Quantitative Methods for Economic Analysis

EC2104

Lecture 2
August 18, 2015

Outline

Readings: SH, Chapters 6, 7.7-7.12

Notation and Importance of Differentiation
Limits
Definition and Rules for Differentiation
Applications: Growth Rates and Elasticities
Continuity
Intermediate Value Theorem

Notation for Derivatives

Lagranges notation:
Derivative of f (x) is denoted f 0 (x).
Also y 0 for y = f (x).
Higher order derivatives: f 00 (x), f 000 (x), f (4) (x), . . . , f (n) (x)
Leibnizs notation:
df
d
Derivative of f (x) is denoted
(x) or
f (x).
dx
dx
dy
Also
for y = f (x).
dx
d 3f
d nf
d 2f
Higher order derivatives:
(x),
(x), . . . ,
(x)
2
3
dx
dx
dx n
Newtons notation (only used for time derivatives):
Derivative of y = f (t): y
Higher order derivative: y

Importance of Differentiation

The derivative gives us a way to find the slopes of functions.

This has many many uses both in and out of economics.
Rate of Change
Marginal Concepts

Graphical Approach: Linear Functions

How do we find slopes?

Linear functions: f (x) = ax + b.
We said the slope is a. Why?
Slope is 4y
4x .
If we change x from x1 to x2 , f (x) changes from ax1 + b to
ax2 + b.
Slope is then:
f (x2 ) f (x1 )
ax2 + b ax1 b
=
=a
x2 x1
x2 x1
Slope of a line is the same everywhere on the line.

Graphical Approach:Nonlinear Functions

What about for curves?

Slope of the curve changes throughout the curve.
We want the slope of the curve at a particular point on the

curve.
We are going to find the slope of the line tangent to the

curve at the point.

Nonlinear Functions
f(x)
4

0
-1

-1

a+h

Nonlinear Functions

Take two points on the function, at x values a and a + h.

Draw the line connecting these two points.
The slope of this line is:

f (a + h) f (a)
h
Gradually reduce h, moving the connecting line.
Eventually, as h approaches 0, the connecting line will

approach the tangent line.

This slope then becomes the slope of the tangent line.

Nonlinear Functions
f(x)
4

0
-1

-1

a+h

Nonlinear Functions
f(x)
4

0
-1

-1

a+h

Definition of the Derivative

The derivative of f (x) at x = a, written as f 0 (a), is

f (a + h) f (a)
h0
h

f 0 (a) = lim

Limits
Sometimes, functions are defined around certain points, but

not necessarily defined at those points.

Limits are used to study the behavior of functions around

these points.
We say that L is the limit of f (x) as x approaches the value c

if, as x gets close to c, f (x) gets close to L.

lim f (x) = L

xc

This must be true regardless of the direction you approach c.

Both one-sided limits must exist and be equal for this limit to

exist.
lim f (x) = L

xc

iff

lim f (x) = lim f (x) = L

xc +

xc

Examples of limits

Let H(t) =

0, if t < 0
1, if t 0

lim H(t)

t0

t
H(t)

-0.1
0

-0.01
0

-0.001
0

0.001
1

0.01
1

0.1
1

The left limit is 0 while the right limit is 1. The limit does
not exist.
x2 1
lim
x1 x 1
x
x 2 1
x1

0.9
1.9

0.99
1.99

0.999
1.999
2

1.001
2.001

1.01
2.01

1.1
2.1

1
As x gets close to 1, xx1
gets close to 2, but is undefined at
x = 1. The limit is 2.

lim H(t)

t0

H(t)
2

0
-1

-1

x2 1
lim
x1 x 1
f(x)
3

0
-2

-1

-1

Properties of the Derivative

Power rule: If f (x) = x n , where n is a real number, then

f 0 (x) = nx n1 .
Constants: If f (x) = C , where C is a constant, then

f 0 (x) = 0 for all values of x.

Constant multiples: If F (x) = a f (x), then F 0 (x) = a f 0 (x),

where a is a constant.
Sums and differences: If F (x) = f (x) + g (x), then

F 0 (x) = f 0 (x) + g 0 (x). Similarly,

G (x) = f (x) g (x) G 0 (x) = f 0 (x) g 0 (x).
Products: If F (x) = f (x) g (x), then

F 0 (x) = f (x) g 0 (x) + f 0 (x) g (x).

