EC115 - Methods of Economic Analysis

Lecture 4
Optimization with more than one variable
Renshaw - Chapter 15
University of Essex - Department of Economics
Week 19
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 1 / 37
Introduction
A function of several variables is a relation between
some independent variables x
1
, x
2
, x
3
, ...x
n
and some
dependent variable z such that:
z = f (x
1
, x
2
, x
3
, ...x
n
)
species the value of z given the values of
x
1
, x
2
, x
3
, ...x
n
.
Today we will analyze the maximum and minimum
values of these type of functions.
We do this by building on our knowledge of partial
derivatives.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 2 / 37
Stationary Points
Consider the function z = f (x, y). The point
(x = x
0
, y = y
0
) is called a stationary point of z if:
z
x
=
z
y
= 0 at (x = x
0
, y = y
0
).
This is just like the denition of a stationary point for a
function of one variable: there the function w = g(x)
had a stationary point at x = x
0
if
dw
dx
= 0 at x = x
0
.
However, when we deal with functions of more than one
variable then it turns that there are three kinds of
stationary points: maximum points, minimum points
and saddlepoints.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 3 / 37
Conditions for a Minimum
Consider the following function
z = (x
2
+ y
2
).
The rst and second order partial derivatives are given
by
z
x
= 2x ;

2
z
x
2
= 2,
z
y
= 2y ;

2
z
y
2
= 2,

2
z
xy
=

2
z
yx
= 0.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 4 / 37
Can we use these derivatives to establish whether the
function has a minimum or a maximum?
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 5 / 37
Conditions for a Minimum
The function clearly has a minimum. In order to study it
we rst assume that one of the variables is a constant.
Assume y = y
0
= 0. Graph this function. What is the
value of x that makes z as small as possible?

Here f (x, y
0
) = f (x, 0) = x
2
which is minimized with respect to x
when x = 0.
Assume x = x
0
= 0. Graph this function. What is the
value of y that makes z as small as possible?

Here f (x
0
, y) = f (0, y) = y
2
which is minimized with respect to y
when y = 0.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 6 / 37
Using the iso-x section to nd necessary conditions for a minimum
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 7 / 37
Note that for any value of y, the function decreases for
all values of x < 0 and then increases.
z
x
< 0 for all x < 0 and
z
x
> 0 for all x > 0.
Also note that for any value of x, the function
decreases for all values of y < 0 and then increases.
z
y
< 0 for all y < 0 and
z
y
> 0 for all y > 0.
Note that in both cases the second order partial
derivative is always positive.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 8 / 37
The rst order conditions (FOC) for z = f (x, y) to
have a minimum at (x = x
0
, y = y
0
) are given by:
z
x
= 0 at (x = x
0
, y = y
0
),
z
y
= 0 at (x = x
0
, y = y
0
).
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 9 / 37
The second order conditions (SOC) for z = f (x, y) to
have a minimum at (x = x
0
, y = y
0
) are given by:

2
z
x
2
> 0 at (x = x
0
, y = y
0
),

2
z
y
2
> 0 at (x = x
0
, y = y
0
),

2
z
x
2


2
z
y
2
>

2
z
xy


2
z
yx
=

2
z
xy

2
at (x = x
0
, y = y
0
),
where the last equality follows from Youngs Theorem.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 10 / 37
The rst order conditions and the rst two parts of the
second order conditions for z = f (x, y) to have a
minimum at (x = x
0
, y = y
0
) are the same as the rst
and second order conditions for f (x, y
0
) to have a
minimum with respect to x at x = x
0
and f (x
0
, y) to
have a minimum with respect to y at y = y
0
.
The third part of the second order conditions is needed
in addition to the rst two parts because we can vary x
and y in other ways than just keeping one of them xed
while changing the other.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 11 / 37
Conditions for a Maximum
Consider the following function:
z = (x
2
+ y
2
).
The rst and second order partial derivatives are given
by:
z
x
= 2x ;

2
z
x
2
= 2
z
y
= 2y ;

2
z
y
2
= 2

2
z
xy
=

2
z
yx
= 0.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 12 / 37
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 13 / 37
Assume y = y
0
= 0. Graph this function. What is the
value of x that makes z as big as possible?

