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Basic Mathematics I_B

Masakazu Someya

[Link] Sydsater & PeterJ. Mammonod Mathematics for Economic Analysis, Prentice Hall
2. Angel de la Fuente, Mathematical Methods and Models for Economist, Cambridge
3. Alpha [Link] Fundamental Method of Mathematical Economics McGraw-Hill
4. Simon Blume Mathematics for Economist, Norton
5. Phoebus J. Dhrymes, Mathematics for Econometrics, Springer
6. Bernd Luderer and others, Mathematical Formulas for Economists, Springer.
7. Murray R. Spiegel and others, Mathematical Handbook of Formulas and Tables,
McGraw-Hill

Derivative
Differentiation is to show how
much Y changes with respect
to a small change in X. Y

𝑌=𝑓 𝑥

y2
Differentiating Y with respect y1
to x is expressed in

𝑑𝑦 𝑦2 − 𝑦1 ∆𝑦
=𝑓 = ≅
𝑑𝑥 𝑥2 − 𝑥1 ∆𝑥
Differentiating Y=2x with
respect to x is derived as
𝑑𝑦
=𝑓 =2
𝑑𝑥 0 x1 x2 X

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Differentiation
Y

拡大図
y2

y2
y1
∆𝑦

y1

X1 X2
∆𝑥

0 x1 x2 X

• y=1+2x
• When this is
evaluated at x=10,
y=f(10)=1+2*10=
21.
• When this is
evaluated at x=11,
y=f(11)=1+2*11=
23.

∆
• = = =2
∆

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Differentiation
y= f(x) is a function such as f(x)=1+2x.

y=f(x)=1+2x
y=f(10)=1+2*10=21
y=f(11)=1+2*11=23
∆𝑦 23 − 20 2
= = =2
∆𝑥 11 − 10 1
When this is evaluated at x=10, y=f(10)=1+2*10=21. When this is evaluated
at x=10, y=f(11)=1+2*11=23.

When this is evaluated at x=a, y=f(a)=1+2a

𝑓 𝑎 + ∆𝑥 − 𝑓 𝑎 23 − 21
lim =𝑓 𝑎 =2=
∆ → ∆𝑥 1

Second Derivative
𝑓 𝑥 > 0 for up to 50,000: f is increasing.

𝑓 𝑥 >0 for up to 28,000: f is increasing

at an increasing growth rates.

Inflection point at around 28,000.

𝑓 𝑥 <0 for after 28,000: f is increasing

at an decreasing growth rates.

𝑓 𝑥 < 0 after 50,000 : f is decreasing.

What will happen after 50,000?

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Find the first derivative of y with respect to x, i.e., ( )in the

equations below. All the Greek letter such as ‘α’, ’β’, ‘𝛾 ‘, ‘t’ and
‘m’are constant. ‘y, x, z, L and K are all variables
1. y=5x
2. y=6x+3z
3. y=αx
4. y=αx+βz
5. y=αx+βx
6. 𝑦 = 𝑥
7. 𝑦 = 𝑥 + 4
8. 𝑦 = 𝑥 𝑧
9. 𝑦 = 𝑥
10. 𝑦 = 𝑥 𝑧

Differentiation of Natural Exponential Function

( )
1.f 𝑥 = 𝑒 , =𝑒 𝑔 (𝑥)
( )
2. f 𝑥 = 𝑎 , = 𝑎 ln (a)
( )
3. f 𝑥 = 𝑎 , =𝑎 𝑔 (𝑥) ln (a)
( )
4. f 𝑥 = 𝑒 , =𝑒
( ) ( ) ( )
5. f 𝑥 = ln 𝑔(𝑥), = = 𝑔 (𝑥)
( ) ( )
( )
6. f 𝑥 = log 𝑔(𝑥), = 𝑔 (𝑥) log 𝑒 = 𝑔 (𝑥)
( ) ( )
7. = 𝑐𝑜𝑠𝑥
8. = −𝑠𝑖𝑛𝑥
9. = = 1 + 𝑡𝑎𝑛 𝑥

