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Workbook

An Introduction to
Mathematical
Economics
Part 1

Q2

Loglinear Q1
Publishing
Michael Sampson
Copyright 2001 Michael Sampson.
Loglinear Publications: http://www.loglinear.com Email: mail@loglinear.com.

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Contents

1 The Mathematical Method 1


1.1 Proof by Contradiction . . . . . . . . . . . . . . . . . . . . . . . . 1
1.1.1 Proof by Induction . . . . . . . . . . . . . . . . . . . . . . 3

2 Univariate Calculus 9
2.1 Maximization,Minimization, Concavity, Convexity . . . . . . . . 9
2.2 The Perfectly Competitive Firm . . . . . . . . . . . . . . . . . . 18
2.3 Cost Minimization . . . . . . . . . . . . . . . . . . . . . . . . . . 31
2.4 Utility Maximization . . . . . . . . . . . . . . . . . . . . . . . . . 33
2.5 Mark Maximization . . . . . . . . . . . . . . . . . . . . . . . . . 39
2.6 Monopoly . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
2.7 Price Discrimination . . . . . . . . . . . . . . . . . . . . . . . . . 47
2.8 Inverse Functions . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
2.9 Product, Quotient and Chain Rules . . . . . . . . . . . . . . . . 52
2.10 Polynomials and Taylor Series . . . . . . . . . . . . . . . . . . . . 54
2.11 Exponential Functions and Logarithms . . . . . . . . . . . . . . . 59
2.12 Linear Regression . . . . . . . . . . . . . . . . . . . . . . . . . . . 85
2.13 Maximum Likelihood . . . . . . . . . . . . . . . . . . . . . . . . . 87

3 Matrix Algebra 92
3.1 Multiplication, Transpose, Determinants and Inverse . . . . . . . 92
3.2 Applications to Econometrics . . . . . . . . . . . . . . . . . . . . 98
3.3 Systems of Equations, Cramers Rule . . . . . . . . . . . . . . . . 113
3.4 Quadratic Forms, Eigenvalues and Eigenvectors . . . . . . . . . . 119

4 Multivariate Calculus 133


4.1 Unconstrained Optimization . . . . . . . . . . . . . . . . . . . . . 133
4.2 Prot Maximization . . . . . . . . . . . . . . . . . . . . . . . . . 149
4.3 Linear Regression . . . . . . . . . . . . . . . . . . . . . . . . . . . 162
4.4 Maximum Likelihood . . . . . . . . . . . . . . . . . . . . . . . . . 166
4.5 Multivariate Chain Rule . . . . . . . . . . . . . . . . . . . . . . . 167
4.6 Lagrangians and Constrained Optimization . . . . . . . . . . . . 168
4.6.1 Utility Maximization . . . . . . . . . . . . . . . . . . . . . 168
4.6.2 Cost Minimization . . . . . . . . . . . . . . . . . . . . . . 178

i
CONTENTS ii

4.6.3 Eigenvectors, Eigenvalues and Constrained Optimization . 181


Chapter 1

The Mathematical Method

1.1 Proof by Contradiction


p
Problem 1 Prove that p is irrational where p is any prime number (a prime
number has only one and itself as factors). Hint: it is a fact that any integer n
can be factored uniquely into r prime numbers; for example 60 = 2 2 3 5
where 2; 2; 3 and 5 are prime numbers.

Answer
p p a
Assume that p is rational so that: p = b where a and b are integers.
Then:
p a
p= =) a2 = b2 p:
b
Now if integer a has r prime factors (for example 30 has r = 3 factors; i:e:;
30 = 2 3 5 ) then a2 has 2r prime factors (for example 302 has r = 3 2
= 6 factors; i:e:; 302 = 2 2 3 3 5 5 ) and so a2 has an even number
of prime factors: 2r. The same argument applies to b2 ; that is b2 must have an
even number of prime factors; say 2s. From this it follows that b2 p has an odd
number of prime factors 2s + 1 since p is odd. But a2 = b2 p and so a2 has an
odd number of prime factors: 2s + 1. Thus we have shown that a2 has both an
even and an odd number of prime factors, which is a contradiction. Therefore
p
p is irrational.

Problem 2 Prove that there are an innite number of prime numbers. Hint:
suppose that pmax is the largest prime number so that the prime numbers are
2; 3; 5; 7; : : : pmax and consider the number:

n = 2 3 5 7 pmax + 1:

1
CHAPTER 1. THE MATHEMATICAL METHOD 2

Answer
Under the assumption that there are a nite number of primes: 2; 3; 5; 7; : : : pmax
construct the number:

n = 2 3 5 7 : : : pmax + 1:

Clearly n is an integer. Either n is a prime number or it is not a prime number.


If n prime then clearly n > pmax which contradicts the assumption that pmax is
the largest prime number. If n is not prime then it has at least one prime factor
say p^ > 1: Now p^ being a divisor of n implies that p^ 6= 2; 3; 5; 7; : : : pmax since
otherwise:
n 2 3 5 7 : : : pmax 1
= +
p^ p^ p^
|{z} | {z } |{z}
integer integer non-integer

which is not possible. Since 2; 3; 5; 7; : : : pmax is the list of all primes up to pmax
it must be that p^ > pmax ; which contradicts pmax being the largest prime. Thus
we derive a contradiction if either n is prime or not prime. It follows that there
is no largest prime number.
To make the proof a little more concrete, suppose that one thought that 5
was the largest prime number so that the primes are 2; 3; 4 and 5: Then:

n = 2 3 5 + 1 = 31:

But 31 itself is a prime number (no integer besides 31 and 1 divides 31) and is
greater than 5 which contradicts our belief that 5 was the largest prime number.
p
Problem 3 Consider the function y = x which is plotted below:

30

25

20

15

10

0 200 400 600 800 1000


x :
p
y= x
Note that the function
p gets atter and atter as x increases. A natural
p conjec-
ture then is that x never gets p bigger than any number so that x c: Prove
that this is not the case; that x is in fact unbounded.
CHAPTER 1. THE MATHEMATICAL METHOD 3

Answer
p
Assume to the contrary that x is bounded so that
p
xc

for all x for some c < 1: Now we are free to choose any x we like so let
x = (c + 1)2 : The then have:
q
p
x = (c + 1)2
= c+1
> c
=) 1 > 0:
p
> 0 contradicts the fact that 0 < 1 the assumption that x c is false
Since 1 p
and so x is unbounded.

1.1.1 Proof by Induction


Problem 4 Use mathematical induction to prove that:
n3 n2 n
Sn = 12 + 22 + 32 + + n2 = + + :
3 2 6

Answer
Proof by Induction. Let Sn = 12 + 22 + 32 + + n2 : Clearly S1 = 12 = 1:
Now make the induction hypothesis so we assume that the result is true for
3 2
i < n; in particular for we can assume that: Sn1 = (n1) 3 + (n1)
2 + n1
6 :
Thus:

Sn = 12 + 22 + 32 + + (n 1)2 + n2
| {z }
=Sn1
3
(n 1) (n 1)2 n 1
= + + + n2
3 2 6
n3 3n2 + 3n 1 n2 2n + 12 n 1
= + + + n2
3 2 6
n3 n2 n 2 2
1 1 1
= + + + n + n + (n + n) + +
3 2 6 3 2 6
n3 n2 n
= + + :
3 2 6

Problem 5 Show that the sum of the rst n odd numbers is n2 : For example
the sum of the rst 4 odd numbers is 42 = 16 since:

1 + 3 + 5 + 7 = 16:
CHAPTER 1. THE MATHEMATICAL METHOD 4

Problem 6 Show that

13 + 23 + 33 + + n3 = (1 + 2 + 3 + : : : + n)2 :

Problem 7 Is it the case that


2
14 + 24 + 34 + + n4 = 12 + 22 + 32 + : : : + n2 ?

Problem 8 Suppose that the binomial coecients are dened by:



n n1 n1
= +
k k k1

where

0
=1:
0

This is illustrated below in Pascals triangle:

1
1 1
1 2 1
1 3 3 1
1 4 6 4 1
1 5 10 10 5 1

where the rst row gives 00 = 1 , the second gives 10 and 11 ; the third 20
2 2 n
, 1 and 2 and so on. To illustrate the generation k consider n = 5 and
k = 3: Going to the fth row we nd that:

5 4 4
10 = = + = 4 + 6:
3 3 2

Use induction then to prove that:



n n!
= :
k k! (n k)!
5 5!
where for example 5! = 5 4 3 2 1 = 120 and 3 = 3!2! = 10: Recall as
well that 0! = 1:

Answer
For n = 0 and k = 0 we have:

0 0! 1
= = = 1:
0 0!0! 11
CHAPTER 1. THE MATHEMATICAL METHOD 5

Now assume the result is true for n 1: We then have:



n1 n1 (n 1)! (n 1)!
+ = +
k k1 k! (n 1 k)! (k 1)! (n k)!
(n 1)! (n 1)!
= +
k (k 1)! (n 1 k)! (k 1)! (n k) (n 1 k)!

(n 1)! 1 1
= +
(k 1)! (n 1 k)! k n k

(n 1)! nk+k
=
(k 1)! (n 1 k)! k (n k)

(n 1)! n
=
(k 1)! (n 1 k)! k (n k)
n (n 1)!
=
(k (k 1)!) ((n k) (n 1 k)!)
n!
= :
k! (n k)!

Problem 9 Use induction and the previous result to prove the binomial theo-
rem; that:

n n n 0 n n1 1 n n2 2 n 0 n
(x + y) = x y + x y + x y + + x y :
0 1 2 n

Answer
It is clearly true for n = 1 since:

1 1 1 0 1 0 1
(x + y) = x + y = x y + x y :
0 1

Now assume it is true for n 1: We then have:

(x + y)n = (x + y) (x + y)n1

n 1 n1 0 n 1 n2 1 n 1 n3 2 n 1 0 n1
= (x + y) x y + x y + x y + + x y
0 1 2 n1

n1 n 0 n 1 n1 1 n 1 n2 2 n 1 1 n1
= x y + x y + x y ++ x y
0 1 2 n1

n 1 n1 1 n 1 n2 2 n 1 n3 3 n1 0 n
+ x y + x y + x y + + x y
0 1 2 n1

n1 n 0 n1 n1 n1 n1
= x y + + xn1 y 1 + + xn2 y2
0 1 0 2 1

n1 n1 n1 0 n
+ + + x1 yn1 + x y
n2 n1 n1
CHAPTER 1. THE MATHEMATICAL METHOD 6

By multiplying the two terms in brackets you will nd that the coecient on
xnj y j is

n1 n1 n
+ = :
j j 1 j

The two terms on xn y 0 xn y 0 have to be treated a little dierently but these


work as well since:

n1 n n1 n
=1= ; =1= :
0 0 n1 n

Thus:

n n 0 n n1 1 n n2 2 n 0 n
(x + y)n = x y + x y + x y + + x y :
0 1 2 n

Problem 10 The Fibonacci numbers are dened as

fn = fn1 + fn2

with f1 = f2 = 1: Thus:

f3 = f2 + f1 = 1 + 1 = 2
f4 = f3 + f2 = 2 + 1 = 3
f5 = f4 + f3 = 3 + 2 = 5
..
.
p
There is a close link between these numbers and = 1+2 5 = 1:618: For example
the ratio of subsequent numbers approaches ; for example ff54 = 53 = 1:6 :
Use proof by induction to show that:
p n p n
1+ 5
2 12 5
fn = p
5
and from this show that:
p
fn 1+ 5
lim = :
n!1 fn1 2

Answer
For n = 1 we have:
p 1 p 1
1+ 5
12 5 p
2 5
p = p = 1 = f1
5 5
CHAPTER 1. THE MATHEMATICAL METHOD 7

and so the result is true for n = 1: Now we assume the result is true for
1; 2; : : : n 1 and attempt to show it is true for n: Thus:

fn = fn1 + fn2
p n1 p n1 p n2 p n2
1+ 5
2 12 5 1+ 5
2 12 5
= p + p
5 5
p p n2 p n1 p n2
n1
1+ 5
2 + 1+2 5 1 5
2 + 12 5
= p
5
p n2 p p n2 p
1+ 5 1+ 5 1 5 1 5
2 2 + 1 2 2 + 1
= p
5
p n2 p p n2 p
1+ 5 3+ 5
2 2 12 5 3 5
2
= p :
5
But since:
p !2 p p !2 p
1+ 5 3+ 5 1 5 3 5
= ; =
2 2 2 2

we have:
p n2 p 2 p n2 p 2
1+ 5 1+ 5
2 2 12 5 1 5
2
fn = p
5
p n p n
1+ 5
2 12 5
= p
5
and the result is proven.
Now we have:
p n p n

1+ 5 1 5
fn 2 2
= p n1 p n1 :
fn1 1+ 5
2 12 5
p p n p n1

Since 12 5 = 0:618 is a fraction, 12 5 ! 0 as n ! 1 and 12 5 !
CHAPTER 1. THE MATHEMATICAL METHOD 8

0 as n ! 1 so that:
p n p n
1+ 5 1 5
fn 2 2
lim = lim p n1
n!1 fn1 n!1 1+p5 n1 1 5
2 2
p n
1+ 5
2
= lim
n!1 1+p5 n1
2
p
1+ 5
= :
2
Chapter 2

Univariate Calculus

2.1 Maximization,Minimization, Concavity, Con-


vexity
Problem 11 Consider the following function:

f (x) = x1=2 x3=2

for x > 0: Find f 0 (x) and show that f (x) is globally concave. Find the global
maximum x explaining how you know it is a global maximum. Is f (x) globally
increasing or globally decreasing?

Answer
Since:
1 1 3 1
f 0 (x) = x 2 x2
2 2
1 12 3 12
=) f 0 (x ) = 0 =) (x ) (x ) = 0
2 2
1 1 12
=) (x ) 2 = (x )
3
1 1
=) x = (multipling both sides by (x ) 2 )
3
Similarly:
1 3 3 1
f 00 (x) = x 2 x 2 < 0
4 4
3 1
(since x 2 > 0 and x 2 > 0) so that f (x) is globally concave which in turn
implies that x = 13 is a global maximum. Note that f (x) is neither globally

9
CHAPTER 2. UNIVARIATE CALCULUS 10

1
increasing nor decreasing since f 0 (x) > 0 for x < 3 and f 0 (x) < 0 for x > 13 .
See the plot of f (x) = x1=2 x3=2 below:

0.3

0.2

0.1

0 0.2 0.4 0.6 0.8 1 1.2


x
-0.1

-0.2

:
1=2 3=2
f (x) = x x

Problem 12 Consider the following function:

f (x) = 5x4=5 2x

for x > 0: Find f 0 (x) and show that f (x) is globally concave. Find the global
maximum x explaining how you know it is a global maximum. If f (x) = 0
then what is x?

Answer
We have:
1
f 0 (x) = 4x 5 2

and f (x) is globally concave since for all x:


4 6
f 00 (x) = x 5 < 0:
5
To solve for x note that:
1
f 0 (x ) = 0 = 4 (x ) 5 2
1 1
=) (x ) 5 =
2
5
1
=) x = = 32:
2

Since f (x) is globally concave x = 32 is a global maximum. (Note it is not


enough to say that f 00 (32) < 0 since this only proves that x = 32 is a local
maximum. )
CHAPTER 2. UNIVARIATE CALCULUS 11

f (x) is neither globally increasing nor globally decreasing since


1
f 0 (x) = 4x 5 2

1 1
= 4 x 5
2
1 1

= 4 x 32 5
5

1 1

= 4 x 5 (x ) 5
1
so that f 0 (x) > 0 for x < 32 since: x 5 > (x ) 5 while f 0 (x) < 0 for x > 32
1

1
since x 5 < (x ) 5 :
1

Let r be the root which satises f (r) = 0 for r > 0: Now:


f (r) 0 =) 5r4=5 2r = 0
=
2
=) r4=5 = r:
5
Since r > 0 we can divide both sides by x
~ to obtain:
2
r1=5 =
5
5
2
=) r = = 97:656:
5
The function f (x) is plotted below:

16
14
12
10
8
6
4
2

0 20 40 60 80 100
x

f (x) = 5x4=5 2x
Problem 13 Consider the following function:
f (x) = 3x2=3 5x;
for x > 0: Find f 0 (x) and show that f (x) is globally concave. Find the global
maximum x explaining how you know it is a global maximum. If g (x) =
1
1 + x1 and h (x) = g 3x2=3 5x ; then nd the x which solves the rst-
order conditions for h (x) :
CHAPTER 2. UNIVARIATE CALCULUS 12

Answer
Since:
1
f 0 (x) = 2x 3 5
1
=) f 0 (x ) = 0 =) 2 (x ) 3 5 = 0
1 5
=) (x ) 3 =
2
3
5 8
=) x = = :
2 125
Similarly:
2 4
f 00 (x) = x 3 < 0
3
4
(since x 3 > 0 ) so that f (x) is globally concave which in turn implies that
8
x = 125 is a global maximum. Note that f (x) is neither globally increasing
8 8
nor decreasing since f 0 (x) > 0 for x < 125 and f 0 (x) < 0 for x > 125 . See the
plot of f (x) below:

0.16
0.14
0.12
0.1
0.08
0.06
0.04
0.02

0 0.05 0.1 0.15 0.2


x :
f (x) = 3x2=3 5x
1
If g (x) = 1 + x1 then:
1
g0 (x) = 2 > 0:
1 + x1 x2
Therefore:
h0 (x ) = g 0 (f (x ))f 0 (x ) = 0
| {z }
+
1

=) g (f (x )) 2 (x ) 3 5 = 0
0

| {z }
f 0 (x )
8
=) x =
125
CHAPTER 2. UNIVARIATE CALCULUS 13

from work with f (x) above.


Alternatively working directly with h (x) we nd that:

h (x) = g 3x2=3 5x
1
1
= 1 + 2=3
3x 5x
3x2=3 5x
= :
3x2=3 5x + 1
Using the quotient rule it follows that:
2=3 1
1

3x 5x + 1 2x 3 5 3x2=3 5x 2x 3 5
h0 (x) = 2
3x2=3 5x + 1
1

2x 3 5 3x2=3 5x + 1 3x2=3 5x
= 2
3x2=3 5x + 1
1

2x 3 5
= 2
3x2=3 5x + 1

so that:
1
h0 (x ) = 0 =) 2 (x ) 3 5 = 0
8
=) x = :
125
Problem 14 Suppose f (x) is given by:

f (x) = x1=2 x

for x > 0: Find f 0 (x) and show that f (x) is globally concave. Determine the
rst-order conditions and use these to nd that x which maximizes f (x) :Prove
that x is a global
p maximum. Is f (x) globally increasing or globally decreasing?
If h (x) = g ( x x) where g (x) is monotonically increasing, nd the value of
x which maximizes h (x) :

Answer
We have:
1 1
f 0 (x) = x 2 1
2
and f (x) is globally concave since for all x:
1 3
f 00 (x) = x 2 < 0:
4
CHAPTER 2. UNIVARIATE CALCULUS 14

To solve for x note that:


1 12
f 0 (x ) = 0= (x ) 1
2
1
=) (x ) 2 = 2
1
=) x = (2)2 = :
4
Since f (x) is globally concave
x = 14 is a global maximum. (Note it is not
enough to say that f 4 < 0 since this only proves that x = 14 is a local
00 1

maximum. f (x) is neither globally increasing nor globally decreasing since


f 0 (x) > 0 for x < 14 while f 0 (x) < 0 for x > 14 :
Now:

p 1 1
h0 (x) = g 0 x x x 2 1
2
p
using the chain rule. But since g 0 ( x x) > 0 it follows that if h0 (x ) = 0
1
then 12 (x ) 2 1 = 0 or x = 14 as above.

