant of a matrix
Determinants are only defined for square matrices.
It is a uniquely defined scalar associated with the matrix.
The determinant of a matrix B is denoted as:
|𝑩|
i. Determinant of a 1 x 1 matrix
𝐵 = [𝑎11 ]
Its determinant is given as
|𝐵| = 𝑏11
𝐼𝑓 𝐵 = [10] 𝑖𝑡𝑠 𝑑𝑒𝑡𝑒𝑟𝑚𝑖𝑛𝑎𝑛𝑡 = 10
Page 99 of 167
ii. Determinant of a 2 x 2 matrix
𝑎11 𝑎12
𝐵 = [𝑎 𝑎22 ]
21
|𝐵| = 𝑎11 𝑎22 − 𝑎21 𝑎12
For example
8 6
𝐵=[ ]
9 1
|𝐵| = (8 𝑥 1) − (9 𝑥 6) = 8 − 54
= −48
Compute the determinant of matrix C below
8 0
𝐶=[ ]
4 1
iii. Determinant of a 3 x 3 matrix
𝑎11 𝑎12 𝑎13

𝐴 = [𝑎21 𝑎22 𝑎23 ]
𝑎31 𝑎32 𝑎33
This is easily done by rewriting the 1st 2 columns of matrix A next to the matrix on the right hand
side.
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The first 3 principal diagonals from left to right going down formed are added while other 3
diagonals (auxiliary diagonals) formed from left to right up are subtracted from the sum of the
previous 3.
For example
4 2 0
𝐴 = [8 9 2]
1 5 3
4 2 0 4 2
|𝐴| = |8 9 2| 8 9
1 5 3 1 5
4 2 0 4 2
|𝐴| = |8 9 2| 8 9
1 5 3 1 5
(𝐴) = {4 𝑥 9 𝑥 3 + 2 𝑥 2 𝑥 1 + 0 𝑥 8 𝑥 5} − {1 𝑥 9 𝑥 0 − 5 𝑥 2 𝑥 4 − 3 𝑥 8 𝑥 2}
= 108 + 4 + 0 − 0 − 40 − 48 = 24
Exercise
Compute the determinant of matrix B:
8 2 2
𝐵 = [6 5 10]
1 9 3
Solution: -518
Page 101 of 167

NOTE
In the course of this lecture we will learn about another method of getting the determinant of any
square matrix. The method is called Laplace Expansion.
Properties of determinants
i. If you interchange the rows and columns of a matrix it leaves the determinant unchanged.
Hence the determinant of the transpose is the same as the determinant of the original matrix.
For example:
5 8 (𝐵) = 5 − 72 = −67
𝐵=[ ]
9 1
5 9
𝐵𝑇 = [ ] = (𝐵𝑇 ) = 5 − 72 = −67
8 1
ii. If you interchange any 2 rows or any 2 columns, of a matrix it changes the sign of a matrix.
For example
15 1 (𝐶) = 45 − 2 = 43
𝐶=[ ]
2 3
12 3
𝐶1 = = |𝐶1 | = 12 − 45 = −43
15 1
Example 2
3 4 6 3 𝑥 5 𝑥0 + 4 𝑥 1 𝑥 2 + 6 𝑥 1 𝑥 1
𝐷 = [1 5 1] |𝐷| = −2 𝑥 5𝑥 6 − 1 𝑥 1 𝑥 3 − 0𝑥1 𝑥 4
2 1 0 = 0 + 8 + 6 − 60 − 3 − 0 = −49
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If we interchange the 2nd and 3rd column we get another matrix given as:
3 6 4 3𝑥1𝑥1+6𝑥5𝑥2+4𝑥1𝑥0
𝐷1 = [1 1 5] |𝐷| = −2 𝑥 1 𝑥 4 − 0 𝑥 5 𝑥 3 − 1 𝑥 1 6
2 0 1 = 3 + 60 − 8 − 6 = 63 − 14 = 49
|𝐷| = −|𝐷1 |
iii. If each of the elements in a row or column is multiplied by a constant 𝑥, then the determinant
of the new matrix will be multiplied by 𝑥.
e.g.
8 2
𝐶=[ ] |𝐶| = 24 − 2 = 22
1 3
If x=2
16 4
𝐶 𝑛𝑒𝑤 = [ ]
1 3
|𝐶 𝑛𝑒𝑤| = |16 4
| = 48 − 4 = 44
1 3
Hence, |𝐶 𝑛𝑒𝑤| = 2|𝐶|
iv. Determinant of a matrix with 2 identical rows is 0.
8 8 2
𝐷 = [1 1 0]
3 3 7
8 8 2
|𝐷| = |1 1 0|
3 3 7
=8𝑥1𝑥7+8𝑥0𝑥3+2𝑥1𝑥3−3𝑥1𝑥2−3𝑥0𝑥8−7𝑥1𝑥8
=0
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v. If a matrix has 2 row or 2 columns which are multiples of one another, the determinant of the
matrix is zero.
5 10
e.g. 𝐸=[ ] 𝑖. 𝑒. 2𝑛𝑑 𝑐𝑜𝑙𝑢𝑚𝑛 𝑖𝑠 𝑡𝑤𝑖𝑐𝑒 𝑡ℎ𝑒 1𝑠𝑡 𝑐𝑜𝑙𝑢𝑚𝑛.
2 4
|𝐸| = 20 − 20 = 0
vi. If in any matrix, the elements of any of the row or column are all zero, the determinant of the
matrix is zero.
1 0 9
|𝑋| 1 𝑥 0 𝑥 18 + 0 𝑥 12 𝑥 5 + 9 𝑥 2 𝑥 0
𝑋 = [2 0 12]
−5 𝑥 0 𝑥 9 − 0 𝑥 12 𝑥 1 − 18 𝑥 2 𝑥 0 = 0
5 0 18
vii. If a matrix 𝐷∗ is formed from matrix 𝐷 by adding or subtracting a multiple of one row or
column to another row or column of then
|𝐷∗ | = |𝐷|
8 5 2 8 5 2
𝐷 = [1 6 4] 𝐷∗ = [17 16 8]
2 1 3 2 1 3
𝑤ℎ𝑒𝑟𝑒 𝑅2 𝑖𝑛 𝐷 ∗ 𝑖𝑠 𝑔𝑖𝑣𝑒𝑛 𝑎𝑠:
𝑁𝑒𝑤 𝑟𝑜𝑤2 = 𝑂𝑙𝑑 𝑅2 + 2 𝑜𝑙𝑑 𝑅1
|𝐷| = 115 |𝐷∗ | = 115
Page 104 of 167

8.2.4 Matrix Operations
a) Matrix addition and subtraction
We can only add/subtract matrices if they are of the same size (dimension). When
adding/subtracting matrices, elements in the same positions are added /subtracted. The
sum/difference of two matrices A and B will be a matrix of the same size as A and B.
Example:
4 9 10 1 15 4
𝐴 = [5 2 0] 𝐵 = [3 2 7]
6 1 6 8 3 5
𝐴+𝐵 =𝐶
5 24 14
𝐶=[8 4 7]
14 4 11
𝐴−𝐵 =𝐷
3 −6 6
𝐷=[ 2 0 −7]
−2 −2 1
b) Matrix multiplication
Matrix multiplication is a little more complex than addition and subtraction. Two matrices A and
B can only be multiplied in the order 𝐴𝑥𝐵 if they are conformable.
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Two matrices are conformable if the number of columns in the first matrix is the same as the
number of rows in the second matrix.
For example, if A is a 𝑚𝑥3 matrix, it can only be multiplied by another matrix of the order 3𝑥𝑛.
The reason for this requirement is the method used when multiplying the matrices.
Example
5 2 1 9 6
If: 𝐴 = [ ] 𝐵=[ ]
3 1 4 0 8
We can write this these matrices as:
𝑎11 𝑎12 𝑏11 𝑏12 𝑏13

𝐴 = [𝑎 𝑎22 ] 𝐵=[ ]
21 𝑏21 𝑏22 𝑏23
𝐴𝑥𝐵 𝑤𝑖𝑙𝑙 𝑏𝑒 𝑎𝑛𝑜𝑡ℎ𝑒𝑟 𝑚𝑎𝑡𝑟𝑖𝑥. 𝐿𝑒𝑡𝑠 𝑎𝑠𝑠𝑢𝑚𝑒 𝐴𝐵 = 𝐶
The dimensions of matrix C will be determined by the 2 matrices. It will have the same number of
rows as A and same number of columns as B i.e. C will be a 2x3 matrix.
𝑐11 𝑐12 𝑐13

𝐶 = [𝑐 𝑐22 𝑐23 ]
21
How do we get the elements of matrix C?
𝑐𝑖𝑗 = 𝐼𝑡 𝑖𝑠 𝑡ℎ𝑒 𝑝𝑟𝑜𝑑𝑢𝑐𝑡 𝑜𝑏𝑡𝑎𝑖𝑛𝑒𝑑 𝑏𝑦 𝑚𝑢𝑙𝑡𝑖𝑝𝑙𝑦𝑖𝑛𝑔 𝑡ℎ𝑒 𝑒𝑙𝑒𝑚𝑒𝑛𝑡𝑠 𝑖𝑛 𝑡ℎ𝑒 𝑖𝑡ℎ 𝑟𝑜𝑤
𝑜𝑓 𝑚𝑎𝑡𝑟𝑖𝑥 𝐴 𝑏𝑦 𝑡ℎ𝑒 𝑒𝑙𝑒𝑚𝑒𝑛𝑡𝑠 𝑖𝑛 𝑡ℎ𝑒 𝑗𝑡ℎ 𝑐𝑜𝑙𝑢𝑚𝑛 𝑜𝑓 𝑚𝑎𝑡𝑟𝑖𝑥 𝐵.
Page 106 of 167

𝑐11 = 𝑎11 . 𝑏11 + 𝑎12 . 𝑏21 𝑐12 = 𝑎11 . 𝑏12 + 𝑎12 . 𝑏22 𝑐13 = 𝑎11 . 𝑏13 + 𝑎12 . 𝑏23
𝑐21 = 𝑎21 . 𝑏11 + 𝑎22 . 𝑏21 𝑐22 = 𝑎21 . 𝑏12 + 𝑎22 . 𝑏22 𝑐23 = 𝑎21 . 𝑏13 + 𝑎22 . 𝑏23
Using our example:
5 2 1 9 6
𝐴=[ ] 𝐵=[ ]
3 1 4 0 8
𝑐11 = 5𝑥1 + 2𝑥4 𝑐12 = 5𝑥9 + 2𝑥0 𝑐13 = 5𝑥6 + 2𝑥8
𝑐21 = 3𝑥1 + 1𝑥4 𝑐22 = 3𝑥9 + 1𝑥0 𝑐23 = 3𝑥6 + 1𝑥8
13 45 46
𝐶=[ ]
7 27 26
4 5
4 3 7
Two matrices A and B are given as: 𝐴 = [ ]. This is a 2𝑥3 matrix and 𝐵 = [6 2] 𝑡his
1 2 5
8 9
is a 3𝑥2 matrix. The resultant matrix will be a 2𝑥2 matrix.
4 5
4 3 7
𝐴𝐵 = 𝐶 𝐴=[ ] 𝐵 = [6 2]
1 2 5
8 9
𝑐11 𝑐12 16 + 18 + 56 20 + 6 + 63 90 89
.𝐶 = [𝑐 𝑐22 ] = [ 4 + 12 + 40 ]=[ ]
21 5 + 4 + 45 56 54
Page 107 of 167

