FINANCIAL

MATHEMATICS

U4

INTRODUCTION
MATHEMATICAL
ECONOMICS

prepared by

Gyaneshwar Rao
Unit 4: Introduction Mathematical Economics 4.2
Study Organiser
Before you begin this unit, please check through your study organiser. It shows the
topics that we will be covering, the skills you need to acquire (the outcomes) and the
activities you will do to help you acquire these skills.
Topic Learning outcomes Activities
4.1 Economic Models • Discuss the Economic models Activity 4.1, 4.2, 4.3
4.2 Elasticity and its • Analyse elasticity and its
Relationship between relationship between Total
Total Revenue/ Total revenue/ total Costs
Costs
4.3 Taxation and • Discuss taxation and the Activity 4.4
Implications for tax implications for tax burden on
burden on producers producers and consumers
and consumers

4.4 Elasticity, Total • Explain elasticity, total revenue Activity 4.5, 4.6, 4.7
Revenue and Marginal and marginal revenue
Revenue

4.5 Cost Curves using • Demonstrate cost curves using Activity 4.8, 4.9
Calculus calculus

4.6 Ceteris Paribus • Explain ceteris paribus Activity 4.10

Assumption and Partial assumption and partial
derivatives derivatives

You are expected to spend 12 hours on this unit.

Unit 4: Introduction Mathematical Economics 4.3

Introduction
The nature of Mathematical Economics
Mathematical economics is an approach to economic analysis. It is not a distinct
branch of economics but rather an approach to economic analysis. In this approach
an economist uses mathematical symbols in the statement of the problem and draws
upon mathematical theorems to aid in reasoning. Non-mathematical approach to
economic analysis uses simple elementary geometry and algebra in the analysis but
mathematical economics goes beyond it to use matrix algebra, differential and
integral calculus and differential equations in an economic analysis.

The advantage of mathematical economics is that the :

• analysis is more rigorous; and

• language used is more concise and precise.

Mathematical economics is a broad subject area. Thus this component of the course
provides you with a basic overview of how mathematics is used in economics. In
this module we will examine the most common use of mathematics in economic
analysis and also to familiarise you with the common mathematical concepts that
you will later use in the study of economics in more advanced economic courses.

The basic mathematical concepts have already been covered in the mathematics
module of this course. We shall only consider the application of these concepts to
economic analysis.

The structure of this module is as follows:

a. We begin by introducing an economic model by describing its basic structure or

ingredients. We shall consider the demand and supply model to introduce the
concept of equilibrium in economics, particularly partial equilibrium analysis.
This model is widely used and is a very powerful technique to explain the
behaviour of market participants (i.e. consumers and producers) in a competitive
market.

b. The concept of ‘rates of change’, captured by the technique of differentiation in

mathematics, is useful in economics to show and measure changes in economic
variables over a time period. The rates of change concept can also be applied to
the concept of elasticity, determine relationships between total revenue, marginal
revenue and elasticity of demand, cost curves and demand and marginal revenue
curves.
c. A key assumption on which Neo-classical economics is based is that the
consumers maximize satisfaction or utility, producers minimize costs and
maximize profits. The mathematical technique of ‘optimisation’ to model the
behaviour of consumers and producers and to seek solutions to their
optimization problems, that is, utility maximisation, cost minimisation or profit
maximisation. Differential equations can also be used to model consumer and
producer behaviour.
You will need to revise your knowledge of calculus from the mathematics
module before you begin this section.

Unit 4: Introduction Mathematical Economics 4.4

4.1 Economic Models
Economists use economic models to explain the economic phenomenon. The models
are an abstraction from the complex real world. This is necessary to understand the
particular economic phenomenon under scrutiny. Economists pick out the primary
factors and relationships relevant to the problem and concentrate on these alone. An
economic model is a theoretical framework. This theoretical framework can be
described mathematically1. If a model is mathematical, it will usually contain a set
of equations that would describe the structure of the model. These models would
contain two types of variables. The endogenous variables are those variables whose
solution values we seek from the model. The model may also contain those variables
whose values are determined by forces external to the model. The model itself does
not determine their values. Such variables are called exogenous variables.

