Review: Mathematics for Economics

Functions of one variable

Functions of several variables

Optimization

Constrained optimization (several variables)

Advanced topics

2
1.1 Functions of one variable
1.1.1 First derivatives and slope

I Consider a single-variable function y = f (x)

I First derivative measures the slope1 of the function which is the change in
function due to a small (“infinitesimal”) change in x, mathematically:

df (x) f (x + x) f (x)
= f 0 (x) = lim (1.1)
dx x!0 x
f 0 (x) > 0: function is increasing over x

f 0 (x) < 0: function is decreasing over x

f 0 (x) = 0: function is horizontal over x

(function is not changing over x ) this will be central in finding optima)

1
Slope is the geometric counterpart of derivative
3
1.1 Functions of one variable
1.1.1 First derivatives and slope

IEP
y yIEP
Q f(x) U tangent line Q f(x)
f(x2) f(x2) 2
U1 T U
U
!y = f(x2) f(x1) f(x★) f(
E1
P P V S
f(x1) R f(x1) R
!x = x2 x1 E★
x3

x1 x2 x x★ x1 x2 x

(a) Slope of secant line P Q (b) Slope of tangent line

Figure 1.1: Understanding the slope of a function at point P

4
1.1 Functions of one variable
1.1.1 First derivatives and slope

I Consider the change from P to Q; the average rate of change between

these two points is given by the slope of the connecting line (or secant
line) P Q as
y f (x2 ) f (x1 ) QR
= = (1.2)
x x2 x1 PR
I To calculate slope of the function at point P , we can think about
successively smaller amounts of change in x; see figure 1.1(b)

I At the limit, when the change x is infinitesimal we have derivative

f (x + x) f (x)
f 0 (x) = lim (1.3)
x!0 x
which measures instantaneous rate of change

5
1.1 Functions of one variable
1.1.2 Second derivatives and curvature

I Second derivative explains the curvature of a function; it measures the rate

of change of slope for a small (“infinitesimal”) change in x
h i
I Usual notation: d
dx
df (x)
dx
= f 00 (x)

f 00 (x) > 0: slope of function is increasing over x (function is convex)

f 00 (x) < 0: slope of function is decreasing over x (function is concave)

f 00 (x) = 0: slope of function is constant over x (function is linear)

I The above curvature properties will also be relevant for optimization

6
1.1 Functions of one variable
1.1.2 Second derivatives and curvature

y y IEP

f(x) U2 f(x)
U1
f'(x) > 0
f(x★) f
★ f''(x) > 0
E E1 E★
f'(x) > 0 x2
f''(x) < 0 x3
x1

x x★ x
(a) Upward sloping concave (b) Upward sloping convex

Figure 1.2: Curvature of upward sloping functions (f 0 (x) > 0)

7
1.1 Functions of one variable
1.1.2 Second derivatives and curvature

y y IEP
U2
f'(x) < 0
U1
f''(x) > 0
f(x★) f
E★ E1 E★
f'(x) < 0 f(x) x2
f''(x) < 0 x3
f(x)
x1

x x★ x
(a) Downward sloping concave (b) Downward sloping convex

Figure 1.3: Curvature of downward sloping functions (f 0 (x) < 0)

8
1.1 Functions of one variable
1.1.3 Alternative definitions of concavity and convexity

I A function f is concave if for any pair of points on the graph of the

function the line connecting the two points lies on or below the graph

points on and below the graph of a concave function give a convex set

I A function f is convex if for any pair of points on the graph of the

function the line connecting the two points lies on or above the graph

points on and above the graph of a convex function give a convex set

I Convex sets will be discussed in the last section

9
1.1 Functions of one variable
1.1.4 Rules for calculating derivatives

1 If b is a constant
d d
(b) = 0, [bf (x)] = bf 0 (x) (1.4)
dx dx

2 Power rule:
d ⇣ b⌘
x = bxb 1
(1.5)
dx
3 For any constant a
d
(ax ) = ax lna (1.6)
dx
4 Sum rule:
d
[f (x) + g(x)] = f 0 (x) + g 0 (x) (1.7)
dx