Note: When multiplying matrices, 𝐴𝑥𝐵 ≠ 𝐵𝑥𝐴
It may not always be possible to multiply the matrices in the reverse order unless the two matrices
are square.
NB: Matrix division will be discussed in LECTURE NINE
a) Given the following matrix:
4 9 10
𝐴 = [5 2 0]
6 1 6
i) What is the order of the matrix?
ii) Compute the transpose of the matrix.
iii) Compute the determinant of the matrix.
b) Compute the product AB and BA for the following matrices
4 9 10 1 15 4
𝐴 = [5 2 0] 𝐵 = [3 2 7]
6 1 6 8 3 5
8.4 E-References
1. Allen R.G.D. Mathematical analysis for Economics

2. Bradley T. and Paul P. (1999) Essential Mathematics for Economics and Business,
John Willey and Sons Ltd, England.
4. Holden K., Pearson A.W. (1985), Introductory Mathematics for Economists,
Macmillan press, London
6. Monga G.S. (2005) Mathematics and Statistics for Economics, second revised edition,
Vikas publishing press
Page 108 of 167

LECTURE NINE: MATRIX ALGEBRA II
9.1 Introduction
In this Lesson, we will discuss how to perform matrix division. We will also discuss how to
compute the rank of a matrix.
9.2.1 Understand Matrix Inversion
9.2.2 Understand Cramer’s Rule
9.2.3 Compute the rank of a matrix
Before we discuss how to divide matrices, we discuss the following concepts.
i) Minor of a matrix
The minor of a square matrix C are determinants of square sub matrices of C.
𝑐11 𝑐12 𝑐13

𝑐
𝐴𝑠𝑠𝑢𝑚𝑒 𝐶 = [ 21 𝑐22 𝑐23 ]
𝑐31 𝑐32 𝑐33
To get the minor of the entire matrix we first get the minors of each of the elements.
The minor of any element is the determinant of the matrix formed by deleting the row and the
column where that element is found. By abbreviating the minor as 𝑀 then:
Page 109 of 167

𝑐22 𝑐23 𝑐21 𝑐23 𝑐21 𝑐22
𝑀(𝐶11 ) = |𝑐 𝑐33 | 𝑀(𝐶12 ) = |𝑐 𝑐33 | 𝑀(𝐶13 ) = |𝑐 𝑐32 |
32 31 31
𝑐12 𝑐13 𝑐11 𝑐13 𝑐11 𝑐12

𝑀(𝐶21 ) = |𝑐 𝑐33 | 𝑀(𝐶22 ) = |𝑐 𝑐33 | 𝑀(𝐶23 ) = |𝑐 𝑐33 |
32 31 31
𝑐12 𝑐13 𝑐11 𝑐13 𝑐11 𝑐12

𝑀(𝐶31 ) = |𝑐 𝑐23 | 𝑀(𝐶32 ) = |𝑐 𝑐23 | 𝑀(𝐶33 ) = |𝑐 𝑐32 |
22 21 31
Example:
5 0 7
𝐶 = [2 9 3]
8 10 4
9 3 2 3 2 9
𝑀(5) = | |=6 𝑀(0) = | | = −16 𝑀(7) = | | = −52
10 4 8 4 8 10
0 7 5 7 5 0
𝑀(2) = | | = −70 𝑀(9) = | | = −36 𝑀(3) = | | = 50
10 4 8 4 8 10
0 7 5 7 5 0
𝑀(8) = | | = −63 𝑀(10) = | |=1 𝑀(4) = | | = 45
9 3 2 3 2 9
The minor of matrix C is therefore:
6 −16 −52
𝑀 (𝐶) = [−70 −36 50 ]
−63 1 45
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ii) Cofactor of an element
This is given by the minor of an element multiplied by ( −1) raised to the power of the addition
of its subscripts.
e.g.
𝑐𝑜𝑓𝑎𝑐𝑡𝑜𝑟 𝑜𝑓 𝑎11 = 𝑀𝑖𝑛𝑜𝑟 (𝑎11 )𝑥(−1)1+1
Example
Find the cofactors of the elements in matrix C below:
5 2 6 𝐶11 𝐶12 𝐶13

𝐶 = [8 5 4] = [ 𝐶21 𝐶22 𝐶23 ]
1 1 7 𝐶31 𝐶32 𝐶33
5 4
𝑀(𝑐11 ) = | | = 35 − 4 = 31
1 7
8 4
𝑀(𝑐12 ) = | | = 56 − 4 = 52
1 7
8 5
𝑀(𝑐13 ) = | |=8−5=3
1 1
Page 111 of 167

𝐶𝑜𝑓(𝐶11 ) = 𝑀(𝐶11 ) 𝑥 (−1)1+1 = 31 𝑥 (−1)2 = 31
𝐶𝑜𝑓(𝐶12 ) = 𝑀(𝐶12 ) 𝑥 (−1)1+2 = 52 𝑥 (−1)3 = −52
𝐶𝑜𝑓(𝐶13 ) = 𝑀(𝐶13 ) 𝑥 (−1)1+3 = 3 𝑥 −14 = 3
Cofactor matrix
The cofactor matrix of C is the matrix formed by the cofactors corresponding to the elements of
matrix C.
e.g.
𝑐11 𝑐12 𝑐13

𝐶 = [𝑐21 𝑐22 𝑐23 ]
𝑐31 𝑐32 𝑐33
𝐶11 𝐶12 𝐶13

𝐶𝑜𝑓 (𝐶) = [𝐶21 𝐶22 𝐶23 ]
𝐶31 𝐶32 𝐶33
Example
Find the cofactor matrix of matrix C below:
5 2 6
𝐶 = [8 5 4]
1 1 7
Minors:
5 4 5 4 8 5
𝑀(5) = | | = 31 𝑀(2) = | | = 52 𝑀(6) = | |=3
1 7 1 7 1 1
Page 112 of 167

2 6 5 6 5 2
𝑀(8) = | |=8 𝑀(5) = | | = 29 𝑀(4) = | |=3
1 7 1 7 1 1
2 6 5 6 5 2
𝑀(1) = | | = −22 𝑀(1) = | | = −28 𝑀(7) = | |=9
5 4 8 4 5 5
𝐶𝑜𝑓(5) = (−1)1+1 ∗ 𝑀(5) = 31
𝐶𝑜𝑓(5) = −11+1 (31) = 31 𝐶𝑜𝑓(2) = −11+2 (52) = −52 𝐶𝑜𝑓(6) = −11+3 (3) = 3
𝐶𝑜𝑓(8) = −12+1 (8) = −8 𝐶𝑜𝑓(5) = −12+2 (29) = 29 𝐶𝑜𝑓(4) = −12+3 (3) = 3
𝐶𝑜𝑓(1) = −13+1 (−22) = −22 𝐶𝑜𝑓(1) = −13+2 (−28) = 28 𝐶𝑜𝑓(7) = −13+3 (9) = 9
31 −52 3
𝐶𝑜𝑓𝑎𝑐𝑡𝑜𝑟 𝑜𝑓 𝐶 = [ −8 29 −3]
−22 28 9
iii) Adjoint matrix
This is the transpose of a cofactor matrix.
Example 1
In our example above, the adjoint of C will be given as the Transpose of the cofactor matrix of C.
31 −52 3
𝐶𝑜𝑓 𝐶 = [ −8 29 −3]
−22 28 9
Page 113 of 167

31 −8 −22
𝐴𝑑𝑗𝑜𝑖𝑛𝑡 𝐶 = [−52 29 28 ]
3 −3 9
Example 2
Compute the adjoint of the following matrix
4 1
𝐴=[ ]
8 9
𝑀(4) = 9 𝑀(1) = 8 𝑀(8) = 1 𝑀(9) = 4
9 8
𝑀(𝐴) = [ ]
1 4
𝐶𝑜𝑓𝑎𝑐𝑡𝑜𝑟𝑠 𝑜𝑓 𝐴 = −11+1 (9) = 9 (−1)1+2 (8) = −8
−12+2 (1) = −1 (−1)2+2 (4) = 4
9 −8
𝐶𝑜𝑓 (𝐴) = [ ]
−1 4
The adjoint matrix is the transpose of the cofactor matrix
9 −1
𝐴𝑑𝑗𝑜𝑖𝑛𝑡 (𝐴) = [ ]
−8 4
iv) Inverse Matrix
The inverse of matrix C denoted as
𝐶 −1 𝑖𝑠 𝑑𝑒𝑓𝑖𝑛𝑒𝑑 𝑎𝑠:
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𝐴𝑑𝑗𝑜𝑖𝑛𝑡 𝐶
𝐶 −1 =
|𝐶|
Example
10 9
𝐶=[ ]
2 4
Find the inverse of matrix C.
Steps
4 2
1. Get minor of 𝐶=[ ]
9 10
4 −2
2. Get cofactor of 𝐶 = [ ]
−9 10
4 −9
3. Get ad joint of 𝐶 = [ ]
−2 10
10 9
4. Get determinant of 𝐶 = | | = 40 − 18 = 22
2 4
𝐴𝑑 𝑗𝑜𝑖𝑛𝑡 𝐶
5. Get inverse of 𝐶 = 𝐶 −1 = |𝐶|
4 −9
[ ]
= [ −2 10 ]
22
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4⁄ −9⁄ 2 −9⁄
𝐶 −1 = 1⁄22 [
4 −9
] = [ 22 22] = [ ⁄11 22]
−2 10 −2⁄ 10⁄ −1⁄ 5⁄
22 22 11 11
Example 2
Get the inverse of matrix B
6 2 1
𝐵 = [4 5 2]
1 3 1
Step 1
−1 2 7
1. Get minor 𝐵 = [−1 5 16]
−1 8 22
−1 −2 7
2. Get cofactor of 𝐵 = [ 1 5 −16]
−1 −8 22
−1 1 −1
3. Get adjoint 𝐵 = [−2 5 −8]
7 −16 22
4. Get determinant of B
|𝐵|
= 30 + 4 + 12 − 5 − 36 − 8
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= 46 − 49 = −3
−1 1 −1 1⁄ −1⁄ 1⁄
[−2 5 −8] 3 3 3
𝐴𝑑𝑗 𝐵 7 −16 22 2 −5⁄ 8⁄
5. Get 𝐵 −1 = |𝐵|
= = ⁄3 3 3
−3
−7 16⁄ −22⁄
[ ⁄3 3 3]
The inverse of a matrix multiplied by the original matrix gives an identity matrix. 𝐵. 𝐵 −1 = 𝑰
Cofactor expansion of the determinant
We can get the determinant of a matrix by using the method of cofactor expansion. This is done
by choosing any row or column and using it for the expansion. For example:
𝑐11 𝑐12 𝑐13 5 2 6

