The Mathematics of Optimization
Many economic theories begin with the
assumption that an economic agent is
seeking to find the optimal value of some
function
This chapter introduces the mathematics
common to these problems
THE MATHEMATICS OF
OPTIMIZATION
Maximization of a Function of
One Variable
Maximization of a Function of
One Variable
Simple example: Manager of a firm
wishes to maximize profits
The manager will likely try to vary q to see
where the maximum profit occurs
*
= f(q)
= f (q)
>0
q
*
= f(q)
2
1
q*
Quantity
3
q1
q2
q*
Quantity
4
Maximization of a Function of
One Variable
If output is increased beyond q*, profit will
decline
The derivative of = f(q) is the limit of
/q for very small changes in q
d df
f (q + h ) f (q1 )
=
= lim 1
dq dq h0
h
<0
q
*
= f(q)
Note that the value of this ratio depends
on the value of q1
q*
Quantity
q3
Value of a Derivative at a Point
The evaluation of the derivative at the
point q = q1 can be denoted
In our previous example,
d
=0
dq q = q *
First Order Condition for a
Maximum
df
=0
dq q = q *
d
<0
dq q =q
For a function of one variable to attain
its maximum value at some point, the
derivative at that point must be zero
d
dq q = q
d
>0
dq q =q
Derivatives
Second Order Conditions
Second Order Conditions
The first order condition (d/dq) is a
necessary condition for a maximum, but
it is not a sufficient condition
If the profit function was u-shaped,
the first order condition would result
in q* being chosen and would
be minimized
q*
This must mean that, in order for q* to
be the optimum,
d
d
> 0 for q < q * and
< 0 for q > q *
dq
dq
Therefore, at q*, d/dq must be
decreasing
Quantity
9
10
Second Derivatives
Second Order Condition
The derivative of a derivative is called a
second derivative
The second derivative can be denoted
by
The second order condition to represent
a (local) maximum is
d 2
d 2f
or
or f ' ' (q)
dq 2
dq 2
11
d 2
<0
dq 2 q = q *
12
Rules for Finding Derivatives
db
= 0.
dx
2. If a and b are constants and b 0,
dax b
then
= bax b 1.
dx
d ln x 1
3.
=
dx
x
x
da
4.
= a x ln a for any constant a.
dx
1. If b is a constant, then
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Rules for Finding Derivatives
5.
d[f (x) + g(x)]
= f ' (x) + g ' (x)
dx
6.
d[f (x) g(x)]
= f (x)g ' (x) + f ' (x)g(x)
dx
( f (x) %
d&
#
g
(
x
)
$ = f ' (x)g(x) f (x )g ' (x ) provided
7. '
dx
[g(x )]2
that g(x ) 0.
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Rules for Finding Derivatives
Example of Profit Maximization
8. If y = f (x ) and x = g(z) and if both f ' (x )
dy dy dx df dg
and g ' (z) exist, then
=
dz dx dz dx dz
Suppose that the relationship between
profit and output is
= 1,000q - 5q2
The first order condition for a maximum is
d/dq = 1,000 - 10q = 0
q* = 100
Since the second derivative is always -10,
q=100 is a global maximum.
This is called the chain rule. The chain rule
allows us to study how one variable (z) affects
another variable (y) through its influence on
some intermediate variable (x).
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16
Important Points to Note:
Important Points to Note:
Using mathematics provides a convenient,
short-hand way for economists to develop
their models
Derivatives are often used in economics
because economists are often interested in
how marginal changes in one variable
affect another
The mathematics of optimization is an
important tool for the development of
models that assume that economic agents
rationally pursue some goal
Most economic optimization problems
involve constraints on the choices that
agents can make
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Important Points to Note:
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Important Points to Note:
The Lagrangian multiplier is used to help
solve constrained maximization problems
The implicit function theorem illustrates the
dependence of the choices that result from
an optimization problem on the parameters
of that problem
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The envelope theorem examines how
optimal choices will change as the
problem s parameters change
First-order conditions are necessary but not
sufficient for ensuring a maximum or
minimum
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