We use such a model here to show an important concept of ‘market equilibrium’ in

economics.

The Demand and Supply Model

The demand curve is the relationship between the quantity of a good that consumers
are willing to buy (QD) and the price of a good (Px).

Quantity of X demanded(QD) = d x (PX )

This is a simple linear relationship which assumes that quantity demanded only
depend on price of that commodity. However, in real world QD depend on other
things also.

Quantity of X demanded(QD) = d x ( PX , PY , I ; preferences, etc)

Therefore, let us assume following demand function for bread for an individual.
Qd = 150 − 20 p − 4 pb + 3 pc + 2 y (equation 1)
Qd represents the quantity of bread demanded ,
p represents the price of the bread,
pb represents the price of butter2. Let pb =4
pc represents the price of Breakfast crackers3. Let pc =3
y represents the consumer’s income level in $000. Let y =12

We model the relationship between the price of bread and the quantity demanded,
we use that ceteris paribus assumption, to keep other factors affecting the demand
for bread unchanging.

1
Economic models can also be described graphically as well as in words.
2
Butter represents complementary good. An increase in price of complementary good will lead to fall
in demand of other, indicated by minus sign.
3
Breakfast crackers are substitute of bread. Substitute goods are those that can be used as an
alternative. Like tea and coffee, bus or taxi etc. an increase in price of substitute goods will lead to
increase in demand of another i.e. positive related and thus positive sign.

Unit 4: Introduction Mathematical Economics 4.5

Thus we get:
Qd = 150 − 20 p − 4(2) + 3 pc (3) + 2(12)
Qd = 175 − 20 P (equation 2)

This shows deriving simplified liner equation for demand of bread by applying
ceteris paribus assumption4. The equilibrium price and quantity are determined by
the model and would be regarded as endogenous variables. The income levels,
prices of other goods etc would be regarded as the exogenous variables. To help you
understand this concept, attempt the activity below.

Activity 4.1

Housing Demand

Spend 15 minutes on this activity.

Suppose you are asked to study the demand for housing in your country.

a. Discuss the variables you are going to include in your demand model to
explain the demand for housing.

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b. Formulate an equation like equation (1) to specify the demand function of

housing. Pay particular attention to the signs (minus or plus) that you use in
the equation for each variable that you are using.
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c. Explain the economic rationale for the ‘signs’ you have used in (b).

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4
According to this assumption other variables apart from one being studied are held constant, to
make an analysis possible and simple.

Unit 4: Introduction Mathematical Economics 4.6

The individual demand curve (2) can be used to further show the impact of changes
in demand conditions. For example, to approximate the changes in quantity
demanded due to change in price of bread.

Example 4.1

Let P 1 = initial price P 2 = new price, therefore ∆P =P 2 – P 1

∆ Qd = Qd ( P2 ) − Q D ( P1 )

Using equation (2), we get (175-20 P 2) – (175 -20 P 1) = -20(P2-P1) = -20(∆P)

Now substituting price change in the above equation would provide corresponding
change in quantity demanded. According to the Law of demand, a rise in price
would lead to a fall in the demand and is indicated by a negative coefficient.

In the above example we have considered an individual demand. If we know the

demand curve for all consumers of a product, then we can determine market demand
for a particular product. Market demand for private good is horizontal summation of
all individual demand curves. That is at a particular price level what quantity is
demanded by different consumers.

Market demand = Qd 1 + Qd 2 + Qd 3 + ......... + Qdn

The table below shows an example.

Price ($) Qd 1 Qd 2 Qd 3 Qmarket demand

5 10 12 8 30
10 8 10 7 25
15 6 8 6 20

To get the market demand curve, we add up the individual demand curves
horizontally.

Example 4.2
qd 1 = 8 − 2 p1
qd 2 = 5 − p2
qd 3 = 10 − p3

Market Demand = q d 1 + qd 2 + qd 3
QD = 23 − 6 P
A similar analysis can be done for supply.