10
1.1 Functions of one variable
1.1.4 Rules for calculating derivatives

5 Product rule:
d
[f (x)g(x)] = f (x)g 0 (x) + g(x)f 0 (x) (1.8)
dx

6 Quotient rule:

d f (x) g(x)f 0 (x) f (x)g 0 (x)
= (1.9)
dx g(x) [g(x)]2

7 Chain rule: if y = f (x) and x = g(z), then

dy dy dx
= = f 0 (x)g 0 (z) (1.10)
dz dx dz

11
1.1 Functions of one variable
1.1.4 Rules for calculating derivatives

8 Logarithmic function rule:

d f 0 (x) d 1
[lnf (x)] = , (lnx) = (1.11)
dx f (x) dx x

9 Exponential function rule:

d f (x) d x
[e ] = ef (x) f 0 (x), (e ) = ex (1.12)
dx dx

12
1.2 Functions of several variables
1.2.1 Preliminaries and notation

I Economic models will usually have functions of several variables

y = f (x1 , x2 , ..., xn ) (1.13)

e.g., utility functions, production functions, etc.

I For graphical convenience: we will often deal with

y = f (x1 , x2 ) (1.14)

I Understanding slope and curvature properties of such functions will require

knowledge of partial derivatives

understand that f (x1 , x2 ) is a surface and it changes over two variables

13
1.2 Functions of several variables
1.2.2 Understanding a function over several variables

1 1
Figure 1.4: Understanding the function f (x1 , x2 ) = 10x12 x22

14
1.2 Functions of several variables
1.2.2 Understanding a function over several variables

1 1
Figure 1.5: Understanding the function f (x1 , x2 ) = 10x12 x22

15
1.2 Functions of several variables
1.2.3 First partial derivatives and slopes

I For the f (x1 , x2 ) function, we define two first partial derivatives

@f
@x1
= f1 : rate of change of function for small change in x1 with x2 fixed
@f
@x2
= f2 : rate of change of function for small change in x2 with x1 fixed

I Formally: for the y = f (x1 , x2 ) function

@f f (x1 + x1 , x 2 ) f (x1 , x2 )
= lim (1.15)
@x1 x1 !0 x1

@f f (x1 , x2 + x2 ) f (x1 , x2 )
= lim (1.16)
@x2 x2 !0 x2

16
1.2 Functions of several variables
1.2.4 Understanding the first partial derivatives

Figure 1.6: Understanding first partial derivatives of function y = f (x1 , x2 )

17
1.2 Functions of several variables
1.2.5 Second partial derivatives and curvature

I A second partial derivative measures the rate of change of the slope of the
function over a particular variable

I For the f (x1 , x2 ) function, we define the direct partial derivatives

✓ ◆ ✓ ◆
@ @f @ @f
f11 = and f22 = (1.17)
@x1 @x1 @x2 @x2

I For the f (x1 , x2 ) function, we define the cross partial derivatives

✓ ◆ ✓ ◆
@ @f @ @f
f12 = and f21 = (1.18)
@x2 @x1 @x1 @x2

I Young’s Theorem: f12 = f21

18
1.2 Functions of several variables
1.2.6 Example: calculating partial derivatives

Consider the function: f (x1 , x2 ) = ax21 + bx1 x2 + cx22

I Calculate and check the first partial derivatives:

f1 = 2ax1 + bx2 and f2 = bx1 + 2cx2 (1.19)

I Calculate and check the second partial derivatives:

f11 = 2a, f12 = b, f21 = b and f22 = 2c (1.20)

19
1.3 Optimization
1.3.1 Introduction

I Optimization is central to any economic problem

recall: the subject of economics deals with human behavior as it pertains to

using scarce resources to achieve alternative goals

the notion of “doing the best we can” (or being “efficient”) is then
fundamental to any economic problem

I Optimization problems can be both ...