Problem 15 Consider the following function:

f (x) = 8x3=4 3x;

for x > 0: Is f (x) a monotonically increasing or decreasing function? Is f (x)


concave or convex? Using the rst order conditions nd any local maxima or
minima of f (x) : What is the global maximum of f (x)? Explain.

Answer
Since:
1
f 0 (x) = 6x 4 3
1
=) f 0 (x ) = 0 = 6 (x ) 4 3
1 3 1
=) (x ) 4 = =
6 2
4
1
=) x = = 16:
2
CHAPTER 2. UNIVARIATE CALCULUS 15

Since f 0 (x) > 0 for x < 16 and f 0 (x) < 0 for x > 16 as illustrated in the graph
below:

0 5 10 15 20 25
x

f 0 (x)

the function f (x) is neither monotonically increasing nor decreasing.


Since

+
z}|{z}|{
00 3 5
f (x) = x 4 < 0
2
the function f (x) is globally concave with a unique global maximum at x = 16:
This is illustrated in the graph below:

16

14

12

10
8

6
4

10 20 30 40 50
x
3=4
f (x) = 8x 3x

Problem 16 Consider the function:

f (x) = xa xb

for x > 0 where 0 < a < 1 and b > 1: Show that f (x) has a unique global
maximum x , nd x ; and show that f (x) is globally concave.
CHAPTER 2. UNIVARIATE CALCULUS 16

Answer
We have:

f 0 (x) = axa1 bxb1


f 0 (x ) = 0 =) a (x )a1 b (x )b1 = 0
=) a (x )a1 = b (x )b1
(x )a1 b
=) =
(x )b1 a
b
=) (x )ab =
a
ab
1
b
=) x = :
a

To show that f (x) has a unique global maximum at x note that:

+ + +
z}|{z }| { z}|{z }| {
00
f (x) = a (a 1)xa2 b (b 1)xb2 < 0

where a 1 < 0 since a < 1 and b 1 > 0 since b > 1. Therefore f (x) is globally
b ab
1
concave so that x = a is a global maximum.

Problem 17 Consider the function:

f (x) = Axa Bxb

for x > 0 where 0 < a < 1; A > 0; B > 0 and b > 1: Show that f (x) has a
unique global maximum x , nd x ; and show that f (x) is globally concave.

Answer
We have:

f 0 (x) = Aaxa1 Bbxb1


f 0 (x ) = 0 =) A a (x )a1 B b (x )b1 = 0
a1
=) a (x ) = b (x )b1
(x )a1 Bb
=) =
(x )b1 Aa
Bb
=) (x )ab =
Aa
1
B b ab
=) x = :
Aa
CHAPTER 2. UNIVARIATE CALCULUS 17

To show that f (x) has a unique global maximum at x note that:


+
+ z }| { + + +
z}|{z}|{ z}|{z}|{z }| {
00
f (x) = A a (a 1)xa2 B b (b 1)xb2 < 0

where a 1 < 0 since a < 1 and b 1 > 0 since b > 1. Therefore f (x) is globally
1
Bb ab
concave so that x = Aa is a global maximum.

Problem 18 Consider the following function dened on x > 0:

f(x) = 5x3 4x2 2x + 5;

Use rst order conditions to nd the possible local maxima or minima, Use
second order conditions to determine which are local maxima and which are
local minima. Is the function convex or concave and what are the global minima
and maxima?

Answers
We have:

f 0 (x) = 15x2 8x 2
=) f 0 (x ) = 0 = 15(x )2 8(x ) 2
4 1p
=) x = + 46 = 0:71882
15 15
4 1
p
since x = 15 15 46 = 0:18549 is ruled out by the requirement that x > 0:
Now:

f 00 (x) = 30x 8

so that:

f 00 (0:71882) = 30 0:71882 8 = 13:565 > 0

and hence x = 0:71882 is a local minimum. The function is neither globally


8 8
concave nor convex since f 00 (x) < 0 for x < 30 and f 00 (x) > 0 for x > 30 with
8
x = 30 and inection point where f (x) changes from being concave to convex.
CHAPTER 2. UNIVARIATE CALCULUS 18

This is illustrated in the plot below:

5.5

4.5

3.5
0 0.2 0.4 0.6 0.8 1 1.2
x :
3 2
f (x) = 5x 4x 2x + 5
4 1
p
From the graph it is clear that x = 15 + 15 46 is a global minimum and
4 1
p
that f (x) has no global maximum. To prove that x = 15 + 15 46 is a global
minimum note that:

f 0 (x) = 15x2 8x 2

4 1p 4 1p
= 15 x 46 x + 46
15 15 15 15
4 1
p
and that x 15 15 46 > 0 for x > 0: It follows that f 0 (x) < 0 for x <
4 1
p 0
4 1
p
4 1
p
15 + 15 46 and f (x) > 0 for x > 15 + 15 46 so that x = 15 + 15 46
is a global minimum.

2.2 The Perfectly Competitive Firm


The next two problems are based on the following information: Sup-
pose in the short-run a perfectly competitive rm faces a price P; a nominal
The rms
wage W; a rental cost of capital R; and a xed amount of capital K:
short-run production function relating Q output to L labour is given by:

Q = f (L) = L2=3 :

Problem 19 What is the marginal product of labour? Show that this production
function satises the assumption of a diminishing marginal product of labour.
Find prots as a function of L or (L) and show that (L) is globally concave.
Derive the rms demand curve for labour L and determine the elasticity of
demand.
CHAPTER 2. UNIVARIATE CALCULUS 19

Answer
We have a positive marginal product of labour since:
+
z}|{
2 1
M PL (L) = f 0 (L) = L 3 > 0
3
and a diminishing marginal product of labour since:
+
z}|{
2 4
M PL0 (L) = f (L) = L 3 < 0:
00
9
Prots as a function of L is found by replacing Q with L2=3 as:
2

(L) = P L 3 W L RK

so that:
2 1
0 (L) = P L 3 W
3
2 4
(L) = P L 3 < 0 =) (L) is globally concave:
00
9
From the rst-order conditions for prot maximization we have for real wage
w= WP :

2 1
0 (L ) = 0 = P (L ) 3 W
3
13 3W 3
=) (L ) = = w
2P 2
3 3
3 3
=) L = w = w3 :
2 2

Since L has the form: y = Axb the elasticity of demand is the exponent on w
or 3:

Problem 20 If instead of the production function Q = f (L) one writes L =


g (Q) ; then what is g (Q) given the rms production function above? Use this to
obtain the rms cost function and show that the cost function is convex. Derive
(Q) (prots as a function of Q) and Q ; the rms supply curve.

Answer
By solving for L from Q = L2=3 we have:

Q = L2=3 =) L = Q3=2 :
CHAPTER 2. UNIVARIATE CALCULUS 20

3
The cost function is then found by replacing L with Q 2 to obtain costs as a
function of Q :
3
= W Q 2 + RK:
C (Q) = W L + RK

Dierentiation of C (Q) then yields:


3 1
MC (Q) = C 0 (Q) = W Q 2
2
+
z }| {
3 1
=) M C 0 (Q) = C 00 (Q) = W Q 2 > 0; =) C (Q) is globally convex.
4
Prots are found by replacing W L + RK with C (Q) as:

(Q) = P Q W L + RK
= P Q C (Q)
3
= P Q W Q 2 RK
P
so that letting p = W be the real price of Q :
3 1
0 (Q ) = 0 =) P W (Q ) 2 = 0
2
12 2P 2
=) (Q ) = = p
3W 3
2 2
2 2
=) Q = p = p2 :
3 3

Since Q has the form y = Axb with p the 0 x0 variable and Q the 0 y 0 variable,
the elasticity of supply is the exponent on p or 2:

Problem 21 Suppose in the short run a perfectly competitive rm faces a price


P and nominal wage W: The rms short run production function relating Q
output to L labour is given by:

Q = f (L) = 9L1=3 :

What is the marginal product of labour? Show that this production function
satises the assumption of a diminishing marginal product of labour. If one
rewrote f (L) in the form: f (L) = ea+b ln(L) , then what are a and b? Derive
(L) (prots as a function of L) and show that it is concave. Derive the rms
demand curve for labour and determine the elasticity of the demand curve.

Answer
The marginal product of labour is
2
MPL (L) = f 0 (L) = 3L 3 :
CHAPTER 2. UNIVARIATE CALCULUS 21

Since
5
M PL0 (L) = f 00 (L) = 2L 3 < 0

there is a diminishing marginal product of labour.


This is illustrated in the graphs below

24
22
20
18
16
14
12
10
8
6
4
2 4 6 8 10 12 14 16 18 20
L

f (L)

2 4 6 8 10 12 14 16 18 20
L

M PL (L)
If

f (L) = ea+b ln(L)


=) ea+b ln(L) = ea eb ln(L)
b
= ea eln(L)
= ea Lb
1
= 9L 3 :

Therefore ea = 9 or a = ln (9) and b = 13 :


CHAPTER 2. UNIVARIATE CALCULUS 22

Prots are given by replacing Q with 9L1=3 as:



(L) = P 9L1=3 W L

so that:
2
0 (L) = 3P L 3 W
5
00 (L) = 2P L 3 < 0 ) (L) is globally concave.

Now from
2
0 (L ) 0 = 3P (L ) 3 W
=
2 1W w
=) (L ) 3 = =
3P 3
W
where w = P is the real wage. It follows that:
2
32 w 32
(L ) 3 =
3
32
1
=) L (w) = w :
3

Since this is of the form y = Axb the elasticity of demand is 32 :

Problem 22 If the rms production function is:

Q = f (L) = 9L1=3

nd L as a function of Q or L (Q) : Use this to obtain the rms cost function


when labour is the only factor of production and W is the nominal wage. Show
that for this rm that marginal cost: MC (Q) is positive, that M C 0 (Q) is also
positive and that the cost function is convex.

Answer
1
From Q = 9L 3 it follows that:
3
11 1
L = Q =) L (Q) =
3 Q3 :
9 9
1 3
Therefore cost as a function of Q is found by replacing W L with 9 Q3 as:

C (Q) = W L
3
1
= W Q3 :
9
CHAPTER 2. UNIVARIATE CALCULUS 23

Thus:
3
1
M C (Q) = C 0 (Q) = 3W Q2 > 0:
9
so that marginal cost is positive.
Since:
3
1
C 00 (Q) = MC 0 (Q) = 6W Q>0
9
for all Q it follows that C (Q) is globally convex and marginal cost is increasing.
The is illustrated in the plot below for

0.01

0.008

0.006

0.004

0.002

0 0.5 1 1.5 2
Q :
1 3
C (Q) = W 9 Q3

Problem 23 Suppose a rm faces a cost function


C (Q) = 5Q4 + 120:
Find the marginal cost function MC (Q) = C 0 (Q) and the average cost function
C (Q)
AC (Q) = :
Q
Show that the cost function is globally convex. Show that the average cost func-
tion AC (Q) is also globally convex and nd that Q at which average cost is at
a minimum. If P = 10 then what will the prot maximizing Q be?

Answer
Marginal MC (Q) and average cost AC (Q) are:
M C (Q) = C 0 (Q) = 20Q3
C (Q) 5Q4 + 120 120
AC (Q) = = = 5Q3 +
Q Q Q
CHAPTER 2. UNIVARIATE CALCULUS 24

and

C 00 (Q) = MC 0 (Q) = 60Q2 > 0

for all Q so that C (Q) is globally convex.


Now:
120
AC 0 (Q) = 15Q2
Q2
240
AC 00 (Q) = 30Q + 3 > 0 for all Q
Q

so that AC (Q) is globally convex as illustrated in the plot below:

1200

1000

800

600

400

200

1 2 3 4 5 :
Q

120
AC (Q) = 5Q3 + Q

To nd the minimum of AC (Q) note that:


120
AC 0 (Q ) = 0 = 15 (Q )2
(Q )2
120
=) (Q )4 = =8
15
1
=) Q = (8) 4 = 1:6818:

Now:

(Q) = 10Q C (Q)



= 10Q 5Q4 + 120
=) 0 (Q ) = 0 = 10 20 (Q )3
10
=) (Q )3 =
20
13
1
=) Q = = 0:7937:
2
CHAPTER 2. UNIVARIATE CALCULUS 25

Alternatively set P = MC (Q) : Note that:


00 (Q) = 60Q2 < 0
1
so that (Q) is globally concave and Q = 12 3 is a global maximum. (Q) is
plotted below:

-114

-115

-116

-117

-118

-119

-120
3 0 0.2 0.4 0.6 0.8 1 1.2
Q

(Q) = 10Q 5Q4 + 120
Problem 24 Suppose that the rm has a production function Q = f (L) = L
where 0 < < 1: Derive the rms demand curve for labour L = L (w) and
1
show that the elasticity of demand is 1 while the elasticity of supply is 1 :

Answer
We have:
(L) = P L W L
=) (L ) = P (L )1 W = 0
W w
=) (L )1 = =
P
w 1
1 1
1
1 1
=) L = = w 1 :

1
The elasticity of labour demand is then the exponent on the real wage 1 <0
since < 1:
Now
Q = f (L ) = (L )
1
w 1
=


W 1
=
P
1
W
= P 1 :

CHAPTER 2. UNIVARIATE CALCULUS 26


The elasticity of supply is the exponent on P : 1 > 0 since 0 < < 1.

Problem 25 Suppose a rm has a production function given by:


1
1
Q = f (L) = 1 + :
L

Show that this production function is globally increasing and concave. Show that
the marginal product of labour: M PL (L) is positive and diminishing. Find the
prot maximizing L when the price the rm receives is P and the nominal wage
is W: Find the rms labour demand curve and prove that the labour demand
curve is downward sloping. Is the elasticity constant?

Answer
We have:
2
1 1
f 0 (L) = 1 + 2
L L

1 2 2
= 1+L L
1
2
= 1+L L
1
= (1 + L)2 = > 0:
(1 + L)2
1
Since f 0 (L) = (1+L)2
it follows that:

3 2
f 00 (L) = 2 (1 + L) = < 0:
(1 + L)3

Therefore f (L) is globally concave. Since M PL (L) = f 0 (L) > 0 and M PL0 (L) =
f 00 (L) < 0 by above the marginal product of labour in positive and diminishing.
Since from prot maximization we know that MPL (L ) = w or
1
= w
(1 + L )2
=) (1 + L )2 = w
1
=) (1 + L ) = w 2
1
=) L = w 2 1:

Therefore:
dL 1 3
= w 2 < 0
dw 2
CHAPTER 2. UNIVARIATE CALCULUS 27

so the labour demand curve is downward sloping. The elasticity is not constant
since:
dL w 1 3 w
(!) = = w 2 1
dw L 2 w 2 1
1
1 w 2
=
2 w 12 1
or as illustrated in the plot below:

-2
-4
-6
-8
-10
-12
-14
-16
-18
-20
1.5 2 2.5 3
w
3.5 4 4.5 5 :
1
w 2
(w) = 1
w 2 1

The next 3 problems are based on the following information: Sup-


pose the rms production function is given by:

Q = (L1=2 + K 1=2 )2

where L is labour and K is capital. In the short-run the amount of capital is


given by K = 16:

Problem 26 Find the short-run production function. Show that the marginal
product of labour is positive and that the diminishing marginal product of labour
assumption is satised.

Answer
The short-run production function is:

Q = f (L) = (L1=2 + 161=2 )2


1
= L + 8L 2 + 16:

Therefore:
+
z}|{
1
MPL (L) = f (L) = 1 + 4L 2 > 0
0
CHAPTER 2. UNIVARIATE CALCULUS 28

and
+
z}|{
3
M PL0 (L) = f 00 (L) = 2L 2 < 0:

Problem 27 Assume that the rm is perfectly competitive in the goods market


and the labour market. Derive the rms demand curve for labour from the prot
maximizing condition and show that it is downward sloping.

Answer
From the prot maximizing condition
W
MPL (L ) = w =
P
we have:
1
1 + 4 (L ) 2 = w
1 1
=) (L ) 2 = (w 1)
4
2
1 16
=) L = (w 1) = :
4 (w 1)2

Note that this requires that w > 1: We then have:


dL 32
= < 0:
dw (w 1)3
| {z }
+

Problem 28 Find the rms cost function C(Q) , marginal cost and show that
C 00 (Q) > 0:

Answer
Solving Q = (L1=2 + 161=2 )2 for L we nd that:
1 2
Q = (L1=2 + 4)2 =) L = Q 2 4
1
=) L = Q 8Q 2 + 16:
1
with Q 8Q 2 + 16 we obtain:
Replacing L in C = W L + RK
1

C (Q) = W Q 8Q 2 + 16 + RK
1

=) M C (Q) = C 0 (Q) = W 1 4Q 2
3
=) M C 0 (Q) = C 00 (Q) = 2W Q 2 > 0:
CHAPTER 2. UNIVARIATE CALCULUS 29

Problem 29 Suppose that a rms short-run production is given by:


2
1 ln L10 =80ln L 16 12 ln( 14 )
Q = f (L) = L 4 e ( )
where Q is output and L is the number of workers. Calculate the marginal
product of labour and show that there is a diminishing marginal product of labour.
Find the rms demand curve for labour and the elasticity of labour demand.

Answer
Simplifying (in excruciating detail) we have:
2
1 ln L10 =80ln L 16 12 ln( 14 )
f (L) = L 4 e ( )
p
= L 4 e10 ln(L)=80+ 16 ln(L)+ln( 4)
1 2

1 1
= L 4 e 4 ln(L)+ln(2)
1 1
= L 4 e 4 ln(L) eln(2)
1
14
= L 4 eln(L) 2
1 1
= 2L 4 L 4
1
= 2L 2 :
Thus f (L) is a disguised Cobb-Douglas production function. Therefore:
1
M PL (L) = f 0 (L) = L 2
and
1 3
M PL0 (L) = f 00 (L) = L 2 < 0
2
so there is a diminishing marginal product of labour. From the prot maximizing
condition:
MPL (L ) = w
we have:
1
(L ) 2 = w
1
=) L = w2 =
w2
so that the elasticity of demand is 2:
Problem 30 Suppose in the short-run a perfectly competitive rm faces a price
P; a nominal wage W; a rental cost of capital R; and a xed amount of capital
The rms short-run production function relating Q output to L labour is
K:
given by:
1
2
Q = f (L) = 1 + L 2 :
CHAPTER 2. UNIVARIATE CALCULUS 30

What is the marginal product of labour? Show that this production function
satises the assumption of a diminishing marginal product of labour. Derive the
rms demand curve for labour L and show that the demand curve for labour
is downward sloping if W > P . Find the rms cost function C (Q), calculate
MC (Q) and show that C (Q) is globally convex. Would the rm ever produce
where Q < 1?