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Examples
1. y=5+3x 𝑓 𝑥 =3
2. 𝑦 = 𝑓 𝑥 = 𝑥 𝑓 𝑥 = 3𝑥

3. 𝑦 = 𝑓 𝑥 𝑔 𝑥 = 5𝑥 4 + 3𝑥 = 𝑓 𝑥 𝑔 𝑥 + 𝑓 𝑥 𝑔 𝑥 = 15𝑥 4 + 3𝑥 + 5𝑥 (3)

( ) ( ) ∗ ∗
4. y = = 𝑦 = =
( ) ( )

5. y = 𝑓 𝑔 𝑥 = (1 + 4𝑥)
( ) ( )
𝑦 = = 3𝑔 𝑥 = 3𝑔 𝑥 4 = 3(1 + 4𝑥) 4
( )
( )
Where g(x)=1+4x, =4

( )
6. 𝑦 = 𝑓 𝑔 𝑥 = 𝑙𝑛 𝑥 + 1 where 𝑔 𝑥 = 𝑥 + 1 and = 3𝑥
𝑑𝑓 𝑑𝑔(𝑥) 1 3𝑥
𝑦 = = 3𝑥 =
𝑑𝑔(𝑥) 𝑑𝑥 𝑥 +1 𝑥 +1

Find the first derivative of y with respect to x, i.e., ( ) in the equations below.

1. 𝑦 = 4𝑥 − 3 2𝑥
2. 𝑦 = 2𝑥 + 5 3𝑥 − 8
3. 𝑦 = 3 − 12𝑥 5 + 4𝑥
4. 𝑦=
5. 𝑦=
6. 𝑦=
7. 𝑦 = 6𝑥 + 9
8. 𝑦=
9. 𝑦 = 34 − 6𝑥
10. 𝑦 =

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Example
• Differentiate both equations with respect to K, i.e., ( ) and L, i.e.,
( ) where Y=GDP, L=Labor, K=Capital Stock, A=Productivity, alpha
and beta are parameters.

Y = A𝐾 𝐿 Cobb-Douglas

Y = A 𝛼𝐾 + 1−𝛼 𝐿 Constant Elasticity of Substitution (CES)

=Marginal Product of Capital

= Marginal Product of Labor

Question 2
• Question: Real GDP grew from 100 in Q4 2022 to 102 in Q1,2023.
Find the average growth rates for Q1, 2023 and annualize it.

• Question: CPI (consumer price indicator) grew from 120 in December

2021 to 128 in October, 2022. What is the annualized rate of inflation?

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Interest Compounding
A principal P compounded annually at interest rate, i, is expressed as:
S=P 1+𝑖
A principal P compounded annually at interest rate, i, paid at m times per
year is expressed as:
𝑖
S=P 1+
𝑚

Suppose = and so m=n*i

𝑖 1 1
S=P 1+ =P 1+ =𝑃 1+
𝑚 𝑛 𝑛
We know 𝑒 = lim 1 +
→

• 𝑃 × lim 1+ = 𝑃𝑒 = 𝑆 (Continuous compounding)

→

Elasticity 2-1
∆𝐷
𝐷 𝑃 ∆𝐷 𝑃 ∆𝐷
𝑒 , = = =
∆𝑃 ∆𝑃 𝐷 𝐷 ∆𝑃
𝑃

Y = A𝑘

∆𝑌
𝑌 𝑘 ∆𝑌 𝑘 𝑑𝑌
𝑒 , = = =
∆𝑘 𝑌 ∆𝑘 𝑌 𝑑𝑘
𝑘
𝑑𝑌 𝛼𝐴𝑘 𝛼𝑌
= 𝛼𝐴𝑘 = =
𝑑𝑘 𝑘 𝑘
𝑘 𝑑𝑌 𝑘 𝛼𝑌
𝑒 , = = =𝛼
𝑌 𝑑𝑘 𝑌 𝑘
Alpha is an elasticity and indicates how much Y (GDP) will increase when
one unit of k (capital per labor) increases.

