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Dudley Cooke
Trinity College Dublin
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Reading
1
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Multi-variable Calculus
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Partial Derivatives
Consider a function y = f (x1 , . . . , xn ).
The partial derivative of f with respect to xi is the derivative of f with
respect to xi treating all other variables as constants and is denoted,
f
or fxi
xi
Consider the following function: y = f (u, v ) = (u + 4) (6u + v ).
We can apply the usual rules of differentiation, now with two
possibilities:
f
= 1 (6u + v ) + 6 (u + 4) = 12u + v + 24
u
f
= 0 (6u + v ) + 1 (u + 4) = u + 4
v
Dudley Cooke (Trinity College Dublin)
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y
y
dx1 +
dx2
x1
x2
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Jacobian Matrix
h
|
y
x1
y
x2
{z
y
x1 dx1
y
x2 dx2 )
and recast it
i dx
1
dx
2
}
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General Functions
Now consider a more general two variable function, y = f (x1 , x2 ).
With a general function y = f (x1 , x2 ), the idea is to find a plane
which looks locally like the function around the point (x1 , x2 ).
Since the partial derivatives give the rates of change in x1 and x2 , it
makes sense to pick the appropriate plane which passes through the
point (x1 , x2 ) and has slopes f /x1 and f /x2 in the two
directions.
The derivative (or the total derivative)
of
h
i the function f (x1 , x2 ) at
y
y
(x1 , x2 ) is simply the vector x1 x2 where the partial derivatives
are evaluated at the point (x1 , x2 ).
We can interpret the derivative as the slopes in the two directions of
the plane which looks like the function around the point (x1 , x2 ).
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An Example
When we have a function y = f (hx1 , . . . , xn ), the derivative
at
i
y
y
(x1 , . . . , xn ) is simply the vector x1 . . . xn .
Take a more concrete example. Suppose,
y = 8 + 4x12 + 6x2 x3 + x3
The Jacobian must be,
8x1 6x3 1
y
x1
y
x2
y
x2
So we can write,
dy =
8x1 6 1
dx1
dx2
dx3
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An Economic Example
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f
xi
2 f
xi xj
is the
with respect to xj .
The above may suggest that the order in which the derivatives are
f
taken matters: in other words, the partial derivative of x
with
i
f
respect to xj is different from the partial derivative of xj with respect
to xi .
While this can happen, it turns out that if the function f (x1 , . . . , xn )
is well-behaved then the order of differentiation does not matter. This
result is called Youngs Theorem.
We shall only be dealing with well-behaved functions (i.e., Youngs
Theorem will always hold).
Dudley Cooke (Trinity College Dublin)
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Economic Example
For the production function y = K 0.25 L0.75 , we can evaluate the
2 y
second-order partial derivative, K
L , in two different ways.
y
First, since K
= 0.25K 0.75 L0.75 , taking the partial derivative of this
with respect to L, we get,
y
3
= K 0.75 L0.25
L K
16
And since
f
L
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Economic Interpretation
2 y
3
= K 1.75 L0.75
2
K
16
This is negative, so long as K > 0 and L > 0.
This tells us that the marginal productivity of capital decreases as we
add more capital.
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Economic Interpretation
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Suppose y = f (x1 , x2 ).
The first order differential is dy = fx1 dx1 + fx2 dx2 .
Think of dy as a function. Its differential is,
d (dy ) = [fx1 x1 dx1 + fx1 x2 dx2 ] dx1 + [fx1 x2 dx1 + fx2 x2 dx2 ] dx2
Collecting terms,
d 2 y = fx1 x1 (dx1 )2 + 2fx1 x2 dx1 dx2 + fx2 x2 (dx2 )2
The second-order total differential depends on the second-order
partial derivatives of f (x1 , x2 ).
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d 2y =
fx x dxi dxj
i j
i =1 j =1
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Maxima/Minima/Saddle Points
As in the single variable case, we are really after maxima and minima.
The first order conditions alone cannot distinguish between local
maxima and local minima.
Likewise, the first order conditions cannot identify whether a
candidate solution is a local or global maxima. We thus need second
order conditions to help us.
For a point to be a local maxima, we must have d 2 y < 0 for any
vector of small changes (dx1 , . . . , dxn ); that is, y needs to be a
strictly concave function.
Similarly, for a point to be a local minima, we must have d 2 y > 0 for
any vector of small changes (dx1 , . . . , dxn ); that is, y needs to be a
strictly convex function.
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f11 f12
is called the Hessian matrix, H. It is simply
f12 f22
the matrix of second-order partial derivatives.
The matrix
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In the general case, the second order differential can be written as,
dx
1
f11 f12 . . . f1n
dx2
f
f
.
.
.
f
12
22
2n
d 2 y = dx1 dx2 . . . dxn
.
... ... ... ...
..
f1n f2n . . . fnn
dxn
If we want to know something about d 2 y all we need to do is
evaluate the Hessian.