𝐶 = [𝑐21 𝑐22 𝑐23 ] = [8 5 4]
𝑐31 𝑐32 𝑐33 1 1 7
If we use the first column, we can get the determinant of matrix C as follows:
|𝐶| = 𝑐11 ∗ 𝑐𝑜𝑓 𝑜𝑓 𝑐11 + 𝑐21 ∗ 𝑐𝑜𝑓 𝑜𝑓 𝑐21 + 𝑐31 𝑐𝑜𝑓 𝑜𝑓𝑐31
5 4 2 6 2 6
= 5 ∗ (−1)1+1 | | + 8(−1)2+1 | | + 1(−1)3+1 | |
1 7 1 7 5 4
= 5 ∗ (35 − 4) − 8(14 − 6) + 1(8 − 30)
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= 5 ∗ 31 − 8 ∗ 8 + 1 ∗ −22
= 69
Note: Check by the other method if the answer is the same.
Division of matrices
Now that we know how to compute the inverse of a matrix, it will be very easy to divide matrices.
To show how we divide matrices, we will use the case of a system of simultaneous equations. We
will learn the inverse method and also the Cramer’s rule of matrix division.
9.2.1 Matrix Inverse Method
If we have 2 simultaneous equations given as:
𝑎11 𝑋1 + 𝑎12 𝑋2 = 𝐷1
𝑎21 𝑋1 + 𝑎22 𝑋2 = 𝐷2
We can rewrite the equations in matrix form as:
𝑎11 𝑎12 𝑋1 𝐷1
[𝑎 𝑎22 ] ∗ [𝑋2 ] = [𝐷2 ]
21
𝑎11 𝑎12
If we represent the coefficients matrix [𝑎 𝑎22 ] 𝑎𝑠 𝐴
21
𝑋1 𝐷
The matrix of the variables [ ] 𝑎𝑠 𝑋 and the matrix of the constants [ 1 ] 𝑎𝑠 𝐷, we can rewrite
𝑋2 𝐷2
the system of the equations as:
𝐴𝑋 = 𝐷
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where A and D are known matrices and X is unknown, we can get matrix X by the following
operation:
𝐷
𝑋 = 𝐴 = 𝐴−1 . 𝐷
We pre-multiply matrix D with the inverse of matrix A.
Note: If we multiply 𝐷 by the inverse of 𝐴 it will not be possible because there is no conformity.
𝐴−1 = 2 ∗ 2 𝑚𝑎𝑡𝑟𝑖𝑥 𝐷 = 2 ∗ 1 ℎ𝑒𝑛𝑐𝑒, 2 ∗ 1 𝑎𝑛𝑑 2 ∗ 2 𝑖𝑠 𝑛𝑜𝑡 𝑝𝑜𝑠𝑠𝑖𝑏𝑙𝑒.
Hence to ensure we can get matrix 𝑋 which is a 2 ∗ 1 matrix, we have to ensure we mutiply the
inverse of 𝐴 by 𝐷
Example
If we have 2 simultaneous equations given as:
4𝑋1 + 6𝑋2 = 10
𝑋1 + 10𝑋2 = 30
4 6 𝑋 10
We can rewrite the matrices as:[ ] ∗ [ 1] = [ ]
1 10 𝑋2 30
10
[ ]
𝑋1 4 6 −1 10
[ ] = 30 = [ ] [ ]
𝑋2 4 6 1 10 30
[ ]
1 10
4 6
To get the inverse of the matrix [ ] we proceed as follows
1 10
Get the Determinant = 40-6=34
Get the minors
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10 1
=[ ]
6 4
Get the cofactors
10 −1
=[ ]
−6 4
Get the adjoint
10 −6
=[ ]
−1 4
10 6
−1 1 10 −6 −
4 6
[ ] = [ ] = [ 34 34]
1 10 34 −1 4 1 4
−
34 34
10 6 10 6 80
𝑋1 − ∗ 10 − ∗ 30 −
[ ] = [ 34 34] [10] = [ 34 34 ] = [ 34]
𝑋2 1 4 30 1 4 110
− − ∗ 10 + ∗ 30
34 34 34 34 34
80 40
𝑋1 = − =−
34 17
𝑤ℎ𝑖𝑙𝑒
110 55
𝑋2 = =
34 17
9.2.2 Cramer’s Rule Method
Given a system of two equations as below:
𝑎1 𝑋 + 𝑏1 𝑌 = 𝐶1 − − − − − − − 𝑖
𝑎2 𝑋 + 𝑏2 𝑌 = 𝐶2 − − − − − − − ii
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If we want to get the values of X and Y, we can use the substitution method to eliminate one
of them and finally get a solution as follows:
𝑎1 𝑋 = 𝐶1 − 𝑏1 𝑌
𝐶1 − 𝑏1 𝑌
𝑋=
𝑎1
If we substitute this in the second equation, we get:
𝐶1 −𝑏1 𝑌
𝑎2 + 𝑏2 𝑌 = 𝐶2
𝑎1
Solving for Y we get
𝑎2 𝐶1 − 𝑎2 𝑏1 𝑌+𝑎1 𝑏2 𝑌
= 𝐶2
𝑎1
𝑎2 𝐶1 − 𝑎2 𝑏1 𝑌+𝑎1 𝑏2 𝑌 = 𝑎1 𝐶2
𝑌(𝑎1 𝑏2 − 𝑎2 𝑏1 ) = 𝑎1 𝐶2 − 𝑎2 𝐶1
𝑎1 𝐶2 − 𝑎2 𝐶1
𝑌=
𝑎1 𝑏2 − 𝑎2 𝑏1
By replacing these values in the expression of X, we get:
𝐶1 𝑏2 − 𝐶2 𝑏1
𝑋=
𝑎1 𝑏2 − 𝑎2 𝑏1
Notice that the numerator and the denominator are a product of two values, just like a determinant
of a 2𝑥2 matrix. We can therefore write the expressions of Y and X using determinants as:
Page 121 of 167

𝑎1 𝐶1
| |
𝑎 𝐶2
𝑌= 2
𝑎 𝑏1
| 1 |
𝑎2 𝑏2
and
𝐶 𝑏1
| 1 |
𝐶2 𝑏2
𝑋=
𝑎 𝑏1
| 1 |
𝑎2 𝑏2
In general, Cramer’s rule is written as:
𝑎1 𝑋 + 𝑏1 𝑌 = 𝐶1
𝑎2 𝑋 + 𝑏2 𝑌 = 𝐶2
𝑎1 𝑏1 𝑋 𝐶
[ ] ∗ [ ] = [ 1]
𝑎2 𝑏2 𝑌 𝐶2
𝐶 𝑏1
| 1 |
𝐶 𝑏2
𝑋= 2
𝑎 𝑏1
| 1 |
𝑎2 𝑏2
X can be obtained by getting the determinant of the matrix formed by replacing the 1st column
of the coefficients matrix by the matrix on the right hand side of the equation and dividing it
by the determinant of the coefficients matrix.
Y on the other hand is given as:
𝑎1 𝐶1
| |
𝑎 𝐶2
𝑌= 2
𝑎 𝑏1
| 1 |
𝑎2 𝑏2
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Y can be obtained by getting the determinant of the matrix formed by replacing the 2nd column
of the coefficients matrix by the matrix on the right hand side of the equation and dividing it
by the determinant of the coefficients matrix.
Example
A system of two simultaneous equations is given as:
𝑋 + 2𝑌 = 10
5𝑋 + 8𝑌 = 40
Determine the values of X and Y using the Cramer’s rule
Solution
1 2 𝑋 10
[ ]∗[ ]=[ ]
5 8 𝑌 40
10 2
| | 80 − 80 0
𝑋 = 40 8 = =
1 2 8 − 10 −2
| |
5 8
𝑋=0
1 10
| |
𝑌= 5 40 = 40 − 50 = − 10
1 2 8 − 10 −2
| |
5 8
𝑌=5
If we have a system of three simultaneous equations given as:
Page 123 of 167

𝑎11 𝑋1 + 𝑎12 𝑋2 + 𝑎13 𝑋3 = 𝐶1
𝑎21 𝑋1 + 𝑎22 𝑋2 + 𝑎23 𝑋3 = 𝐶2
𝑎31 𝑋1 + 𝑎32 𝑋2 + 𝑎33 𝑋3 = 𝐶3
We can rewrite the equations as:
𝑎11 𝑎12 𝑎13 𝑋1 𝐶1

[𝑎21 𝑎22 𝑎23 ] ∗ [𝑋2 ] = [𝐶2 ]
𝑎31 𝑎32 𝑎33 𝑋3 𝐶3
The values of the unknown 𝑋1 , 𝑋2 , 𝑎𝑛𝑑 𝑋3 𝑤𝑖𝑙𝑙 𝑏𝑒 𝑔𝑖𝑣𝑒𝑛 𝑎𝑠:
𝐶1 𝑎12 𝑎13 𝑎11 𝐶1 𝑎13 𝑎11 𝑎12 𝐶1

|𝐶2 𝑎22 𝑎23 | |𝑎21 𝐶2 𝑎23 | |𝑎21 𝑎22 𝐶2 |
𝐶 𝑎 𝑎 𝑎 𝐶 𝑎 𝑎 𝑎 𝐶
𝑋1 = 𝑎 3 𝑎32 𝑎33 𝑋2 = 𝑎 31 𝑎 3 𝑎33 𝑋3 = 𝑎 31 𝑎 32 𝑎 3
11 12 13 11 12 13 11 12 13
𝑎
| 21 𝑎 22 𝑎 23 | 𝑎
| 21 𝑎 22 𝑎 23 | 𝑎
| 21 𝑎 22 𝑎 23 |
𝑎31 𝑎32 𝑎33 𝑎31 𝑎32 𝑎33 𝑎31 𝑎32 𝑎33
For example:
𝑋1 + 𝑋2 + = 12
2𝑋1 + 5𝑋2 + 2𝑋3 = 20
6𝑋1 + 3𝑋2 + 6𝑋3 = 0
1 1 0 𝑋1 12
[2 5 2] ∗ [𝑋2 ] = [20]
6 3 6 𝑋3 0
12 1 0
|20 5 2|
168
𝑋1 = 0 3 6 = =7
1 1 0 24
|2 5 2|
6 3 6
1 12 0
|2 20 2|
𝑋2 = 6 0 6 = 120 = 5
1 1 0 24
|2 5 2|
6 3 6
Page 124 of 167