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Elasticity 2-2
∆𝑇
𝑇 𝑌 ∆𝑇 𝑌 ∆𝑇
𝑒 , = = =
∆𝑌 ∆𝑌 𝑇 𝑇 ∆𝑌
𝑌
where T=tax and Y=GDP.
What does this elasticity imply?
∆𝑌
𝑌 𝑌 ∆𝑇𝑅 𝑌 ∆𝑇𝑅
𝑒 , = = =
∆𝑇𝑅 ∆𝑌 𝑇𝑅 𝑇𝑅 ∆𝑌
𝑇𝑅
where TR=tax rate.
What does this elasticity imply? Is the sign of the elasticity positive or
negative? If negative, what is the policy implication to fiscal policy?

Growth Accounting and Total Factor Productivity (TFP)

Y = A𝐾 𝐿
• Converting into natural log and differentiate with respect to time t
lnY = lnA + α ln 𝐾 + 1 − 𝛼 ln 𝐿

• Take a derivative w.r.t time (t) Can we differentiate w.r.t time?

𝜕lnY 𝜕𝑌 𝜕lnA 𝜕𝐴 𝜕lnK 𝜕𝐾 𝜕lnL 𝜕𝐿

= +α + 1−𝛼
𝜕𝑌 𝜕𝑡 𝜕𝐴 𝜕𝑡 𝜕𝐾 𝜕𝑡 𝜕𝐿 𝜕𝑡
1 1 1 1
̇𝑌 = 𝐴̇ + α 𝐾̇ + 1 − 𝛼 𝐿̇
𝑌 𝐴 𝐾 𝐿

𝑌̇ 𝐴̇ 𝐾̇ 𝐿̇
= +α + 1−𝛼
𝑌 𝐴 𝐾 𝐿
• 𝛼 = 𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝐾 𝑡𝑜 𝑌 and Share of Capital in GDP.
%∆Y = %∆A + α%∆K + (1 − α)%∆L
%∆A = %∆Y − α%∆K − (1 − α)%∆L

• Note that it is crucial to explain why “A” goes up or goes down.

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Question 1
Find the first derivative of y with respect to x, i.e., ( )in the equations below. All
the Greek letter such as ‘α’, ’β’, ‘𝛾 ‘, ‘t’ and ‘m’are constant. ‘y, x, z, L and K are
all variables.

1. y=
2. y=
3. 𝑌=𝐿 𝐾 , find
4. 𝑌=𝐿 𝐾 , find

5. Find =, from above two questions without using exponential forms such as 𝐿 , i.e., no power expression. The answer
?
should be .
? ?
6. Y = A𝑒
7. Y = A𝑒
8. Y = ln𝑥
9. Y = ln𝑥
10. Y = ln𝐿 , find .

11. Y = S 1+ , find .

12. Y = A 𝛼𝐾 + 1−𝛼 𝐿 , find

MaClaurin Series
MaClaurin series is an expansion evaluated at x=0 while Taylor series is an
expansion around the point of x = 𝑥 .
f 𝑥 =𝑎 +𝑎 𝑥+𝑎 𝑥 +𝑎 𝑥 +𝑎 𝑥 +𝑎 𝑥 +𝑎 𝑥 𝑎 𝑥 = 𝑎𝑥