Here f (x, y
0
) = f (x, 0) = x
2
which is maximized with respect to x
when x = 0.
Assume x = x
0
= 0. Graph this function. What is the
value of y that makes z as big as possible?

Here f (x
0
, y) = f (0, y) = y
2
which is maximized with respect to y
when y = 0.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 14 / 37
For any value of y, the function is increasing for all
values of x < 0 and then decreases.
z
x
> 0 for all x < 0 and
z
x
< 0 for all x > 0.
For any value of x, the function is increasing for all
values of y < 0 and then decreases.
z
y
> 0 for all y < 0 and
z
y
< 0 for all y > 0.
Note that in both cases the second order own partial
derivative is always negative.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 15 / 37
Using the iso-y section to nd necessary conditions for a maximum
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 16 / 37
The rst order conditions for z = f (x, y) to have a
maximum at (x = x
0
, y = y
0
) are given by:
z
x
= 0 at (x = x
0
, y = y
0
),
z
y
= 0 at (x = x
0
, y = y
0
).
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 17 / 37
The second order conditions for z = f (x, y) to have a
maximum at (x = x
0
, y = y
0
) are given by:

2
z
x
2
< 0 at (x = x
0
, y = y
0
),

2
z
y
2
< 0 at (x = x
0
, y = y
0
),

2
z
x
2

2
z
y
2
>

2
z
xy

2
z
yx
=

2
z
xy

2
at (x = x
0
, y = y
0
),
where, again, the last equality follows from Youngs
Theorem.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 18 / 37
Example of Failure of SOC for a Maximum
Consider the following function:
z = (x + y)
2
2(x y)
2
= x
2
+ 6xy y
2
.
The rst and second order partial derivatives are given
by:
z
x
= 6y 2x ;

2
z
x
2
= 2;
z
y
= 6x 2y ;

2
z
y
2
= 2;

2
z
xy
=

2
z
yx
= 6.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 19 / 37
Example of Failure of SOC for a Maximum
At x = y = 0 then
z
x
= 0,

2
z
x
2
= 2,
z
y
= 0,

2
z
y
2
= 2.
Therefore the value of x which makes z as large as
possible when y = 0 is x = 0 and, similarly, the value
of y which makes z as large as possible when x = 0 is
y = 0. In addition, x = y = 0 is the only solution to
the rst order conditions.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 20 / 37
Example of Failure of SOC for a Maximum
However, since

2
z
xy
=

2
z
yx
= 6 then

2
z
xy

2
= 36
while

2
z
x
2


2
z
y
2
= 4 < 36 so that the third part of the
second order conditions is not satised.
At x = y = 0 then z = 0 but at x = y = a then
z = 4a
2
which is greater than zero whenever a = 0.
Therefore, z does not have a maximum at x = y = 0.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 21 / 37
Need for third part of 2nd order conditions
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 22 / 37
Conditions for a Saddle point
The rst order conditions for z = f (x, y) to have a
saddlepoint at (x = x
0
, y = y
0
) are given by:
z
x
= 0 at (x = x
0
, y = y
0
),
z
y
= 0 at (x = x
0
, y = y
0
).
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 23 / 37
The second order conditions for z = f (x, y) to have a
saddlepoint at (x = x
0
, y = y
0
) are given by:

2
z
x
2

2
z
y
2
<

2
z
xy

2
z
yx
=

2
z
xy

2
at (x = x
0
, y = y
0
),
where, again, the last equality follows from Youngs
Theorem.
This condition is automatically met if

2
z
x
2
and

2
z
y
2
have
opposite signs.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 24 / 37
Example of a saddle point
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 25 / 37
Strategy for Optimization
Identify locations of stationary points by determining
where rst order conditions are satised.

The rst order conditions are necessary conditions for a stationary

point.
For each stationary point determine whether it is of the
desired type (maximum, minimum, saddlepoint) by
examining whether or not it satises the appropriate
second-order conditions.