Unit 4: Introduction Mathematical Economics 4.7

Supply curve

The supply curve is the relationship between the quantity of a good that producers
are willing to produce and sell at each price level. The higher the price the more
firms are willing and able to produce and sell.

Other factors affecting supply include production costs, weather conditions, cost of
raw materials, change in technology etc.

Qs = f ( price, production cos t , no. producers)

Qs = 180 + 40 p − 5c + 2s

Qs represents quantity of bread supplied ,

p represents the price of bread,
c represents the cost of producing one unit of bread. Let c = $2
s represents the number of bread suppliers in thousands (000’s). Let S=10

Qs = 180 + 40 p − 5(2) + 2(10)

Qs = 150 + 40 p (equation 3)

The Market supply curve is a horizontal summation of all individual firms supply.

QS = qs1 + qs 2 + qs 3 + ...... where 1,2, 3.. indicate the number of firms in

the industry.

Activity 4.2

Supply Curve

Please spend 15 minutes on this activity.

The following are the individual supply curves for firms in an industry:

qs1 = −1 + P
qs 2 = −2 + 3P
qs 3 = 5 + 4 P

Unit 4: Introduction Mathematical Economics 4.8

Determine the market supply curve.
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Market Equilibrium

Interaction of demand and supply produce market equilibrium in a free market (i.e.
the absence of government intervention).
Market Equilibrium: Qs = Qd

Example 4.3
Q d = a + bP
Q s = c + dP
a t E q u ilib r iu m : a + b P = c + d P
a − c = dP − bP
a − c = P (d − b)
a −c
E q u ilib r iu m P r ic e , P ∗ =
d −b
n o w s u b s titu te P in d e m a n d f u n c tio n :
a −c
Qd = a + b( )
d −b
ab − bc
= a +
d −b
a (d − b) + ab − bc
=
(d − b )
ad − ab + ab − bc
=
(d − b)
ad − bc
E q u ilib r iu m Q u a n ti ty , Q * =
(d − b)

Shifts in Demand and Supply Curves

The supply and demand curves show the relationship between the price of a good
and the quantity supplied or demanded at each price level. However, if other factors
influencing demand and supply change they would lead to an entire shift in the
demand or supply curve either up or down and is called a change in supply/demand.

Example: The supply and demand curves for a good are given below:

Qd = 18 − 3P and Q s = −6 + 9 P

Unit 4: Introduction Mathematical Economics 4.9

A sales tax of $1 is levied on the suppliers. The supply curve shifts. The new supply
curve would be:

Qs∗ = −6 + 9 ( P − 1) . Note that (P-1) means that producers

would receive price minus $1 tax.
Qs∗ = −15 + 9 P.

Example 4.4
A sales tax of $1 instead is placed on the demanders of the product. The new
demand curve would be:
Qd∗ = 18 − 3( P + 1).( P + 1) indicates that demanders now pay a higher price.
Q∗d = 15 − 3P.

The equilibrium before tax is

a−c
P=
d −b
18 − ( −6)
P=
9 − ( −3)
P=2

ad − bc (18 × 9) − ( −3 × −6 ) 144
Q= = = = 12.
d −b 9 − ( −3) 12

The equilibrium after tax if the tax is levied on the supplier is:
a −c
P=
d −b
18 − (−15)
P=
9 − (−3)
P∗ = $2.75

ad − bc (18 × 9) − ( −3 × −15 ) 117

Q∗ = = = = 9.75.
d −b 9 − (−3) 12
Analysing the before and after tax situations, we can determine the change in price
and as well as the incidence of the tax on the producers and the consumers.

∆P = P * − P = $2.75 − $2.00 = $0.75

Unit 4: Introduction Mathematical Economics 4.10

Tax incidence on the consumers is:

∆P 0.75
= = 0.75
∆t 1
This implies that the incidence of the tax on the producer is

∆P
1− = 1 − 0.75 = 0.25
∆t

Activity 4.3

Tax Levy

Spend 15 minutes on this activity.