1 1 12
|2 5 20|
𝑋3 = 6 3 0 = −228 = −9.5
1 1 0 24
|2 5 2|
6 3 6
9.2.3 The Rank of a matrix
The rank of a matrix is the maximum number of linearly independent rows in a matrix.
The rank of an 𝑚 𝑥 𝑛 matrix is the maximum order of a non-vanishing determinant that can be
constructed from the rows and columns of that matrix.
The rank can be at most 𝑚 𝑜𝑟 𝑛 whichever is smaller, because the determinant is defined for only
square matrices.
e.g. 𝑓𝑜𝑟 𝑎 4 𝑥 2 𝑚𝑎𝑡𝑟𝑖𝑥, 𝑟𝑎𝑛𝑘 𝑐𝑎𝑛 𝑏𝑒 𝑎𝑡 𝑚𝑜𝑠𝑡 2.
𝑖𝑓 𝑤𝑒 ℎ𝑎𝑣𝑒 𝑎 𝑚𝑎𝑡𝑟𝑖𝑥 𝐴 𝑡ℎ𝑒𝑛 𝑟𝑎𝑛𝑘 (𝐴) ≤ min(𝑚, 𝑛)
How to find the rank of a matrix of order 𝒎 𝒙 𝒏.
1. Can be done by inspection for smaller dimension matrix.
2. Transform the matrix into an Echelon matrix
An echelon matrix is a matrix such that all elements in principal diagonal are one and all
elements below the principal diagonal are zeros.
1 6 10
0 1 5
0 0 1
This can be done by at least 3 operations.
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i. Interchange any 2 rows in matrix.
ii. Multiply / divide row by any scalar (𝐾) ≠ 0
iii. Add 𝑘 times any row to another row.
None of these operations alters the rank of the matrix.
Example 1
Compute the rank of the following matrix
0 −1 −4
𝐵 = [3 1 2]
6 1 0
Interchange row 1 and row 3
6 1 0
𝐵1 = 3 1 2
0 −1 −4
Change 6 in the1st row 1st column into a 1 by dividing the entire row 1 by 6.
1 1⁄6 0
3 1 2
0 −1 −4
Change the 3 in row 2, 1st column into a 0. This will be done by the following operation:
New𝑅2 = 𝑂𝑙𝑑𝑅𝑜𝑤2 − 3𝑛𝑒𝑤𝑅𝑜𝑤1
1 1⁄6 0
0 1⁄2 2
0 −1 −4
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Next step:
Change ½ in row 2, 2nd column into a 1 by multiplying the entire row 2 by 2
1 1⁄6 0
𝐵4 = 0 1 4
0 −1 −4
Change −1 in 𝑟𝑜𝑤 3 𝑖𝑛𝑡𝑜 𝑎 0 by the following operation:
𝑁𝑒𝑤𝑅3 = 𝑂𝑙𝑑𝑅3 + 𝑁𝑒𝑤𝑅2
1 1⁄6 0
0 1 4
0 0 0
This is an Echelon matrix
→ 2 non zero rows
Hence the matrix has a rank of 2.
4 1 2
a) Given a matrix A =5 8 11
3 0 9
Determine the inverse of the matrix.
b) Compute the rank of the following matrix
7 6 3 3
𝐵=0 1 2 1
8 0 0 8
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c) Given the following system of equations, Compute the equilibrium values of the unknowns
using matrix inversion and Cramer’s Rule.
2𝑋1 + 2𝑋2 + = 24
4𝑋1 + 10𝑋2 + 4𝑋3 = 40
12𝑋1 + 6𝑋2 + 12𝑋3 = 0

press, London
Page 128 of 167

LECTURE TEN: ECONOMIC APPLICATIONS OF MATRIX ALGEBRA I
10.1 Introduction
In this Lesson, we will discuss how matrix algebra is applied in economics.
10.2.1 Understand the input-output model
10.2.2 Understand market equilibrium analysis using matrix algebra
10.2.1 Input-Output Model
In any economy, there are several industries that are interdependent. The output of an industry is
likely to be sold to other industries as an input, can be bought by the industry itself, or can be used
for final demand. For example, the output of a poultry farmer, who is in agriculture industry, can
be eggs among other products. The eggs can be bought by other farmers for hatching, can be
bought by bakers in the service industry or can be bought by consumers for final consumption. An
industry also requires inputs from other industries.
An input-output model helps to know the level of output required for each industry to satisfy the
inter-industry requirements and final demand. The correct level of output depends on total
Page 129 of 167

requirements by all industries. Due to inter industry dependence correct output levels are
determined by input requirements in whole economy.
Assumptions
1. Each industry produce 1 homogenous product.
2. Each industry uses a fixed input-output ratio (factor combination) for production of a unit of
output.
3. Production is subject to constant returns to scale. i.e. if we multiply inputs by a constant 𝑘
output changes by a multiple of K.
Consider the following case of an economy with three sectors Agriculture, manufacturing and
service sectors. All figures are given in million Kshs.
Input to
Agriculture Manufacturing Services Final Total
demand Output
Output Agriculture 150 225 125 100 600
From Manufacturing 210 250 140 300 900
Service 170 0 30 100 300
Other inputs 70 425 5
Total inputs 600 900 300
The total output from each of the sectors must satisfy the final demand and the inter-industry
requirements.
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For example, 150 million worth of output from agriculture is sold to agriculture as input, 225
to manufacturing, 125 is sold to service and 100 for final demand.
The output from an industry can also be demanded for final consumption. This can be by the
local consumers and also for exports. The final demand for each sector is represented in the
column labeled Final demand.
An industry requires output from other industries as inputs (raw materials) in its production
activities. For example, the services sector requires 125 million worth of inputs from
agriculture, 140 million from manufacturing and 30 million from itself (service). In addition,
an industry also requires other inputs such as labour and imported raw materials. This is
represented in the row labeled other inputs. The total requirements of the service sector for
other inputs is 5 million.
From your knowledge in macroeconomics, the total product should be used to purchase inputs
in the firm. Hence total output for each sector/industry should be equal to the total inputs for
each sector/industry.
To produce output in 𝑗 𝑡ℎ sector, the input required from 𝑖 𝑡ℎ sector is a fixed amount denoted as
𝑎𝑖𝑗 .
1𝑠𝑡 𝑠𝑢𝑏𝑠𝑐𝑟𝑖𝑝𝑡 𝑑𝑒𝑛𝑜𝑡𝑒𝑠 𝑡ℎ𝑒 𝑖𝑛𝑝𝑢𝑡 𝑤ℎ𝑖𝑙𝑒 𝑡ℎ𝑒 2𝑛𝑑 𝑠𝑢𝑏𝑠𝑐𝑟𝑖𝑝𝑡 𝑑𝑒𝑛𝑜𝑡𝑒𝑠 𝑡ℎ𝑒 𝑜𝑢𝑡𝑝𝑢𝑡
Considering a case of 3 sectors, the fixed input-output ratios can be represented in matrix form
as:
Input – output Coefficient Matrix
Page 131 of 167

𝑎11 𝑎12 𝑎13
𝑎21 𝑎22 𝑎23
𝑎31 𝑎32 𝑎33
Output
𝐼𝑛𝑝𝑢𝑡
𝐼 𝐼𝐼 𝐼𝐼𝐼
𝑂𝑢𝑡𝑝𝑢𝑡 𝐼 𝑎11 𝑎12 𝑎13
𝐼𝐼 𝑎21 𝑎22 𝑎23
[𝐼𝐼𝐼 𝑎31 𝑎32 𝑎33 ]
𝑎12 → How much of input from sector 1 is required to produce 1 unit of output in sector 2.
In order to calculate the fixed input-output ratios, divide the input to the sector from each sector
by the total output in the sector. This can be done as shown in the table below:
Input
Agriculture Manufacturing Services
Output Agriculture 150/600 225/900 125/300
Manufacturing 210/600 250/900 140/300
Service 170/600 0/900 30/300
The input-output coefficient matrix will be given as:
Page 132 of 167

𝐼𝑛𝑝𝑢𝑡
𝐼 𝐼𝐼 𝐼𝐼𝐼
𝑂𝑢𝑡𝑝𝑢𝑡 𝐼 0.25 0.25 0.42
𝐼𝐼 0.35 0.28 0.47
[𝐼𝐼𝐼 0.28 0 0.10]
The matrix is also known as the input-output matrix or matrix of technical coefficients.
The proportion of primary inputs which are the other inputs required by an industry apart from
what it buys from other sectors e.g. labour, imported raw materials e.t.c. can be obtained by the
following:
i) Add the elements in each column in the input output table i.e.
𝑛
∑ 𝑎𝑖𝑗 =< 1 𝐹𝑜𝑟 𝑠𝑒𝑐𝑡𝑜𝑟 1, 𝑡ℎ𝑖𝑠 𝑐𝑎𝑛 𝑏𝑒 𝑔𝑖𝑣𝑒𝑛 𝑎𝑠:

𝑖=1
𝑎11 + 𝑎21 + 𝑎31 = 0.25 + 0.35 + 0.28 = 0.88
iv) Deduct the total sum from step (i) from 1.
𝑝𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛 𝑜𝑓 𝑃𝑟𝑖𝑚𝑎𝑟𝑦 𝑖𝑛𝑝𝑢𝑡𝑠 = 1 − ∑ 𝑎𝑖𝑗

𝑖=1
𝐼𝑛 𝑜𝑢𝑟 𝑐𝑎𝑠𝑒 𝑡ℎ𝑖𝑠 𝑤𝑖𝑙𝑙 𝑏𝑒 𝑔𝑖𝑣𝑒𝑛 𝑎𝑠:
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛 𝑜𝑓 𝑝𝑟𝑖𝑚𝑎𝑟𝑦 𝑖𝑛𝑝𝑢𝑡𝑠 𝑖𝑛 𝑠𝑒𝑐𝑡𝑜𝑟 1 = 1 − 0.88 = 0.12
Page 133 of 167

