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Chapter 11 - Optimization:
More Than One Choice Variable
Alpha Chiang, Fundamentals of
Mathematical Economics, 3rd Edition
Lecturer: Dr. Khong Tien Dung
School of Economics, Can Tho University
One variable case
z = f ( x)
dz = 0 necessary but not sufficient
dz = f '( x)dx for either maximum or minimum
Max: d 2 z 0
Min: d 2 z 0
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Function of 2 variables
z = f ( x, y )
dz = f x dx + f y dy
dz = 0 f x = f y = 0 for dx and dy not both zero
z z
fx , fy = first partials
x y
2 z z
f xx ( fx ) or
x x 2
x x
second order partials
2 z z
f yy ( f y ) or
x y 2 y y
z 2 z
f xy or
x y xy
z 2 z
f yx or
y x yx
Young's theorem: f xy = f yx
Examples:
1. z = x3 + 5 xy − y 2
f x = 3x 2 + 5 y
f y = 5x − 2 y
f xx = 6 x
f yy = −2
f xy = 5
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Examples:
2. z = x 2e− y
f x = 2 xe − y f xx = 2 xe − y
f xy = −2 xe − y
f y = −1x 2e− y f yy = x 2e − y
2nd Order Total Differential
dz = f x dx + f y dy
d 2 z = d (dz ) = (dz )dx + (dz )dy
x y
= ( f x dx + f y dy )dx + ( f x dx + f y dy )dy
x y
= ( f xx dx + f yx dy )dx + ( f xy dx + f yy dy )dy
= f xx dx 2 + f yx dydx + f xy dxdy + f yy dy 2
= f xx dx 2 + 2 f xy dxdy + f yy dy 2
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Examples:
3. z = x3 + 5 xy − y 2
Find dz, d 2 z
dz = f x dx + f y dy
( )
= 3x 2 + 5 y dx + ( 5 x − 2 y ) dy
d 2 z = 6 xdx 2 + 2(5)dxdy − 2dy 2
Second Order Condition:
z = f ( x, y )
d 2z 0 for maximum, arbitrary values of dx and dy
d 2z 0 for minimum
d 2z 0 iff f xx 0, f yy 0, f xx f yy f xy 2
f xx f xy
0
f yx f yy
d 2z 0 iff f xx 0, f yy 0, f xx f yy f xy 2
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Conditions for Relative Extremum
CONDITIONS FOR RELATIVE EXTREMUM
Maximum Minimum
FOC - first order
conditions fx = f y = 0 fx = f y = 0
SOC - 2nd order f xx 0, f yy 0 f xx 0, f yy 0
conditions
f xx f yy f xy 2 f xx f yy f xy 2
Objective Functions With
More Than Two Variables
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Objective Functions With
More Than Two Variables
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3 variables:
dz = f1dx1 + f 2 dx2 + f3dx3
(dz ) (dz ) (dz )
d 2z = dx1 + dx2 + dx3
x1 x2 x3
= ( f1dx1 + f 2 dx2 + f3dx3 )dx1
x1
+ ( f1dx1 + f 2 dx2 + f3dx3 )dx2
x2
+ ( f1dx1 + f 2 dx2 + f3dx3 )dx3
x3
d 2z = f11dx12 + f12 dx1dx2 + f13dx1dx3
+ f 21dx2 dx1 + f 22 dx2 2 + f 23dx2 dx3
+ f31dx3dx1 + f32 dx3dx2 + f33dx32
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3 variables:
dz = f1dx1 + f 2 dx2 + f3dx3
(dz ) (dz ) (dz )
d 2z = dx1 + dx2 + dx3
x1 x2 x3
= ( f1dx1 + f 2 dx2 + f3dx3 )dx1
x1
+ ( f1dx1 + f 2 dx2 + f3dx3 )dx2
x2
+ ( f1dx1 + f 2 dx2 + f3dx3 )dx3
x3
d 2z = f11dx12 + f12 dx1dx2 + f13dx1dx3
+ f 21dx2 dx1 + f 22 dx2 2 + f 23dx2 dx3
+ f31dx3dx1 + f32 dx3dx2 + f33dx32
This is a quadratic form
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3 variables:
Technique: regard dxi as variables that can take on any values, fij as coefficients
We have a symmetric Hessian Determinant
f11 f12 f13
H = f 21 f 22 f 23
f31 f32 f33
Successive principal minors
f11 f12
H1 = f11 , H2 = , H3 = H
f 21 f 22
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3 variables:
Rules:
maximum
H1 0, H 2 0, H 3 0 d z is negative definite
2
z is a if or 2
minimum H1 0, H 2 0, H 3 0
d z is positive definite
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3 variables:
Example: Find the extreme values of
z = 2 x12 + x1 x2 + 4 x2 2 + x1 x3 + x32 + 2
f1 = 4 x1 + x2 + x3 = 0
f2 = x1 + 8 x2 =0
f3 = x1 + 2 x3 = 0
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3 variables:
Solution:
− x1 −x
x2 = , x3 = 1
8 2
−x −x
4 x1 − 1 − 1 = 0
8 2
32 x1 − x1 − 4 x1 = 0
27 x1 = 0
x1 = 0, x2 = 0, x3 = 0, z =2
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3 variables:
Solution: cont’d
f11 f12 f13 4 1 1
H = f 21 f 22 f 23 = 1 8 0
f31 f32 f33 1 0 2
H1 = f11 = 4
f11 f12 4 1
H2 = = = 31
f 21 f 22 1 8
H 3 = H = 4(16 − 0) − 1(2 − 0) + 1(0 − 8) = 64 − 2 − 8 = 54
H1 0, H 2 0, H 3 0 positive definite, z*=2 is a minimum
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n-variable case:
z = f ( x1 , x2 , , xn )
dz = f1dx1 + f 2 dx2 + + f n dxn
f11 f12 f1n
f 21 f 22 f2n
H =
f n1 fn2 f nn
Principal minors: H1 , H 2 , , Hn
F.O.C.: f1 = f 2 = = fn = 0
S.O.C.: n principal minors must be positive (minimum)
n principal minors must alternate in sign (maximum)
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Economic Applications
⚫ Multiproduct firm:
⚫ Assume a two-product firm under pure competition.
⚫ Prices are exogenous P10 and P20
⚫ Firm’s Revenue function:
R1 = P10Q1+ P20Q2
where Qi is output level of the ith product per unit time.
⚫ Firm’s cost function:
C = 2Q12 + Q1Q2 +2 Q22
⚫ Note: ∂C/∂Q1 = 4Q1+Q2 and ∂C/∂Q2 = Q1+2Q2. . The
marginal costs of one product also depends on the output
of the other product.
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Economic Applications
⚫ Multiproduct firm:
Revenue: R1 = P10Q1 + P20Q2
Cost: C = 2Q12 + Q1Q2 + 2Q22
Profit: = TR − TC = P10Q1 + P20Q2 − 2Q12 − Q1Q2 − 2Q22
Problem: find the levels of Q1 and Q2 which in combination,
will maximize .
Take first partials and equate to zero:
1 = P10 − 4Q1 − Q2 = 0
Q1
2 = P20 − Q1 − 4Q2 = 0
Q2
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Economic Applications
⚫ Multiproduct firm:
2 simultaneous equations:
4Q1 + Q2 = P10
Q1 + 4Q2 = P20
Solution:
4 P10 − P20 4 P20 − P10
Q1* = and Q2 * =
15 15
Second order condition:
11 12 −4 −1
H = =
21 22 −1 −4
H1 = −4 0 and H 2 = 15 0
Conclusion: the Hessian matrix or d 2 z is negative definite,
and the solution does maximize profit.
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Economic Applications
⚫ Multiproduct firm: - monopolist
Demands facing the monopolist:
Q1 = 40 − 2 P1 + P2
Q2 = 15 + P1 − P2
Prices are related to output levels.