Take a derivative.
𝑓 𝑥 = 𝑎 + 2𝑎 𝑥 + 3𝑎 𝑥 + 4𝑎 𝑥 + 5𝑎 𝑥 + 6𝑎 𝑥 𝑛𝑎 𝑥 = 𝑖𝑎 𝑥

𝑓 𝑥 = 2𝑎 + 3 2 𝑎 𝑥 + 4 3 𝑎 𝑥 + 5 4 𝑎 𝑥 + 6 5 𝑎 𝑥 𝑛 𝑛−1 𝑎 𝑥
= 𝑖 𝑖−1 𝑎 𝑥

𝑓 𝑥 =3 2 𝑎 +4 3 2 𝑎 𝑥 +5 4 3 𝑎 𝑥 +6 5 4 𝑎 𝑥 𝑛 𝑛−1 𝑛−2 𝑎 𝑥
= 𝑖 𝑖−1 𝑖−2 𝑎 𝑥

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• f 𝑥 =𝑎 +𝑎 𝑥+𝑎 𝑥 +𝑎 𝑥 +𝑎 𝑥 +𝑎 𝑥 +𝑎 𝑥 𝑎 𝑥 =∑ 𝑎𝑥

• 𝑓 𝑥 = 𝑎 + 2𝑎 𝑥 + 3𝑎 𝑥 + 4𝑎 𝑥 + 5𝑎 𝑥 + 6𝑎 𝑥 𝑛𝑎 𝑥 =∑ 𝑖𝑎 𝑥

• 𝑓 𝑥 = 2𝑎 + 3 2 𝑎 𝑥 + 4 3 𝑎 𝑥 + 5 4 𝑎 𝑥 + 6 5 𝑎 𝑥 𝑛 𝑛−1 𝑎 𝑥 =∑ 𝑖(𝑖 −
1)𝑎 𝑥

• 𝑓 𝑥 = 3 2 𝑎 +4 3 2 𝑎 𝑥 +5 4 3 𝑎 𝑥 +6 5 4 𝑎 𝑥 𝑛 𝑛 − 1 (𝑛 −
2)𝑎 𝑥 =∑ 𝑖 𝑖−1 𝑖−2 𝑎 𝑥

• 𝑓 𝑥 = 𝑛 𝑛 − 1 𝑛 − 2 𝑛 − 3 𝑛 − 4 ⋯3 2 1 = ∏ 𝑎 = n! 𝑎

Let us evaluate all derivatives above at x=0.

• From the right,
•𝑓 0 = 𝑎
•𝑎 =
!
•𝑓 0 = 𝑎 • 𝑎 =
!

•𝑓 0 = 2! 𝑎 •𝑎 =
!

•𝑎 =
• 𝑓 0 = 3 2 𝑎 = 6𝑎 = 3! 𝑎 !

•𝑎 =
!
• 𝑓 0 = 24𝑎 = 4! 𝑎

•𝑓 0 =∏ 𝑎 = n! 𝑎 •𝑎 =
!

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Substituting these above into original equation, i.e.,

• f 𝑥 =𝑎 +𝑎 𝑥+𝑎 𝑥 +𝑎 𝑥 +𝑎 𝑥 +𝑎 𝑥 +𝑎 𝑥 𝑎 𝑥 =∑ 𝑎𝑥

• We have a new polynomial function as below:

•f 𝑥 = + 𝑥+ 𝑥 + 𝑥 + 𝑥 + 𝑥 + 𝑥
! ! ! ! ! ! !
+ 𝑥 =∑ 𝑥
! !

Example 1
• f 𝑥 = 2 + 4𝑥 + 3𝑥 , f(0) =2
• 𝑓 𝑥 = 4 + 6𝑥, 𝑓 0 =4
• 𝑓 𝑥 = 6, 𝑓 0 =6

f 0 𝑓 0 𝑓 0 4 6
f 𝑥 = + 𝑥+ 𝑥 = 2 + 𝑥 + 𝑥 = 2 + 4𝑥 + 3𝑥
0! 1! 2! 1! 2!

