Chapter One:
Derivatives in Use
Derivatives in Use
1.1. Univariate Calculus: y = f(x) 1.2. Multivariate Calculus : y = f(x1,x2,…)
• sign of the first order derivative • Homogeneous functions and
• indicates whether the function is Euler's theorem
increasing/decreasing
• the second order derivative • Total differentials and
• Indicates whether the function is implicit differentiation
concave/convex.
• Used in linear approximation and
polynomial approximation
• Used for estimation of functions
(Maclaurin and Taylor’s series)
• Used in discussing about Intermediate value
theorem and Newton Method
1.1.1 First order derivative
Given the function Y = f(x), 𝑓 ′ 𝑎 = 0 implies that the function is at its optimum point at x = a
• 𝑓 ′ 𝑎 > 0 implies that the function is • 𝑓 ′ 𝑎 < 0 implies that the function is
increasing at x = a decreasing at x = a
Elasticity: Definition and as Logarithmic Derivative
• Elasticity is a measure of a proportionate change in the dependent variable which
results from a proportionate change in the independent variable.
Elasticity of demand (𝜺𝒑 ) is a measure of the percentage change in quantity demanded
due to a percentage change in the factors which determine demand.
∆𝑄
𝑄 ∆𝑄 𝑃 ∆𝑄 𝑃
𝜀𝑝 = = 𝑄 * ∆𝑃 = ∆𝑃 * 𝑄
∆𝑃/𝑃
It gives the average price elasticity of demand over the price range of P to (P+ ∆𝑃 ).
And, price elasticity of demand at a particular point P, i.e., as ∆𝑃 approaches to zero is:
𝑃 ∆𝑄 𝑃 𝑑𝑄
𝜀𝑝 = lim =
𝑄 ∆𝑃→0 ∆𝑃 𝑄 𝑑𝑃
Eg.1. Find the price elasticity of demand at P = 4 if the demand function is Q = 𝑃2 − 6𝑃 + 36
Eg.2. Find the price elasticity of demand at P = 2 if the demand function is given as Q = 10 − 𝑃2
Point elasticity
Elasticity as Logarithmic Derivative
• The instantaneous rate of growth of the function is the derivative of
natural logarithm of the function with respect to time.
𝑑 ln 𝑓(𝑡)
i.e., Rate of growth =
dt
𝐾
Eg.1. Find point elasticity of demand for Q =
𝑃𝑛
ln Q = ln 𝐾 − 𝑛 ln P
𝑑 ln 𝑄
𝜀𝑝 = = −n
ln 𝑃
Relationship between MR, AR and elasticity of Demand
1.1.2 Higher Order Derivatives
Higher order derivative enables us to have alternative criteria for determining the relative
maximum or minimum point of a function.
Given the function Y = f(x),
𝑑𝑌
• First order derivative: 𝑓 ′ 𝑥 = 𝑑x
𝑑2𝑌 𝑑 𝑑𝑌
′′
• Second order derivative: 𝑓 𝑥 = 𝑑𝑥 2 = 𝑑𝑋
, where 𝑓 ′ 𝑥 is a function of x and is
𝑑𝑋
differentiable.
𝑑2 𝑌
𝑑3𝑌 𝑑
𝑑𝑥2
• Third order derivative: 𝑓 ′′′ 𝑥 = 𝑓 3 𝑥 = 𝑑𝑥 3 = 𝑑𝑋
, where 𝑓 ′′ 𝑥 is a function of x and is
differentiable.
….
Eg.1. Find the first through the fourth derivative of the following function.
f(X) = 5𝑋 3 + 2𝑋 2 + 3𝑋 + 4
2𝑋
Eg.2. Find the first four derivatives of the function given as: f X = ,X ≠1
1−𝑋
1. describe concavity and convexity
2. describe linear and polynomial approximation (Quadratic and Higher Order Approximation)
3. Explain estimation of Functions (Maclaurin and Taylor’s series)
If the given function is differentiable, it is possible to expand around X = 0 or X = 𝑋0 .