Answer
The derivations are a little easier if f (L) is rst simplied as:
1
2
Q = f (L) = 1 + L 2
1
= 1 + 2L 2 + L:
The marginal product of labour is then given by:
1
MPL (L) = f 0 (L) = 1 + L 2
and the assumption of a diminishing marginal product of labour is satised
since:
+
z}|{
1 3
M PL0 (L) = f 00 (L) = L 2 < 0:
2
1
To nd prots as a function of L replace Q with 1 + 2L 2 + L as:
1

(L) = P 1 + 2L 2 + L W L RK
1

=) 0 (L ) = 0 = P 1 + (L ) 2 W
W
1
=) (L ) 2 = 1 =w1
P
1
=) L = (w 1)2 = :
(w 1)2
Therefore assuming w > 1:
dL 2
= < 0:
dw (w 1)3
To obtain C (Q) note that:
1
2 1 2
Q = 1 + L 2 =) L = Q 2 1
1 2
so that replacing L with Q 2 1 yields cost as a function of Q as:

C (Q) = W L + +RK
1 2
= W Q 2 1 + RK
1


= W Q 2Q 2 + 1 + RK:
CHAPTER 2. UNIVARIATE CALCULUS 31

Thus:
1

M C (Q) = W 1 Q 2

and
1 3
C 00 (Q) = W Q 2 > 0 =) C (Q) is globally convex.
2
Note that M C (Q) < 0 for Q < 1 and since M C (Q) = P > 0 the rm would
always produce at Q > 1:

2.3 Cost Minimization


Problem 31 Suppose that a rm has a Cobb-Douglas production function:
1 1
Q = L2 K 2

and is faced with the problem of choosing L and K (we are in the long-run now!)
to minimize cost of producing a xed Q or:

W L + RK:

Since Q is xed, once L is chosen so too is K since:


1 1 1 1
Q = L 2 K 2 =) K 2 = QL 2
=) K = Q2 L1

Therefore we can write cost solely as a function of L as:

C (L) = W L + RK
= W L + RQ2 L1 :

Thus:

C 0 (L ) = W RQ2 (L )2 = 0
W
=) (L )2 = Q2
R
1 1
=) L = QW 2 R 2 :

This gives the cost minimizing amount of labour L : To nd the optimal K


calculate the required K need to produce Q as:

K = Q2 (L )1
1 1
1
= Q2 QW 2 R 2
1 1
= QW 2 R 2 :
CHAPTER 2. UNIVARIATE CALCULUS 32

The rms long-run cost function is then:

C = W L + RK
1 1 1 1
= W QW 2 R 2 + RQW 2 R 2
1 1 1 1
= QW 2 R 2 + QW 2 R 2
1 1
= 2QW 2 R 2 :

Note that
dC 1 1
= QW 2 R 2 = L
dW
dC 1 1
= QW 2 R 2 = K
dR
which illustrates Shephards lemma.

Problem 32 Suppose that a rm has a Cobb-Douglas production function:

Q = L K

and is faced with the problem of choosing L and K (we are in the long-run) to
minimize cost of producing a xed Q or:

W L + RK:

Since Q is xed, once L is chosen so too is K since:

Q = L K =) K = QL
1
=) K = Q L

Therefore we can write cost solely as a function of L as:

C (L) = W L + RK
1
= W L + RQ L :

Thus:
1
C 0 (L ) = W RQ (L ) 1 = 0

1 W
=) (L ) 1 = Q
R

(+) 1 W
=) (L ) = Q
R
+ +
W 1
=) L = Q +
R
+
1
=) L = W + R + Q + :

CHAPTER 2. UNIVARIATE CALCULUS 33

This gives the cost minimizing amount of labour L : To nd the optimal K


calculate the required K needed to produce Q as:
1
K = Q (L )
!
1 + 1
= Q W + R + Q +

+
1 1
= W + R + Q +

+

W + R + Q (1 + )
1
=

+

W + R + Q ( + )
1
=

+
1
= W + R + Q + :

2.4 Utility Maximization


Problem 33 Suppose that a household consuming apples Q1 and oranges Q2
gets utility:

U = 0:4 ln (Q1 ) + 0:6 ln (Q2 ) :

The household has income Y = 10; the price of Q1 is P1 and the price of Q2 is
P2 = 5 so that the budget constraint is:

10 = P1 Q1 + 5Q2 :

Solve for Q2 as a function of Q1 and write utility then as a function of Q1 ; say


f (Q1 ) : Find the utility maximizing Q1 from the rst-order conditions and show
that Q1 is a global maximum. What is the elasticity of demand?

Answer
From the budget constraint:
10 P1 Q1 P1
Q2 = =2 Q1
5 5
so that

P1
U (Q1 ) = 0:4 ln (Q1 ) + 0:6 ln 2 Q1
5
CHAPTER 2. UNIVARIATE CALCULUS 34

so that using the chain rule:


0:4 P1 0:6
U 0 (Q1 ) =
Q1 5 2 P51 Q1
0:4 P1 0:6
=) U 0 (Q1 ) = 0 =
Q1 5 2 P51 Q1
0:4 0:6
=) = P1
Q1 10 P1 Q1
=) 0:4 (10 P1 Q1 ) = 0:6 P1 Q1
=) 4 = P1 Q1
4
=) Q1 = = 4P11 :
P1
The elasticity of demand is the exponent on P1 which is 1:
Taking the second derivative we nd that:
2
00 0:4 P1 0:6
U (Q1 ) = 2 2 <0
Q1 5 2 P1
5 Q1

so that U (Q1 ) is globally concave and hence Q1 is a global maximum.

Problem 34 Suppose that a household consuming apples Q1 and oranges Q2


gets utility:

U = 0:3 ln (Q1 ) + 0:7 ln (Q2 ) :

The household has income Y; the price of Q1 is P1 and the price of Q2 is P2 so


that the income constraint is:

Y = P1 Q1 + P2 Q2 :

Find the utility maximizing Q1 . What is the elasticity of demand for Q1 and
the income elasticity of demand for Q1 ?

Answer
First solve for Q2 as a function of Q1 as:
Y P1 Q1 Y P1
Q2 = = Q1
P2 P2 P2
and use this to write U as a function of Q1 only as:

Y P1
U (Q1 ) = 0:3 ln (Q1 ) + 0:7 ln Q1 :
P2 P2
CHAPTER 2. UNIVARIATE CALCULUS 35

Dierentiating U (Q1 ) with respect to Q1 and using the chain rule for the second
term yields:
0:3 P1 0:7
U 0 (Q1 ) =
Q1 P2 Y
P2 PP2 Q1
1

so that the rst-order conditions for utility maximization require:


0:3 P1 0:7
U 0 (Q1 ) = 0=
Q1 P2 Y
P2 P
P2 Q1
1

0:3 P1 0:7
=) =
Q1 P2 P
Y
P2

P2 Q1
1

0:3 0:7
=) = P1
Q1 Y P1 Q1
=) 0:3 (Y P1 Q1 ) = 0:7P1 Q1
=) 0:3Y = P1 Q1
0:3Y
=) Q1 = = 0:3Y 1 P11 :
P1
The income elasticity is the exponent on Y or 1 while the own price elasticity
is the exponent on P1 or 1:

Problem 35 Suppose that a household consuming apples Q1 and oranges Q2


gets utility:

U = ln (Q1 ) + (1 ) ln (Q2 ) :

where: 0 < < 1: The household has income Y; the price of Q1 is P1 and the
price of Q2 is P2 so that the income constraint is:

Y = P1 Q1 + P2 Q2 :

Find the utility maximizing Q1 . What is the elasticity of demand for Q1 and
the income elasticity of demand for Q1 ? What does the taste parameter de-
termine?

Answer
First solve for Q2 as a function of Q1 as:
Y P1 Q1 Y P1
Q2 = = Q1
P2 P2 P2
and use this to write U as a function of Q1 only as:

Y P1
U (Q1 ) = ln (Q1 ) + (1 ) ln Q1 :
P2 P2
CHAPTER 2. UNIVARIATE CALCULUS 36

Dierentiating U (Q1 ) with respect to Q1 and using the chain rule for the second
term yields:

P1 (1 )
U 0 (Q1 ) =
Q1 P2 Y
P2 P P2 Q1
1

so that the rst-order conditions for utility maximization require:

P1 (1 )
U 0 (Q1 ) = 0=
Q1 P2 Y
P2P
P2 Q1
1

P1 (1 )
=) =
Q1 P2 Y
P2 P
P2 Q1
1

(1 )
=) = P1
Q1 Y P1 Q1
=) (Y P1 Q1 ) = (1 ) P1 Q1
=) Y = P1 Q1
Y
=) Q1 = = Y 1 P11 :
P1
The income elasticity is the exponent on Y or 1 while the own price elasticity
is the exponent on P1 or 1: Since:
P1 Q1
=
Y
the taste parameter determines the budget share of good 1: Thus if = 0:4
then the household always spends 40% of its income on good 1:

Problem 36 Suppose that a household consuming apples Q1 and oranges Q2


gets utility:
p p
U = 0:3 Q1 + 0:7 Q2 :

The household has income Y; the price of Q1 is P1 and the price of Q2 is P2 so


that the income constraint is:

Y = P1 Q1 + P2 Q2 :

Find the utility maximizing Q1 . What is the elasticity of demand for Q1 and
the income elasticity of demand for Q1 ?

Answer
First solve for Q2 as a function of Q1 as:
Y P1 Q1 Y P1
Q2 = = Q1
P2 P2 P2
CHAPTER 2. UNIVARIATE CALCULUS 37

and use this to write U as a function of Q1 only as:


r
p Y P1
U (Q1 ) = 0:3 Q1 + 0:7 Q1 :
P2 P2
Dierentiating U (Q1 ) with respect to Q1 and using the chain rule for the second
term yields:
1 0:3 1 P1 0:7
U 0 (Q1 ) = p q
2 Q1 2 P2 Y P1
P2 P2 Q1

so that the rst-order conditions for utility maximization require:


1 0:3 1 P1 0:7
U 0 (Q1 ) = 0= p q
2 Q1 2 P2 Y P1
P2 P2 Q1
0:3 P 0:7
=) p = 1q
Q1 P2 Y P1
P2 P2 Q1
2
(0:3)2 P1 (0:7)2
=) =
Q1 P2 Y P1
P2 P2 Q1
2
Y P1 P1
=) (0:3)2 Q1 = (0:7)2 Q1
P2 P2 P2
2 Y
(0:3) P2
=) Q1 = 2
(0:3)2 P1
P2 + (0:7)2 P1
P2
2 P2
(0:3) P1 Y
=) Q1 =
(0:3)2 P2 + (0:7)2 P1
The income elasticity is the exponent on Y or 1:
Problem 37 Suppose that a household consuming apples Q1 and oranges Q2
gets utility:
U = U1 (Q1 ) + U2 (Q2 ) :
where U100 (Q1 ) < 0 and U200 (Q2 ) < 0: The household has income Y; the price of
Q1 is P1 and the price of Q2 is P2 so that the income constraint is:
Y = P1 Q1 + P2 Q2 :
Find the rule for utility maximization. Show that Q1 and Q2 are normal goods.

Answer
First solve for Q2 as a function of Q1 as:
Y P1 Q1 Y P1
Q2 = = Q1
P2 P2 P2
CHAPTER 2. UNIVARIATE CALCULUS 38

and use this to write U as a function of Q1 only as:



Y P1
U (Q1 ) = U1 (Q1 ) + U2 Q1 :
P2 P2

Dierentiating U (Q1 ) with respect to Q1 and using the chain rule for the second
term yields:

0 0 P1 0 Y P1
U (Q1 ) = U1 (Q1 ) U Q1
P2 2 P2 P2

so that the rst-order conditions for utility maximization require:



P1 0 Y P1
U 0 (Q1 ) = 0 = U10 (Q1 ) U2 Q1
P2 P2 P2

P1 0 Y P1
=) U10 (Q1 ) = U2 Q1
P2 P2 P2
P 1 0
=) U10 (Q1 ) = U (Q )
P2 2 2
Y P1
since Q2 = P2 P2 Q1 : We can write this in turn as:

U10 (Q1 ) U 0 (Q )
= 2 2
P1 P2
or the household allocates goods so that the marginal utility of each good divided
by its price is the same for both goods.
To show that both goods are normal write Q1 (Y ); that is the demand for
good 1 as a function of income Y: From the rst-order condition then we have:

0 P1 0 Y P1
U1 (Q1 (Y )) = U Q (Y ) :
P2 2 P2 P2 1

Dierentiating both sides with respect to Y and using the chain rule yields:

dQ1 (Y ) P1 00 Y P1 1 P1 dQ1 (Y )
U100 (Q1 (Y )) = U2 Q1 (Y )
dY P2 P2 P2 P2 P2 dY

P1 00 Y P1

dQ1 (Y ) (P2 )2 U2 P2 P2 Q1 (Y )
=) = 2
dY
U100 (Q1 (Y )) + P12 U200 PY2 P
P
P2 Q1 (Y )
1


P1 U200 PY2 P P2
1
Q
1 (Y )
= >0
P2 U1 (Q1 (Y )) + P1 U200 PY2 P
2 00 2 1
P2 1Q (Y )

since U100 < 0 and U200 < 0 implies that both the numerator and denominator are
CHAPTER 2. UNIVARIATE CALCULUS 39

negative. For Q2 (Y ) we have:



dQ2 (Y ) d Y P1
= Q (Y )
dY dY P2 P2 1
1 P1 dQ1 (Y )
=
P2 P2 dY

P2 U100 PY2 P
P2 Q1 (Y )
1

= > 0:
P22 U100 (Q1 (Y )) + P12 U200 PY2 P
P2 Q1 (Y )
1

2.5 Mark Maximization


Problem 38 Suppose you are writing an exam with two questions. The mark
you receive on question 1 is M1 (t1 ) where: M1 (t1 ) = 60 (1 et1 ) and t1 is
the time spent on question 1: Similarly the mark on question 2 is: M2 (t2 ) =
40 (1 et2 ) where t2 is the time spent on question 2: Show for question 1 that
the marginal mark is positive and diminishing. If the exam is 1 hour long so
that t1 + t2 = 1; nd the optimal amount of time t1 and t2 that you would spend
on each question. What grade would you receive?

Answer
For question 1:
+
z}|{
M10 (t1 ) = 60et1 > 0 =) marginal mark is positive
+
z}|{
M100 (t1 ) = 60et1 < 0 =) diminishing marginal mark.

Since t2 = 1 t1 we can write the mark as a function of t1 alone as:

M (t1 ) = M1 (t1 ) + M2 (1 t1 )

= 60 1 et1 + 40 1 e(1t1 )

so that:

M 0 (t1 ) = 60et1 40e(1t1 )



=) M 0 (t1 ) = 0 = 60et1 40e(1t1 )

=) 60et1 = 40e(1t1 )
60 3
=) = = e(1t1 ) e(t1 ) = e2t1 1
40 2
3
=) 2t1 1 = ln
2

1 1 3
=) t1 = + ln = 0:702:
2 2 2
CHAPTER 2. UNIVARIATE CALCULUS 40

Thus t2 = 1 t1 = 1 0:702 = 0:297: Thus the student spends about 70% of the
time on question 1 (about 42 minutes) and about 30% of the time on question
2 (about 18 minutes). The student receives a grade of:

M (t1 ) = 60 1 e0:702 + 40 1 e(10:702)
= 40:572

or a grade of about 41%: The grade as a function of t1 is plotted below:

40

38

36

34

32

30

28

26
0 0.2 0.4 0.6 0.8 1

M (t1 ) = 60 (1 et1 ) + 40 1 e(1t1 )

Problem 39 Suppose you are writing an exam with two questions. Let t1 be
the amount of time you spend on question 1 and t2 the amount of time your
spend on question 2: Let M1 (t1 ) = 0:6 ln (t1 ) be the mark you get on question 1
and let M2 (t2 ) = 0:4 ln (t2 ) be the mark you get on question 2 so that your total
grade is:

M = 0:6 ln (t1 ) + 0:4 ln (t2 ) :

Let

T = t1 + t2

be the total time you have to write the exam. Find t1 and t2 ; the optimal
amount of time to spend on each question, and prove that what you nd is a
global maximum.

Answer
By replacing t2 with T t1 we have:

M (t1 ) = 0:6 ln (t1 ) + 0:4 ln (T t2 )


CHAPTER 2. UNIVARIATE CALCULUS 41

so that:
0:6 0:4
M 0 (t1 ) =
t1 T t1
0:6 0:4
=) M 0 (t1 ) = 0 =
t1 T t1
0:6 0:4
=) =
t1 T t1
=) 0:6 (T t1 ) = 0:4t1
=) t1 = 0:6T:

Since t2 = T t1 we have:

t2 = 0:4T

so that it optimal to spend 60% of the time on question 1 and 40% on question
2:
t1 = 0:6T is a global maximum since:
0:6 0:4
M 00 (t1 ) = 2 <0
t1 (T t1 )2

so that M (t1 ) is globally concave.

Problem 40 Suppose you are writing an exam with two questions. The mark
you receive on question 1 is M1 (t1 ) and the mark on question 2 is: M2 (t2 )
where t2 is the time spent on question 2: Find rule the optimal amount of time
t1 and t2 that you would spend on each question. Show that the solution to the
rst-order conditions is a global maximum if M1 (t1 ) and M2 (t2 ) are concave.
Show that t1 and t2 are normal goods, that is if T increases (the instructor gives
you more time) then both t1 and t2 increase.

Answer
We have:

t2 = T t1

so that we can write the mark as a function of t1 alone as:

M (t1 ) = M1 (t1 ) + M2 (T t1 )

so that using the chain rule for M2 (T t1 ):

M 0 (t1 ) = M10 (t1 ) M20 (T t1 )


=) M 0 (t1 ) = M20 (T t1 )
=) M 0 (t1 ) = M20 (t2 )
CHAPTER 2. UNIVARIATE CALCULUS 42

where t2 = T t1 is the optimal amount of time spent on question 2: Thus the


student should allocate his or her time so as to equate the marginal mark in
each question.
Given that M100 (t1 ) < 0 and M200 (t2 ) < 0 we have:

M 0 (t1 ) = M10 (t1 ) M20 (T t1 )


=) M 00 (t1 ) = M100 (t1 ) + M200 (T t1 ) < 0

so that M (t1 ) is globally concave and the solution to the rst-order conditions
is a global maximum.
We can write t1 (T ) ; that is the optimal amount of time spent on question
1 will depend on the amount of time available. This satises:

M10 (t1 (T )) = M20 (T t1 (T )) :

Dierentiating both sides with respect to T and using the chain rule we nd
that:

00 dt1 (T ) 00 dt1 (T )
M1 (t1 (T )) = M2 (T t1 (T )) 1
dT dT
dt1 (T ) M200 (T t1 (T ))
=) = 00 >0
dT M1 (t1 (T )) + M200 (T t1 (T ))

since given M100 (t1 ) < 0 and M200 (t2 ) < 0 both the numerator and denominator
dt
1 (T )
are negative. Furthermore since t2 (T ) = T dT we have:

dt2 (T ) dt1 (T )
= 1
dT dT
M200 (T t1 (T ))
= 1
M100 (t1 (T )) + M200 (T t1 (T ))
M100 (T t1 (T ))
= > 0:
M1 (t1 (T )) + M200 (T t1 (T ))
00

2.6 Monopoly
The next two problems are based on the following information: Con-
sider a monopolist who faces an inverse demand function of the form:

P = P (Q) ; P 0 (Q) < 0

so that unlike the perfectly competitive rm a monopolist must reckon with the
fact that selling more will cause the price he receives to drop. Revenue for the
monopolist is given by:

R (Q) = P (Q) Q;
CHAPTER 2. UNIVARIATE CALCULUS 43

so that marginal revenue is:


MR (Q) = R0 (Q) :
Suppose that the cost function of the monopolist is of the form:
C (Q)
which is increasing and convex so that:
M C (Q) = C 0 (Q) > 0
M C 0 (Q) = C 00 (Q) > 0:
Problem 41 What rule should the rm use to decide how much of Q to produce.