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Taylor Series
Take a Maclaurin expansion for 𝑔 δ , evaluated at δ =a,

𝑓 a 𝑔 𝑎 𝑔 𝑎 𝑔 𝑎
𝑔 x ≈ = x−𝑎 + x−𝑎 + x−𝑎 +⋯
𝑛! 0! 1! 2!

Suppose 𝑔 x = and a=1, N=2

−1
𝑔 𝑥 =
𝑥
2
𝑔 𝑥 =
𝑥
𝑔 𝑎 𝑔 𝑎 𝑔 𝑎
𝑔 x ≈ x−𝑎 + x−𝑎 + x−𝑎
0! −1 1! 2 2!
1
= 1 x−1 + 1 x−1 +1 x−1 =1+ x−1 + x−1
0! 1! 2!

Taylor Series
Take a Maclaurin expansion for 𝑔 δ , evaluated at δ =a, 𝑔 x ≈ ∑ = + x−𝑎 + (x −
! ! ! !
𝑎) + ⋯

Suppose 𝑔 x, y = 𝑥𝑦 and x=a and y=b,N=2

𝑔 x, y = 𝑦
𝑔 x, y = 2𝑥𝑦
𝑔 x, y = 0
𝑔 x, y = 2𝑥
𝑔 x, y = 2𝑦

, , , , ,
𝑔 x, 𝑦 ≈ + x−𝑎 + x−𝑏 + x−𝑎 + x − 𝑎 (y −
! ! ! ! !
, ,
𝑏) + y−𝑏 x−𝑎 + y−𝑏 = + x−𝑎 + 𝑦−𝑏 +
! ! ! ! !
x−𝑎 + 2 x−𝑎 y−𝑏 + y − 𝑏 =a𝑏 + 𝑏 x − 𝑎 + 2𝑎𝑏 𝑦 − 𝑏 + 0 +
! ! !
2𝑏 x − 𝑎 y − 𝑏 + 𝑎 y − 𝑏

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Taylor Series
Take a Maclaurin expansion for 𝑔 δ , evaluated at δ =a,

𝑓 a 𝑔 𝑎 𝑔 𝑎 𝑔 𝑎
𝑔 δ ≈ = δ−𝑎 + δ−𝑎 + δ−𝑎 +⋯
𝑛! 0! 1! 2!

Suppose x=x0+δwhere x0 is a fixed number, δis a deviation from x0 and is a

variable.
Based on the above equation,
f 𝑥 = 2 + 4𝑥 + 3𝑥 = 2 + 4 𝑥 + 𝛿 + 3 𝑥 + 𝛿 = 𝑔 𝛿
Once x is substituted by x0+δ, 2 + 4 𝑥 + 𝛿 + 3 𝑥 + 𝛿 is not a function of x but
a function of δ. Remember 𝑥 is a fixed number.
2+4 𝑥 +𝛿 +3 𝑥 +𝛿 =𝑔 𝛿
𝑔 δ = 4+6 𝑥 +𝛿
𝑔 δ =6

• Remember x=x0 at δ = 0 in Maclaurin expansion, which means

𝑔 δ =𝑓 𝑥 .

f 𝑥 = 2 + 4𝑥 + 3𝑥 and f 𝑥 = 𝟐 + 𝟒𝒙𝟎 + 𝟑𝒙𝟎 𝟐

𝑔 𝛿 = 2 + 4 𝑥 + 𝛿 + 3 𝑥 + 𝛿 and
𝑔 0 = 2 + 4 𝑥 + 0 + 3 𝑥 + 0 = 𝟐 + 𝟒𝒙𝟎 + 𝟑𝒙𝟎 𝟐 = 𝒇(𝒙𝟎 )
𝑔 δ = 4 + 6 𝑥 + 𝛿 = 4 + 6𝑥 = 𝑓 𝑥
𝑔 δ =6=𝑓 𝑥

• Since 𝑔 δ = 𝑓 𝑥 , 𝑔 δ = 𝑓 𝑥 and 𝑔 δ = 𝑓 𝑥
• Therefore, substitute all the above into Maclaurin expansion which is
evaluated at δ = 0,

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𝑔 0 𝑔 0 𝑔 0 𝑓 𝑥 𝑓 𝑥 𝑓 𝑥
𝑔 δ = + δ+ δ = + δ+ δ
0! 1! 2! 0! 1! 2!
𝑓 𝑥 𝑓 𝑥 𝑓 𝑥
= + 𝑥−𝑥 + 𝑥−𝑥
0! 1! 2!