How can we represent the total output requirements for each sector/industry?
As noted earlier, the output from a sector is required for inter-industry requirements and also for
final demand.
For an industry to produce an output that will meet input demands and the final demand
𝑡ℎ𝑒𝑛.
𝑋1 = 𝑎11 𝑋1 + 𝑎12 𝑋2 + 𝑎13 𝑋3 + 𝐷1
𝑋2 = 𝑎21 𝑋1 + 𝑎22 𝑋2 + 𝑎23 𝑋3 + 𝐷2
𝑋3 = 𝑎31 𝑋1 + 𝑎32 𝑋2 + 𝑎33 𝑋3 + 𝐷2
Putting the like terms together.
𝑋1 − 𝑎11 𝑋1 − 𝑎12 𝑋2 − 𝑎13 𝑋3 = 𝐷1
𝑋2 − 𝑎21 𝑋1 − 𝑎22 𝑋2 − 𝑎23 𝑋3 = 𝐷2
𝑋3 − 𝑎31 𝑋1 − 𝑎32 𝑋2 − 𝑎33 𝑋3 = 𝐷2
(1 − 𝑎11 )𝑋1 − 𝑎12 𝑋2 − 𝑎13 𝑋3 = 𝐷1
−𝑎21 𝑋1 + (1 − 𝑎22 )𝑋2 − 𝑎23 𝑋3 = 𝐷2
−𝑎31 𝑋1 − 𝑎32 𝑋2 + (1 − 𝑎33 ) 𝑋3 = 𝐷2
In matrix form the three equations can be written as:
(1 − 𝑎11 ) 𝑎12 𝑎13 𝑋1 𝐷1

[ 𝑎21 (1 − 𝑎22 ) 𝑎23 ] [𝑋2 ] = [𝐷2 ]
𝑎31 𝑎32 (1 − 𝑎33 ) 𝑋3 𝐷3
There are three matrices in this formulation:
Page 134 of 167

(1 − 𝑎11 ) 𝑎12 𝑎13
1. [ 𝑎21 (1 − 𝑎22 ) 𝑎23 ] which can also be denoted as 𝐼 − 𝐴, that is, the
𝑎31 𝑎32 (1 − 𝑎33 )
identity matrix minus the input-output coefficient matrix. This matrix ( 𝐼 − 𝐴) is known as
the Leontief matrix.
𝑋1
𝑋
2. [ 2 ] is the matrix of outputs from the three sectors. It can be denoted as 𝑋.
𝑋3
𝐷1
3. [𝐷2 ] is the final demand matrix denoted as 𝐷.
𝐷3
The three matrices can be represented as:
[1 − 𝐴 ] [ 𝑋 ] = 𝐷
If we know the fixed input-output ratios, the final output that can be produced to satisfy
the inter-industry requirements and the final demand is given as:
𝐷
𝑋= = (𝐼 − 𝐴)−1 𝐷
(𝐼 − 𝐴)
To get the total output requirements we pre-multiply the final demand matrix by the inverse
of the Leontief matrix.
Example
The input-output ratio coefficients for a three sector economy are given as:
𝑎11 𝑎12 𝑎13 0.2 0.3 0.2
𝑎
𝐴 = [ 21 𝑎22 𝑎23 ] = [0.4 0.1 0.2] while the final demand matrix is given as:
𝑎23 𝑎32 𝑎33 0.1 0.3 0.2
10
𝐷=[5]
6
Determine the total output required in each of the three sectors to meet the inter-industry input
requirements and the final demand.
Page 135 of 167

Solution
The Leontief matrix [1 − 𝐴 ] will be given as:
1 0 0 0.2 0.3 0.2

𝐼 − 𝐴 = [0 1 0] − [0.4 0.1 0.2]
0 0 1 0.1 0.3 0.2
0.8 −0.3 −0.2

1 − 𝐴 = [−0.4 0.9 −0.2]
−0.1 −0.3 0.8
Determinant of matrix (𝐼 − 𝐴) = 0.384
Inverse of matrix 𝐼−𝐴 is given as
1 1 0.66 0.30 0.24

[1 − 𝐴 ]−1 = [𝐴𝑑𝑗 𝐴 ] = [0.34 0.62 0.24]
|1 − 𝐴 | 0.384
0.21 0.27 0.60
The output for the three sectors is given as: 𝑋 = [1 − 𝐴 ]−1 𝐷
1 0.66 0.30 0.24 10

= [0.34 0.62 0.24] [ 5 ]
0.384
0.21 0.27 0.60 6
24.84
𝑋 = [20.68]
18.36
X represents the output required in the three sectors to meet the inter-industry input
requirements and the final demand.
Page 136 of 167

10.2.2 Application of matrix algebra in the market equilibrium models
The equilibrium prices and quantities for a market with 3 commodities can be determined using
the matrix method. If the demand and supply functions for the three commodities is given as:
A 3 product market model is given as:
𝑄𝑑1 = 50 − 2𝑃1 + 5𝑃2 − 3𝑃3 𝑄𝑠1 = 8𝑃1 − 5
𝑄𝑑2 = 22 + 7𝑃1 − 2𝑃2 + 5𝑃3 𝑄𝑠2 = 12𝑃2 − 5
𝑄𝑑3 = 17 + 𝑃1 + 5𝑃2 − 3𝑃3 𝑄𝑠3 = 4𝑃3 − 1
Determine the equilibrium prices and quantities for the three products.
At equilibrium:
If we equate the demand and the supply for each of the three products, we get:
50 − 2𝑃1 + 5𝑃2 − 3𝑃3 = 8𝑃1 − 5
22 + 7𝑃1 − 2𝑃2 + 5𝑃3 = 12𝑃2 − 5
17 + 𝑃1 + 5𝑃2 − 3𝑃3 = 4𝑃3 − 1
This gives us 3 simultaneous equations:
Page 137 of 167

10𝑃1 − 5𝑃2 + 3𝑃3 = 55
−7𝑃1 + 14𝑃2 − 5𝑃3 = 27
−𝑃1 − 5𝑃2 + 7𝑃3 = 18
We can rewrite the equations as:
10 −5 3 𝑃1 55
𝑃
[−7 14 −5] ∗ [ 2 ] = [27]
−1 −5 7 𝑃3 18
55 −5 3
|27 14 −5|
𝑃1 = 18 −5 7 = 7
10 −5 3
|−7 14 −5|
−1 −5 7
10 55 3
|−7 27 −5|
𝑃2 = −1 18 7 = 9
10 −5 3
|−7 14 −5|
−1 −5 7
10 −5 55
|−7 14 27|
𝑃3 = −1 −5 18 = 10
10 −5 3
|−7 14 −5|
−1 −5 7
TASK: Solve for the equilibrium quantities by substituting for the values of the
equilibrium prices into the demand or supply functions
𝑄1 = 51 𝑄2 = 103 𝑄3 = 39
Page 138 of 167

Given the following information of a 3-sector economy
Input to
Agriculture Manufacturing Services Final Total
demand Output
Output Agriculture 300 450 250 200 1200
From Manufacturing 420 500 280 600 1800
Service 340 0 60 200 600
Other inputs 140 850 10
Total inputs 1200 1800 600
Required:
i) The input-output matrix
ii) The Leontief Matrix
400
iii) The output requirement for each sector given that the final demand changes to 𝐷 = (1200)
400
10.4 E-References
press, London
Page 139 of 167

LECTURE ELEVEN: ECONOMIC APPLICATIONS OF MATRIX ALGEBRA II
11.1 Introduction
In this Lesson, we will discuss how matrix algebra is applied in economics.
11.2.1 Compute the equilibrium national income using matrix algebra
11.2.2 Compute general equilibrium in the IS-LM framework using matrix algebra
11.2.1 Application of matrix algebra in the National Income Model
A Simple national income model is given as:
𝑌 = 𝐶 + 𝐼0 + 𝐺0
𝐶 = 𝑐0 + 𝑐1 (𝑌 𝑑 )
𝐶 = 𝑐0 + 𝑐1 (𝑌 − 𝑇)
𝑇 = 𝑡0 + 𝑡1 𝑌
𝑌 = 𝑛𝑎𝑡𝑖𝑜𝑛𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒, 𝐶 = 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒,
𝑌 𝑑 = 𝑑𝑖𝑠𝑝𝑜𝑠𝑎𝑏𝑙𝑒 𝑖𝑛𝑐𝑜𝑚𝑒, 𝑇 = 𝑡𝑎𝑥
𝑤ℎ𝑒𝑟𝑒 𝑐0 > 0 0 < 𝑐1 < 1
Page 140 of 167

𝑡0 > 0 0 < 𝑡1 < 1
i) Write this model in three simultaneous equations representing the three endogenous
variables.
𝑌 − 𝐶 = 𝐼0 + 𝐺0
−𝑐1 𝑌 + 𝐶 + 𝑐1 𝑇 = 𝑐0
−𝑡1 𝑌 + 𝑇 = 𝑡0
This can also be written as:
1 −1 0 𝑌 𝐼0 + 𝐺0
[−𝑐1 1 𝑐1 ] ∗ [𝐶 ] = [ 𝑐0 ]
−𝑡1 0 0 𝑇 𝑡0
ii) Use Cramer’s rule to determine the expressions for the equilibrium values of the
endogenous variables (𝑌, 𝐶 and 𝑇)..
𝐼0 + 𝐺0 −1 0
| 𝑐0 1 𝑐1 |
𝑡0 0 0
𝑌=
1 −1 0
|−𝑐1 1 𝑐1 |
−𝑡1 0 0
𝑐0 + 𝐼0 + 𝐺0 − 𝑐1 𝑡0
𝑌=
(1 − 𝑐1 + 𝑐1 𝑡1 )
1 𝐼0 + 𝐺0 0
|−𝑐1 𝑐0 𝑐1 |
−𝑡1 𝑡0 0
𝐶=
1 −1 0
| 1 1 𝑐1 |
−𝑐
−𝑡1 0 0
Page 141 of 167

𝑐0 + 𝑐1 (1 − 𝑡1 )( 𝐼0 + 𝐺0 ) − 𝑐1 𝑡0
𝐶=
(1 − 𝑐1 + 𝑐1 𝑡1 )
1 −1 𝐼0 + 𝐺0
|−𝑐1 1 𝑐0 |
−𝑡1 0 𝑡0
𝑇=
1 −1 0
| 1 1
−𝑐 𝑐1 |
−𝑡1 0 0
𝑡0 (1 − 𝑐1 )𝑐0 + 𝑡1 (𝑐0 + 𝐼0 + 𝐺0 )
𝑇=
(1 − 𝑐1 + 𝑐1 𝑡1 )
Example 1
Find the equilibrium income, consumption and tax given the following national income model:
𝑌 =𝐶+𝐼+𝐺
𝐶 = 100 + 0.8𝑌 𝑑
𝑇 = 10 + 0.1𝑌
𝐼 = 50
𝐺 = 30
Step 1: Rewrite the equations putting the endogenous variables on the L.H.S and the exogenous variables
on the R.H.S
𝑌 − 𝐶 = 𝐼 + 𝐺 (Substitute for I and G)
𝑌 − 𝐶 = 50 + 30
𝑌 − 𝐶 = 80…………………………………………………………………. (1)
𝐶 = 100 + 0.8𝑌 𝑑
𝐶 = 100 + 0.8(𝑌 − 𝑇)
𝐶 = 100 + 0.8𝑌 − 0.8𝑇)
−0.8𝑌 + 𝐶 + 0.8𝑇 = 100……………………………………………………. (2)
𝑇 = 10 + 0.1𝑌
Page 142 of 167