Answer
Prots are given by:
(Q) = R (Q) C (Q)
= P (Q) Q C (Q)
so that the rst-order condition for prot maximization is:
0 (Q ) = R0 (Q ) C 0 (Q )
= MR (Q ) MC (Q )
=) MR (Q ) = MC (Q ) :
Problem 42 Use proof by contradiction to show that if P 0 (Q) < 0 then the
monopolist who equates marginal revenue with marginal cost will produce less
output than a perfectly competitive industry where price equals marginal cost.

Answer
Let PM and QM be the monopolists price and output and let PC and QC
be the competitive level of output.
Assume for the sake of argument that QM QC . Since P 0 (Q) < 0 we have:
P (QM ) P (QC )
=) P (QC ) P (QM ) 0:
Since M C 0 (Q) > 0 we have:
QM QC =) M C (QM ) M C (QC ) :
Therefore:
M R (QM ) = M C (QM ) MC (QC ) = P (QC )
=) M R (QM ) = P (QM ) + P 0 (QM ) QM P (QC )
=) P 0 (QM ) QM P (QC ) P (QM ) 0
=) P 0 (QM ) 0:
CHAPTER 2. UNIVARIATE CALCULUS 44

But by we know that P 0 (QM ) < 0 so we have a contradiction.


Therefore QM < QC and since P 0 (Q) < 0 we have: PM = P (QM ) >
P (QC ) = PC :
Problem 43 If the inverse demand is P (Q) = AQ for 0 < < 1 and the
monopolists technology is Q = f (L) = BL for 0 < < 1: Find the prot
maximizing level of output.

Answer
We have:
(L) = P (Q) Q W L
= A (BL )1 W L
AB 1 L(1) W L
=) 0 (L ) = 0 = (1 ) AB 1 (L )(1)1 W
W
=) (L )(1)1 =
(1 ) AB 1
1(1)
1

W
=) L =
(1 ) AB 1
so that:
Q = B (L )
1(1)
1 !
W
= B :
(1 ) AB 1
1
Problem 44 If the inverse demand is P (Q) = Q 2 ; W = 2 and the monopo-
1
lists technology is Q = f (L) = L 3 nd the prot maximizing level of output.

Answer
We have:
(L) = P (Q) Q W L
1
= L 6 2L
1 56
=) 0 (L ) = 0 = (L ) 2
6
5
=) (L ) 6 = 12
6
=) L = (12) 5
so that:
1
6
13
Q = (L ) 3 = (12) 5
2
= (12) 5 :
CHAPTER 2. UNIVARIATE CALCULUS 45

Problem 45 Given the demand curve: Q = P105 what is the elasticity of de-
mand? Is demand elastic or inelastic? If Q (P ) = P105 + 5 then what is the
elasticity of demand when P = 1? Prove that if revenue is given by: R (P ) =
P Q (P ) then for any demand curve R0 (P ) = Q (P ) (1 + (P )) where (P )
is the elasticity of demand. If a rm maximizes sales (instead of prots) at P ;
then what will the elasticity of demand be?

Answer
The elasticity of demand is = 5: Demand is elastic since < 1:
If Q (P ) = P105 + 5 Solution: then Q0 (P ) = P506 so that:

Q0 (P ) P 50P 5
(P ) = =
Q (P ) 10P 5 + 5
and hence:
50
(1) = = 3:33:
10 + 5
In general (P ) varies with P as shown below:

P
1 2 3 4 5
0

-1

-2

-3

-4

-5

50P 5
Plot of (P ) = 10P 5 +5

Problem 46 Suppose a monopolist faces an inverse demand curve: P (Q) =


1
2Q 4 and cost function C (Q) = 5Q3 + 10: What are the marginal revenue,
marginal cost and average cost functions? Determine Q ; the prot maximizing
level of output for the monopolist and P ; the resulting price.

Answer
Revenue and marginal revenue are given by:
3
R (Q) = P (Q) Q = 2Q 4
3 1
=) MR (Q) = R0 (Q) = Q 4 :
2
CHAPTER 2. UNIVARIATE CALCULUS 46

The inverse demand curve P (Q) and marginal revenue curve M R (Q) are plot-
ted below:

2.4
2.2
2
1.8
1.6
1.4
1.2
1
0.8

5 10 15 20 25
Q

Marginal M C (Q) and average cost AC (Q) are:

M C (Q) = C 0 (Q) = 15Q2


C (Q) 5Q3 + 10 10
AC (Q) = = = 5Q2 +
Q Q Q
and are plotted below:

30

25

20

15

10

5
0.6 0.8 1 1.2 1.4
Q

M C (Q) and AC (Q)

From M R (Q ) = MC (Q ) we have:
3 14
(Q ) = 15 (Q )2
2
3 1
=) (Q )2+ 4 =
2 15
49
1
=) Q = = 0:36:
10
CHAPTER 2. UNIVARIATE CALCULUS 47

Therefore:
49 ! 14
14 1 1
P = 2 (Q ) =2 = 2 10 9 = 2:5831:
10

2.7 Price Discrimination


Consider a rm (a monopolist) who is able to price discriminate between two
markets; for example an airline which can charge one price for an economy fare
to a tourist and another price for business class.
Let P1 and Q1 be the price and quantity sold to the rst market and let
P2 and Q2 be the price and quantity sold to the second market. The inverse
demand curves are given respectively by:

P1 = P1 (Q1 ) ; P10 (Q1 ) < 0


P2 = P2 (Q2 ) ; P20 (Q2 ) < 0

so that revenue for the two markets is given by:

R1 (Q1 ) = P1 (Q1 ) Q1 ;
R2 (Q2 ) = P2 (Q2 ) Q2

and marginal revenue for market 1 is given by:

MR1 (Q1 ) = R10 (Q1 )



Q1
= P1 (Q1 ) + P10 (Q1 ) Q1 = P1 (Q1 ) 1 + P10 (Q1 )
P1 (Q1 )
= P1 (Q1 ) (1 + 1 (Q1 ))

1
= P1 (Q1 ) 1 +
~1

where 1 (Q1 ) = ~1 < 0 is the elasticity of the inverse demand curve which is
1
the inverse of the elasticity of the demand curve ~1 : Similarly for market 2:

M R2 (Q2 ) = P2 (Q2 ) (1 + 2 (Q2 ))



1
= P2 (Q2 ) 1 +
~2

where 2 (Q2 ) = ~1 < 0 is the elasticity of the inverse demand curve which is
2
the inverse of the elasticity of the demand curve ~2 : Suppose that the rm has
already chosen the prot maximizing total level of output Q = Q1 + Q2 :

Problem 47 What rule should the rm use to decide how much of Q to allocate
to the two markets; for example with an airline, how many seats should be
economy and how many should be business class.
CHAPTER 2. UNIVARIATE CALCULUS 48

Answer
Since Q is xed so too are costs. The rm therefore needs to allocate Q
amongst Q1 and Q2 so as to maximize the revenue it makes given by:
R = R1 (Q1 ) + R2 (Q2 ) :
We can write R as a function of Q1 alone using:
Q2 = Q Q1
so that:
R (Q1 ) = R1 (Q1 ) + R2 (Q Q1 ) :
Dierentiating with respect to Q1 and using the chain rule to dierentiate
R2 (Q Q1 ) with respect to Q1 we nd that :
R0 (Q1 ) = R01 (Q1 ) R02 (Q Q1 )
= MR1 (Q1 ) M R2 (Q Q1 )
=) R0 (Q1 ) = 0 = MR1 (Q1 ) M R2 (Q Q1 )
=) MR1 (Q1 ) = M R2 (Q2 )
where: Q2 = Q Q1 : Thus the rst should allocate Q1 and Q2 between the two
markets so as to equate marginal revenue in each market.
This in turn implies that:
P1 (Q1 ) (1 + 1 (Q1 )) = M R1 (Q1 ) = M R2 (Q2 ) = P2 (Q2 ) (1 + 2 (Q2 ))
or:
P1 (Q1 ) (1 + 1 (Q1 )) = P2 (Q2 ) (1 + 2 (Q2 ))
or:

1
P1 (Q1 ) (1 + 2 (Q2 )) 1+
~2
= = :
P2 (Q2 ) (1 + 1 (Q1 )) 1+ 1

~1

From this it follows that if ~2 < ~1 so that demand is more elastic in market
2 than market 1; or equivalently if 1 (Q1 ) > 2 (Q2 ) ; then P2 < P1 : Thus the
rm charges the higher price to the market where demand is more inelastic or
more price insensitive.
Problem 48 Suppose that the inverse demand for economy seats and business
class seats is given respectively by:
14 1
P1 = A1 Q1 , P2 = A2 Q2 2 :

What will P
P2 ; the ratio of the price of economy seats to business class seats be?
1

If Q = 200 then what will Q1 and Q2 be?


CHAPTER 2. UNIVARIATE CALCULUS 49

Answer
Here since the demand curves take the form y = Axb the elasticity of
demand is constant for both markets with ~1 = 4 and ~2 = 2: We therefore
have:

1 1
P1 1 +
~2 1 + 2 2
= = =
P2 1+ 1
1+ 1 3

~1 4
2
so that P1 = 3 P2 :
Thus economy seats will be two-thirds the price of business
class seats.
To calculate Q1 and Q2 we use:
1
A1 Q1 (1 1 ) = A2 (Q Q1 )2 (1 2 )
1

12 A1 (1 1 ) 2
=) (Q1 ) = (Q Q1 )
A2 (1 2 )
1 1

12 A1 (1 1 ) 2 A1 (1 1 ) 2
=) (Q1 ) + Q1 Q=0
A2 (1 2 ) A2 (1 2 )
so that:
1 1
A1 (1 1 ) 2 A1 (1 1 ) 2
(Q1 )2 + Q1 Q = 0:
A2 (1 2 ) A2 (1 2 )

2.8 Inverse Functions


Problem 49 If f 0 (x) > 0 and f 00 (x) < 0 so that f (x) is concave prove that
the inverse function g (x) will be convex or g 00 (x) > 0:

Answer
Dierentiating both sides of f (g (x)) = x with respect to x and using the
chain rule leads to:
f 0 (g (x)) g 0 (x) = 1:
Since f 0 (g (x)) > 0 it follows that
1
g 0 (x) = > 0:
f 0 (g (x))
Dierentiating both sides of f 0 (g (x)) g0 (x) = 1 with respect to x and using
the chain and product rules leads to:
f 00 (g (x)) g 0 (x)2 + f 0 (g (x)) g 00 (x) = 0
+
z }| {z }| {
f 00 (g (x))g 0 (x)2
=) g 00 (x) = > 0:
f 0 (g (x))
| {z }
+
CHAPTER 2. UNIVARIATE CALCULUS 50

Problem 50 If
3
1
f (x) = p
x
then what is the inverse function and what is the elasticity of the inverse func-
tion?

Answer
If
3
1 3
f (x) = p = x 2
x
2
=) g (x) = x 3

since:
3 23 3 2
g (f (x)) = x 2 = x 2 3 = x1 = x
2 32 2 3
f (g (x)) = x 3 = x 3 2 = x1 = x:

The elasticity of g (x) is the exponent on x or 23 :

Problem 51 If the demand curve takes the form

Q = Q (P ) = AP

what is the inverse demand curve P = P (Q)? . What is the elasticity of Q (P )


and what is the elasticity of P (Q) and how are the two elasticities related?

Answer
Here:
1 1
P (Q) = A Q :

Since both Q (P ) and P (Q) have the form Axb the elasticity of Q (P ) is
while the elasticity of P (Q) is 1 :

Problem 52 If a demand curve takes the form Q = Q (P ) where f 0 (P ) < 0


show that it has an inverse demand curve P = P (Q) : If (P ) is the elasticity
of the demand curve and ~ (Q) is the elasticity of the inverse demand curve,
show that:
1
(P ) =
~ (Q (P ))
1
~ (Q) = :
~ (P (Q))
CHAPTER 2. UNIVARIATE CALCULUS 51

Answer
Problem 53 If g (x) and f (x) are two functions, then what does the chain rule
give as the derivative of h (x) = f (g (x)) is? If g (x) is the inverse function of
f (x) then what is f (g (x)) equal to? Under what conditions does an inverse
function exist? What is the inverse function of f (x) = x2 for 1 < x < 1?
What is the inverse function of f (x) = x2 for 0 < x < 1? Show that f (x) =
x2 + 3x + 5 for x > 0 has an inverse function. Show that if f (x) is a globally
decreasing and convex function then its inverse function g (x) is convex.

Answer
We have using the chain rule:

h0 (x) = f 0 (g (x)) g0 (x)

and if f (x) and g (x) are inverses then f (g (x)) = x: To have an inverse we
require f 0 (x) > 0 or f 0 (x) < 0 for all x in the domain of f (x) : If f (x) = x2
for 1 < x < 1 then f (x) does not have an inverse since f 0 (x) = 2x > 0 for
x > 0 and f 0 (x) = 2x < 0 for x < 0: For f (x) = x2 with 0 < x < 1 the inverse
1
function is f (x) = x 2 since f 0 (x) > 0 for x > 0:
Now dierentiating both sides of f (g (x)) = x with respect to x we obtain:

f 0 (g (x)) g 0 (x) = 1:
1
Since f 0 (g (x)) < 0 it follows that g0 (x) = f 0 (g(x)) < 0: Again dierentiating
with respect to x we obtain:

f 00 (g (x)) g0 (x)2 + f 0 (g (x)) g00 (x) = 0


+ +
z }| {z }| {
f (g (x))g 0 (x)2
00
=) g 00 (x) = >0
f 0 (g (x))
| {z }

so that g (x) is convex.

Problem 54 Suppose that for x > 0 that f (x) is given by:

f (x) = x2 + 2x + 1:

Show that f (x) has an inverse function g (x) and nd g (x).

Answer
Since:

f 0 (x) = 2x + 2 > 0 since x > 0


CHAPTER 2. UNIVARIATE CALCULUS 52

it follows that f (x) has an inverse function. If y = g (x) then f (g (x)) = x or:

f (y) = y 2 + 2y + 1 = x
=) (y + 1)2 = x
1
=) y + 1 = x 2
1
=) g (x) = y = x 2 1:

A more careful analysis would explain why we take the positive and not the
negative square root of x in the third line.

Problem 55 Suppose that for x > 0 that f (x) is given by:

f (x) = x2 2x + 1:

Show that f (x) does not have an inverse function. Show how by restricting the
domain of f (x) further you can allow for the existence of an inverse function.

Answer
Since:

f 0 (x) = 2x 2

so that f 0 (x) < 0 for x < 12 and f 0 (x) > 0 for x > 12 it follows that f (x) is not
monotonic and hence has no inverse function.
If we restrict the domain of f (x) so that x > 12 (or 0 < x < 12 will do too)
then f 0 (x) < 0 and so f (x) is monotonic. If we dene y = g (x) then:

f (y) = y 2 2y + 1 = x
=) (y 1)2 = x
1
=) y 1 = x 2
1
=) g (x) = y = x 2 + 1:

2.9 Product, Quotient and Chain Rules


Problem 56 Suppose that f (x) and g(x) are two monotonically increasing con-
vex functions so that for all x; f 0 (x) > 0; g 0 (x) > 0; f 00 (x) > 0 and g 00 (x) > 0.
Construct a new function h(x) = g(f (x)): Show that h (x) is monotonically
increasing and convex.

Answer
We have from the chain rule that:

h0 (x) = g 0 (f (x)) f 0 (x) > 0


CHAPTER 2. UNIVARIATE CALCULUS 53

since g 0 (f (x)) > 0 and f 0 (x) by assumption. Dierentiating yet again we nd


that:
2
h00 (x) = g 00 (f (x)) (f 0 (x)) + g0 (f (x)) f 00 (x) > 0
2
since: g 00 (f (x)) > 0; (f 0 (x)) > 0; g 0 (f (x)) > 0 and f 00 (x) > 0:
Problem 57 If C (Q) is the cost function and AC(Q) = C(Q)=Q is the aver-
age cost function, show that average cost is increasing whenever marginal cost
exceeds average cost.

Answer
Dierentiating AC(Q) and using the quotient rule we nd that:
dAC(Q) QC 0 (Q) C (Q)
=
dQ Q2
0 C(Q)
Q C (Q) Q
=
Q Q
M C (Q) AC (Q)
= :
Q
Since the denominator Q is positive we have:
dAC(Q)
> 0 , MC (Q) > AC (Q)
dQ
dAC(Q)
< 0 , MC (Q) < AC (Q) :
dQ
Problem 58 If h (x) = f (g (x)) then what does the chain rule say h0 (x) is?
If h (x) = F (g1 (x) ; g2 (x)) then what is h0 (x)? Suppose Q = f (L) where
f 0 (L) > 0 and f 00 (L) < 0: If the demand for labour is: L = g (w) dened
by: f 0 (g (w)) = w; then show that g0 (w) < 0:
Problem 59 Suppose that W (t) is the nominal wage at time t and P (t) is the
price level at time t so that the real wage at time t is:
W (t)
w (t) = :
P (t)
w0 (t) W 0 (t)
The growth rate of w (t) is ! (t) = w(t) ; the growth rate of W (t) is (t) = W (t)
P 0 (t)
and the growth rate of P (t) (i.e., the rate of ination) is (t) = P (t) : Prove
that:
! (t) = (t) (t) :
using 1) the quotient rule 2) the product rule, and 3) the chain rule. For example
if nominal wages increase by 10% and ination is 4% then real wages increase
by 10% 4% = 6%:
CHAPTER 2. UNIVARIATE CALCULUS 54

Answer
Using the quotient rule we have:
P (t) W 0 (t) W (t) P 0 (t)
w0 (t) =
P (t)2
w0 (t)
=) ! (t) =
w (t)
P (t)W 0 (t)W (t)P 0 (t)
P (t)2
= W (t)
P (t)
0 0
W (t) P (t)
=
W (t) P (t)
= (t) (t) :

To use the product rule write W (t) = w (t) P (t) and apply the product rule.
To use the chain rule apply ln () to both sides of w (t) = W (t)
P (t) to obtain:

ln (w (t)) = ln (W (t)) ln (P (t))


and dierentiate both sides with respect to t using the chain rule.
Problem 60 Suppose f 0 (x) > 0, f 00 (x) < 0; g 0 (x) > 0 and g00 (x) < 0: If
h (x) = g (f (x)) then show that h0 (x) > 0 and determine if h (x) is concave or
convex.