Since 𝑔 δ = 𝑓 𝑥 , the equation above is re-expressed as below

because now 𝑓 𝑥 is a function of x (x0 is a fixed number not a
variable) while 𝑔 δ is a function of δ:
Taylor Expansion at 𝑥

𝑓 𝑥 𝑓 𝑥 𝑓 𝑥
𝑓 𝑥 = + 𝑥−𝑥 + 𝑥−𝑥 =𝑓 𝑥
0! 1! 2!

This gives an approximation of f(x) evaluated around x0.

Example
From f 𝑥 = 2 + 4𝑥 + 3𝑥

𝑓 𝑥 = 2 + 4𝑥 + 3𝑥
𝑓 𝑥 = 4 + 6𝑥
𝑓 𝑥 =6

Therefore,
𝑓 𝑥 𝑓 𝑥 𝑓 𝑥
𝑓 𝑥 ≈ + 𝑥−𝑥 + 𝑥−𝑥
0! 1! 2!
2 + 4𝑥 + 3𝑥 4 + 6𝑥 6
= + 𝑥−𝑥 + 𝑥−𝑥
0! 1! 2!
= 2 + 4𝑥 + 3𝑥 + 4𝑥 − 4𝑥 + 6𝑥 𝑥 − 6𝑥 + 3𝑥 − 6𝑥 𝑥 + 3𝑥 = 2 + 4𝑥 + 3𝑥

This shows that Taylor expansion below gives a correct original function!
One of the beauties of the Taylor expansion is to give alternative way to evaluate in case that n-th
degree polynomial f(x) cannot be solved or evaluated.
𝑓 𝑥 𝑓 𝑥 𝑓 𝑥 𝑓 𝑥 𝑓 𝑥
𝑓 𝑥 = + 𝑥−𝑥 + 𝑥−𝑥 𝑥−𝑥 = 𝑥−𝑥
0! 1! 2! 𝑛! 𝑛!

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Log-linearlization

Maximization
A function is maximized when the y=100-(-10+x)^2
slope or the first derivative is zero. 120

• 𝑓 𝑥 = −2 −10 + 𝑥 = 0
100

80

• X=10 60
y

40

20

When you find the relation or 0

equation which guarantees the first 1 2 3 4 5 6 7 8 9 10 11

X
12 13 14 15 16 17 18 19 20

derivative is equal to zero, that is

the condition for maximization.

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Derive First Order Condition and find the value

1. max 𝑓 𝑥 = − 𝑥 + 4𝑥
2. max 𝑓 𝑥 = 𝑙𝑜𝑔𝑥 − 3𝑥
3. min 𝑓 𝑥 = 10𝑥 − 𝑥
4. argmin 𝑓 𝑥 = 𝑥 − 𝑎 − 𝑥−𝑏

Constrained Optimization
• argmax 𝑓(𝑥, 𝑦) == 4𝑥 − 2𝑥𝑦 + 6𝑦 𝑠𝑢𝑗𝑒𝑐𝑡 𝑡𝑜 𝑥 + 𝑦 = 72
,
Substituting y=72-x
• 𝑓(𝑥, 𝑦) = = 4𝑥 − 2𝑥 72 − 𝑥 + 6 72 − 𝑥 =?