Maclaurin series (Expansion of a function around X = 0 )
Taylor's Series (Expansion of a function around X = 𝑋0 where 𝑋0 is any value of X.)
4. Discuss about Intermediate value theorem and Newton Method
Intermediate Value Theorem
Newton's Method
1. Convexity and Concavity of a Function
For convex shape, no line segment joining two points For concave shape, no line segment joining two
on the graph lies below the graph at any point points on the graph lies above the graph at any point
• 𝑓 ′′ 𝑎 > 0 ⇒ the function is convex at x = a. • 𝑓 ′′ 𝑎 < 0 ⇒ the function is concave at x = a
• A positive first derivative coupled with a positive
second derivative at x = a shows that the function • A positive first derivative coupled with a negative
increases at an increasing rate at x = a. second derivative at x = a , shows that the function
is increasing at a decreasing rate at this point.
A function that is neither concave nor convex:
the line segment shown lies above the graph at some points and below it at others.
𝑓 ′′ 𝑎 = 0, x = a is the point at which the curvature of the function is changed.
A negative first derivative with a positive second derivative shows
that the function is decreasing at an increasing rate.
A negative first derivative with negative second divertive at x= a ,
implies that the function decreases at a decreasing rate at x = a .
Eg. If f X = 𝑋 3 − 12𝑋 2 + 36𝑋 + 8
a) Is it increasing or decreasing at x = 3?
b) Is it convex or concave at x = 3?
• Determine the intervals on which the • Determine the intervals on which the
function f X = 4𝑋 − 𝑋 2 is increasing or function f X = 2𝑋 3 − 6𝑋 2 − 36𝑋 + 2 is
decreasing increasing or decreasing
2. Linear Approximation
• In order to avoid complexity of complicated functions in economics, try to find a simpler function
which approximates the original function.
Given y = f(x) , the equation of a straight line which passes through point (𝑥1 , 𝑦1 ) and having a slope
𝑦−𝑦1
b is represented as: 𝑦 = 𝑏 𝑥 − 𝑥1 + 𝑦1 because 𝑏 = , so 𝑏 𝑥 − 𝑥1 = 𝑦 − 𝑦1
𝑥−𝑥1
i.e., equation of the tangent line which passes through the graph of the function y =f(x) at x = a
provided that f(x) is continuous and smooth at x = a , is expressed as:
𝑦 − 𝑓 𝑎 = 𝑓 ′ 𝑎 (x-a)
𝑦 = 𝑓 ′ 𝑎 (x-a)+ 𝑓 𝑎
• When we approximate the graph of f (x) by its tangent line at x = a , then the resulting
approximation is referred to as linear approximation.
Eg. 1. Find the linear approximation of the function 𝑓 𝑥 = 4 𝑥, about x = 1.
And compare the actual value of f (1.02) with the approximation
2. Identify an approximate value of(1.001)50
2. Polynomial Approximation
a) Quadratic Approximation of the function as x is close to a:
1 ′′
𝑓 𝑥 ≈𝑓 𝑎 + 𝑓′ 𝑎 (𝑥 − 𝑎) + 𝑓 𝑎 (𝑥 − 𝑎) 2
2
b) Higher Order Approximation
functions with higher order derivatives can be better approximated
near one point by using polynomial function of higher degree.
• The polynomial approximation of the function as x is close to a:
𝑓′ 𝑎 𝑓′′ 𝑎 2 𝑓3 𝑎 3 𝑓𝑛 𝑎
𝑓 𝑥 ≈𝑓 𝑎 + 𝑥−𝑎 + (𝑥 − 𝑎) + (𝑥 − 𝑎) + … + (𝑥 − 𝑎) 𝑛
1! 2! 3! 𝑛!
3. Estimation of Functions
(Maclaurin and Taylor series)
a) Maclaurin series (Expansion of a function around x = 0).
𝑓′ 0 𝑓′′ 0 2 𝑓3 0 3 𝑓𝑛 0
𝑓 𝑥 ≈𝑓 0 + 𝑥 + (𝑥) + (𝑥) + … + (𝑥) 𝑛
1! 2! 3! 𝑛!