A tax of $1 is levied on the demand side of the market.

.
The supply and demand curves are as follows:

Qd = 18 − 3P and Q s = −6 + 9 P

a. Determine the new equilibrium price and quantity after tax. Note your answer
must be the same as in example 4.
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b. Determine the tax burden on the consumers and the producers.

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c. Compare your answers with the answers given in example 4.4.

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Unit 4: Introduction Mathematical Economics 4.11

Choosing at the Margin and Calculus

Economic choices that people make are a consequence of the scarcity of goods and
services. In making choices people respond to incentives. In the neo-classical or the
marginalist paradigm, people make this choice, as they respond to incentives, at the
margin.

For example, the benefit that arises from an increase in one activity is called
marginal benefit. The associated cost of an increase in the activity is called marginal
cost. The activity is undertaken only if the marginal benefit at least exceeds the
marginal cost.

The technique of differentiation in Calculus can be used to evaluate this analysis at

the margin.

Example 4.5

T o tal C o st = T C , th erefo re M C , defined as chan ge in to tal co st

dTC
w h en on e m ore un it is co nsidered is g iven by or
dq
m arginal revenu e (M R ), defined as ch an ge in to tal revenu e (T R ) w hen
dTR
on e m ore un it is so ld is g iven by
dq

Example 4.6
Examine the demand and supply model,

Q d = 1 8 − 3 P an d Q s = − 6 + 9 P .

∆Qd dqd ∂q
= o r w h e n p a r t ia lly d if f e r e n tia tin g ,
∆P dp ∂p
∆Qs dqs ∂q
= o r w h e n p a r t ia lly d if f e r e n tia tin g , .
∆P dp ∂p
This technique is widely used in Economics.

Unit 4: Introduction Mathematical Economics 4.12

4.2 Elasticity and its Relationship
between Total Revenue/ Total
Costs
We will now examine simple applications calculus to economics. In particular, we
look at the following applications:

a. Elasticity and incidence of tax.

b. Elasticity, Total Revenue and Marginal Revenue

c. Cost Curves using Calculus

Elasticity and Incidence of Tax

Elasticity of demand at a point is given by

%∆ Qty demanded ∆Qd ∆P ∆Qd P ∆Qd P dQd P

ξd = = ÷ = * = * =- *
%∆ price Q P Q ∆P ∆P Q dP Qd

Elasticity of Supply at point is given by

% ∆ Q ty supplied ∆ Q s P dQ s P
ξs = = * = * .
% ∆ price ∆P Qs dP Q s

We go back to our demand and supply model given in Activity 4.3

Qd = 18 − 3P and Q s = −6 + 9 P

Note that the equilibrium solution is given by: P = 2 and Q=12

Calculations of relevant elasticities

dQ d P
ξd = - *
dP Qd
2 dQ d
= − (− 3) * s in c e = −3
12 dp
= 0 .5

Unit 4: Introduction Mathematical Economics 4.13

 ∆Qs P dQ s P dQ S
ξs = . = * since =9
∆P Q dP Q dp
2
= (9) *
12
= 1.5

4.3 Taxation and Implications for

tax burden on producers and
consumers
We found out earlier the impact of $1 tax on producers and how tax burden is
shared. We will do a similar analysis using elasticity. Note that any changes in the
price of a good induced by a tax or any other economic phenomenon and its burden
on the consumers and producers depends upon elasticity of demand for the product.
The following example illustrates this point clearly.

Example 4.7
∆p
From our earlier analysis we know that ∆p = $0.75, = 0.75, ξ d =0.5, ξ s =1.5
∆t
∆p
We know that = tax burden on consumers
∆t
∆p ξs
= assuming ξ d is given as positive OR
∆t ξ s + ξ d
∆p ξs
= assuming ξ d is given as negative.
∆t ξ s − ξ d
∆p 1.5 1.5
= = = 0.75
∆t 1.5 + 0.5 2

By making ∆p subject of formula we get the change in price consumers pay,

ξs
∆p = * ∆t
ξs +ξd
= 0.75*1
= $0.75
Compare the above analysis with the previous one which used another method of
analysis.