• = 24𝑥−? = 0,

Use of Lagrangian Multiplier

• 𝑓(𝑥, 𝑦) = = 4𝑥 − 2𝑥𝑦 + 6𝑦 + 𝜆 72 − 𝑥 − 𝑦
• 𝑓(𝑥, 𝑦) = = 4𝑥 − 2𝑥𝑦 + 6𝑦 + 𝜆 𝑥 + 𝑦 − 72
• 𝑓 𝑥, 𝑦 = = 4𝑥 − 2𝑥𝑦 + 6𝑦 − 𝜆 72 − 𝑥 − 𝑦
• 𝑓(𝑥, 𝑦) = = 4𝑥 − 2𝑥𝑦 + 6𝑦 + 𝜆 𝑥 + 𝑦 − 72

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Constrained Optimization Exercises

1. argmax 𝑓 𝑥, 𝑦 = 26𝑥 − 3𝑥 + 5𝑥𝑦 − 6𝑦 + 12𝑦, 𝑠𝑢𝑗𝑒𝑐𝑡 𝑡𝑜 3𝑥 + 𝑦 = 170
,
2. argmax 𝑓 𝑥, 𝑦, 𝑧 = 4𝑥𝑦𝑧 , 𝑠𝑢𝑗𝑒𝑐𝑡 𝑡𝑜 𝑥 + 𝑦 + 𝑧 = 56
, ,
3. argmax 𝑓 𝑥, 𝑦, 𝑧 = 5𝑥𝑦 + 8𝑥𝑧 + 3𝑦𝑧 𝑠𝑢𝑗𝑒𝑐𝑡 𝑡𝑜 2𝑥𝑦𝑧 = 1920
, ,
. .
4. argmax 𝑓 𝐾, 𝐿 = 𝐾 𝐿 𝑠𝑢𝑗𝑒𝑐𝑡 𝑡𝑜 6𝐾 + 2𝐿 = 384
,
5. argmax 𝑓 𝐾, 𝐿 = 𝐴𝐾 𝐿 𝑠𝑢𝑗𝑒𝑐𝑡 𝑡𝑜 𝑌 = 𝑟𝐾 + 𝑤𝐿
,

Cobb-Douglas Production Function

Firms maximize the profit, which is production 𝑌 = 𝐴𝐾 𝐿 minus
cost r*K+w*L where Y=GDP or production, K=capital, L=Labor,
A=productivity, r=real interest rates, w=real wage and alpha is a share
parameter.

𝜋 = 𝐴𝐾 𝐿 − 𝑟𝐾 − 𝑤𝐿
• FOC where the first derivative is equal to zero, the profit is maximized.
• = 𝛼𝐴𝐾 𝐿 − 𝑟 = 0 or MPK=r
• = 1 − 𝛼 𝐴𝐾 𝐿 − 𝑤 = 0 or MPL=w

• Marginal Production of Capital: = 𝛼𝐴𝐾 𝐿 =𝛼 = 𝑀𝑃𝐾

• Marginal Production of Labor: = 1 − 𝛼 𝐴𝐾 𝐿 = (1 − 𝛼) = 𝑀𝑃𝐿

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Cobb-Douglas Production Function

𝑌
𝑀𝑃𝐾 𝛼𝐾 𝛼 𝐿 𝑟
= = =
𝑀𝑃𝐿 (1 − 𝛼) 𝑌 1 − 𝛼 𝐾 𝑤
𝐿
• From =
𝛼 𝑤 𝐾
=
1−𝛼 𝑟 𝐿
• From 𝛼 = r, demand function for capital can be derived as below:
𝑌
𝛼 =𝐾
𝑟
• Alpha is a share parameter for capital.
𝑟𝐾
𝛼=
𝑌
• From (1 − 𝛼) = w, demand function for labor can be derived as below:
𝑌
1−𝛼 =𝐿
𝑤
• (1-alpha) is a share parameter for labor.
𝑤𝐿
1−𝛼 =
𝑌