Answer
We have using the chain rule that:
+ +
z }| {z }| {
h0 (x) = g0 (f (x))f 0 (x) > 0:
Dierentiating again with respect to x we obtain:
+ +
z }| {z }| { z }| {z }| {
2
h00 (x) = g00 (f (x))f 0 (x) + g 0 (f (x))f 00 (x) < 0:

2.10 Polynomials and Taylor Series


Problem 61 Consider the following functions dened on x > 0:
f(x) = 5x3 4x2 2x + 5:
Use the rst order conditions to nd the possible local maxima or minima. Use
the second order conditions to determine which are local maxima and which are
local minima. Is the function globally convex or globally concave. Is x a global
maximum or minimum?
CHAPTER 2. UNIVARIATE CALCULUS 55

Answer
We have:

f 0 (x) = 15x2 8x 2
=) f 0 (x ) = 0 = 15 (x )2 8x 2
q
(8) (8)2 4 (15) (2)
=) x =
2 (15)
4 1 p
=) x = + 46 = 0:719:
15 15
4 1
p
The other root: 15 15 46 is negative and hence is not in the domain of f (x) :
Now:

f 00 (x) = 30x 8:

Since:

f 00 (0:719) = 30 0:719 8 = 13:57 > 0

it follows that: x = 0:719 is a local minimum.


The function f (x) is neither globally concave nor convex since f 00 (x) < 0
8 8 8
for x < 30 and f 00 (x) > 0 for x > 30 with x = 30 an inection point. This is
illustrated in the graph below:

5.5

4.5

3.5
0 0.2 0.4 0.6 0.8 1 1.2
x :
3 2
f (x) = 5x 4x 2x + 5

From the graph it appears that x is in fact a global minimum even though
f (x) is not globally convex. We can prove this by factoring f 0 (x) as:

f 0 (x) = 15x2 8x 2

4 1p 4 1p
= 15 x + 46 x 46 :
15 15 15 15
CHAPTER 2. UNIVARIATE CALCULUS 56

From this you can show that f 0 (x) < 0 for 0 < x < x since this implies that:

4 1p 4 1p
x + 46 < 0; x 46 >0
15 15 15 15
=) f 0 (x) < 0:
Similarly for x > x we have:

4 1p 4 1p
x + 46 >0; x 46 >0
15 15 15 15
=) f 0 (x) > 0:
4 1
p
Thus x = 15 + 15 46 is a global minimum. (This would not be the case if
the domain were not restricted to x > 0 ):
3
Problem 62 If f (x) = x3 2x2 + 3x + 7 nd the solutions to the rst-order
conditions (i.e., any local maxima or minima). Given any function f (x) what
is the formula for f~ (x): the second order Taylor series approximation of f (x)
around x = xo ? What kind of function is f~ (x)? If f (x) = x2 ex nd the second
order Taylor series approximation f~ (x) around xo = 1:

Answer
Since:
f 0 (x) = x2 4x + 3
=) f 0 (x ) = 0 = (x )2 4x + 3
q

(4) (4)2 4 3
=) x =
2
=) x1 = 1; x2 = 3:
The formula for the second order Taylor series, which is a quadratic or a
second degree polynomial, around x0 is:
f 00 (x0 )
f~ (x) = f (x0 ) + f 0 (x0 ) (x x0 ) + (x x0 )2 :
2
For f (x) = x2 ex and x0 = 1 we have:
f (1) = 12 e1 = e1
f 0 (x) = 2xex x2 ex =) f 0 (1) = 2 1 e1 12 e1 = e1
f 00 (x) = 2ex 4xex + x2 ex =) f 00 (1) = 2 e1 4 e1 + 12 e1 = e1
so that the Taylor series is:
1
e
f~ (x) = e1 + e1 (x 1) (x 1)2
! 2
2
(x 1)
= e1 x :
2
CHAPTER 2. UNIVARIATE CALCULUS 57

The actual function f (x) = x2 ex and the Taylor series around x0 = 1 are
plotted below:

0.4
0.2
x
1 2 3 4 5
0
-0.2
-0.4
-0.6
-0.8
-1

Problem 63 If f (x) = x3 6x2 + 9x + 7 nd the solutions to the rst-order


conditions (i.e., any local maxima or minima) and determine which is a local
maximum and which a local minimum. Given any function f (x) what is the
formula for f~ (x): the second order Taylor series approximation of f (x)around
x = xo ? What kind of function is f~ (x)? For the function f (x) = ln 1 x2
calculate the second-order Taylor series around xo = 0:

Answer
Since for f (x) = x3 6x2 + 9x + 7

f 0 (x) = 3x2 12x + 9


=) f 0 (x ) = 0 = 3 (x )2 12x + 9
q
(12) (12)2 4 3 9
=) x =
23
=) x1 = 1; x2 = 3:

Since:

f 00 (x) = 6x 12

and

f 00 (1) = 6 1 12 = 6 < 0
f 00 (3) = 6 3 12 = 6 > 0
CHAPTER 2. UNIVARIATE CALCULUS 58

it follows that x1 = 1 is a local maximum and x2 = 3 is a local minimum. This


is illustrated in the plot below:

11

10

7
0 1 2 3 4
x

f (x) = x3 6x2 + 9x + 7

The formula for the second order Taylor series, which is a quadratic or a
second degree polynomial, around x0 is:

f 00 (x0 )
f~ (x) = f (x0 ) + f 0 (x0 ) (x x0 ) + (x x0 )2 :
2

For f (x) = ln 1 x2 and x0 = 0 we have:

0
f (0) = ln 1 =0
2
1 1 1
f 0 (x) = =) f 0 (0) = =
2 1 12 x 2 1 12 0 2
1 1 1
f 00 (x) = 00
2 =) f (0) = =
1 1 2 4
4 1 2x 4 1 20

so that the Taylor series is:


1 1
f~ (x) = x x2 :
2 8

The actual function f (x) = ln 1 x2 and the Taylor series around x0 = 0 are
CHAPTER 2. UNIVARIATE CALCULUS 59

plotted below:

0.4
0.2 x
-1.5 -1 -0.5 0.5 1 1.5
0
-0.2
-0.4
-0.6
-0.8
-1
-1.2
-1.4


f (x) = ln 1 x2 and f~ (x)

2.11 Exponential Functions and Logarithms


Problem 64 Consider the following function dened on x > 0:
3
x
f (x) = ln 4x:
2
Use the rst order conditions to nd the possible local maxima or minima. Use
the second order conditions to determine which are local maxima and which are
local minima. Is the function globally convex or globally concave. Is x a global
maximum or minimum?

Answer
We have that f (x) can be simplied since:
3
x
f (x) = ln 4x = 3 ln (x) 4x ln (2) :
2
Therefore:
3
f 0 (x) = 4
x
3
=) f 0 (x ) = 0 = 4
x
3
=) x = = 0:75:
4
Now:
3
f 00 (x) = <0
x2
CHAPTER 2. UNIVARIATE CALCULUS 60

3
so that f (x) is globally concave. It follows that x = 4 is a global maximum.
This is illustrated in the graph below:

-4.6
-4.8
-5
-5.2
-5.4
-5.6
-5.8
-6
-6.2
-6.4
-6.6
0.2 0.4 0.6 0.8 1
x
1.2 1.4 1.6 1.8 2 :
3

x
f (x) = ln 2 4x

Problem 65 Consider the following function dened on x > 0:


f (x) = (3x 1)e2x :
Use the rst order conditions to nd the possible local maxima or minima. Use
the second order conditions to determine which are local maxima and which are
local minima. Is the function globally convex or globally concave. Is x a global
maximum or minimum?

Answer
We have:
f 0 (x) = 3e2x 2 (3x 1) e2x
= e2x (5 6x) :

=) f 0 (x ) = 0 = e2x (5 6x )
=) 5 6x = 0
since e2x > 0: Therefore:
5
x = :
6
Now:
f 00 (x) = 12e2x + 4 (3x 1) e2x
= e2x (12x 16)
Since:

5
00

f = e2x (12x 16) jx= 56
6
5
= 6e 3 < 0
CHAPTER 2. UNIVARIATE CALCULUS 61

it follows that x = 56 is a local maximum. The function f (x) is neither globally


concave nor convex since f 00 (x) < 0 for x < 43 and f 00 (x) > 0 for x > 43 with
x = 43 an inection point. This is illustrated in the graph below:

0.2
x
1 2 3 4
0
-0.2

-0.4

-0.6

-0.8

-1
:
f (x) = (3x 1)e2x

From the graph it appears that x = 56 is a global maximum even though


f (x) is not globally concave.
We can prove that x = 56 is a global maximum by noting that:

f 0 (x) = e2x (5 6x)



5
= 6e2x x
6
5
so that f 0 (x) > 0 for x < 6 and f 0 (x) < 0 for x > 56 :
Problem 66 Consider the function:
2
f (x) = x3 ex =2

for x > 0: Calculate f 0 (x) and the local maxima or minima of f (x) : Calculate
h (x) = ln (f (x)) ; and h0 (x) : What are the local maxima and minima of h (x) :
Is h (x) concave or convex? Explain. Can this be used to determine which of
the local maxima or minima of f (x) and h (x) are global maxima or minima?
Explain.

Answer
Since:
1 2 1 2
f 0 (x) = 3x2 e 2 x x4 e 2 x
1 2
= x2 e 2 x 3 x2
1 2

=) f 0 (x ) = 0 = (x )2 e 2 (x )
3 (x )2
=) 3 (x )2 = 0
CHAPTER 2. UNIVARIATE CALCULUS 62

2
since (x )2 > 0 and e 2 (x
1
)
> 0 (because x > 0 and ex > 0 for all x): Therefore:
p
x = 3 = 1:7321:
p
Note we exclude x = 3 since the domain is restricted to x > 0: Note that
f (x) is not globally concave since:
1 2 1 2 1 2
f 00 (x) = 6xe 2 x 7x3 e 2 x + x5 e 2 x
1 2
= e 2 x x 6 7x2 + x4
1 2
= e 2 x x x2 1 x2 6 :
1 2
2x
2 x >
Since 20 and e > 0 it follows that the sign of f 00 (x) will depend on
x 1 x 6 : We have:

z }| {z }| {
for 0 < x < 1 =) x2 1 x2 6 > 0 =) f 00 (x) > 0 =) f (x) is convex
+
p z }| {z }| {
for 1 < x < 6 =) x2 1 x2 6 < 0 =) f 00 (x) < 0 =) f (x) is concave
+ +
p z }| {z }| {
for x > 6 =) x2 1 x2 6 > 0 =) f 00 (x) > 0 =) f (x) is convex.
p p
Thus fp(x) is convex for 0 < x < 1 and x > 6 but concave for 1 < x < 6
(note 6 = 2:4495) and hence is neither globally concave nor globally convex.
This is illustrated in the plot below:

0.8

0.6

0.4

0.2

0 1 2 3 4
x
2
f (x) = x3 ex =2

2
Since f (x) = x3 ex =2 is neither
p globally concave nor globally convex, we
dont know at this stage if x = 3 is a global maximum although it certainly
appears so from the graph. We can show that it is a local maximum since:
p 1 2 1 2 1 2

f 00 3 = 6xe 2 x 7x3 e 2 x + x5 e 2 x jx=p3
p 3
= 6 3e 2 < 0:
CHAPTER 2. UNIVARIATE CALCULUS 63
p
We now show that x = 3 is a global maximum for f (x) since it is a global
maximum of h (x) = ln (f (x)) : We have:
h (x) = ln (f (x))
2

= ln x3 ex =2
2

= ln x3 + ln ex =2
x2
= 3 ln (x) :
2
Therefore:
3
h0 (x) = x
x
3
=) h0 (x ) = 0 = x
x
3
=) = x
x
=) 3 = (x )2
p
=) x = 3:
The function h (x) is globally concave since:
3
h00 (x) =
1<0
x2
p
so h (x) is globally concave and hence x = 3 is a global maximum of h (x) :
Since h (x) = ln (f (x)) and since ln (x) is monotonically increasing, that is
d ln(x) p
dx = x1 > 0 for x > 0 it follows that x = 3 is a global maximum of
2
f (x) too. Alternatively, while f (x) = x3 ex =2 is not globally concave it is
globally quasi-concave and so the solution to the rst-order conditions yields
2
a global maximum. This is illustrated in the plots of f (x) = x3 ex =2 and
2 p
h (x) = 3 ln (x) x2 where both curves reach a maximum at x = 3 :

0.5

01 1.5 2 2.5 3
x

-0.5

-1

f (x) and h (x)


CHAPTER 2. UNIVARIATE CALCULUS 64

The next two problems are based on the following information: A


perfectly competitive rm faces price P; nominal wage W; rental cost of capital
R; and xed capital K: The rms short run production function relating Q
output to L labour is given by:
Q = f (L) = eln(L)+ln(A) ; 0 < < 1:
Problem 67 Show that in order for the marginal product of labour to be positive
and diminishing, it must be the case that 0 < < 1: What is the inverse function
L (Q)? Show that L0 (Q) > 0 and that L (Q) is convex.

Answer
This is just an ordinary Cobb-Douglas production function since:
f (L) = eln(L)+ln(A)
= eln(A) ln(L)
e
= A eln(L)
= AL :
Therefore:
f 0 (L) = AL1 > 0
=) > 0 since A > 0 and L1 > 0:
Similarly:
f 00 (L) = ( 1) AL2 < 0
=) 1 < 0 since A > 0; > 0 and L2 > 0
=) < 1:
Alternatively you could work directly with f (L) = eln(L)+ln(A) using the
chain rule as:

f 0 (L) = eln(L)+ln(A) > 0
L
=) > 0
since eln(L)+ln(A) > 0 and L > 0: Similarly:
2
f 00 (L) = eln(L)+ln(A) eln(L)+ln(A) 2
L L
eln(L)+ln(A)
= ( 1) < 0
L2
=) < 1:
Problem 68 Derive (L) (prots as a function of L) and show that it is con-
cave. Derive the rms demand curve for labour, show that it is downward
sloping, and determine the elasticity of the demand curve.
CHAPTER 2. UNIVARIATE CALCULUS 65

Answer
W
We have with real wage w = P :

(L) =
P AL W L RK
=) 0 (L ) = 0 = P A (L )1 W
1 W 1
=) (L )1 = = w
A P A
1
1
1 1
=) L = (w) 1
A
1
so the elasticity of labour demand is 1 < 0 since < 1: Since the elasticity
is negative the labour demand curve is downward sloping. Alternatively:
1
1
dL 1 1 1
= (w) 1 1 < 0:
dw 1 A
Problem 69 Suppose a function f (x) has the property that
f (x)
f (x) = x:

Show that
1
1 ln (x)
f 0 (x) = 1+ :
x f (x)

Answer
f (x)
Take the ln ( ) of both sides of f (x) = x to yield:

ln (f (x)) f (x) = ln (x) :

Dierentiate both sides with respect to x to yield:


1 0 1
ln (f (x)) f 0 (x) + f (x) f (x) =
f (x) x
1
=) (1 + ln (f (x))) f 0 (x) =
x
1
=) f 0 (x) = 0 1:
B C
xB C
@1 + |ln (f{z(x))}A
ln(x)
= f (x)

ln(x)
since from ln (f (x)) f (x) = ln (x) we have: ln (f (x)) = f (x) :

Problem 70 Prove that f (x) = ln x7 for x > 0 is globally increasing and
concave.
CHAPTER 2. UNIVARIATE CALCULUS 66

Answer
The calculations are easier if you rst simplify as

f (x) = ln x7 = 7 ln (x) :

Thus:
7
f 0 (x) = >0
x
since x > 0: Similarly:
7
f 00 (x) = <0
x2

so that f (x) = ln x7 is globally concave. This is illustrated in the plot below:

10

5
x
1 2 3 4 5
0

-5

-10

-15

:

f (x) = ln x7

Problem 71 Prove that f (x) = e3x is globally decreasing and convex.

Answer
For f (x) = e3x we have using the chain rule:
+
z}|{
f (x) = 3e3x > 0
0

so that f (x) is globally decreasing while:


+
z}|{
f 00 (x) = 9e3x > 0
CHAPTER 2. UNIVARIATE CALCULUS 67

so that f (x) is globally convex. This is illustrated in the plot below:

-0.4 -0.2 0 0.2 0.4 0.6 0.8 1


x :
3x
f (x) = e

Problem 72 Prove that y = eln(x)=2 is globally increasing and concave.

Answer
Problem 73 If f (x) is globally increasing and convex, and g (x) is globally
increasing and convex, prove that h (x) = f (g (x)) is globally increasing and
convex.