Unit 4: Introduction Mathematical Economics 4.14

 Activity 4.4

Gasoline Demand

Spend 15 minutes on this activity

Gasoline demand and supply in a country are given by:

QdG = 150 − 25P

QsG = 60 + 20 P

a. Calculate the equilibrium quantity and equilibrium price.

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b. Estimate the incidence of a $1.00 tax on the consumers and on the producers.
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c. Determine how much more the consumers would need to pay for gasoline after
the tax.
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Unit 4: Introduction Mathematical Economics 4.15

4.4 Elasticity, Total Revenue and
Marginal Revenue
Let us take the demand curve for a good to be:

Q = a − bP, where P is price of the good and Q is the quantity demanded.

a Q
⇒ P= − . This is the inverse form of the demand function.
b b

T o ta l R e v e n u e , T R = P .Q
 a 1  a 1
=  − Q Q = Q − Q 2

b b  b b
d (T R ) a 2
MR = = − Q
dQ b b

We establish the relationship between demand and marginal revenue.

a 2
MR = − Q
b b

and demand is

a Q
P = −
b b
Two characteristics to note here are that:

a. Both the demand curve and the marginal revenue cures have the same
a
intercept, .
b
b. The slope of the MR curve is twice the slope the demand curve.

Unit 4: Introduction Mathematical Economics 4.16

 Price
a/b Demand Curve:
a Q
P = −
b b

MR curve
a 2
MR = − Q
b b
Output

So from the demand curve, the marginal revenue curve can easily be derived.
Attempt the next activity as it will give you a better understanding this concept.

Activity 4.5

Demand function for gasoline

Spend 15 minutes on this activity

The following is the demand function for gasoline in a country:

QdG = 150 − 25 P

a. Determine the inverse demand curve.

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b. Hence determine the marginal revenue curve.

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Unit 4: Introduction Mathematical Economics 4.17

Relationship between Elasticity, TR and MR

From economic theory we know that when MR=0, TR is maximised. We use this
truth to establish the relationship between Elasticity, TR and MR.

a 2
Take, Qd = a − bP, ⇒ MR = − Q
b b
When MR = O, TR is maximised, so let MR=0.
a 2 2 a a b
⇒ − Q = 0, Q = ⇒ Q = *
b b b b b 2
a
∴ at Q = , TR is maximized.
2

a
W h a t is th e p ric e a t Q =
2
a 1 a 1 a 
P = − Q → P = −  
b b b b 2 
a
P = ⇒ a t th is p ric e , T R is m a x im iz e d .
2b

a a 
F in d ξ d at th e p o in t  ,  o n th e d em an d cu rve: Q d = a − b P
 2 2b 
− dQ P
ξd = * ,
dP Q
 a a dQ
= −(−b) *  ÷  sin ce = −b
 2b 2  dP
ξd =1

At MR = 0, ξ d on the demand curve is 1 and TR is maximized.

Unit 4: Introduction Mathematical Economics 4.18

 Total TR is maximized
Revenue
($)

Price,
MR
($)
Elasticity of
Demand = 1

|| ||
MR = 0 Q

Take a break now and attempt the activity below to help you get a better grasp of
this concept.

Activity 4.6

Maximizing proceeds

Spend 15 minutes on this activity

Having gained exclusive rights to his library of tapes, Jack plans to sell them, with
the objective of maximizing his proceeds from the sale. The demand curve for these
tapes is given by Q = 700 – 35P. What price should he have set, given that the same
price must be charged for all tapes?
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Unit 4: Introduction Mathematical Economics 4.19

Further develop the relationship between MR and
Elasticity of Demand.

