Appendix 2A

Differential Calculus
Techniques in Management
• A function with one decision variable, X,
can be written as Y = f(X)
• The marginal value of Y, with a small
increase of X, is My = Y/X
• For a very small change in X, the derivative
is written:
dY/dX = limit Y/X
 X  B
©2008 Thomson * South-Western Slide 1
 Marginal = Slope = Derivative
• The slope of line C-D Y D
is Y/X Y
• The marginal at point X
C is My is Y/X
• The slope at point C is
the rise (Y) over the C
run (X)
• The derivative at point
C is also this slope
X
Slide 2
• Finding the maximum flying range for the Stealth
Bomber is an optimization problem.
• Calculus teaches that when the first derivative is zero,
the solution is at an optimum.
• The original Stealth Bomber study showed that a
controversial flying V-wing design optimized the
bomber's range, but the original researchers failed to find
that their solution in fact minimized the range.
• It is critical that managers make decision that maximize,
not minimize, profit potential!

Slide 3
 Quick Differentiation Review
Name Function Derivative Example
• Constant Y = c dY/dX = 0 Y=5
Functions dY/dX = 0

• A Line Y = c•X dY/dX = c Y = 5•X

dY/dX = 5

• Power Y = cXb dY/dX = b•c•X b-1 Y = 5•X2

Functions dY/dX = 10•X

Slide 4
 Quick Differentiation Review
• Sum of Y = G(X) + H(X) dY/dX = dG/dX + dH/dX
Functions
example Y = 5•X + 5•X2 dY/dX = 5 + 10•X

• Product of Y = G(X)•H(X)
Two Functions dY/dX = (dG/dX)H + (dH/dX)G
example Y = (5•X)(5•X2 )
dY/dX = 5(5•X2 ) + (10•X)(5•X) = 75•X2

Slide 5
 Quick Differentiation Review
• Quotient of Two Y = G(X) / H(X)
Functions
dY/dX = (dG/dX)•H - (dH/dX)•G
H2
Y = (5•X) / (5•X2) dY/dX = 5(5•X2) -(10•X)(5•X)
(5•X2)2
= -25X2 / 25•X4 = - X-2

• Chain Rule Y = G [ H(X) ]

dY/dX = (dG/dH)•(dH/dX) Y = (5 + 5•X)2
dY/dX = 2(5 + 5•X)1(5) = 50 + 50•X
Slide 6
 Applications of Calculus in
Managerial Economics
• maximization problem: A profit function
might look like an arch, rising to a peak and then declining at
even larger outputs. A firm might sell huge amounts at very
low prices, but discover that profits are low or negative.
• At the maximum, the slope of the profit function is zero. The
first order condition for a maximum is that the derivative at
that point is zero.
• If  = 50·Q - Q2, then d/dQ = 50 - 2·Q, using the rules of
differentiation.
• Hence, Q = 25 will maximize profits where 50 - 2•Q = 0.

Slide 7
 More Applications of Calculus
• minimization problem: Cost minimization
supposes that there is a least cost point to produce. An
average cost curve might have a U-shape. At the least
cost point, the slope of the cost function is zero.
• The first order condition for a minimum is that
the derivative at that point is zero.
• If C = 5·Q2 - 60·Q, then dC/dQ = 10·Q - 60.
• Hence, Q = 6 will minimize cost where 10•Q -
60 = 0.

Slide 8
 More Examples
• Competitive Firm: Maximize Profits
» where  = TR - TC = P•Q - TC(Q)
» Use our first order condition:
d/dQ = P - dTC/dQ = 0.
TC a function of Q
» Decision Rule: P = MC.
Problem 1 Problem 2
 Max = 100•Q - Q2  Max= 50 + 5•X2
100 -2•Q = 0 implies So, 10•X = 0 implies
Q = 50 and  = 2,500 Q = 0 and= 50

Slide 9
 Second Derivatives and the
Second Order Condition:
One Variable
• If the second derivative is negative, then it’s
a maximum
• If the second derivative is positive, then it’s
a minimum

Problem 1 Problem 2
Max= 50 + 5•X2
Max = 100•Q - Q 2

100 -2•Q = 0 10•X = 0

second derivative is: -2 second derivative is: 10
implies Q =50 is a MAX implies Q = 0 is a MIN
Slide 10
 Partial Differentiation
• Economic relationships usually involve several
independent variables.
• A partial derivative is like a controlled experiment
-- it holds the “other” variables constant
• Suppose price is increased, holding the disposable
income of the economy constant as in Q = f (P,
I ), then Q/P holds income constant.

Slide 11
 Problem 7 page 73:
• Sales are a function of advertising in
newspapers and magazines ( X, Y)
• Max S = 200X + 100Y -10X2 -20Y2 +20XY
• Differentiate with respect to X and Y and set equal
to zero.
S/X = 200 - 20X + 20Y= 0
S/Y = 100 - 40Y + 20X = 0
• solve for X & Y and Sales

Slide 12
 Solution: 2 equations & 2 unknowns
• 200 - 20X + 20Y= 0
• 100 - 40Y + 20X = 0
• Adding them, the -20X and +20X cancel, so
we get 300 - 20Y = 0, or Y =15
• Plug into one of them: 200 - 20X + 300 =
0, hence X = 25
• To find Sales, plug into equation: S=
200X + 100Y -10X2 -20Y2 +20XY = 3,250

Slide 13