... constrained (e.g., utility maximization, cost minimization), and

... unconstrained (e.g., profit maximization)

20
1.3 Optimization
1.3.2 Unconstrained optimization (one variable)

I Consider the single variable unconstrained optimization problem

Maximize: y = f (x) (1.21)

x

x is the choice variable, f (x) is the objective function

objective: we want to find the maximum (or “peak”) of f (x)

I First order necessary condition (FONC): f (x) is maximized at x? if

f 0 (x? ) = 0 (1.22)

i.e., no further change in function value for a small change in x (tangent

line is completely horizontal at x? )

21
1.3 Optimization
1.3.2 Unconstrained optimization (one variable)

I Alternatively, we want to find the minimum (or “trough”) of f (x)

Minimize: y = f (x) (1.23)

x

I First order necessary condition (FONC): function is minimized at x? if

f 0 (x? ) = 0 (1.24)

I Caution: FOC is necessary but not sufficient for further distinction between
maximum, minimum and inflection points

inflection point is a point where function changes curvature

I FOC can be solved to obtain the value of x? (critical value)

22
1.3 Optimization
1.3.2 Unconstrained optimization (one variable)

y yIEP I

f'(x★) = 0 U2
f(x★)
U1 U
f(x)

E★ E1 E★
x2
f(x) x3
f(x★) x
1 f'(x★) = 0

x★ x x★ x

(a) Maximization over x (b) Minimization over x

Figure 1.7: First order condition for unconstrained optimization over x

23
1.3 Optimization
1.3.2 Unconstrained optimization (one variable)

y y IEP
U2
f'(x★) = f''(x★) = 0 U1 f'(x★) = f''(x★) = 0
f(x)
f(x★) f
E★ E1 E★
x2
x3
f(x)
x1

x★ x x★ x
? ?
(a) Inflection point at x (b) Inflection point at x

Figure 1.8: Two types of inflection points at x?

24
1.3 Optimization
1.3.2 Unconstrained optimization (one variable)

I Second order sufficiency conditions require

f 00 (x? ) < 0 for a maximum at x? (1.25)

00 ?
f (x ) > 0 for a minimum at x? (1.26)
00 ? ?
f (x ) = 0 for an inflection point at x (1.27)

I f 00 (x? ) < 0: function value decreases for any movement away from x? and
so x? must give a maximum of the function

I f 00 (x? ) > 0: function value increases for any movement away from x? and
so x? must give a minimum of the function

25
1.3 Optimization
1.3.3 Unconstrained optimization (several variables)

I Consider the multi-variable unconstrained optimization problem

Maximize: y = f (x1 , x2 ) (1.28)

x1 ,x2

where (x1 , x2 ) are the choice variables and we want to find the maximum
of the surface f (x1 , x2 )

I First order necessary condition (FONC) requires that f (x1 , x2 ) is

maximized over both x1 and x2 which means

f1 (x?1 , x?2 ) = f2 (x?1 , x?2 ) = 0 (1.29)

i.e., no further change in function value for a small change in either x1 or

x2 (tangent plane is completely horizontal at x?1 , x?2 )

26
1.3 Optimization
1.3.3 Unconstrained optimization (several variables)

Figure 1.9: Unconstrained optima (minimum on the left and maximum on the right)

27
1.3 Optimization
1.3.3 Unconstrained optimization (several variables)

Figure 1.10: Unconstrained maximum and tangent plane

28
1.3 Optimization
1.3.3 Unconstrained optimization (several variables)

I If either f1 6= 0 or f2 6= 0 then function value can still be increased by

changing either x1 or x2

I Second order sufficiency condition requires2

2
f11 < 0, f22 < 0, f11 f22 f12 >0 for a maximum (1.30)
2
f11 > 0, f22 > 0, f11 f22 f12 >0 for a minimum (1.31)

I Inflection point: when f11 and f22 have same sign and f11 f22 2
f12 <0

I Saddle point: when f11 and f22 have opposite signs and f11 f22 2
f12 <0

I Second derivative test is inconclusive if f11 f22 2

f12 =0

2
All second derivatives evaluated at critical point (x?1 , x?2 )
29
1.3 Optimization
1.3.3 Unconstrained optimization (several variables)

Figure 1.11: Saddle point – an optimum that is both maximum and minimum

30
1.3 Optimization
1.3.3 Unconstrained optimization (several variables)

I Intuitively: condition (1.30) implies function is maximized at (x?1 , x?2 ) only

if any movement away from that point decreases the function value

f11 < 0 implies that f is decreasing for movement in the x1 -direction

f22 < 0 implies that f is decreasing for movement in the x2 -direction

2 > 0 implies the negativity of f , f
f11 f22 f12 11 22 are strong enough to
outweigh any possible perverse cross e↵ect because of f12