−0.1𝑌 + 𝑇 = 10……………………………………………………………… (3)
Presenting (1), (2) and (3) in matrix form we have:
𝑌 − 𝐶 = 80
−0.8𝑌 + 𝐶 + 0.8𝑇 = 100
−0.1𝑌 + 𝑇 = 10
1 −1 0 𝑌 80
⌊−0.8 1 0.8⌋ ⌊𝐶 ⌋ = ⌊100⌋
−0.1 0 1 𝑇 10
Using Cramer’s Rule:
80 −1 0
|100 1 0.8|
𝑌 = 10 0 1 = 172 = 614.29
1 −1 0 0.28
|−0.8 1 0.8|
−0.1 0 1
1 80 0
|−0.8 100 0.8|
𝐶 = −0.1 10 1 = 149.6 = 534.29
1 −1 0 0.28
|−0.8 1 0.8|
−0.1 0 1
1 −1 80
|−0.8 1 100|
𝑇 = −0.1 0 10 = 20 = 71.43
1 −1 0 0.28
|−0.8 1 0.8|
−0.1 0 1
Example 2
You are given the following national income model:
𝐶 = 120 + 0.8𝑌
𝐼 = 100 + 0.1𝑌
Page 143 of 167

𝐺 = 300
Required:
i) Present this information in matrix format:
ii) Using Cramer’s rule, find the equilibrium values of the endogenous variables
Solution:
𝑌 − 𝐶 − 𝐼 = 300………………………………………………………………… (1)
−0.8𝑌 − 𝐶 = 120……………………………………………………………….. (2)
0.1𝑌 + 𝐼 = 100………………………………………………………………….. (3)
1, 2 and 3 in matrix form:
1 −1 −1 𝑌 300
⌊−0.8 1 0 ⌋ ⌊𝐶 ⌋ = ⌊120⌋
−0.1 0 1 𝐼 100

300 −1 −1
|120 1 0|
𝑌= 100 0 1 = 520 = 5,200
1 −1 −1 0.1
|−0.8 1 0|
−0.1 0 1
1 300 −1
|−0.8 120 0 |
𝐶 = −0.1 100 1 = 428 = 4,280
1 −1 −1 0.1
|−0.8 1 0|
−0.1 0 1
1 −1 300
|−0.8 1 120|
62
𝐼 = −0.1 0 100 = = 620
1 −1 −1 0.1
|−0.8 1 0|
−0.1 0 1
Page 144 of 167

11.2.2 Application of matrix algebra in computing equilibrium in the IS-LM framework
Equilibrium in the goods market: Represented by the IS Curve / Equation

Given:
𝑌 =𝐶+𝐼
𝐶 = 250 + 0.2𝑌
𝐼 = 10 − 0.4𝑟
𝑌 = 250 + 0.2𝑌 + 10 − 0.4𝑟
0.8𝑌 + 0.4𝑟 = 250…………………………………………….. IS Equation
Equilibrium in the money market: Represented by the LM Curve / Equation
𝑀𝑑 = 120 + 0.1𝑌 − 0.3𝑟

𝑀 𝑠 = 140
At equilibrium: 𝑀𝑑 = 𝑀 𝑠
120 + 0.1𝑌 − 0.3𝑟 = 140

0.1𝑌 − 0.3𝑟 = 20………………………………………………………. LM Equation
The general equilibrium

It requires simultaneous equilibrium in both the goods and money markets. From the equations derived
above:
0.8𝑌 + 0.4𝑟 = 250

0.1𝑌 − 0.3𝑟 = 20
Presenting the two equations in matrix format:
0.8 0.4 𝑌 250
[ ]⌈ ⌉ = ⌈ ⌉
0.1 −0.3 𝑟 20

250 0.4
| | −83
𝑌 = 20 −0.3 = = 296.43
0.8 0.4
| | −0.28
0.1 −0.3
Page 145 of 167

0.8 250
| | −9
𝑟 = 0.1 20 = = 32.14
0.8 0.4
| | −0.28
0.1 −0.3

a) Given the following national income model, compute the equilibrium values of the endogenous
variables using matrix inversion and Cramer’s rule:
𝐶 = 180 + 0.7𝑌 𝑑
𝑇 = 70
𝐼 = 60 + 0.1𝑌
𝐺 = 80
b) Determine how matrix algebra can be applied in determining the equilibrium values of interest
rates and national income in the macro economy using the following IS and LM functions.
IS equation: 𝑟 = 8 − 0.006𝑦
LM equation: 𝑟 = −3 + 0.003𝑦
11.4 E-References
press, London
Page 146 of 167

LECTURE TWELVE: INTEGRATION
12.1 Introduction
In this lesson we shall learn the different rules that are used to integrate functions
12.2.1 Understand the meaning of integration
12.2.2 Understand the rules of integration
12.2.3 Understand the meaning and computation of definite integrals
12.2.1 The meaning of integration
Integration is simply the reverse of differentiation. If we differentiate a function, we get the slope
of the function. On the other hand, if we have the slope, and we want to get back to the original
function, we use the process of integration.
For example:
If 𝑌 = 𝑋 𝑛
𝜕𝑌
= 𝑛𝑋 𝑛−1
𝑑𝑋
To get back to the original function, we do the reverse of what we have done.
i.e. add 1 to the power and divide by the new power.
Page 147 of 167

𝑛𝑋 𝑛−1+1
𝑌=
𝑛
Integration can also be interpreted as the area below a curve between specified limits.
Consider the following two functions: 𝐹(𝑥), a primary function and 𝑓(𝑥), the derived
function i.e. the derivative of 𝐹(𝑥).
In order to obtain the primary function 𝐹(𝑥)from the derived function 𝑓(𝑥), we have to
integrate the derived function 𝑓(𝑥).
𝑑
∫ 𝑓(𝑥)𝑑𝑥 = ∫ 𝐹(𝑥)𝑑𝑥 = 𝐹(𝑥)
𝑑𝑥
We will therefore define the term integration as the process of obtaining a primary function from
the corresponding derived function.
Constant of integration
Consider the primary function:
𝐹(𝑥) = 𝑥 2
The derivative of this function with respect to x is:
𝑓(𝑥) = 2𝑥
If we integrate the derived function, we obtain the primary function:
∫ 𝑓(𝑥)𝑑𝑥 = ∫ 2𝑥𝑑𝑥 = 𝑥 2
It is important to note that, we have other functions whose derivative is 2𝑥 as shown below.
𝐹(𝑥) = 𝑥 2 + 13
𝐹(𝑥) = 𝑥 2 + 9
𝐹(𝑥) = 𝑥 2 + 40
among others.
Page 148 of 167

Due to this fact, whenever integration is performed, it is important to add an arbitrary constant to
the solution known as the constant of integration.
∫ 𝑓(𝑥)𝑑𝑥 = 𝐹(𝑥) + 𝑐
Where: 𝑐 is the constant of integration.
Examples
Compute the following:
i) ∫ 2𝑥 𝑑𝑥
ii) ∫ 3𝑥 2 𝑑𝑥
Solution
i) ∫ 2𝑥 𝑑𝑥 = 𝑥 2 + 𝑐
ii) ∫ 3𝑥 2 𝑑𝑥 = 𝑥 3 + 𝑐
Initial and boundary conditions
In some instances, it may be necessary to determine the specific numerical values of the constant
of integration. This is possible when the problem being discussed provides initial conditions e.g.
𝒚 = 𝟕𝟎, 𝑤ℎ𝑒𝑛 𝒙 = 𝟎 or boundary conditions e.g. 𝒚 = 𝟔𝟗, 𝑤ℎ𝑒𝑛 𝒙 = 𝟓.
Example 1
Compute the following given the boundary condition stated in the problem:
𝑦 = ∫ 2𝑥 𝑑𝑥 𝑦 = 125 𝑤ℎ𝑒𝑛 𝑥 = 5
Solution
𝑦 = ∫ 2𝑥 𝑑𝑥 = 𝑥 2 + 𝑐
Page 149 of 167

𝑦 = 125 𝑤ℎ𝑒𝑛 𝑥 = 5
125 = 52 + 𝑐
𝑐 = 125 − 25 = 100
𝑦 = 𝑥 2 + 100
Example 2
Compute the following given the initial condition stated in the problem:
𝑦 = ∫ 3𝑥 2 𝑥 = 0 𝑤ℎ𝑒𝑛 𝑦 = 77
Solution
𝑦 = ∫ 3𝑥 2 = 𝑥 3 + 𝑐
77 = 03 + 𝑐
𝑐 = 77
𝑦 = 𝑥 3 + 77
12.2.2 Rules of integration
a) Constant function Rule
∫ 𝐾. 𝑑𝑥 = 𝐾𝑥 + 𝐶
The constant rule can be understood further by using the power multiplied by a constant rule.
The rule can be written as:
𝐾𝑥 0+1
∫ 𝐾𝑥 0 . 𝑑𝑥 = 1
+ 𝐶 = 𝐾𝑥 + 𝐶
The constant 𝐶 is added because it is usually lost in the process of differentiating. It can take
many values.
Examples
i) ∫ 10. 𝑑𝑥 = 10𝑥 + 𝑐
Page 150 of 167

ii) ∫ 99. 𝑑𝑥 = 99𝑥 + 𝑐
b) Power Rule
𝑛
𝑥 𝑛+1
∫ 𝑥 . 𝑑𝑥 = +𝑐
𝑛+1
Examples
𝑥 4+1 𝑥5
i) ∫ 𝑥 4 . 𝑑𝑥 = 5
+𝑐 =5 +𝑐
3 7
4
ii) ∫ 𝑥 4 . 𝑑𝑥 = 7 𝑥 4 + 𝑐
c) Power multiplied by constant rule
𝑛
𝐴𝑥 𝑛+1
∫ 𝐴𝑥 . 𝑑𝑥 = +𝑐
𝑛+1
Examples
5𝑥 4
i) ∫ 5𝑥 3 . 𝑑𝑥 = 5 ∫ 𝑥 3 . 𝑑𝑥 = 4
+𝑐
ii) ∫ 10𝑥 4 . 𝑑𝑥 = 10 ∫ 𝑥 4 . 𝑑𝑥 = 2𝑥 5 + 𝑐
d) Sum/difference rule
The integral of a sum/difference of two functions
∫(𝑔(𝑥) ± ℎ(𝑥)) 𝑑𝑥 = ∫(𝑔(𝑥))𝑑𝑥 ± ∫ ℎ(𝑥)𝑑𝑥 + 𝑐
Example
20𝑥 2 3𝑥 3
∫(20𝑥 + 3𝑥 2 ) 𝑑𝑥 = ∫(20𝑥)𝑑𝑥 + ∫ 3𝑥 2 𝑑𝑥 + 𝑐 = + + 𝑐 = 10𝑥 2 + 𝑥 3 + 𝑐
2 3
e) Integration of linear function raised to a power
1 (𝑚𝑥+𝑘)𝑛+1
∫(𝑚𝑥 + 𝑘)𝑛 . 𝑑𝑥 = 𝑚 𝑛+1
+𝐶
Example
1 (2𝑥+10)4
∫(2𝑥 + 10)3 . 𝑑𝑥 = 2 4
+𝐶
Page 151 of 167

