ECON1003 Quantitative Methods in Economics

Tutorial 6 (Wk7): Single-variable Optimisation, Elasticity of Demand

Revisit

Carlton Li

School of Economics
The University of Sydney

Carlton Li ECON1003 Qnt. Methods Economics 1 / 16

Tutorial Outline

1 Single-variable optimisation in production

2 Elasticity of demand revisit

Carlton Li ECON1003 Qnt. Methods Economics 2 / 16

Firm’s problem: Profit maximisation

A firm’s goal is to maximise the profit. Note that profit = total revenue -
total cost.

Take the market price as given, a firm choose an appropriate output level
to maximise the profit:

max π = P(Q)Q − C (Q)

Q | {z } | {z }
Total revenue Total cost

The first-order condition (i.e. differentiating the profit function w.r.t. Q):

P ′ (Q)Q + P(Q) − C ′ (Q) =0

| {z } | {z }
Marginal revenue Marginal cost

So we have the optimal quantity setting (or pricing) condition: MR = MC .

Carlton Li ECON1003 Qnt. Methods Economics 3 / 16

Firm’s problem: Cost minimisation

Sometimes it is not easy for a firm to manipulate the price and demand
(e.g. in competitive market). However, minimising cost can also help
maximising profit. Therefore, it is also important to know about the cost
structure of a firm.

Some concepts in the cost structure:

Total cost: TC (Q) - usually a (quasi-)concave function (You will learn
how they are obtained in intermediate or advanced microeconomic)
Average cost: AC (Q) = TC (Q)/Q
Marginal cost: MC (Q) = TC ′ (Q)

Carlton Li ECON1003 Qnt. Methods Economics 4 / 16

Firm’s problem: Efficient production

If firm can produce as many outputs as possible while using as few inputs
as possible, this is another way of profit-maximisation and
cost-minimisation. In this sense, the firm’s problem is:

max Q(x)
x

where x is the input for production. When we learn multivariate function

optimisation, we can consider more than 1 input and x can be a vector
(i.e. list of many variables).

Carlton Li ECON1003 Qnt. Methods Economics 5 / 16

Q2

The output from a pottery is related to the number of labour units

employed according to the production function Q = 9L2 − 0.11L3 . (a)
Determine the number of labour units which should be employed to
maximise output Q. (b) Find the point of inflection.

Carlton Li ECON1003 Qnt. Methods Economics 6 / 16

Q2

The output from a pottery is related to the number of labour units

employed according to the production function Q = 9L2 − 0.11L3 . (a)
Determine the number of labour units which should be employed to
maximise output Q. (b) Find the point of inflection.

(a)

dQ
= 0 =⇒ 18 − 0.3L2 = 0
dL
L = 0 or L = 60

Next, check concavity - we want maximal output so we need the optimal

point in the concave (downwards) region.

Carlton Li ECON1003 Qnt. Methods Economics 6 / 16

 d 2Q
= 18 − 0.6L
dL2
d 2Q
L = 0, = 18 > 0 (Not concave)
dL2
d 2Q
L = 60, < 0 (Concave)
dL2
So output is maximised when 60 labour units are used.
d 2Q
(b) The point of inflection is where dL2
= 0.

18 − 0.6L = 0 =⇒ L = 30
Q(30) = 9 × 302 − 0.1 × 303 = 5400

Carlton Li ECON1003 Qnt. Methods Economics 7 / 16

Q5

A firm has an average cost function AC = 10 − 3Q + Q 2 . (a) Write down

the equations for TC, MC. (b) Determine the values of Q at which: (i)
MC is minimised, (ii) AC is minimised. (c) Plot the AC and MC curves on
the same diagram. Confirm algebraically that the curves intersect at the
minimum point on the AC curve.

Carlton Li ECON1003 Qnt. Methods Economics 8 / 16

Q5

A firm has an average cost function AC = 10 − 3Q + Q 2 . (a) Write down

the equations for TC, MC. (b) Determine the values of Q at which: (i)
MC is minimised, (ii) AC is minimised. (c) Plot the AC and MC curves on
the same diagram. Confirm algebraically that the curves intersect at the
minimum point on the AC curve.

TC = Q × AC = 10Q − 3Q 2 + Q 3
MC = 10 − 6Q + 3Q 2

Carlton Li ECON1003 Qnt. Methods Economics 8 / 16

 TC = 10Q − 3Q 2 + Q 3
AC = 10 − 3Q + Q 2
MC = 10 − 6Q + 3Q 2

(b) Determine the values of Q at which: (i) MC is minimised, (ii) AC is

minimised.

Carlton Li ECON1003 Qnt. Methods Economics 9 / 16

 TC = 10Q − 3Q 2 + Q 3
AC = 10 − 3Q + Q 2
MC = 10 − 6Q + 3Q 2

(b) Determine the values of Q at which: (i) MC is minimised, (ii) AC is

minimised.