I A function that satisfies the above properties will be a concave function

() see figure 1.8 (a))

in general: a concave function lies below any tangent plane

31
1.3 Optimization
1.3.3 Unconstrained optimization (several variables)

I An alternative mechanism to check conditions (1.30) and (1.31) is to form

the following Hessian matrix

f11 f12
H =
f21 f22
2
and check the signs of |H1 | = |f11 | and |H2 | = |H| = f11 f22 f12

I Decision rule:

H1 < 0, H2 > 0 H is negative definite; (x?1 , x?2 ) is a maximum

H1 > 0, H2 > 0 H is positive definite; (x?1 , x?2 ) is a minimum

where all determinants are evaluated at critical point (x?1 , x?2 )

32
1.4 Constrained optimization (several variables)
1.4.1 The general problem

I Consider the general constrained maximization problem:

Maximize: f (x1 , x2 ) s.t. g(x1 , x2 ) = c (1.32)

x1 ,x2

where we are considering an equality constraint

I We will use the method of Lagrange starting with:

L(x1 , x2 ; ) = f (x1 , x2 ) + [c g(x1 , x2 )] (1.33)

where is the Lagrange multiplier

I If the constraint holds, the f and the L functions are equivalent

33
1.4 Constrained optimization (several variables)
1.4.2 First order conditions

I Given that constraint holds, the first order conditions are

L1 = f1 (x?1 , x?2 ) ?
g1 (x?1 , x?2 ) = 0 (1.34)
L2 = f2 (x?1 , x?2 ) ?
g2 (x?1 , x?2 ) = 0 (1.35)
L = c g(x?1 , x?2 ) = 0 (1.36)

which must be satisfied at the critical point (x?1 , x?2 , ?

)

I Solve FOCs to obtain the solution (x?1 , x?2 , ?

) which will ...

1 ... satisfy the constraint, and

2 ... maximize the given function

34
1.4 Constrained optimization (several variables)
1.4.3 Interpreting the Lagrange multiplier

I The Lagrange multiplier ? indicates by how much the optimal value of

the objective function f (x1 , x2 ) increases if the constraint g(x1 , x2 ) = c is
relaxed by the marginal unit

? @f (x?1 , x?2 )
= (1.37)
@c

I Lagrange multiplier ?
is the shadow price of constraint level c

if ? > 0, the constraint positively a↵ects the objective function

I In utility maximization: ?
is the marginal utility of income

shows how much maximum utility changes if income changes marginally

35
1.4 Constrained optimization (several variables)
1.4.4 Second order conditions

I To check SOCs for constrained optimization problems, we write the

bordered Hessian matrix
2 3 2 3
L L 1 L 2 0 g1 g2
H = 4 L1 L11 L12 5 = 4 g1 f11 f12 5 (1.38)
L2 L21 L22 g2 f21 f22

and check the sign of |H2 | = H

I Note: bordered Hessian matrix is only a convenient tool for listing all
second partial derivatives of a function and then for checking SOCs

I The dimensions of the bordered Hessian matrix depends on the number of

independent variables

36
1.4 Constrained optimization (several variables)
1.4.4 Second order conditions

I Decision rule:

|H2 | < 0 sufficient condition for minimum

|H2 | > 0 sufficient condition for maximum

I From (1.38), using the FOCs, we can write

2 f1 f2 3 2 3
0 0 f1 f2
1 4
H = 4 f1
f11 f12 5 = 2
f1 f11 f12 5
f2
f21 f22 f2 f21 f22
1
= 2
f12 f22 2f1 f2 f12 + f22 f11 (1.39)

which means f12 f22 2f1 f2 f12 + f22 f11 must be negative; a function which
satisfies this property is a quasiconcave function () more on this later)

37
1.5 Advanced topics
1.5.1 Convex sets

I The set S is a convex set if, for any two points in the set, all weighted
averages (or convex combinations) of these two points also lie entirely
within the same set

a set is nonconvex if, for any two points in the set, all weighted averages (or
convex combinations) of these two points do not lie within the same set

convex sets do not have any holes, breaks or awkward curvatures in them

I Formally: S ⇢ IRn is a convex set if, for any x1 2 S and x2 2 S, we have

tx1 + (1 t)x2 2 S (1.40)

for all t in the interval 0  t  1

38
 1.5 Advanced topics
1.5.1 Convex sets

x2
x x2
y x

x
x
x
y x
y y
y
(a) Convex sets x1 (b) Nonconvex sets x1

Figure 1.12: Convex versus nonconvex sets

39
1.5 Advanced topics
1.5.2 Level curves

I Consider the function y = f (x1 , x2 ); given that the graph of this function
is a 3-dimensional surface we will often work with level curves of such
functions in (x1 , x2 )-space