Self Checklist: Some Examples of Derivatives

f1 (x) = 5x
f2 (x) =
f3 (x) =

x +2

x2

+ 2x 3

f4 (x) = (x + 3)(2x 1)
f5 (x) = a0 + a1 x + a2 x 2 + . . . + an x n

Quotient Rule

0
If F (x) = gf (x)
(x) , then F (x) =

Example: f6 (x) = 5xx5

2 +2

g (x) f 0 (x) f (x) g 0 (x)

(g (x))2

Application: Relationship between Average Cost and

Marginal Cost
Show that MC exceeds Average Cost iff AC increases as

output increases
Hint: Differentiate Average Cost wrt output

Chain Rule

If F (x) = (f g )(x) = f (g (x)), then F 0 (x) = f 0 (g (x)) g 0 (x).

Differentiate this: f7 (x) = (5x 2 + 1)3

Exponential Function

If f (x) = ax where a is a constant, then f 0 (x) = ax ln a.

A special case: If f (x) = e x , then f 0 (x) = e x .

Differentiate this: f8 (x) = 5e x

Logarithm Function

If f (x) = loga x where a is a constant, then

A special case: If f (x) = ln x, then f 0 (x) =

Differentiate this: f9 (x) = ln(x)

x

f 0 (x) =
1
x.

1
x ln a .

Application: Growth Rates

By definition, Growth Rate of N = g =

Now, prove that g =

d
lnN(t)
dt

dN/dt
N
=
N
N

Application: Elasticities
In economics, we frequently deal with how certain variables

change in response to changes in other variables.

This is exactly how the derivative works.
So, if a $1 increase in the price of a kilogram of coffee reduces

demand for coffee by 500000 kg, we could have found this by

taking the demand function for coffee and differentiating:
dD(p)
dQ
=
= 500000 kg/$
dp
dp
However, this is sensitive to the units used as well as the type

of good. We cannot compare this to other goods meaningfully.

So, we use relative changes instead: by what percentage does
quantity demanded change when price increases by 1%?
This is known as the price elasticity of demand:
D =

%4 in Q
=
%4 in p

4Q
Q
4p
p

dQ p
dp Q

Elasticities

Using this, we can compare the price responsiveness of

different goods to each other.

More generally, we can have elasticities of anything. The

elasticity of f with respect to x is:

ELx f (x) =
Let us prove that now !

df (x) x
d ln f (x)
=
dx f (x)
d ln x

Elasticities

If |ELx f (x)| > 1, then f is elastic at x.

If |ELx f (x)| = 1, then f is unit elastic at x.
If |ELx f (x)| < 1, then f is inelastic at x.
If |ELx f (x)| = 0, then f is perfectly inelastic at x.

Example: Elasticities
Assume that demand for a product is given by
D(p) = ln (p + 1) + 5
Find the elasticity of D(p) when p = 100?

Continuity

A function f (x) is continuous at x = a if all of the following are

true:
f (a) exists
lim f (x) exists
xa

f (a) = lim f (x)

xa

Continuity
f(x)
3

0
-2

-1

-1

Continuity
f(x)
3

0
-2

-1

-1

Continuity
f(x)
3

0
-2

-1

-1

Continuity
f(x)
3

0
-2

-1

-1

Differentiability
A function f (x) is differentiable at x = a as long as the limit

in the definition of the derivative exists:

f (a + h) f (a)
h0
h
lim

Essentially, the slope of the function from the right and from

the left must both exist and be equal.

If a function is differentiable at x = a, then it is also

continuous at x = a (Differentiability Continuity).

This means, logically, that (Not Continuous Not

Differentiable)
However, the reverse is not true. (Continuity 6

Differentiability).
Interpretations: Continuity - graph connects. Differentiability

- slopes connect.

Example: Continuity and Differentiability

Determine whether f (x) = |x| is continuous and/or differentiable
at x = 0.

f (x) = |x|
f(x)
1

0
-1

-1

Question

Draw a graph of the function f (x) = min(3x+2, 9 4x)

where x is a real number

Is the function differentiable?
Is the function continuous?

Increasing/Decreasing Functions

We know the derivative gives the slope of a function at any

point.
Derivative positive at a point function upward sloping

function is increasing
Derivative negative at a point function downward sloping

function is decreasing

Graph of 13 x 3 + 2x 2 3x + 1
f(x)
4

0
-1

-1

Extension of Limits: LHopital Rule

If f(a)=g(a)=0, and g(a) is non zero:

f (x)
f 0 (x)
= 0
xa g (x)
g (x)
lim

Example:

ex 1
x0
x
lim

Intermediate Value Theorem

Let f be a function continuous in the closed interval [a,b]

If f(a) and f(b) have different signs, then there is at least 1 c

in (a,b) such that f(c) = 0.

If f(a) not equal to f(b), then for every intermediate value y in

the open interval between f(a) and f(b), there is at least one c
in (a,b) such that f(c) = y.