[
i.e. it represents the polynomial approximation of the function around x= 0.
b) Taylor's Series (Expansion of f (x) around any point 𝑥 = 𝑥0 ).
𝑓′ 𝑥0 𝑓′′ 𝑥0 2 𝑓3 𝑥0 3 𝑓𝑛 𝑥0
𝑓 𝑥 ≈ 𝑓 𝑥0 + 𝑥 − 𝑥0 + (𝑥 − 𝑥0 ) + (𝑥 − 𝑥0 ) + … + (𝑥 − 𝑥0 ) 𝑛
1! 2! 3! 𝑛!
i.e. expansion of the primitive function provided that the function is continuous and smooth,
around any point 𝑥 = 𝑥0
Eg.1. Determine the quadratic approximation to a function
𝑓 𝑥 = 4 𝑥, about x = 1.
2. Determine the quadratic approximation to a function
𝑓 𝑥 = (5𝑥 + 3) −2 , about x = 0.
3. Find the fourth order approximation of the function
𝑓 𝑥 = 𝑥 + 1, about x = 0.
4. Determine the Maclaurin series of the function
f(X) = 5𝑋 3 + 2𝑋 2 + 3𝑋 + 1
4. Intermediate value theorem and Newton Method
Intermediate Value Theorem Newton's Method
If f(X) is continuous for all values of X in the closed
interval 𝑎, 𝑏 i.e.
1. f x is continous at x = a: lim+ f 𝑥 = 𝑓(𝑎) ,
𝑥→𝑎
2. f x is continous at x = b: lim− f 𝑥 = 𝑓(𝑏)
𝑥→𝑏
3. f x is continous at x = c[ i.e., a < c < b ]
And f(a) and f(b) are not equal and have opposite
signs, the intermediate value theorem states that
there is at least one value of X, c ∈ 𝑎, 𝑏 such that
f c = 0.
Newton's Method
• We can get better approximation of solution starting with initial estimate
(educated guess).
𝑓(𝑥𝑛 )
𝑥𝑛+1 = 𝑥𝑛 −
𝑓′(𝑥𝑛 )
Steps:
Given y = f(𝑥) and assume f 𝑥 = 𝑎 = 0
• For an Initial estimate 𝑥0 ; draw a tangent line passing through 𝑥0 and f(𝑥0 )
• Then, get 𝑥1 which is nearer to a, with tangent line passing through 𝑥1 and f(𝑥1 )
Note that the equation is: f 𝑥 − f(𝑥0 )= f′(𝑥0 )(𝑥 − 𝑥0 )
And at 𝑥1 , f(𝑥1 )=0; f 𝑥1 = 0 = f(𝑥0 )+f′(𝑥0 )(𝑥 − 𝑥0 )
f(𝑥0 )
Thus, 𝑥1 = 𝑥0 −
f′(𝑥0 )
Exercises
1. Check if 2𝑋 2 + 3𝑋 = 2 has a solution in 0,1
2. Check if 𝑋 2 − 1 = 3𝑥 has a solution in 0,1
3. Check if Y = 𝑋 6 + 3𝑋 2 − 2𝑋 − 1 = 0 is continuous and has a
solution in 0,1 ; then find an approximate solution in 0,1
4. Find approximate solution of 𝑋 2 − 3𝑋 = 3𝑥 in 0,1
1.2. Multivariate Calculus
describe what partial derivative is
explain second partials and the Young's theorem states
describe the multivariate chain rule
describe homogenous functions and Euler’s theorem
explain about total differential of a function and implicit differentiation
Partial Derivatives
• Partial differentiation is a technique of deriving the rate of change of
the function with respect to change in one of the independent
variables when all other variables are held constant.
Economic Applications
a) Elasticity
b) Utility Functions
c) Production Function
d) Revenue and Cost Functions
e) Keynesian Multiplier
Young's theorem
• According to the young's theorem, the mixed (cross) partial derivatives of a given
function are always equal if both cross partials exist and they are continuous.
i.e. for Z(𝑥, 𝑦), 𝑍𝑥𝑦 = 𝑍𝑦𝑥
Eg1. 𝑄1 = 𝑃1−1.7 𝑃20.8 and 𝑄2 = 𝑃10.5 𝑃2−0.2
a) Find the first and second partial derivatives
b) Are the two commodities complementary or substitutes? See first order partials
c) Check if young’s theorem is fulfilled.