I The level set3

L(y 0 ) ⌘ {(x1 , x2 )|f (x1 , x2 ) = y 0 } (1.41)
0
is a set of all such points that give some given function value y

I Equation of a level curve in (x1 , x2 )-space is defined as

f (x1 , x2 ) = y 0 ) x2 = g(x1 ) (1.42)

I Recall: level curve for a utility function is the indi↵erence curve

3
In 2-dimensional space, level set is just a level curve
40
1.5 Advanced topics
1.5.2 Level curves

U x2

N Projec(on of LN
L
U1 K
J

Projec(on of JK
x2 x1
U0
U=U1

U=U0
0 x1

(a) Utility surface (b) Utility contours

Figure 1.13: From Utility function to its level (or indi↵erence) curves

41
1.5 Advanced topics
1.5.3 Quasiconcavity

I Definition: a function f with domain X ✓ IRn is quasiconcave

(quasiconvex) if and only if, for any pair of distinct points u and v in the
domain of f , and for 0 < ✓ < 1,
(
f (u)
f (v) f (u) ) f [✓u + (1 ✓)v] (1.43)
 f (v)

I A function f with domain X ✓ IRn is strictly quasiconcave (quasiconvex)

if and only if,
(
> f (u)
f (v) f (u) ) f [✓u + (1 ✓)v] (1.44)
< f (v)

42
1.5 Advanced topics
1.5.3 Quasiconcavity

I Any concave (convex) function is also quasiconcave (quasiconvex) but not

vice versa

similar for a strictly concave (convex) function

I Alternatively: a function f (x) is quasiconcave (quasiconvex) if and only if,

for any constant level k, the upper (lower) contour set is a convex set

upper contour set: set of points such that function value is at least k
) see set % (x0 ) in figure 1.12(a)

lower contour set: set of points such that function value is maximum k
) see set - (x0 ) in figure 1.12(a)

43
1.5 Advanced topics
1.5.3 Quasiconcavity

x2
x2
x1
1 ≿(x0)
x ≿(x0) x0

x2
x0 ≾(x0)

x2
≾(x0) (x0) (x0)
x1 x1
(a) Convex upper contour set (b) Convex lower contour set

Figure 1.14: Quasiconcave and quasiconvex functions

44
1.5 Advanced topics
1.5.3 Quasiconcavity

f(x) f(x)

M M N

x x
u v u v
(a) Strictly quasiconcave function (b) Quasiconcave function

Figure 1.15: Single-variable quasiconcave functions

45
1.5 Advanced topics
1.5.3 Quasiconcavity

x2 x1 x x1
2

(a) Strictly concave function (b) Strictly quasiconcave function

Figure 1.16: Concave versus quasiconcave function

46
1.5 Advanced topics
1.5.3 Quasiconcavity

I For a twice continuously di↵erentiable f (x1 , x2 ), form the Bordered

Hessian4 matrix, 2 3
0 f1 f2
[H] = 4 f1 f11 f12 5 (1.45)
f2 f21 f22
where note that |H1 | = f12 is always negative

I Decision rule: f (x1 , x2 ) is strictly

quasiconcave if |H 2 | = |H| > 0

(if sign alternates for each successive determinant)

quasiconvex if |H 2 | = |H| < 0

(if sign is negative for each successive determinant)

4
The usual Hessian matrix bordered by first derivatives of the function
47
1.5 Advanced topics
1.5.3 Quasiconcavity

I If we calculate the complete determinant

|H| = f12 f22 2f1 f2 f12 + f22 f11 (1.46)

we see that we need f12 f22 2f1 f2 f12 + f22 f11 < 0 for |H| > 0

I Quasiconcavity of the f (x1 , x2 ) function is also sufficient for having a

constrained maximum of the same function subject to a linear constraint

48