The appropriate second-order conditions combined with the rst order

conditions are sucient conditions for the desired type of stationary
point.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 26 / 37
A few examples - 1
Find the maximum or the minimum of the following
function:
z = f (x, y) = 6 x
2
2xy 3y
2
3x + 4y;
First Step: Search for all the critical points of the
function = look for all the points that satisfy the rst
order conditions
FOCs
z
x
= 0 2x 2y 3 = 0
z
y
= 0 2x 6y + 4 = 0
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 27 / 37
Example 1 - Cont.
The FOCs are represented by two equations, simultaneously
equal to 0. We solve the as a system and the solutions are
going to represent the candidate points for maxima and/or
minima.
Second Step: Solve the FOCs

2x 2y 3 = 0
2x 6y + 4 = 0

x =
3
2
y
3 + 2y 6y + 4 = 0

=
13
4
y

=
7
4
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 28 / 37
Example 1 - Cont.
So the point

13
4
,
7
4

is the only candidate. Is it a max or

a min (or maybe a saddle point)?
Third Step: Check the signs of ALL the second
order conditions:

2
z
x
2
> < 0 ?

2
z
y
2
> < 0 ?

2
z
x
2


2
z
y
2
> <

2
z
xy

2
?
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 29 / 37
Example 1 - Cont.
In our case:

2
z
x
2
= 2 < 0 x, y

2
z
y
2
= 6 < 0 x, y
It looks like were dealing with a maximum. Really? YES:
(2)(6) =

2
z
x
2

2
z
y
2
= 12 >

2
z
xy

2
= (2)
2
= 4
So, the function:
z = f (x, y) = 6 x
2
2xy 3y
2
3x + 4y has a
maximum at

13
4
,
7
4

Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 30 / 37

Economic Applications
A rm produces good Q in a competitive market and sells
it at price P. This rm need both capital and labour to be
able to produce any quantity of Q. It hires labour at a
wage of w and rents capital at a rate of r . Let the
production function of the rm be Cobb-Douglas:
Q = K
1/2
L
1/3
.
Write down the rms prot function.
What are the demands for labour and capital if this
rm maximizes prots?
Graph your answer.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 31 / 37
Solution - 1
The prot function is
= p K
1/2
L
1/3
wL rK
and the rst order conditions associated with it are:

K
= 0
1
2
pK
1/2
L
1/3
r = 0

L
= 0
1
3
pK
1/2
L
2/3
w = 0
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 32 / 37
Solution - 2
Solving simultaneously the two FOCs we can obtain:
1
2
pK
1/2
L
1/3
1
3
pK
1/2
L
2/3
=
r
w
By simplifying and solving with respect to L we get:
L =
2
3
r
w
K (1)
which we can now plug back into any of the two FOCs.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 33 / 37
Solution - 3
Substituting (1) into the rst FOC we obtain:
1
2
pK
1/2

2
3
r
w
K

1/3
r = 0
that can be solved for K in order to get
K

=
p
6
144r
4
w
2
Substituting K into (1) we eventually obtain:
L

=
p
6
216r
3
w
3
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 34 / 37
Solution - 4
So the point

=
p
6
144r
4
w
2
, L

=
p
6
216r
3
w
3

is a critical
point. Is it a max? Lets check the second order conditions.

K
2
=
1
4
pK
3/2
L
1/3
< 0, for any positive p, K, L

L
2
=
2
9
pK
1/2
L
5/3
< 0, for any positive p, K, L
So the rst two SOCs are satised, for any value of K and
L, and hence also for K

, L

(remember that K and L are

production inputs, so assuming that they are always
positive is a very mild hypothesis).
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 35 / 37
Solution - 5
Furthermore:

KL
=
1
6
pK
1/2
L
2/3
> 0, for any positive p, K, L
so:

K
2


2

L
2
=

1
4
pK
3/2
L
1/3

2
9
pK
1/2
L
5/3

=
2
36
p
2
K
1
L
4/3
>
1
36
p
2
K
1
L
4/3
=

KL

2
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 36 / 37
Solution - 6
So, as all the necessary second order conditions are
satised, the point

=
p
6
144r
4
w
2
, L

=
p
6
216r
3
w
3

indeed
represents a maximum.
Domenico Tabasso (University of Essex - Department of Economics) Lecture 4 Week 19 37 / 37