Eg 2. Q = 6K + 0.3𝐾 2 𝐿 + 1.2𝐿2
Find and interpret second order derivatives
Multivariate chain rule
Given Z = f(𝑥, 𝑦) and x = f(𝑡) and y = f(𝑡)
𝑑𝑍 𝑑𝑥 𝑑𝑦
= 𝑍𝑥 + 𝑍𝑦
𝑑𝑡 𝑑𝑡 𝑑𝑡
Given y = f(𝑥, 𝑤) and x = g(𝑤)
𝑑𝑦 𝑑𝑥
= 𝑓𝑥 + 𝑓𝑤 ,
𝑑𝑤 𝑑𝑤
𝑑𝑥
where 𝑓𝑥 is the indirect effect of w on y while 𝑓𝑤 is the direct effect of w on y
𝑑𝑤
Examples
𝑑𝑈
1. Given the utility function U = 𝑥 2 + 𝑥𝑦 + 𝑦 2 ; x = 𝑡 3 + 1, and y = t − 𝑡 3 , find 𝑑𝑡
2. Suppose that the relationship between revenue R, output Q produced and sold each week is given by
𝑅 = 400𝑄 − 𝑄2 . In addition, suppose that Q is a function of t, i.e. time period, 𝑄 = 𝑓 𝑡 .
When Q = 30 and that the Management is considering to increase production by five units per wee. Show that
the management decision to increase production by five units per week increases total revenue by 1700 units.
Homogenous functions and Euler’s Theorem
• A function is referred to as homogenous of degree r if and only if
f 𝑡𝑥1 , 𝑡𝑥2 , … , 𝑡𝑥𝑛 = 𝑡 𝑟 𝑓(𝑥1 , 𝑥2 , … , 𝑥𝑛 ) where t is an arbitrary parameter.
Euler's theorem 1
If f(𝑥) is homogenous of degree r, 𝑓𝑥1 𝑥1 + 𝑓𝑥2 𝑥2 + … +𝑓𝑥𝑛 𝑥𝑛 = 𝑟𝑓(𝑥1 , 𝑥2 , … , 𝑥𝑛 )
Euler's theorem 2
If f(𝑥) is homogenous of degree r, first partials are homogenous of degree (𝑟 − 1)
Eg. Consider the Cobb- Douglas production function Q = b𝐿∝ 𝐾 1−∝
If r = 1, a function exhibits constant returns to scale.
If r > 1, a function exhibits increasing returns to scale.
If r < 1, a function exhibits decreasing rectums to scale.
1. Find the degree of homogeneity of the function
f(x, y) = 𝑥 4 + 𝑥 2 𝑦 2 using Euler's theorem.
2. Check Euler's theorem 2 on
f(x, y) = 𝑥 4 + 𝑥 2 𝑦 2
3. Check homogeneity of the following function:
f x, y = 3𝑥 3 + 5𝑥 2 𝑦 + 2𝑦 3
Total differential and implicit differentiation
• for u(𝑥1 , 𝑥2 ); du = 𝑢𝑥1 𝑑𝑥1 + 𝑢𝑥2 𝑑𝑥2
𝑑𝑦 −𝑓𝑥
If u 𝑥1 , 𝑥2 = 0; =
𝑑𝑥 𝑓𝑦
Eg. The theory of production states that the slope of the isoquant
represents the marginal rate of technical substitution (MRTS) between
two inputs.
Given the production function Q = f 𝐿, 𝐾 Show that MRTS between
the two inputs is equal to the ratio of the marginal products of the two
𝑀𝑃𝐿 𝑑𝐾
inputs. i.e. 𝑀𝑅𝑇𝑆𝐿𝐾 = − =
𝑀𝑃𝐾 𝑑𝐿