Why are they substitute goods? P1 , Q2 , P2 , Q1
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Economic Applications
⚫ Multiproduct firm: - monopolist
Express prices in terms of sales volumes:
−2 P1 + P2 = Q1 − 40
P1 − P2 = Q2 − 15
Solving P1 and P2 by Cramer's rule or by substitution,
P1 = 55 − Q1 − Q2
P2 = 70 − Q1 − 2Q2
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Economic Applications
⚫ Multiproduct firm: - monopolist
Since P1 AR1 and P2 AR2 ,
Total Revenue:
R = PQ
1 1 + P2Q2
= (55 − Q1 − Q2 )Q1 + (70 − Q1 − 2Q2 )Q2
= 55Q1 + 70Q2 − 2Q1Q2 − Q12 − 2Q22
Total Cost:
C = Q12 + Q1Q2 + Q22
Profit Function:
= R − C = (55Q1 + 70Q2 − 2Q1Q2 − Q12 − 2Q22 ) − (Q12 + Q1Q2 + Q22 )
= 55Q1 + 70Q2 − 3Q1Q2 − 2Q12 − 3Q22
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Economic Applications
⚫ Multiproduct firm: - monopolist
Objective Function:
= 55Q1 + 70Q2 − 3Q1Q2 − 2Q12 − 3Q22
First partial derivatives, equated to zero (FOC)
1 = 55 − 3Q2 − 4Q1 = 0 4Q1 + 3Q2 = 55
→
2 = 70 − 3Q1 − 6Q2 = 0 3Q1 + 6Q2 = 70
Solution:
Q1* = 8, Q2 * = 7 23 → P1* = 39 13 , P2 * = 46 32 , * = 488 13
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Economic Applications
⚫ Multiproduct firm: - monopolist
SOC:
Second partial derivatives: 11 = −4, 12 = 21 = −3, 22 = −6
−4 −3
H = , H1 = −4 0, H 2 = 15 0,
−3 −6
Therefore * is a maximum
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Economic Applications
⚫ Price Discriminating Monopolist – 3 markets
Total Revenue:
R = R1 (Q1 ) + R2 (Q2 ) + R3 (Q3 )
Total Cost:
C = C (Q) where Q = Q1 + Q2 + Q3
Profit Function:
= R1 (Q1 ) + R2 (Q2 ) + R3 (Q3 ) − C (Q)
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Economic Applications
⚫ Price Discriminating Monopolist – 3 markets
= R1 (Q1 ) + R2 (Q2 ) + R3 (Q3 ) − C (Q)
Q
1 = R1' (Q1 ) − C '(Q) = R1' (Q1 ) − C '(Q) = 0
Q1
Q
2 = R2' (Q2 ) − C '(Q) = R2' (Q2 ) − C '(Q) = 0
Q2
Q
3 = R3' (Q3 ) − C '(Q) = R3' (Q3 ) − C '(Q) = 0
Q3
C '(Q) = R1' (Q1 ) = R2' (Q2 ) = R3' (Q3 )
or MC = MR1 = MR 2 = MR 3
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Economic Applications
⚫ Price Discriminating Monopolist – 3 markets
MC = MR1 = MR 2 = MR 3
The levels of Q1, Q2,Q3 should be chosen such that the marginal
revenue in each market is equal to the marginal cost of total
output Q.
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Economic Applications
⚫ Relationship of MR and P (digression)
R = P Q
dR dQ dP Q dP
MR = =P +Q = P 1 +
dQ dQ dQ P dQ
1 1
= P 1 + = P 1 −
1
MRi = Pi 1 −
i
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Economic Applications
⚫ Relationship of MR and P (digression)
MR1 = MR 2 = MR 3 can be written as
1 1 1
P1 1 − = P2 1 − = P3 1 −
1 2 3
Implication:
The smaller the value of in a particular market,
the higher the price charged in that market.
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Economic Applications
⚫ Price Discriminating Monopolist – 3 markets
Second order condition:
Q
11 = R1 "(Q1 ) − C " (Q) = R1 "(Q1 ) − C "(Q)
Q1
Q
22 = R2 "(Q2 ) − C " (Q) = R2 "(Q2 ) − C "(Q )
Q2
Q
33 = R3 "(Q2 ) − C " (Q) = R3 "(Q3 ) − C "(Q )
Q3
Q
and 12 = 21 = 13 = 31 = 23 = 32 = −C "(Q) since = 1
Qi
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Economic Applications
⚫ Price Discriminating Monopolist – 3 markets
Second order condition:
R1 "− C " −C " −C "
H = −C " R3 "− C " −C "
−C " −C " R3 "− C "
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