MC ′ (Q) = −6 + 6Q = 0 =⇒ Q = 1
MC ′′ (Q) = 6 > 0

So MC (Q) is convex upwards for all Q. Q = 1 is the minimum.

3
AC ′ (Q) = −3 + 2Q = 0 =⇒ Q =
2
AC ′′ (Q) = 2 > 0

So AC (Q) is convex upwards for all Q. Q = 3/2 is the minimum.

Carlton Li ECON1003 Qnt. Methods Economics 9 / 16
(c) Plot the AC and MC curves on the same diagram. Confirm
algebraically that the curves intersect at the minimum point on the AC
curve.

To find the point of intersection algebraically, we set AC = MC :

10 − 3Q + Q 2 = 10 − 6Q + 3Q 2
=⇒ Q = 0, Q = 3/2

Carlton Li ECON1003 Qnt. Methods Economics 10 / 16

Q6(b)
The demand and total cost functions for a good are given by the equations:

P = 80 − 4Q
1
TC = Q 3 − 18Q 2 + 240Q + 1500
3
(i) Write down the equations for MR, MC and profit. (ii) Determine the
number of goods which must be produced and sold to maximise profit.

Carlton Li ECON1003 Qnt. Methods Economics 11 / 16

Q6(b)
The demand and total cost functions for a good are given by the equations:

P = 80 − 4Q
1
TC = Q 3 − 18Q 2 + 240Q + 1500
3
(i) Write down the equations for MR, MC and profit. (ii) Determine the
number of goods which must be produced and sold to maximise profit.

Å ã
1 3
π(Q) = (80 − 4Q)Q − Q − 18Q 2 + 240Q + 1500
| {z } 3
Total revenue
1
= − Q 3 + 14Q 2 − 160Q − 1500
3
MR = 80 − 8Q
MC = Q 2 − 36Q + 240

Carlton Li ECON1003 Qnt. Methods Economics 11 / 16

(ii) Determine the number of goods which must be produced and sold to
maximise profit.

Let MR = MC (or π ′ (Q) = 0):

Q 2 − 36Q + 240 = 80 − 8Q =⇒ Q = 8 or Q = 20

Make sure you check whether they are indeed the maximum by substitute
these values into the profit function.
1
π(8) = − × 83 + 14 × 82 − 160 × 8 − 1500 = −2054.67
3
1
π(20) = − × 203 + 14 × 202 − 160 × 20 − 1500 = −1766.67
3
So maximum profit occurs at Q = 20, and minimum profit occurs at
Q = 8.

Carlton Li ECON1003 Qnt. Methods Economics 12 / 16

Tutorial Outline

1 Single-variable optimisation in production

2 Elasticity of demand revisit

Carlton Li ECON1003 Qnt. Methods Economics 13 / 16

Elasticity

∆Q d /Q d ∆Q d P dQ P
ϵd = = =
∆P/P ∆P Q d dP Q
∆Q d ∆Q d dQ
When ∆P is small, ∆P → dP .
Elastic: ϵd < −1
Unit-elastic: ϵd = −1
Inelastic: −1 < ϵd < 0

Carlton Li ECON1003 Qnt. Methods Economics 14 / 16

Q7b
A firm faces different demand functions for its product in two separate
markets:

Market 1: P = 120 − 3Q
Market 2: P = 180e −0.6Q

For each market, determine the price elasticity of demand when P = 10.

Carlton Li ECON1003 Qnt. Methods Economics 15 / 16

Q7b
A firm faces different demand functions for its product in two separate
markets:

Market 1: P = 120 − 3Q
Market 2: P = 180e −0.6Q

For each market, determine the price elasticity of demand when P = 10.

Market 1: P = 120 − 3Q =⇒ Q = 40 − 13 P

dQ P 1 P
ϵ1 = =− ×
dP Q 3 (40 − 13 P)
1 10 1
ϵ1 |P=10 =− × 1
=−
3 (40 − 3 × 10) 11

Carlton Li ECON1003 Qnt. Methods Economics 15 / 16

Market 2: P = 180e −0.6Q
dP
= 180e −0.6Q × (−0.6) = −108e −0.6Q
dQ | {z }
Chain rule
ã−1
180e −0.6Q
Å
dP P
ϵ2 = = −108e 0.6Q ×
dQ Q Q
180 5
=− · e 0.6Q · e −0.6Q = −
108Q 3Q
At P = 10:
10 = 180e −0.6Q
1
e −0.6Q =
18
−0.6Q 1
ln e = ln
18
1 1
Q=− · ln
0.6 18
5
ϵ2 |P=10 = − 1
≈ −0.346
3 × ln 18
Carlton Li ECON1003 Qnt. Methods Economics 16 / 16