TR = P.Q

By differentiating the TR function with respect to Q, we get the MR:

dTR QdP
MR = = P+ , (Use the product rule to differentiate).
dQ dQ

QdP P
Multiply term by
dQ P

 QdP 
⇒ P 1 + 
 PdQ 
Recall the definition of own price elasticity of demand:

dQ.P QdP 1
ξd = - ⇒ - =−
dP.Q PdQ ξd

We can, therefore, write:

 1 
MR = P  1 - 
 ξd 

Thus: when Ed = 1, MR = 0
when Ed > 1, MR is positive
when Ed < 1, MR is negative

For a linear demand curve, therefore, the relation between price, quantity demanded,
total revenue, marginal revenue and price elasticity of demand.

Attempt the activity below to test your understanding of the concept.

Activity 4.7

Elasticity of Demand

Spend 15 minutes on this activity

The price elasticity of demand for good X is 2 and the marginal revenue of good X is
$4. What is the price of good X?

Unit 4: Introduction Mathematical Economics 4.20

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We can now find the impact of a change in the price of a good on the total amount
spent on that good. From the seller's perspective, we can get the impact of a change in
the price of the good in relation to the total revenue received from its sale.

To do this, we differentiate the TR function with respect to P:

TR = PQ

dTR dQ
= Q + P , we use the product rule to differentiate.
dP dP

PdQ Q
Multiply term by
dP Q

 PdQ 
= Q 1 + 
 QdP 

The right
hand side term in the parenthesis is somewhat familiar to us by now. Recall
the definition of price elasticity of demand:

dQ.P
ξd = -
dP.Q

From this, we can say:

PdQ
− = -ξ d
QdP
We can, therefore, write:

dTR
= Q (1 − ξ d )
dP
Note that the left-hand side term shows the impact of a change in price on the total
revenue.

Unit 4: Introduction Mathematical Economics 4.21

The interpretation of this derivation indicates that total revenue received from the sale
of a good, depends on two things:

1. quantity of the good sold, and

2. price elasticity of demand of that good.

4.5 Cost Curves using Calculus

Total cos t (TC ) = total variable cost (TVC ) + total fixed cost (TFC )

TC TVC + TFC TVC TFC

Average total cost (ATC) = = = +
Q Q Q Q
ATC = AVC + AFC

Example 4.8

TC = Q 3 − 40Q 2 + 430Q
Let us identify TVC,TFC and ATC from above equation.
TFC= Cost which is independent of quanitity produced (Q). This is zero
in above equation as all costs are dependent on Q.
TVC=cost that varies with quantity produced. Here, all cost is variable so TVC=TC,
as TFC=0.
Q 3 − 40Q 2 + 430Q
ATC=AVC = =Q 2 − 40Q + 430
Q
MC= Marginal cost, cost of producing one more unit of output is given by:
dTC
MC = = 3Q 2 − 80Q + 430
dQ

Have you understood the concept? Test your understanding by attempting the
activity on the next page.

Unit 4: Introduction Mathematical Economics 4.22

Activity 4.8

Cost and marginal cost

Spend 15 minutes on this activity.

Total Costs for a firm is given by, TC = 60q - 20q 2 + 2q 3

Determine its average costs and the marginal costs.

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Minimum Efficient Scale of a Firm

The minimum efficient scale of a firm is the output for which the firm’s average
costs are at a minimum. We can use techniques of differentiation to determine this
minimum efficient scale.

We use the total cost function given in example 8.

TC = Q 3 − 40Q 2 + 430Q

To determine the minimum efficient scale of a firm, we need the average cost
function.
TC Q3 − 40Q 2 + 430Q
ATC= = =Q 2 − 40Q + 430
Q Q

Costs
Minimum
Efficient ATC
Scale

Q* Output

Unit 4: Introduction Mathematical Economics 4.23

At minimum efficient scale, the slope is zero. Therefore:

dATC
At min ATC, = 0
dq
⇒ 2q - 40 = 0
⇒ q = 20. The minimum efficient scale of the firm is 20.

Activity 4.9

Minimum efficient scale

Spend 15 minutes on this activity.