Elasticity 3 Constant Elasticity of Substitution

𝐾
𝑑 𝐿
𝐾 𝐾 𝑤
𝐿 𝑑
𝐿 𝑟
σ= = 𝑤
𝑤 𝑑 𝐾
𝑑 𝑟
𝑟 𝐿
𝑤
𝑟
From = , = and also = .
Therefore,
𝐾 𝑤
𝑑 𝐿 𝛼 1−𝛼
σ= 𝑟
𝑤 𝐾 =1−𝛼 𝛼
=1
𝑑
𝑟 𝐿
Elasticity of substitution, or deep parameter, is unity and does not vary,
which is crucial in model building and forecasting.

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Constant Elasticity of Substitution (CES)

Y = A 𝛼𝐾 + 1−𝛼 𝐿
• MPL = = 1−𝛼 𝐿

• MPK = = 𝛼𝐾 We know
MPL 𝑤
=
MPK 𝑟
• From the above,
MPL 1−𝛼 𝐿 1−𝛼 𝐾 𝑤
= = =
MPK 𝛼 𝐾 𝛼 𝐿 𝑟

• From = ,
𝐾 𝛼 𝑤
=
𝐿 1−𝛼 𝑟

CES
• Therefore,
𝐾
𝑑 𝐿 1 𝛼 𝑤 𝑤 1 𝐾 𝑤
𝑤 = =
𝑑 𝛽+1 1−𝛼 𝑟 𝑟 𝛽+1 𝐿 𝑟
𝑟
• Using this, elasticity of substitution can be computed as:
𝐾
𝑑
𝐿
𝐾 𝐾 𝑤 𝑤
𝐿 𝑑 𝐿 1 𝐾 𝑤
σ= = 𝑟 = 𝑟 = 1
𝑤 𝑤 𝐾 𝛽+1 𝐿 𝑟 𝐾 𝛽+1
𝑑 𝑟 𝑑 𝑟
𝐿 𝐿
𝑤
𝑟

• Again, elasticity of substitution, or deep parameter, is constant and does

not vary, which is crucial in model building and forecasting.

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Total Factor Productivity

Y = A𝐾 𝐿
• Converting into natural log and differentiate with respect to time t
lnY = lnA + α ln 𝐾 + 1 − 𝛼 ln 𝐿

𝜕lnY 𝜕𝑌 𝜕lnA 𝜕𝐴 𝜕lnK 𝜕𝐾 𝜕lnL 𝜕𝐿

= +α + 1−𝛼
𝜕𝑌 𝜕𝑡 𝜕𝐴 𝜕𝑡 𝜕𝐾 𝜕𝑡 𝜕𝐿 𝜕𝑡

1 1 1 1
𝑌̇ = 𝐴̇ + α 𝐾̇ + 1 − 𝛼 𝐿̇
𝑌 𝐴 𝐾 𝐿
̇ ̇ ̇ ̇ ̇ ̇ ̇ ̇
= +α + 1−𝛼 or = −α − 1−𝛼
̇
What does imply?

MPK= and MPL=

Labor Wage/Labor Cost Revenue Production Price
2020 10 9,000 90,000 90000 90 1000
2021 11 9,000 99,000 99000 99 1000

2021 11 9,000 99,000 98000 98 1000

• Would you increase production?

• What is marginal cost, marginal product and marginal revenue?
• Marginal revenue come from marginal product of labor. From the
exercise above, Unless the price increases, the production will not
increase.

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Marginal Cost Pricing

Labor Wage/Labor Cost Revenue Production Price
2020 10 9,000 90,000 90000 90 1000
2021 11 10,000 10,000 100000 100 1000

• Average Cost; 𝐶 = 𝑤𝐿
• Marginal Cost (how much cost increases over how much production
increases):
• 𝑀𝐶 = = = = = =

MPL is declining on scale, which means MC is increasing on scale.

MC curve beyond AVC(Average Variable Cost) is Supply Curve.

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