f) Exponential function Rule
i) 𝑦 = 𝑒𝑥
𝑑𝑦
= 𝑒𝑥
𝑑𝑥
∫ 𝑒 𝑥 . 𝑑𝑥 = 𝑒 𝑥 + 𝑐
ii) 𝑦 = 𝑒 𝑘𝑥
𝑑𝑦
= 𝑘𝑒 𝑘𝑥
𝑑𝑥
1
∫ 𝑒 𝑘𝑥 . 𝑑𝑥 = 𝑘 𝑒 𝑘𝑥 + 𝑐
In general:
∫ 𝑓 ′ (𝑥)𝑒 𝑓(𝑥) 𝑑𝑥 = 𝑒 𝑓(𝑥) + 𝑐
Examples
Evaluate:
i) ∫ 2𝑒 𝑥 . 𝑑𝑥
∫ 2𝑒 𝑥 . 𝑑𝑥 = 2 ∫ 𝑒 𝑥 . 𝑑𝑥 = 2𝑒 𝑥 + 𝑐
ii) ∫ 𝑒 7𝑥 . 𝑑𝑥
1
∫ 𝑒 7𝑥 . 𝑑𝑥 = 7 𝑒 7𝑥 + 𝑐
1
𝑥
iii) ∫ 𝑒 2 . 𝑑𝑥
1 1 1
𝑥 1
∫ 𝑒 2 . 𝑑𝑥 = 1 𝑒 2𝑥 + 𝑐 = 2𝑒 2𝑥 + 𝑐
2
Page 152 of 167

g) Logarithm rule
𝑑 1
If 𝑦 = 𝐿𝑛𝑥 𝑡ℎ𝑒𝑛: 𝐿𝑛(𝑥) = 𝑥
𝑑𝑥
This means:
1
∫ 𝑥 𝑑𝑥 = 𝐿𝑛𝑥 + 𝑐
𝑓 ′ (𝑥)
∫ 𝑑𝑥 = 𝐿𝑛 𝑓(𝑥) + 𝑐
𝑓(𝑥)
Examples
4
i) ∫ 𝑥 . 𝑑𝑥
4 1
∫ . 𝑑𝑥 = 4 ∫ . 𝑑𝑥 = 4 𝑙𝑛𝑥 + 𝑐
𝑥 𝑥
1
ii) ∫ 3𝑥 . 𝑑𝑥
1 1 1 1
∫ . 𝑑𝑥 = ∫ . 𝑑𝑥 = 𝑙𝑛𝑥 + 𝑐
3𝑥 3 𝑥 3
3𝑥 2 +3
iii) ∫ 𝑥 3 +3𝑥+4 . 𝑑𝑥
3𝑥 2 + 3
∫ . 𝑑𝑥 = ln(𝑥 3 + 3𝑥 + 4) + 𝑐
𝑥 3 + 3𝑥 + 4
h) Integration by substitution
Used if appropriate
𝑑𝑣
∫ 𝑓(𝑢). . 𝑑𝑥 = ∫ 𝑓(𝑢). 𝑑𝑣 = 𝑓(𝑢) + 𝑐
𝑑𝑥
Page 153 of 167

Comes from chain rule
𝑑 𝑓(𝑢) 𝑑 𝑑𝑣 𝑑𝑣 𝑑𝑣
= 𝑓(𝑢). = 𝑓 ′ (𝑢). = 𝑓𝑢
𝑑𝑥 𝑑𝑣 𝑑𝑥 𝑑𝑥 𝑑𝑥
Example
i. ∫ 2𝑥. (𝑥 2 + 1)𝑑𝑥 𝑙𝑒𝑡 𝑢 = 𝑥 2 + 1
𝑑𝑢 𝑑𝑢
= 2𝑥 𝑑𝑥 =
𝑑𝑥 2𝑥
𝑑𝑢
∫ 2𝑥. 𝑢 = ∫ 𝑢𝑑𝑢
2𝑥
(𝑥 2 + 1)2
= +𝑐
2
3𝑥 2
ii. ∫ (𝑥 3 +18)7 . 𝑑𝑥
𝑑𝑢
Let 𝑢 = 𝑥 3 + 18 = 3𝑥 2
𝑑𝑥
1 −7
−𝑢−6
∫ 𝑑𝑢 = ∫ 𝑢 𝑑𝑢 = +𝑐
𝑢7 6
Substituting for u
−(𝑥 3 + 18)−6 −1
+𝑐 = +𝑐
6 6(𝑥 + 18)6
3
12.2.3 Definite integral
The integrals we have looked at are called indefinite integrals in that we do not have a definite
numerical value for the integral. i.e.
Page 154 of 167

∫ 𝑓(𝑥)𝑑𝑥 = 𝐹(𝑥) + 𝐶
As noted earlier, integration can be defined as the area below a curve between two specified values.
Y=f(x)
0 b X
a
If we choose two values of the independent variable (X), e.g. 𝑎 and 𝑏 where 𝑎 < 𝑏, we can get a
definite value for the integral by substituting the values of 𝑥 in the integral. i.e.
𝐹(𝑥) + 𝐶 = [𝐹(𝑏) + 𝐶] − [𝐹(𝑎) + 𝐶] = 𝐹(𝑏) − 𝐹(𝑎)
This would give us a definite numerical value for the integral by ensuring that the variable 𝑥 and
the constant 𝐶 𝑎𝑟𝑒 not in the final solution.
In the definite integral, 𝑎 is the lower limit and 𝑏 is the upper limit.
If we are interested in getting the definite integral, we can rewrite our integral as:
Page 155 of 167

𝑏
∫ 𝑓(𝑥)𝑑𝑥 = 𝐹(𝑥)]𝑏𝑎 = 𝐹(𝑏) − 𝐹(𝑎)
𝑎
Example
3
i. ∫1 𝑥 2 . 𝑑𝑥
3 3
2
𝑥3 33 13 26
∫ 𝑥 . 𝑑𝑥 = + 𝑐] = − =
1 3 1
3 3 3
3
ii. ∫1 4𝑋 2 . 𝑑𝑥
3 3
4𝑋 3
2
4(3)3 4(1)3
∫ 4𝑋 𝑑𝑥 = ] =[ − ]=
1 3 1 3 3
4 104
= 36 − =
3 3
3
3𝑥 2
∫ . 𝑑𝑥 = [ln(𝑥 3 + 3) + 𝑐]32 = ln(33 + 3 + 𝑐) − ln(23 + 3 + 𝑐)
2 𝑥3 + 3
ln(30) − ln(11)
Simplify
Evaluate the following:
i) ∫ 8𝑒 2𝑥+3 . dx
5𝑥 4 +3𝑥 2
ii) ∫ 𝑥 5 +𝑥 3 +7 . 𝑑𝑥
1
iii) ∫−1(3𝑥 2 + 4𝑥 + 5). 𝑑𝑥
12.4 E-References
Page 156 of 167

press, London
Page 157 of 167

LECTURE THIRTEEN: ECONOMIC APPLICATIONS OF INTEGRATION
13.1 Introduction
In this lesson we will learn how the concept of integration is used in economics.
13.2.1 Understand the computation of the consumer surplus using the concept of integration
13.2.2 Understand the computation of the consumer surplus using the concept of integration
13.2.3 Obtain the cost function from the marginal cost function
13.2.4 Obtain the total revenue function from the marginal revenue function
13.2.5 Obtain the consumption function from the marginal propensity consume
13.2.6 Capital Formation
13.2.1 Consumer surplus
Consumer surplus is the benefit to the consumer because of being able to buy goods at a lower
price than what he/she was willing to pay. It is the difference between what a consumer pays and
what she/he was willing to pay. It is given as the area below the demand curve but above the market
price. If we have a linear demand function, it can be represented as:
Page 158 of 167

Price
Market price/
equilibrium
price
P=f(Q)
0
Equilibrium Quantity demanded
quantity
The shaded area is the consumer surplus.
Using the concept of integration, consumer surplus is given as:
𝑄𝑒
𝐶𝑜𝑛𝑠𝑢𝑚𝑒𝑟 𝑠𝑢𝑟𝑝𝑙𝑢𝑠 = ∫ 𝑝. 𝑑𝑄 − 𝑃𝑒 𝑄𝑒
0
Example
Assume that a demand function is given as:
𝑃 = 40 − 2𝑄
Determine the consumer surplus when 𝑚𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 = 10
𝑊ℎ𝑒𝑛 𝑃 = 10
10 = 40 − 2𝑄
Page 159 of 167

2𝑄 = 40 − 10 = 30
𝑄 = 15
15 15
2𝑄 2
𝐶𝑜𝑛𝑠𝑢𝑚𝑒𝑟 𝑠𝑢𝑟𝑝𝑙𝑢𝑠 = ∫ (40 − 2𝑄). 𝑑𝑄 = 40𝑄 − | − 10 ∗ 15
0 2 0
= 40(15) − 152 − 0 − 150
= 600 − 225 − 150
𝐶𝑜𝑛𝑠𝑢𝑚𝑒𝑟 𝑠𝑢𝑟𝑝𝑙𝑢𝑠 = 225
13.2.2 Producer surplus
This is the benefit to the producer because of being able to sell goods at a higher price than what
he/she was willing to sell. It is the difference between what a producer receives and what she/he
was willing to receive. It is given as the area above the supply curve but below the market price.
If we have a supply function, it can be represented graphically as:
Page 160 of 167