For the total cost function given in activity 4.8, determine its minimum efficient
scale.
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4.6 Ceteris Paribus Assumption

and Partial derivatives
The ceteris paribus assumption is widely used in economic analysis. To estimate the
impact of one particular explanatory variable on the dependent variable, other
explanatory variables are held constant or not changing. The mathematics way of
this analysis is by using the method of partial derivatives.

Unit 4: Introduction Mathematical Economics 4.24

Example 4.9
Consider the following demand function:
Qdp = 2 − 3 p p + pb + 3 pc + 2 y (A)
Qdp = demand of pork p p = price of pork
pb = $1 / kg of beef pc = $3 / kg of chicken, y=income $3(000s)
Qdp = 2 − 3 p p + 1 + 3(3) + 2(3)
Qdp = 18 − 3 p p
Qsp = −6 + 9 p p
Equilibrium price, P=$2 and Quantity, Q=12
The elasticity of demand and elasticity of supply are determined from demand
equation (A) using the method of partial derivatives.
∂Qd P ∂Qs P
ξd = * ξs = *
∂Pp QD ∂Pp QS

Cross-elasticity(between pork and chicken) would evaluated as:

∂Q p Pc
ξ× = *
∂Pc Qp
Income elasticity (between income and quantity):
∂Qd I
ξy = *
∂I QD
There are other applications of partial derivatives in economics. We will deal with
some of them in the next section.

In the meantime test yourself to see if you have understood the concept we
discussed in this section. Attempt the activity on the next page.

Unit 4: Introduction Mathematical Economics 4.25

 Activity 4.10

Price elasticity

Spend 15 minutes on this activity

From example 9, complete the following:

a. Price elasticity of demand

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b. Cross price elasticity of demand for pork and chicken.

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c. Income elasticity of demand.

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Solutions to Selected Activities

Activity 4.1

a. The major determinants would be the price of houses, income level of

buyers, etc

QdH = f ( prices of houses, income of home buyers, etc )

or
QdH = a − b. houses + c. Income +......

b. Prices would be negatively related to demand for housing (-b). This implies
that as prices of home rise, demand for it would fall. Income would be
positively related to demand for houses as incomes rise demand for houses
increases (+c).

Unit 4: Introduction Mathematical Economics 4.26

Activity 4.3

Q d * = 18 − 3( P + 1) → p+1 as consum er have to pay price plus $1 tax.

Q d * = 15 − 3 p Q s = − 15 + 9 p
15 − ( − 6) 21
N ew Eq . : P * = = = $1.75
9 − ( − 3) 12
consum ers w ould pay Eq. price plus $1. i.e. $2.75 ($1.75+$1)
burden on consum ers = ∆ price = $2.75 - $2= $0.75.
Burden on producers= tax- ∆ price = $0.25.

Note that the incidence of a tax is same, irrespective of whether the tax is levied on
the demand side or the supplier side of the market.

Activity 4.5

a. P = 6 − 0 .0 4 Q

b. MR = 6 − 0.08Q

Activity 4.7

 1 
M R =
P  1 − 
 ξ d 
 1 
4 = P  1 − 
 2 
⇒ P = 1 6

Activity 4.9

ATC = 60 − 20q + 2q 2
dATC
= −20 + 4q = 0 at its minimum
dq
-20+4q=0 ⇒ q=5
min imum efficient scale for the firm is 5

Unit 4: Introduction Mathematical Economics 4.27

Glossary
Define the following terms:
Mathematical Analysis

Rate of change

Marginal analysis

Elasticity

Minimum efficient scale

Tax Burden

Differentiation

Partial derivatives

Ceteris paribus assumption

Calculus

Demand and Supply

Market demand and market supply

Summary
In this Unit, the demand and supply models have been discussed. Calculus is used to
explain elasticity which is related to total revenue and costs. The imposition of tax is
explained using elasticity and graphical explanation is also provided.

Unit 4: Introduction Mathematical Economics 4.28