Answer
Problem 74 Suppose that f (x) is given by:
!
10000xx x3 + 3 e0 ln e2
f (x) = ln :
e3 ln(x)

Calculate f 0 (x) , nd x ; the global maximum and show that f (x) is globally
convex.
CHAPTER 2. UNIVARIATE CALCULUS 68

Answer
Here things are much easier if you simplify rst. We have:
0 0 11
1 2
z}|{ z }|
{

B 10000xx B @x3 + 3 e0 ln e2 A C
C
B C
B C
B C
f (x) = ln BB C
3 ln(x)
e| {z } C
B C
B C
@ x3 A


10000xx x3
= ln
x3
= ln (10000) + ln (xx )
= ln (10000) + x ln (x) :

Therefore:

f 0 (x) = 1 + ln (x)
=) f 0 (x ) = 0 = 1 + ln (x )
=) ln (x ) = 1
=) x = e1 :

Furthermore:
1
f 00 (x) = > 0 since x > 0
x
so that f (x) is globally convex and x = e1 is a global minimum. This is
illustrated in the plot below:

10.6
10.4
10.2
10
9.8
9.6
9.4
9.2
9

0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2


x

f (x) = ln (10000) + x ln (x) :


1 2
Problem 75 Consider the function f (x) = x4 e 2 x for x > 0: Calculate
f 0 (x) ; and from f 0 (x) nd the global maximum of this function x and prove
CHAPTER 2. UNIVARIATE CALCULUS 69

that x is a global maximum. If h (x) = ln (f (x)) where f (x) is given above,


nd h0 (x), the global maximum: x ; and prove that x is a global maximum
using h00 (x) :

Answer
1 2
de 2 x 1 2
Using the product and chain rules (note that dx = xe 2 x ) we have:
1 2 1 2
f 0 (x) = 4x3 e 2 x x5 e 2 x
1 2
= x3 e 2 x 4 x2 :

Therefore:
1 2

f 0 (x ) = 0 =) (x )3 e 2 (x )
4 (x )2 = 0
1 2
=) 4 (x )2 = 0; since (x )3 > 0 and e 2 (x )
>0
2
=) (x ) = 4
=) x = 2; since x = 2 is ruled out by the domain restriction x > 0:

Note that since 4 x2 > 0 for x < 2 and 4 x2 < 0 for x > 2 it follows that
x = 2 is a global maximum.
If h (x) = ln (f (x)) then:
1 2

h (x) = ln x4 e 2 x
1 2
= ln x4 + ln e 2 x
1
= 4 ln (x) x2
2
then:
4 4
h0 (x) = x =) h0 (x ) = 0 = x
x x
=) x = 2:

Furthermore
4
h00 (x) = 1<0
x2
so that h (x) is globally concave. It follows that x = 2 is a global maximum of
h (x) and since h (x) = ln (f (x)) and ln (x) is monotonically increasing ( d ln(x)
dx =
1 4 12 x2
x > 0) that x = 2 is a global maximum of f (x) = x e (or that f (x) is
CHAPTER 2. UNIVARIATE CALCULUS 70

quasi-concave). These results are illustrated in the plot below:

1.5

0.5

01 1.5 2 2.5 3
x
-0.5
:

12 x2 1 2
f (x) = x4 e ; h (x) = ln x4 e 2 x

Problem 76 Prove that f (x) = ln 3x2 20x is globally concave. Find x ;
the global maximum of f (x) :

Answer
First simplify as:

f (x) = ln 3x2 20x

= ln (3) + ln x2 20x
= ln (3) + 2 ln (x) 20x:

Thus:
2
f 0 (x) = 20
x
2
=) f 0 (x ) = 0 = 20
x
2
=) = 20
x
2 1
=) x = = :
20 10
Also since for all x
2
f 00 (x) = <0
x2
1
it follows that f (x) = ln 3x2 20x is globally concave and hence x = 10 is
a global maximum. This is illustrated in the plot of f (x) below:
CHAPTER 2. UNIVARIATE CALCULUS 71

-6

-8

-10

-12

-14

-16

0.1 0.2 0.3 0.4 0.5


x

f (x) = ln 3x2 20x

Problem 77 Prove that f (x) = e3x 2x is globally decreasing and convex.


Find x the global minimum of f (x) :

Answer
For f (x) = e3x 2x we have :

f 0 (x) = 3e|{z}
3x
2 <0
+

so that f (x) is monotonically decreasing and

f 00 (x) = 9e|{z}
3x
>0
+

so that f (x) is globally convex. It does not have a global minimum since
f 0 (x) < 0 implies that f 0 (x ) has no solution. This is illustrated in the plot
below:

1
x
0.5 1 1.5 2 2.5 3
0
-1

-2

-3

-4

-5

-6

f (x) = e3x 2x
CHAPTER 2. UNIVARIATE CALCULUS 72

2
Problem 78 Consider the function f (x) = x4 ex+3 ln(x ) for x > 0: Calculate
f 0 (x) ; and from f 0 (x) nd x ; the global maximum of f (x). Prove that x is
a global maximum. If h (x) = ln (f (x)) where f (x) is given above, nd h0 (x),
the global maximum: x ; and prove that x is a global maximum using h00 (x) :

Answer
Simplifying f (x) we nd that:

f (x) = x4 ex+6 ln(x)


6
= x4 ex eln(x)
= x4 x6 ex
= x10 ex :

Thus:

f 0 (x) = 10x9 ex x10 ex


= x9 ex (10 x)

=) f 0 (x ) = 0 =) (x )9 ex (10 x ) = 0
=) 10 x = 0
=) x = 10

since x > 0 and ex > 0:


x = 10 is a global maximum either since f 0 (x) > 0 for x < 10 and f 0 (x) < 0
for x > 10 or because given:

h (x) = ln (f (x)) = 10 ln (x) x

that h (x) is a monotonic transformation of f (x), and h (x) is globally concave


with a global maximum at x = 10 since:
10
h0 (x ) = 0 =) 1 =) x = 10
x
and for all x :
10
h00 (x) = < 0:
x2
Problem 79 Consider the following function dened on x > 0:
3
x
f (x) = ln 5x:
2ex
Use rst order conditions to nd the possible local maxima or minima. Use
second order conditions to determine which are local maxima and which are
local minima. Is the function convex or concave and what are the global minima
and maxima?
CHAPTER 2. UNIVARIATE CALCULUS 73

Answer
Simplifying we have:

x3
f (x) = ln 5x
2ex

= ln x3 ln 2ex 5x

= 3 ln (x) ln (2) ln ex 5x
= 3 ln (x) 5x + x ln (2)
= 3 ln (x) 4x ln (2) :
Therefore:
3
f 0 (x) = 4
x
3
=) f 0 (x ) = 0 = 4
x
3
=) x = :
4
Now:
3
f 00 (x) =
<0
x2

so clearly f 00 34 < 0 and x = 34 is a local maximum. We can say much more
though since f (x) is globally concave and hence x = 34 is a global maximum.
This is illustrated in the plot below:

-4.6
-4.8
-5
-5.2
-5.4
-5.6
-5.8
-6
-6.2
-6.4
-6.6
0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2
x

x3
f (x) = ln 2ex 5x
Problem 80 Consider the following function dened on x > 0:
f (x) = (3x 1)e2x
Use rst order conditions to nd the possible local maxima or minima. Use
second order conditions to determine which are local maxima and which are
local minima. Is the function convex or concave and what are the global minima
and maxima?
CHAPTER 2. UNIVARIATE CALCULUS 74

Answer:
Using the chain and product rules we have:
f 0 (x) = 3e2x 2 (3x 1) e2x
= e2x (5 6x)

=) f 0 (x ) = 0 = e2x (5 6x )

=) 5 6x = 0 since e2x > 0
5
=) x = :
6
Now:
f 00 (x) = 2e2x (5 6x) 6e2x
= e2x (12x 16)
so that:

5 5 5
f 00 = e2 6 12 16
6 6
5
= 6e 3 < 0
so that x = 56 is a local maximum.
The function is neither globally concave nor convex since f 00 (x) < 0 for
x < 16 4 00 4 4
12 = 3 and f (x) > 0 for x > 3 with x = 3 and inection point where
f (x) changes from being concave to convex. This is illustrated in the plot below:

0.25

0.2

0.15

0.1

0.05

0 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8


x
-0.05

f (x) = (3x 1)e2x


Problem 81 Consider the following functions dened on x > 0:
f (x) = xx :
Use rst order conditions to nd the possible local maxima or minima. Use
second order conditions to determine which are local maxima and which are
local minima. Is the function convex or concave and what are the global minima
and maxima?
CHAPTER 2. UNIVARIATE CALCULUS 75

Answer
Changing from base x to base e we have:
x
f (x) = xx = eln(x) = ex ln(x) :

Therefore using the chain and product rules:

f 0 (x) = (1 + ln (x)) ex ln(x)



=) f 0 (x ) = 0 = (1 + ln (x )) ex ln(x )

=) 1 + ln (x ) = 0 since ex ln(x ) > 0
=) ln (x ) = 1
=) x = e1 = 0:36788:

Now:
+
{z }| { z}|{z }| {
+ + +
z }|
1 x ln(x)
f (x) = (1 + ln (x))2 ex ln(x) +
00
e >0
x

so clearly f 00 e1 > 0 and x = e1 is a local minimum. We can say much more
though since f (x) is globally convex and hence x = e1 is a global maximum.
This is illustrated in the plot below:

0.95

0.9

0.85

0.8

0.75

0.7
0 0.2 0.4 0.6 0.8 1
x

f (x) = xx

The following two problems are based on the following information:


Suppose Y (t) is the population of the world at time t; where t is measured in
years. Lets dene today as t = 0 and suppose that the population of the world
today is six billion: Assume that the world population grows at a constant rate
so that Y (t) = Aet :

Problem 82 If population grows at 1:8% per year, then what are A and ?
How long will it take for the worlds population to double? When will the worlds
CHAPTER 2. UNIVARIATE CALCULUS 76

population reach twenty billion (using the conventional dating system, e.g. 1998
etc. ). Suppose you wanted to, by say introducing family planning measures,
reduce the population growth rate so that in the year 2100 there were no more
than ten billion people on the earth. What population growth rates would be
consistent with this objective?

Answer
Here A = 6 (billion) and = 0:018 so that Y (t) = 6e0:018t : If Y (t) = 12
then:

12 = 6e0:018t
12
=) e0:018t = =2
6
=) 0:018t = ln (2)
ln (2)
=) t = = 38:508
0:018
or it will take 38:5 years for the population to double. If Y (t) = 20 then:

20 = 6e0:018t
20
=) e0:018t =
6
20
=) 0:018t = ln
6

ln 20
6
=) t = = 66:887
0:018
or it will take 67 years for the population to reach 20 billion. double.
If t = 100 and

Y (100) 10 = 6e100
=
10 5
=) e100 = =
6 3
5
=) 100 = ln
3
5
ln 3
=) = = 0:0051
100
Problem 83 How long ago was it that the rst person appeared on the earth?
The second person?
CHAPTER 2. UNIVARIATE CALCULUS 77

Answer
If Y (t) = 6e0:018t and then:
1
Y (t) = = 6e0:018t
6000000000
1
=) e0:018t =
6 6000000000

1
=) 0:018t = ln
6 6000000000

1
ln 66000000000
=) t = = 1350
0:018
or about 1350 years ago. Similarly if there were 2 people then
2
Y (t) = = 6e0:018t
6000000000
2
=) e0:018t =
6 6000000000

2
=) 0:018t = ln
6 6000000000

2
ln 66000000000
=) t = = 1312:
0:018
The fact that we historically that people have been around much longer than
1300 years illustrates the grave problems with project exponential growth too
far into either the past or future.
Problem 84 Prove that f (x) = ln (x) is globally increasing and concave
while
1
y = e3x globally decreasing and convex. Prove that f (x)
= ln x2 is globally
decreasing and convex. Prove that f (x) = exp 13 ln (x) is globally increasing
2
and concave. If f (x) = x8 ex show that f (x) is quasi-concave. Find x ; the
global maximum of f (x) and prove that x is a global maximum.

Answer
For f (x) = ln (x) with x > 0
1
f 0 (x) = > 0 =) f (x) is globally increasing
x
1
f 00 (x) = 2 < 0 =) f (x) is globally concave.
x
1
For f (x) = ln x2 = 2 ln (x) and with x > 0
2
f 0 (x) = > 0 =) f (x) is globally decreasing
x
2
f 00 (x) = < 0 =) f (x) is globally convex.:
x2
CHAPTER 2. UNIVARIATE CALCULUS 78
1 1
For f (x) = exp 3 ln (x) = x 3

1 2
f 0 (x) = x 3 > 0 =) f (x) is globally increasing
3
2 5
f 00 (x) = x 3 < 0 =) f (x) is globally concave. :
9
2
For f (x) = x8 ex we have:

h (x) = ln (f (x)) = 8 ln (x) x2

with
8
h00 (x) = 2 < 0:
x2
Since ln (x) is globally increasing and h (x) is globally concave it follows that
2
f (x) = x8 ex is quasi-concave.

Problem 85 Consider the following function:


2
f (x) = ex +2x4
; for 1 < x < 1:

Using the appropriate rst order conditions nd any local maxima or minima.
From the appropriate second order conditions determine whether these solutions
are local maxima or minima. Determine whether if the function is convex or
concave.

Answer
Using the chain rule:
2
f 0 (x) = (2x + 2) ex +2x4
2
) +2x 4
=) f 0 (x ) = (2x + 2) e(x
2
) +2x 4
=) 2x + 2 = 0 since: e(x >0
=) x = 1:

Furthermore:
2 2
f 00 (x) = 2ex + (2x + 2)2 ex +2x4
+2x4

2

= ex +2x4 (2x + 2)2 2
2

=) f 00 (1) = ex +2x4 (2x + 2)2 2 jx=1 = 2e3 < 0

so that x = 1 is a local maximum.


It turns out that f (x) is not globally concave. We can nevertheless show
that x = 1 is a global maximum in at least three dierent ways.
CHAPTER 2. UNIVARIATE CALCULUS 79

The rst way is to note that

x2 + 2x 4 = (x 1)2 3

so that:
2
f (x) = ex +2x4
2
= e(x1) 3
2
= e(x1) e3 :
2
The term e(x1) 1 with equality only when x = 1 since for x 6= 1 it is the
2
case that (x 1) < 0 and the exponent is negative and ex for any negative x
is always less than 1: Thus x = 1 is a global maximum.
The second approach is to show that ln (f (x)) is globally concave and hence
f (x) is quasi-concave. Thus:

h (x) = ln (f (x)) = x2 + 2x 4
=) h0 (x ) = 0 = 2x + 2 =) x = 1
=) h00 (x) = 2 < 0

so that x = 1 is the global maximum for h (x) and f (x) as illustrated in the
CHAPTER 2. UNIVARIATE CALCULUS 80

graph below:

0.05

0.04

0.03

0.02

0.01

-1 0 1 2 3
x
2
f (x) = ex +2x4

-3

-4

-5

-6

-7
-1 0 1 2 3
x

h (x) = x2 + 2x 4
Finally note that:
2
f 0 (x) = (2x + 2) ex +2x4

+
z }| {
2
= 2 (x 1) ex +2x4
so that f 0 (x) > 0 for x < 1, f 0 (x) < 0 for x > 1 so that x = 1 is a global
maximum.

Problem 86 Prove that f (x) = ln 5x2 + 5 for x > 0 is globally increasing
and concave. If
0vu !1
u x3 ln (x2 ) eln(x5 ) + 7 e0 ln (e6 )
f (x) = ln @texp A
ln ex7

calculate f 0 (x) and f 00 (x) : Find x , the solution to the rst-order conditions,
and show that x is a global maximum.
CHAPTER 2. UNIVARIATE CALCULUS 81

Answer

For f (x) = ln 5x2 + 5 we have:

f (x) = 2 ln (x) + ln (5) + 5

so that:
2
f 0 (x) = > 0:
x
so that f (x) is globally increasing and
2
f 00 (x) = <0
x2
so that f (x) is globally concave. (Alternatively, if we work directly with the
original form then using the chain rule we have:
1 2
f 0 (x) = 10x = ):
5x2 x
For the complicated expression we obviously need to simplify. We have:
7 5
ln ex = x7 ; ln x2 = 2 ln (x) ; eln(x ) = x5

e0 = 1; ln e6 = 6

so that:
0vu !1
u x 3 ln (x2 ) eln(x5 ) + 7 e0 ln (e6 )
f (x) = ln @texp A
ln ex7
0 !! 12 1
x3 ln (x) x5 + 7 1 6
= ln @ exp 2 A
x7
!!
1 x3 ln (x) x5 + 7 1 6
= ln exp 2
2 x7

1 ln (x) x3 x5
= 2
2 x7
= x ln (x) :

Therefore:

f 0 (x) = 1 + ln (x)
=) f 0 (x ) = 0 = 1 + ln (x )
=) ln (x ) = 1
=) x = e1 :
CHAPTER 2. UNIVARIATE CALCULUS 82

Problem 87 The Poisson distribution is used to model events which have a


small probability but which occur many times; for example when many cars pass
through an intersection each has a small probability of having an accident and
given that many cars pass through an intersection there may be say 2 accidents
a month. Suppose then that Y is the number of accidents in an intersection and
is the average number of accidents in an intersection which unknown. Then
the probability of there being k accidents is given by:

k
Pr [Y = k] = e :
k!
If = 2 calculate the probability that there will be 0; 1; 2; 3 and 4 accidents in the
intersection. Show that the sum of the probabilities is 1 (Hint: use the Taylor
series for ex ):

Answer
We have
20 2
Pr [Y = 0] = e = 0:135
0!
1
2 2
Pr [Y = 1] = e = 0:271
1!
22 2
Pr [Y = 2] = e = 0:271
2!
23 2
Pr [Y = 3] = e = 0:180
3!
24 2
Pr [Y = 4] = e = 0:090:
4!
Note that these probabilities do not sum to 1 since:

0:135 + 0:271 + 0:271 + 0:180 + 0:090 = 0:947

since there is a probability of 1 0:947 = 0:053 of having 5 or more accidents.


We can prove that the probabilities really do sum to 1 using the Taylor series
for ex which is:
x x2
ex = 1 + + +
1! 2!
CHAPTER 2. UNIVARIATE CALCULUS 83

as follows. We have:
0 1 2
Pr [Y = 0] + Pr [Y = 1] + Pr [Y = 2] + = e + e + e +
0! 1! 2!
1 2

= e 1 + + +
1! 2!
| {z }
=e

= e e
= e+
= e0
= 1:

Problem 88 Find using LHpitals rule.

lim xx :
x!0

Answer
This is not directly in the form with which we can use LHpitals rule.
Consider though rewriting it xx as:

ln(x)x ln (x)
e = exp 1
x

so that:

ln (x)
lim xx = exp lim 1 :
x!0 x!0
x

1
Since limx!0 ln (x) = 1 and limx!0 x = 1 we can apply LHpitals rule as:
1
ln (x) x
lim 1 = lim = lim x = 0
x!0 x!0 12 x!0
x x

so that:

x ln (x)
lim x = exp lim 1 = e0 = 1:
x!0 x!0
x
CHAPTER 2. UNIVARIATE CALCULUS 84

This is illustrated in the plot of xx below:

0.95

0.9

0.85

0.8

0.75

0.7
0.2 0.4 0.6 0.8 1
x :
x
f (x) = x as x ! 0

Problem 89 Show that:

lim xex = 0:
x!1

Answer
Since
x
lim xex = lim ;
x!1 x!1 ex
limx!1 x = 1 and limx!1 ex = 1; we can use LHpitals rules as:
x 1
lim xex = lim = lim = 0:
x!1 x!1 ex x!1 ex
Problem 90 Show that for all n:

lim xn ex = 0:
x!1

Problem 91 Show that for all n > 0 :

lim xn ln (x) = 0:
x!0

Problem 92 Show that for all x > 0 that:


x 1
lim = ln (x) :
!0
This is the basis for the Box-Cox transformation often used in econometrics.
CHAPTER 2. UNIVARIATE CALCULUS 85

Answer
Note that it is that approaches 0 here and not x: We have: f () =
eln(x) 1 and g () = since:
x 1 eln(x) 1
lim = lim :
!0 !0
Using the chain rule: f 0 () = ln (x) eln(x) and g0 () = 1 so that:
x 1 eln(x) 1
lim = lim
!0 !0
ln (x) eln(x)
= lim
!0 1
= ln (x)
since lim!0 eln(x) = 1:

2.12 Linear Regression


Problem 93 Consider the simple linear regression model without a constant:
Yi = + ei ; i = 1; 2; : : : n:
The least squares estimator
^ minimizes:
n
X
S () = (Yi )2
i=1

= (Y1 )2 + (Y2 )2 + + (Yn )2 :


Find the rst-order conditions for minimizing S () : Show from the rst-order
conditions that
n
1X

^= Yi = Y :
n i=1

Show that S () is globally convex.