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dU = ca cb ca cb
dcb
The second-order differential is,
"
2
d U=
where,
"
2 U
ca ca
2 U
cb ca
2 U
ca cb
2 U
cb cb
dca dcb
"
2 U
ca ca
2 U
cb ca
2 U
ca cb
2 U
cb cb
( 1) ca2 cb
1
ca1 cb
#
dca
dcb
ca1 cb
2
( 1) ca cb
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a11 a12
a12 a22
Let A =
... ...
a1n a2n
The principal minors
a1n
a2n
be a n n symmetric square matrix.
...
ann
are the n determinants,
a11 a12 a13
a12
, . . . , |A|
a
a
a
,
12
22
23
a22
a13 a23 a33
...
...
...
...
of A
a
a11 , 11
a12
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Example
Consider the following. Is f (x, y ) = x 1/4 y 1/2 concave or convex
over the domain (x, y ) 0?
Compute the second order partials. E.g.,
fxy (x, y ) = fyx (x, y ) = (1/8) x 3/4 y 1/2 and
fxx (x,y ) = (3/4) (1/4) x 7/4 y 1/2 . So,
(3/4) (1/4) x 7/4 y 1/2 (1/8) x 3/4 y 1/2
H=
(1/4) x 1/4 y 3/2
(1/8) x 3/4 y 1/2
The principle minors are, (3/4) (1/4) x 7/4 y 1/2 < 0 and,
(3/4) (1/4) x 7/4 y 1/2 (1/8) x 3/4 y 1/2
(1/4) x 1/4 y 3/2
(1/8) x 3/4 y 1/2
= (3/64) x 7/4 y 1/2 x 1/4 y 3/2 (1/64) x 3/4 y 1/2 x 3/4 y 1/2
h
i
= (1/64) 2x 6/4 /y > 0
We conclude x 1/4 y 1/2 is convex over the domain (x, y ) 0.
Dudley Cooke (Trinity College Dublin)
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We can now summarize the first and second order conditions for an
optimization problem in the following way:
If (x1 , . . . , xn ) is a local maximum, then the first order conditions
imply that fi (x1 , . . . , xn ) = 0 for i = 1, . . . , n. The second order
condition implies that the Hessian matrix evaluated at (x1 , . . . , xn )
must be negative definite.
If (x1 , . . . , xn ) is a local minimum, then the first order conditions
imply that fi (x1 , . . . , xn ) = 0 for i = 1, . . . , n. The second order
condition implies that the Hessian matrix evaluated at (x1 , . . . , xn )
must be positive definite.
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= 5K 1/4 L1/2 1 = 0
L
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K
L
4
2
Note that since K > 0, L > 0.
15 7/4 1/2
K
L
<0
8
2
5 15 7/4+1/4 3/2+1/2
5
|H | =
K
L
K 3/43/4 L1/21/2
2 8
4
f11 =
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dy
dx
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dK
dL (K0 ,L0 ) .
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0.75
0.75
dL
L0
0.25K0
L0
Note that K0 6= 0, L0 6= 0.
This equation tells us the slope of the isoquant at (K0 , L0 ).
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Indifference Curves
As a final example, consider the following utility function:
1/
U = ca + cb
, where a =apples, b =bananas. This is called a
constant elasticity of substitution utility function. When = 0 we
get back to the Cobb-Douglas utility function.
Holding utility fixed, we have the following:
1/
ca + cb
U0 = 0. Now use the implicit function theorem.
U
dca
ca (ca,0 , cb,0 )
=
U
dcb (ca,0 ,cb,0 )
cb (ca,0 , cb,0 )
ca 1
=
cb
Suppose we look at the MRS at the point (tca , tcb ). The indifference
curves have the same slope at (ca , cb ) and at (tca , tcb ) for any t > 0.
The CES utility function is an example of preferences that are
homothetic.
Dudley Cooke (Trinity College Dublin)
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a + cy
b+
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dp
dp
+ DT = Sp
+ ST
dT
dT
dp
S DT
= T
dT
Dp Sp
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Example Continued
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General Formulation
Suppose we have a general set of equilibrium conditions given by
f 1 ( x1 , . . . , xn ; 1 , . . . , m ) = 0
f 2 ( x1 , . . . , xn ; 1 , . . . , m ) = 0
... = ...
n
f ( x1 , . . . , xn ; 1 , . . . , m ) = 0
Let us suppose that we can solve this set of equations to get
(x1 , . . . , xn ). Note that each xi will be a function of all the
underlying parameters (1 , . . . , n ).
In comparative statics, we typically are interested in knowing how
(x1 , . . . , xn ) change when there is a small change in one of the
parameters, say i .
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General Formulation
dx
dx
dx
f12 1 + f22 2 + . . . + fn2 n = f2i
d i
d i
d i
.. ..
.=.
dx
dx
dx
f1n 1 + f2n 2 + . . . + fnn n = fni
d i
d i
d i
f11
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General Formulation
.
.
.
. .. dx
. d ni
f1n f2n . . . fnn
f1i
f2i
..
.
fni
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Roundup
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