Price
Market price
=equilibrium price
P=f(Qs)
0 Equilibrium Quantity supplied

quantity
The shaded area is the producer surplus. Using the concept of integration, it is calculated
algebraically using the following formula:
𝑄𝑒
𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑟 𝑠𝑢𝑟𝑝𝑙𝑢𝑠 = 𝑃𝑒 𝑄𝑒 − ∫ 𝑝. 𝑑𝑄
0
Example
A supply function for fruits is given as:
𝑃 = −10 + 𝑄
Determine the producer surplus when the Price =30
Solution
When 𝑃 = 30, 𝑄𝑠 = 30 + 10 = 40
40
𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑟 𝑠𝑢𝑟𝑝𝑙𝑢𝑠 = 30 ∗ 40 − ∫ (−10 + 𝑄). 𝑑𝑄
0
Page 161 of 167

40
𝑄2
= (1200) − [−10𝑄 + ]
2 0
40 ∗ 40
= (1200) − [−10(40) + ]−0
2
= 1200 + 400 − 800
𝑃𝑟𝑜𝑑𝑢𝑐𝑒𝑟 𝑠𝑢𝑟𝑝𝑙𝑢𝑠 = 800
13.2.3 Marginal cost and Total cost function
If we have the marginal cost function for a firm, the total cost can be computed by integrating the
marginal cost function.
Example
𝑀𝐶 = 40𝑄 − 6
𝑇𝐶 = ∫ 𝑀𝐶. 𝑑𝑄
𝑇𝐶 = ∫ 40𝑄 − 6. 𝑑𝑄
40𝑄 2
= − 6𝑄 + 𝐶
2
= 20𝑄 2 − 6𝑄 + 𝐶
The arbitrary constant 𝐶 in the total cost function is the fixed cost.
Assume that when 𝑇𝐶 = 5000, 𝑄 = 10
5000 = 20(10 ∗ 10) − 6 ∗ 10 + 𝐶
Page 162 of 167

𝐶 = 5000 − 2000 + 60 = 3060
𝑇𝐶 = 20𝑄 2 − 6𝑄 + 3060
13.2.4 Marginal revenue and Total revenue function
Given the marginal revenue function as 𝑀𝑅 = 𝑓(𝑄)
The total revenue function can be obtained by integrating the marginal revenue function with
respect to output (Q).
TR=∫ 𝑀𝑅. 𝑑𝑄
Example
The marginal revenue function for a firm is given as:
𝑀𝑅 = 20 − 50𝑄
Determine the total revenue function for the firm
50𝑄 2
TR=∫ 𝑀𝑅. 𝑑𝑄=∫ 20 − 50𝑄𝑑𝑄 = 20𝑄 − = 20𝑄 − 25𝑄 2
2
Note
In a total revenue function, we will not need the integration constant because when output is zero,
there will be no revenue hence the value of the constant will be zero.
Page 163 of 167

13.2.5 Consumption function from the marginal propensity to consume.
Assume that the 𝑀𝑃𝐶 = 0.8
Determine the consumption function
𝑑𝐶
𝑀𝑃𝐶 = = 0.8
𝑑𝑌
𝐶 = ∫ 0.8𝑌 𝑑𝑌 = 0.8𝑌 + 𝐾
In the consumption function, K represents the autonomous consumption. We can get its value by
getting a pair of values for C and Y
For example, assume in our above case that when Y=5 billion, C=4.2 billion
𝐶 = 0.8𝑌 + 𝐾
4.2 = 0.8(5) + 𝐾
𝐾 = 4.2 − 4.0
= 0.2
Hence:
𝐶 = 0.2 + 0.8𝑌
13.2.6 Capital Formation
Capital formation refers to the process of adding to a given capital stock. If we denote capital
stock with 𝑲(𝒕), the rate of capital formation / net investment flow, 𝑰(𝒕) is given by:
𝑑𝐾
= 𝐾 = ̇ 𝐼(𝑡)
𝑑𝑡
Page 164 of 167
Given the rate of capital formation, capital stock or the time path of capital is given by:
𝐾(𝑡) = ∫ 𝐼(𝑡) 𝑑𝑡
Once we know the rate of net investment flow function 𝑰(𝒕), we can apply definite integration to
obtain the amount of capital formation or total net investment over some specified period of
time.
𝑡
𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝑭𝒐𝒓𝒎𝒂𝒕𝒊𝒐𝒏 = ∫ 𝐼(𝑡)𝑑𝑡 = [𝐾(𝑡)]𝑡0 = 𝐾(𝑡) − 𝐾(0)
0
Example
Find the time path of capital 𝐾(𝑡), given the following rates of net investment flow functions
2
i) 𝐼(𝑡) = 15𝑡 3
2 3 5 5
𝐾(𝑡) = ∫ 𝐼(𝑡) 𝑑𝑡 = ∫ 15𝑡 3 𝑑𝑡 = ∗ 15 𝑡 3 + 𝑐 = 9𝑡 3 + 𝑐
5
Find the amount of capital formation (total net investment) over the period [2,6] given the
following rates of net investment flows:
1
i) 𝐼(𝑡) = 60𝑡 3
1 4
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑓𝑜𝑟𝑚𝑎𝑡𝑖𝑜𝑛 = ∫ 𝐼(𝑡)𝑑𝑡 = ∫ 60𝑡 3 𝑑𝑡 = [45𝑡 3 + 𝑐]62 = 490.61 − 113.39
= 377.22
Find the time path of capital 𝐾(𝑡), given the rate of capital formation and initial
conditions
Page 165 of 167

1
𝐼(𝑡) = 9𝑡 2 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑠𝑡𝑜𝑐𝑘 𝑎𝑡 𝑡 = 0 𝑖𝑠 𝐾(0) = 20
1 3
𝐾(𝑡) = ∫ 9𝑡 2 𝑑𝑡 = 6𝑡 2 + 𝑐
𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑠𝑡𝑜𝑐𝑘 𝑎𝑡 𝑡 = 0 𝑖𝑠 𝐾(0) = 20

3
20 = 6(0)2 + 𝑐
Thus 𝑐 = 20
3
Hence 𝐾(𝑡) = 6𝑡 2 + 20
a) Find the producer’s surplus given the following supply functions:
i. 𝑃 = 3 + 2𝑄; 𝑃𝑒 = 19
ii. 𝑃 = 3 + 𝑄2; 𝑃𝑒 = 19
b) Find the consumer’s surplus given the following demand functions:
𝑃 = 50 − 0.5𝑄; 𝑃𝑒 = 30
𝑃 = 13 − 𝑄 2; 𝑃𝑒 = 4
c) Assuming that the rate of net investment flow is given by the following function and that
𝐾(0) = 30:
2
𝐼(𝑡) = 24𝑡 5
i) Find the time path of capital stock 𝐾(𝑡)
ii) Find the amount of capital formation over the interval [1,4]
Page 166 of 167

13.4 E-References

press, London
THE END
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EES 200: MATHEMATICS FOR ECONOMISTS II

FACILITATOR: DOROTHY NGINA

equilibrium values in simultaneous equations. Knowledge of solving simultaneous equations will

1.2 Lesson Learning Outcomes

By the end of this lesson, you will be able to:

1.2.3 Compute the equilibrium in the national income model

1.2.1 Equilibrium in the partial market model

Equilibrium: A constellation of selected interrelated variables so adjusted to one another that

explain some few terms that are in this definition

For example: Assume a demand function is given as: 𝑃 = 50 − 2𝑄,

Equilibrium therefore can be simply defined as a situation characterized by lack of tendency to

demand of wheat in that market.

a) Partial market equilibrium - Linear model

Conditions for equilibrium

No excess demand in the market i.e

𝑄𝑑 = 𝑓(𝑃) 𝑤ℎ𝑖𝑐ℎ 𝑐𝑎𝑛 𝑏𝑒 𝑔𝑖𝑣𝑒𝑛 𝑎𝑠:

𝑄𝑠 = 𝑓(𝑃) 𝑎𝑛𝑑 𝑐𝑎𝑛 𝑏𝑒 𝑔𝑖𝑣𝑒𝑛 𝑎𝑠:

when the supply curve intersects with the demand curve.

Determination of the equilibrium price and quantity algebraically

values of P and Q algebraically.

The demand function is given as:

While the supply function will be given as:

If we equate the demand and supply functions, we get:

Let’s replace it in the demand function.

While the supply function will be given as:

Determine the equilibrium price and quantity

If we equate the demand and supply functions, we get:

The demand function is given as:

While the supply function is given as:

Determine the equilibrium price and quantity

b) Partial market equilibrium – Non-linear model

square method, and so on.

For instance, if we use the factorization method, we obtain:

𝑃(𝑃 + 11) − 1(𝑃 + 11) = 0

quantity will be:𝑄𝑑 = 6 − (1)2 = 5

General Market Equilibrium

prices of related commodities.

The demand and supply functions of 2 commodities are given as:

𝑄𝑑1 = 18 − 3𝑃1 + 𝑃2 𝑄𝑑2 = 12 − 𝑃1 − 2𝑃2

𝑄𝑠1 = −2 + 4𝑃1 𝑄𝑠2 = −2 + 3𝑃2

Qd1 = 𝑄𝑠1 𝑎𝑛𝑑

18 − 3𝑃1 + 𝑃2 = −2 + 4𝑃1 ⇒ 7𝑃1 − 𝑃2 = 20

12 − 𝑃1 − 2𝑃2 = −2 + 3𝑃2 ⇒ 𝑃1 + 5𝑃2 = 14

For each market i, equilibrium requires that:

Solving the 1st set of equations:

(𝑎0 − 𝑏0 ) + (𝑎1 − 𝑏1 )𝑃1 + (𝑎2 − 𝑏2 )𝑃2 = 0 − − − − − − − −(𝑖)

From the second set we get:

(𝑐0 − 𝑑0 ) + (𝑐1 − 𝑑1 )𝑃1 + (𝑐2 − 𝑑2 )𝑃2 = 0 − − − − − − − (𝑖𝑖)

𝛾𝑖 we get 2 simultaneous equations:

sign as the denominator.

demand or supply equations of the relevant commodities.

Equilibrium conditions for an n-commodity market

If the quantity demanded of good i is given as:

𝑄𝑑𝑖 = (𝑃1 , 𝑃2 , 𝑃3 , . . 𝑃𝑛 )𝑤ℎ𝑒𝑟𝑒 𝑖 = 1,2 … . . 𝑛

𝑄𝑠𝑖 = (𝑃1 , 𝑃2 , 𝑃3 , . . 𝑃𝑛 ) 𝑤ℎ𝑒𝑟𝑒 𝑖 = 1,2 … . . 𝑛

Equilibrium requires that for the n-markets to be in equilibrium simultaneously,

Equilibrium in National – Income Analysis (for a closed economy)

𝑌 = 𝐶 + 𝐼0 + 𝐺0 𝐶 = 𝑎 + 𝑏𝑌 𝑎 > 00< 𝑏 < 1

equilibrium national income, we substitute the expression for C in the model

This is the expression for the equilibrium national income.

income in the consumption function.

𝑎 − 𝑎𝑏 + 𝑏a+ bI0 +bG0 )