2
Using the chain rule to dierentiate (Yi ) with respect to we have:
S 0 () = 2 (Y1 ) 2 (Y2 ) 2 (Yn )
so that the rst-order conditions require:
S 0 (^
) = 0 = 2 (Y1 ^ ) 2 (Y2 ^ ) 2 (Yn
^)
=) (Y1
^ ) + (Y2 ^ ) + + (Yn ^) = 0
=) n^
= Y1 + Y2 + + Yn
Y1 + Y2 + + Yn
=) = = Y :
n
CHAPTER 2. UNIVARIATE CALCULUS 86

To show that S () is globally convex we calculate:

S 00 () = 2 + 2 + + 2
| {z }
n times
= 2n > 0:

It follows that S 00 () > 0 for all and hence S () is globally convex and is
a global minimum.

Problem 94 Despite its apparent complexity, it is a fact that S () is nothing


more than an ordinary quadratic and hence can be minimized by completing
the square. Show that ^ = Y minimizes S () without using calculus. Hint:
Replace all occurrences of with
^ + (
^ ), keep the brackets around (
^) ;
manipulate and show that:

^ )2 + (Y2
S () = (Y1 ^ )2 + + (Yn
^ )2
^ )2 :
+n (

Use this to show that S () S (^


) for all with equality only when =
^:

Problem 95 Consider the simple linear regression model without a constant:

Yi = Xi + ei ; i = 1; 2; : : : n:

^ minimizes:
The least squares estimator
n
X
S () = (Yi Xi )2
i=1

= (Y1 X1 )2 + (Y2 X2 )2 + + (Yn Xn )2 :

Find the rst-order conditions for minimizing S () : Show from the rst-order
conditions that
Pn
^ Xi Yi X1 Y1 + X2 Y2 + + Xn Yn
= Pi=1
n 2 = :
X
i=1 i X12 + X22 + + Xn2

Show that S () is globally convex as long as one Xi is not equal to zero and
^ is a global minimum.
that

Answer
Using the chain rule to dierentiate (Yi Xi )2 with respect to we have:

S 0 () = 2X1 (Y1 X1 ) 2X2 (Y2 X2 ) 2Xn (Yn Xn )


CHAPTER 2. UNIVARIATE CALCULUS 87

so that the rst-order conditions require:



S0 ^ = 0 = 2X1 Y1 X ^ 1 2X2 Y2 X^ 2 2Xn Yn X
^ n

=) X1 Y1 X ^ 1 + X2 Y2 X ^ 2 + + Xn Yn X
^ n =0
^ 1 + X
=) X1 Y1 + X2 Y2 + + Xn Yn = X ^ 2 + + X
^ n
^ (X1 + X2 + + Xn ) = X1 Y1 + X2 Y2 + + Xn Yn
=)
^ = X1 Y1 + X2 Y2 + + Xn Yn :
=)
X12 + X22 + + Xn2

To show that S () is globally convex we calculate:

S 00 () = 2X12 + 2X22 + + 2Xn2 :

Clearly 2Xi2 0 with equality only when Xi = 0: Therefore if there is at least


one Xi 6= 0 it follows that S 00 () > 0 for all and hence S () is globally convex
^ is a global minimum.
and

Problem 96 Despite its apparent complexity, it is a fact that S () is nothing


more than an ordinary quadratic and hence can be minimized by completing the
^ minimizes S () without using calculus. Hint: Replace all
square. Show that
occurrences of with ^ + ^ , keep the brackets around
^ ; manip-
ulate and show that:
2 2 2
S () = ^ 1 + Y2 X
Y1 X ^ 2 + + Yn X
^ n
2
+ ^ X12 + X22 + + Xn2 :

^ for all with equality only when = :
Use this to show that S () S ^

2.13 Maximum Likelihood


Problem 97 Suppose that Yi N [; 1] so that Yi has a mean of and a
standard deviation of 1: Here instead of we are using the traditional notation :
We wish to estimate using maximum likelihood from a sample Y1 ; Y2 ; : : : ; Yn :
The likelihood function is:
n 2
+(Y2 )2 ++(Yn )2 )
L () = (2) 2 e 2 ((Y1 )
1
:

Find
^ and show how you can construct a 95% condence interval for : If
Y1 = 5:5; Y2 = 3:3; Y3 = 7:1; Y4 = 9:2 and Y5 = 4:1; nd
^ and construct a
95% condence interval for :
CHAPTER 2. UNIVARIATE CALCULUS 88

Answer
The log-likelihood is given by:
n 1
l () = ln (L ()) = ln (2) (Y1 )2 + (Y2 )2 + + (Yn )2
2 2

so that:
dl ()
= (Y1 ) + (Y2 ) + + (Yn )
d
dl (^
)
=) = 0 = (Y1 ^ ) + (Y2
^ ) + + (Yn
^)
d
=) Y1 + Y2 + + Yn = n^
Y1 + Y2 + + Yn
=)
^= = Y :
n
To calculate a condence interval we have:
d2 l ()
= 1 + 1 + + 1
d2
= n

so that:

= ( (n))1
1
= :
n
Thus a 95 % condence interval takes the form:
r
1

^ 1:96 :
n
In the example n = 5 and
5:5 + 3:3 + 7:1 + 9:2 + 4:1

^ =
5
= 5:84

and a 95% condence interval for the unknown is:


1
5:84 1:96 p
5
or:

6:213 0:877:
CHAPTER 2. UNIVARIATE CALCULUS 89

Problem 98 Suppose that Yi N 0; 2 so that Yi has a mean of zero and
a standard deviation of : (Here we use the traditional notation: which is
the standard deviation, instead of : ) We wish to estimate using maximum
likelihood from a sample Y1 ; Y2 ; : : : ; Yn : The likelihood function is:
n 2 2 2
L () = (2) 2 n e 22 (Y1 +Y2 ++Yn ) :
1

Find ^ and show how you can construct a 95% condence interval for the un-
known : If Y1 = 5:5; Y2 = 3:3; Y3 = 7:1; Y4 = 9:2 and Y5 = 4:1; nd ^ and
construct a 95% condence interval for :

Answer
The log-likelihood is given by:
n 1
l () = ln (L ()) = ln (2) n ln () 2 Y12 + Y22 + + Yn2
2 2
so that:
dl () n 1
= + 3 Y12 + Y22 + + Yn2
d
dl (^
) n 1
=) = 0 = + 3 Y12 + Y22 + + Yn2
d ^
^
1 2 2 2
n
=) 3 Y1 + Y2 + + Yn =

^ ^
2 2 2
Y + Y2 + + Yn
=) ^2 = 1
r n
2 2
Y1 + Y2 + + Yn2
=) ^= :
n
To calculate a condence interval we have:
d2 l () n 1
2
= 2 3 4 Y12 + Y22 + + Yn2
d
so that:
2 1
d l (^
)
=
d 2
0 11
B n 1 C
= @ 2 + 3 4 Y12 + Y22 + + Yn2 A

^ ^ |
{z }
2
=n^
1
n 2
n^
= 2 +3 4

^ ^
12
n
= 2 2

^
^2

= :
2n
CHAPTER 2. UNIVARIATE CALCULUS 90

Thus a 95 % condence interval takes the form:


s
^2

^ 1:96 :
2n
In the example n = 5 and
s
(5:5)2 + (3:3)2 + (7:1)2 + (9:2)2 + (4:1)2

^ =
5
= 6:213
and a 95% condence interval for the unknown is:
r
6:2132
6:213 1:96
25
or:
6:213 3:85:
Problem 99 The Poisson distribution is used to model events which have a
small probability but which occur many times; for example when many cars pass
through an intersection each has a small probability of having an accident and
given that many cars pass through an intersection there may be say 2 accidents
a month. Suppose then that Yi is the number of accidents in an intersection
and is the average number of accidents in an intersection which unknown.
deviation of : We wish to estimate using maximum likelihood from a sample
Y1 ; Y2 ; : : : ; Yn : The likelihood function is:
L () = (Y1 +Y2 ++Yn ) en :
Find
^ and show how you can construct a 95% condence interval for : Suppose
the number of accidents in 5 consecutive months is Y1 = 5; Y2 = 3; Y3 = 7;
Y4 = 2 and Y5 = 4 . Find ^ and construct a 95% condence interval for the
unknown :

Answer
The log-likelihood is given by:
l () = ln (L ()) = (Y1 + Y2 + + Yn ) ln () n
so that:
dl () (Y1 + Y2 + + Yn )
= n
d
dl (^
) (Y1 + Y2 + + Yn )
=) =0= n
d ^
(Y1 + Y2 + + Yn )
=) =n

^
Y1 + Y2 + + Yn
=)
^= = Y
n
CHAPTER 2. UNIVARIATE CALCULUS 91

To calculate a condence interval we have:


d2 l () (Y1 + Y2 + + Yn )
=
d2 2
so that:
2 1
d l (^
)
=
d2
0 11
=n^
z }| {
B (Y + Y + + Y ) C
B 1 2 n C
= B C
@ ^2
A

^2

= :
n
Thus a 95 % condence interval takes the form:
s
^2


^ 1:96 :
n

In the example n = 5 and


5+3+7+2+4

^ =
5
= 4:2

and a 95% condence interval for the unknown is:


r
4:22
4:2 1:96
5
or:

4:2 3:68:
Chapter 3

Matrix Algebra

3.1 Multiplication, Transpose, Determinants and


Inverse
Problem 100 Consider the matrices:
2 3 2 3
3 2 6 4
A = 4 1 3 5;B = 4 2 6 5
1 2 2 4

What is AB? What is AT B? What is AB T ? What is det [A]? What are det AT B
1 1
and det B T A ? What are A1 ; AT B and AB T :

Answer
AB is not dened since A is 3 2 and B is also 3 2:
2 3
6 4
T 3 1 1 4 5 22 22
A B = 2 6 = :
2 3 2 22 34
2 4
2 3 2 3
6 4 26 18 14
3 1 1
AB T = 4 2 6 5 = 4 18 20 14 5 :
2 3 2
2 4 14 14 10

det [A] is not dened since A is not square. We have:



22 22
det AT B = det = 264
22 34
2 3
26 18 14
det BAT = det 4 18 20 14 5 = 0:
14 14 10

92
CHAPTER 3. MATRIX ALGEBRA 93

Since A is not square A1 does not exist. We have:



T 1 1 34 22
A B = :
264 22 22
1
The matrix AB T does not exist since det AB T = 0:

Problem 101 Given the matrix:


2 3
1 1
A=4 1 2 5
1 3
1
calculate AT A; AAT and AT AT : Find AT A if it exists.

Answer
We have:
2 3
1 1
T 1 1 1 4 5 3 6
A A = 1 2 = :
1 2 3 6 14
1 3
2 3 2 3
1 1 2 3 4
1 1 1
AAT = 4 1 2 5 = 4 3 5 7 5:
1 2 3
1 3 4 7 10
1 7
T 1 3 6 1 14 6 1
A A = = = 3 :
1
6 14 3 14 6 6 6 3 1 2

Problem 102 Given the matrices:


2 3
1 1
4 5 1 1 1
A= 2 0 ; B=
1 2 3
3 1
1
calculate AB; B T AT and AT A: Find AT A if it exists.
CHAPTER 3. MATRIX ALGEBRA 94

Answer
We have:
2 3 2 3
1 1 2 1 4
1 1 1
AB = 4 2 0 5 = 4 2 2 2 5
1 2 3
3 1 4 1 6
2 3T 2 3
2 1 4 2 2 4
B T AT = (AB)T = 4 2 2 2 5 = 4 1 2 1 5
4 1 6 4 2 6
2 3
1 1
1 2 3 4 14 4
AT A = 2 0 5=
1 0 1 4 2
3 1
1 1
T
1 14 4 13
A A = = 6 :
4 2 13 7
6

Problem 103 Given the two vectors:


2 3
2
X = 4 2 5; Y = 1 2 3
2

calculate XY , Y X and Y X T : What is X 1 ? Calculate: det [XY ] ; det [Y X] ;


(XY )1 and (Y X)1 . Calculate A1 where:

3 2
A=
1 5
1
and calculate AT :

Answer
2 3 2 3
2 2 4 6
XY = 4 2 5 1 2 3 =4 2 4 6 5
2 2 4 6
2 3
2
YX = 1 2 3 4 2 5 = 12
2

Y X T is not dened. X 1 is not dened since only square matrices have inverses.
2 3
2 4 6
det [XY ] = det 4 2 4 6 5 = 0
2 4 6
det [Y X] = det [12] = 12:
CHAPTER 3. MATRIX ALGEBRA 95

Since det [XY ] = 0 it follows that (XY )1 does not exist. (Y X)1 = 121 = 1
12 .
1 5 2

1 3 2 13 13
A = = 1 3
1 5 13 13
T
T 1 T 5 2
13 5 1
13
A = A1 = 13
1 3 = 13
2 3 :
13 13 13 13

Problem 104 Given the two matrices A and B and the vector x:
2 3 2 3
1 1 1
2 2 2
A= ; B = 4 1 2 5 ; x = 4 2 5
2 4 6
1 3 1
T T T 1
calculate
h i A B; BA and B A : What is (AB) : Calculate: det [AB] ;
AB,
det (AB)1 ; and det [A] : Calculate: BAx = 0 and use this result to calculate
det [BA] : Calculate Ax and use this result to calculate det [BA] :

Answer
3 2
1 1
4 2 2 2
5 6 12
AB = 1 2 =
2 4 6 12 28
1 3
T
T T T 6 12 6 12
B A = (AB) = =
12 28 12 28
2 3 2 3
1 1 4 6 8
2 2 2
BA = 4 1 2 5 =4 6 10 14 5 :
2 4 6
1 3 8 14 20
AT B is not dened.
1 7
6 12 1 28 12 12
(AB)1 = = = 6
12 28 24 12 6 12 1
4

6 12
det [AB] = det = 24
12 28
h i 1 1
det (AB)1 = =
det [AB] 24
and det [A] is not dened since A is not square.
2 3
1
2 2 2 4 5 0
Ax = 2 =
2 4 6 0
1
=) BAx = B0 = 0
=) det [BA] = 0
since if for any square matrix C if Cx = 0 for x 6= 0 implies that C is singular
and hence det [C] = 0:
CHAPTER 3. MATRIX ALGEBRA 96

Problem 105 Given the two matrices A and B

2 3
9 18
3 3 3
A= ; B = 4 3 6 5;
12 4 4
4 8

calculate AB, B T AT ; BA; and AT B: Calculate: det [AB] and (AB)1 :

Answer
2 3
9 18
3 3 3 4 3 6 5= 48 96
AB =
12 4 4 104 208
4 8
T
T 48 96 48 104
B T AT = (AB) = =
104 208 96 208
2 3 2 3
9 18 243 99 45
4 3 6 5 3 3 3
BA = = 4 81 33 15 5
12 4 4
4 8 108 44 20

48 96
det [AB] = det = 0:
104 208

Since det [AB] = 0 it follows that (AB)1 does not exist.


Problem 106 Given the matrix:
2 3
3 1 0
A=4 0 4 0 5
0 0 5
T 1
calculate det [A] ; det A ; det A ; tr [A] and A1 :

Answer
Since A is upper triangular its determinant is the product of the diagonal
elements so that:
2 3
3 1 0
det 4 0 4 0 5 = 3 4 5 = 60 = det AT :
0 0 5
1 1
det A1 = =
det [A] 60
T r [A] = 3 + 4 + 5 = 12
2 3
20 5 0
1 4 0 15 0 5 :
A1 =
60 0 0 12
CHAPTER 3. MATRIX ALGEBRA 97

Problem 107 Prove that if A and B are n n symmetric matrices then it


does not follow that either AB or BA is symmetric. Show that ABA and BAB
however are symmetric.

Problem 108 For scalars it is a fact that (a b) (a + b) = a2 + b2 : Given two


square n n matrices A and B does it follow that (A B) (A + B) = A2 B 2 ?

Problem 109 Prove that if x is a n 1 vector withhn > 1 and x 6= 0 then


T 1 1 1 i
x x exists but xxT does not exist. What is det xT x and det xxT ?

Problem 110 Given an m n matrix A; an n m matrix B and a m 1


vector x such that Bx = 0: Suppose that the 5th element of x is equal to the
GNP of Canada. Calculate det [AB] :

Problem 111 Prove that if A is upper (lower) triangular then A1 is upper


(lower) triangular.

Problem 112 Given the matrix:


2 3
1 2 4
A = 4 2 3 2 5
3 1 3

nd det [A] using the Laplace expansion by: 1) going across the rst row, 2)
going down the second column. Calculate the cofactor matrix C and the adjoint
1
matrix adj [A] : Calculate adj [A] A and Aadj [A] : Calculate A1 and AT :

Answer
Going across the rst row we nd:
2 3
1 2 4
det [A] = det 4 2 3 2 5
3 1 3

3 2 2 2 2 3
= 1 det 2 det + 4 det
1 3 3 3 3 1
= 13:

Going down the second column we nd:



2 2 1 4 1 4
det [A] = 2 det + 3 det 1 det
3 3 3 3 2 2
= 13:
CHAPTER 3. MATRIX ALGEBRA 98

The cofactor matrix is:


2 3
3 2 2 2 2 3
6 det det det
6 1 3 3 3 3 1 7
7
6 2 4 1 4 1 2 7
C = 6 6 det 1 det det 7
6 3 3 3 3 1 7
7
4 2 4 1 4 1 2 5
det det det
3 2 2 2 2 3
2 3
7 12 11
= 4 2 9 5 5
8 10 7

so that:
2 3T 2 3
7 12 11 7 2 8
adj [A] = C T = 4 2 9 5 5 = 4 12 9 10 5 :
8 10 7 11 5 7

Thus adj [A] A and Aadj [A] are given by direct calculation as:
2 32 3 2 3
7 2 8 1 2 4 13 0 0
4 12 9 10 5 4 2 3 2 5 = 4 0 13 0 5 = det [A] I
11 5 7 3 1 3 0 0 13
2 32 3 2 3
1 2 4 7 2 8 13 0 0
4 2 3 2 5 4 12 9 10 5 = 4 0 13 0 5 = det [A] I
3 1 3 11 5 7 0 0 13

which illustrates the general fact that adj [A] A = Aadj [A] = det [A] I since
det [A] = 13: Finally:
1
A1 = adj [A]
det [A]
2 3 2 7 2 8
3
7 2 8 13
1 4 5 4 12
13
9
13
10 5:
= 12 9 10 = 13 13 13
13 11 5 7
11 5 7 13 13 13

3.2 Applications to Econometrics


Problem 113 Let X be an n p matrix. Prove that P = X(X T X)1 X T is
symmetric and idempotent. What is T r [P ] ?
CHAPTER 3. MATRIX ALGEBRA 99

Answer
T T T T
First X T X = X T X T = X T X (since (AB) = B T AT and X T =
X ). Now:
0 1T
PT XT A
= @X(X T X)1 |{z}
| {z }
A B
0 1T
T T
= X @ X (X T X)1 A ; since (AB)T = B T AT
|{z}| {z }
A B
T T
= X (X T X)1 X T ; since (AB)T = B T AT and AT = A
0 11
B C T 1
= X @(X T X)T A X T ; since A1 = AT
| {z }
=X T X

= X(X X) X T
T 1

= P by denition.

Since P T = P it follows that P is symmetric.


P is idempotent since:

PP = X(X T X)1 X T X(X T X)1 X T


| {z }
=I since AA1 =I
T 1 T
= X(X X) IX
| {z } since IA = A
=X T
= P:

Since P P = P it follows that P is idempotent.


Since T r [AB] = T r[BA] we have:
2 3
X (X T X)1 X T 5
T r [P ] = T r 4|{z}
| {z }
A B
2 3
6 7
= T r 4(X T X)1 (X T X)5
| {z }| {z }
pp pp
2 3
I 5 = p:
= T r 4|{z}
pp

The following two problems are based on the following information:


CHAPTER 3. MATRIX ALGEBRA 100

Suppose R is an rp matrix, X is a np matrix and is an nn symmetric


matrix. Consider the matrices:

A = X(X T 1 X)1 X T 1
B = X(X T 1 X)1 X T
C = (RX T 1 XRT )1
D = (RT X T 1 XR)1

Problem 114 Find the dimensions of the matrices A ; B and C: What can you
say about the matrix D? Which matrices are symmetric? Which are idempotent?

Answer
A is n n; B is n n; C is r r and D is not dened since XR and RT X T
are not dened. The matrices B and C are symmetric while the matrix A is
idempotent.
T T
Problem 115 Determine AB; BA; B T A; AB T ; B T AT and AT B T :
Make any possible simplications , and if possible avoid any unnecessary work
in your derivations.

Answer
We have:

AB = X(X T 1 X)1 X T 1 X(X T 1 X)1 X T


| {z }
=I
= X(X T 1 X)1 X T = B
BA = X(X T 1 X)1 X T X(X T 1 X)1 X T 1
BT A = BA since B T = B
AB T = AB = B since B T = B
T T T T T T T T
B A = AB = B since B T AT = A B = AB
T T T T T T T T T T
A B = BA (since A B = B A = BA):

Problem 116 Let X be an n p matrix and let be a nonsingular and sym-


metric n n matrix. If A = X T X prove that A is symmetric. Prove that A1
1
is symmetric (assuming the inverse exists). If B = X T 1 X prove that
T 1 1 T 1
B is symmetric (assuming the inverse exists). If C = X X X X
show that C is idempotent.
CHAPTER 3. MATRIX ALGEBRA 101

Answer

AT = (X T X)T
T
= (X)T X T T
since (EF ) = F T E T
T
= X T X since E T =E
= A =) A is symmetric
1 T 1 T 1
A = AT ; since E 1 = E T
= A1 ; since A = AT from above.
= X(X T 1 X)1 X T

For B we have:
T
B T = (X T 1 X)1
1 T 1
= (X T 1 X)T since E 1 = E T
T 1 T
= (X T X T 1 since (EF ) = F T E T
T T T 1
= (X T 1 X ) since (EF )T = F T E T
1 1 T 1 T
= (X T T X since E 1 = E T and E T =E
= (X T 1 X)1 since symmetric =) = T
= B =) B is symmetric.
1 T 1
For C = X X T 1 X X we have:
1 T 1 T 1 1 T 1
CC = X X T 1 X X X X X X
| {z }
=I
1
= X X T 1 X IX T 1
1 T 1
= X X T 1 X X =) C is idempotent.

Problem 117 Given the matrix:


2 3
1 1
6 2 2 7
6 7
X=6
6 3 3 7
7
4 4 4 5
5 5
h
T T
T 1 1
T T
T i T 1 T
calculate X X; XX ; X X ; XX; X , det X X ; det X X ; det X X ,

1 T T 1 T
T r X T X ; T r XX T and T r X X T X X X XT X X :
CHAPTER 3. MATRIX ALGEBRA 102

Answer
2 3
1 1
6 2 2 7
1 2 3 4 5 6 7 55 15
XT X = 6 3 3 7 =
1 2 3 4 5 6 7 15 55
4 4 4 5
5 5
2 3 2 3
1 1 2 0 6 0 10
6 2 2 7 6 0 8 0 16 0 7
6 7 1 2 3 4 5 6 7
XX T = 6 7
6 3 3 7 1 2 3 =66 6 0 18 0 30 7
7
4 4 4 5 4 5 4 0 16 0 32 0 5
5 5 10 0 30 0 50
1 11
T 1 55 15 3
560
X X = = 560
3 11
15 55 560 560
h
T i 55 15
det X T X = det X T X = det = 2800
15 55
h 1 i 1 1
det X T X = T
=
det [(X X)] 2800

T 1 T h 1
i 1
det X X = det X T X =
2800

T 55 15
Tr X X = Tr = 55 + 55 = 110
15 55

T r XX T = 2 + 8 + 18 + 32 + 50 = T r X T X = 110:

T 1 T T T 1 T
To calculate T r X X X X X X X X you could calculate
1 T T 1 T
X XT X X X XT X X and sum the diagonal elements. It
1 T
would however be easier and faster to notice that X X T X X is symmetric
T 1 T
and idempotent and just to calculate X X X X so that:
2 3
1 1
6 2 2 7
T 1 T 6 7 55 15 1 1 2 3 4 5
X X X X 6
= 6 3 3 7 7
4 4 4 5 15 55 1 2 3 4 5
5 5
2 1 3
3
35 0 35 0 17
6 0 1 0 2 0 7
6 3 5 9 5 3 7
= 6 6 35 02 35 04 7 7
7
4 0 0 5 0 5
5
1
7 0 37 0 57
CHAPTER 3. MATRIX ALGEBRA 103

and hence the answer is:


h 1 T i 1 1 9 4 5
T r X XT X X = + + + + = 2:
35 5 35 5 7
Even
h easier would bei to use the fact that T r [AB] = T r [BA] and prove that :
1 T
T r X XT X X = T r [I] = 2 where I is a 2 2 identity matrix.

Problem 118 If X is an n 1 column vector with ith element denoted by Xj


1 T
and P = X X T X X and pij is the i; j th element of P; then what will pij
be equal to?

Answer
2 3
X1
6
6 X2 7
7
XT X = X1 X2 Xn 6 .. 7
4 . 5
Xn
= X12 + X22 + + Xn2 a scalar.
Therefore
T 1
P = X X X XT
| {z }
1
= 2 +X 2 ++X 2
X1 2 n

1
= 2 2 XX T
X1 + X2 + + Xn2
2 3
X1
6 X 7
1 6 2 7
= 6 . 7 X1 X2 Xn
X1 + X2 + + Xn 4 ..
2 2 2 5
Xn
2 3
X12 X1 X2 X1 Xn
6 X1 X2 X22 X2 Xn 7
1 6 7
= 6 .. .. .. .. 7
X12 + X22 + + Xn2 4 . . . .X
n
5
X1 Xn X2 Xn Xn2
so that:
Xi Xj
pij = :
X12 + X22 + + Xn2
The following three problems are based on the following informa-
tion:Suppose Q is an n n matrix and X is a n p matrix. Consider the
matrices:
A = X(X T Q1 X)1 X T Q1
B = X(X T Q1 X)1 X T
CHAPTER 3. MATRIX ALGEBRA 104

Problem 119 Find the dimensions of the matrices A and B: What is the rank
of Q? What is the rank of X T Q1 X? Show that (X T Q1 X)1 is symmetric.
Show that A is idempotent but not symmetric while B is symmetric but not
idempotent.
T
Problem 120 Determine AB; BA; B T A; AB T ; AT B; B T A; B T AT and
T T T
A B : Make any possible simplications , and if possible avoid any unnec-
essary work in your derivations.

Problem 121 Consider the matrix C = I A: Show that C is idempotent and


that CA = AC = 0: What is 0 here? Let X be any column of C and suppose
that at least one element of X is not equal to zero. Show that this implies that
det [A] = 0:

Problem 122 What is the denition of a symmetric matrix? If A and B are


symmetric n n matrices, show that A + B and ABA are symmetric while
AB is not in general symmetric. If C; D and E are nonsingular matrices,
1
show that CDE is nonsingular using determinants and prove that (CDE) =
E 1 D1 C 1: Let X be an n p matrix and let be a nonsingular symmetric
1 T 1
n n matrix. Prove that P = X X T 1 X X is an n n idempotent
matrix and that I P is idempotent.

Answer
A matrix A is symmetric if and only if A = AT :
Since A and B are symmetric we have: AT = A and B T = B so that:

(A + B)T = AT + B T
= A+B
=) A + B is symmetric
(ABA)T = AT B T AT
= ABA
=) ABA is symmetric
(AB)T = B T AT
= BA 6= AB
=) AB is not in general symmetric

If C; D and E are nonsingular matrices then det [C] 6= 0; det [D] 6= 0


det [E] 6= 0 and

det [CDE] = det [C] det [D] det [E] 6= 0


CHAPTER 3. MATRIX ALGEBRA 105

so that CDE is also non-singular. Also:


=I
z }| {
1 1 1 1 1
E D C CDE = E D C 1 CDE
=I
z }| {
1
= E D1 DE
=I
z }| {
= E 1 E
= I:
1
Similarly: CDE E 1 D1 C 1 = I so that (CDE) = E 1 D1 C 1 :
1
Alternatively, assuming (AB) = B 1 A1 (better to prove this!) we have:
1
(CDE) = E 1 (CD)1
= E 1 D1 C 1 :
1 T 1
We have for P = X X T 1 X X that:
=I
z }| {
T 1 1 T 1 T 1 1 T 1
PP = X X X X X X X X
T 1 1 T 1
= X X X IX
T 1 1 T 1
= X X X X
=) P is idempotent.

Also:

(I P ) (I P ) = II IP P I + P P
= I P P + P since P is idempotent
= I P
=) I P is idempotent.

Problem 123 Let X be an n p matrix and let be a symmetric n n


matrix. If A = X T X prove that A is symmetric. If B = X T X prove that B
is symmetric. Prove that C = B 1 is symmetric (assuming the inverse exists).
1 T
If P = X X T X X show that P is an n n idempotent matrix but will
not in general be symmetric.
1
Problem 124 If X is an n p matrix show that A = X T X is symmet-
T 1 T
that P = X X X
ric. Show X is symmetric and idempotent. What is
tr P T P equal to?

Problem 125 Suppose that A = X T X where X is an n p matrix. Show that


A is a positive semi-denite matrix (i.e. show that y T Ay 0 for all y): Does
CHAPTER 3. MATRIX ALGEBRA 106

A1 necessarily exist then? Suppose that the column vectors of X are all linearly
independent, or that rank [X] = p; or that Xc = 0 implies c = 0 where c is a
p 1 vector. Show that in this case A is positive denite. Does A1 necessarily
exist then?

Answer
Let y be any p 1 vector. Then:

y T Ay = y T X T Xy
= zT z
T
where z = Xy and z T = (Xy) = yT X T and since X is n p and y is p 1 it
follows that z is an n 1 column vector. Thus:

y T Ay = zT z
2 3
z1
6
6 z2 7
7
= z1 z2 zn 6 .. 7
4 . 5
zn
= z12 + z22 + + zn2
0

since zi2 0 (a squared number is always non-negative). We therefore conclude


that for all y:

yT Ay 0
=) A is positive semi-denite.

A positive semi-denite matrix is not necessarily positive denite in which


case A1 would not exist. Suppose now that: rank [X] = p; or that Xy = 0
implies y = 0 where y is a p 1 vector. In order to show A is positive denite
we need to show that:

y T Ay = 0 =) y = 0:

Now suppose that:

yT Ay = z T z = 0:

This is only possible if zi = 0 for i = 1; 2; : : : n or z = 0: However,

z = 0 =) Xy = 0 =) y = 0

so we conclude that in this case A is positive denite in which case A1 exists.


CHAPTER 3. MATRIX ALGEBRA 107

Problem 126 Suppose that A = X T X where X is an n p matrix and is


a positive denite matrix. Show that A is a positive semi-denite matrix (i.e.
show that y T Ay 0 for all y): Does A1 necessarily exist then? Suppose that
the column vectors of X are all linearly independent, or that rank [X] = p; or
that Xy = 0 implies y = 0 where y is a p 1 vector. Show that in this case A
is positive denite. Does A1 necessarily exist then?

Answer
Let y be any p 1 vector. Then:

yT Ay = yT y
= z T z
0 (since is postive denite)
=) A = X T X is positive semi-denite.

Here z = Xy and z T = (Xy)T = y T X T and since X is n p and y is p 1 it


follows that z is an n 1 column vector.
The matrix A is not necessarily positive denite since it might be that z =
Xy = 0 in which case A1 would not exist. However if rank [X] = p; or that
Xy = 0 implies y = 0 where y is a p 1 vector then A is positive denite and
A1 does exist.

Problem 127 Recall from statistics that the sample mean and variance are
Pn 1 Pn

given by: Y = n1 i=1 Yi and s2 = n1 2 : Let Y = [Yi ] be an
i=1 Yi Y
n 1 vector and let be an n 1 vector with each element equal to 1: Let P = n1
T : Show that P and I P are symmetric and idempotent, that Y = n1 T Y and
Y T (IP )Y
that s2 = n1 :

Answer
First note that T = n since:
2 3
1
6
6 1 7
7
T = 1 1 1 6 .. 7
4 . 5
1
2 2 2
= 1 +1 + +1
= n:
CHAPTER 3. MATRIX ALGEBRA 108

Multiplying P by itself we nd that:



1 T 1 T
PP =
n n
1 T T
=
n2 |{z}
=n
n T
=
n2
1 T
=
n
= P =) P is idempotent.

Now multiplying I P by itself and using P P = P we nd that:

(I P ) (I P ) = II IP P I + P P
= I P P +P
= I P =) I P is idempotent.

To show that Y = n1 T Y note that:


2 3
Y1
1 T 1 6
6 Y2 7
7
Y = 1 1 1 6 .. 7
n n 4 . 5
Yn
1
= (1 Y1 + 1 Y2 + + 1 Yn )
n
1
= (Y1 + Y2 + + Yn )
n
= Y :

Furthermore:
1 T
(I P ) Y = Y Y
n
1 T
= Y Y
n
| {z }

=Y
= Y Y
2 3
Y1 Y
6 Y2 Y 7
6 7
= 6 .. 7:
4 . 5
Yn Y
CHAPTER 3. MATRIX ALGEBRA 109

Therefore:
2 3T 2 3
Y1 Y Y1 Y
6 Y2 Y 7 6 Y2 Y 7
6 7 6 7
((I P ) Y )T ((I P )) Y = 6 .. 7 6 .. 7
4 . 5 4 . 5
Yn Y Yn Y
2 2 2
= Y1 Y + Y2 Y + + Yn Y
= (n 1) s2 :

But using the fact that I P is symmetric and idempotent we have:

((I P ) Y )T ((I P )) Y = Y T (I P )T (I P ) Y
= Y T (I P ) (I P ) Y
= Y T (I P ) Y

so that:

Y T (I P ) Y = (n 1) s2
Y T (I P ) Y
=) s2 = :
n1
Problem 128 Suppose P is an nn idempotent matrix. What does that mean?
If x is an eigenvector of P and is an eigenvalue of P; what relationship exists
between P; x; and ? Prove that either = 0 or = 1.

Answer
Idempotent means that P P = P: If x is an eigenvector of P and is an
eigenvalue of P then for x 6= 0

P x = x:

Multiplying both sides by P and using P P = P and P x = x:

PPx = P x = 2 x
PPx = P x = x
=) 2 x = x
=) x (1 ) = 0:

Since x 6= 0 either = 0 or = 1:

Problem 129 If Q is a n n symmetric matrix, and X is an n p ma-


1 1
trix, show that X T Q1 X
h is symmetric and that
i X X T Q1 X XQ1 is
1
idempotent. What is T r X X T Q1 X XQ1 ?
CHAPTER 3. MATRIX ALGEBRA 110

Answer
Problem 130 If Q is a n n symmetric matrix, and X is an n p ma-
1 1
trix, show that X T Q1 X
h is symmetric and that
i X X T Q1 X XQ1 is
1
idempotent. What is T r X X T Q1 X XQ1 ?

The next problem is based on the following information: Suppose


the true linear regression model takes the form:

Y = X + e

where Y is a vector of the consumption of 10 families, the rst column of X is


the income and the second column is the wealth. Suppose that the actual data
takes the form:
2 3 2 3
22 10 100
6 88 7 6 25 355 7
6 7 6 7
6 7 7 6 7 10 7
6 7 6 7
6 29 7 6 41 50 7
6 7 6 7
6 8 7 6 7
Y =6 7 ; X = 6 10 3 7 :
6 217 7 6 75 860 7
6 7 6 7
6 35 7 6 21 62 7
6 7 6 7
6 61 7 6 77 107 7
6 7 6 7
4 11 5 4 21 10 5
52 71 45

^
Problem 131 Calculate

Answer
^ we have:
From the formula for
2 3
10 100
6 25 355 7
6 7
6 7 10 7
6 7
6 41 50 7
6 7
10 25 7 41 10 75 21 77 21 71 6 6 10 3 7
7
XT X =
100 355 10 50 3 860 62 107 10 45 6
6 75 860 7
7
6 21 62 7
6 7
6 77 107 7
6 7
4 21 10 5
71 45

20032 89471
=
89471 895652
CHAPTER 3. MATRIX ALGEBRA 111

while:
2 3
22
6 88 7
6 7
6 7 7
6 7
6 29 7
6 7
10 25 7 41 10 75 21 77 21 71 6 6 8 7
7
XT Y =
100 355 10 50 3 860 62 107 10 45 6
6 217 7
7
6 35 7
6 7
6 61 7
6 7
4 11 5
52

29368
= :
232751

^ is given by:
Thus the least squares estimator
T 1 T
^
= X X X Y
1
20032 89471 29368
=
89471 895652 232751

0:5514
= :
0:2048

^ 1 = 0:5514
The estimated marginal propensity to consume out of income is:
while the estimated marginal propensity to consume out of wealth is: ^2 =
0:2048
^
Problem 132 Calculate the least squares residual: e^ = Y X .

Answer
We have:
2 3 2 3 2 3
22 10 100 3:994
6 88 7 6 25 355 7 6 1:511 7
6 7 6 7 6 7
6 7 7 6 7 10 7 6 1:0922 7
6 7 6 7 6 7
6 29 7 6 41 50 7 6 3:8474 7
6 7 6 7 6 7
6 8 7 6 10 3 7 0:5514 6 1:8716 7
e^ = 6
6
76
7 6
7 6
7 0:2048 = 6
7:
7
6 217 7 6 75 860 7 6 :483 7
6 35 7 6 21 62 7 6 10:723 7
6 7 6 7 6 7
6 61 7 6 77 107 7 6 3:3714 7
6 7 6 7 6 7
4 11 5 4 21 10 5 4 2:6274 5
52 71 45 3:6346

^ the vector of tted values.


Problem 133 Calculate Y^ = X ;
CHAPTER 3. MATRIX ALGEBRA 112

Answer
We have:
2 3 2 3
10 100 25:994
6 25 355 7 6 86:489 7
6 7 6 7
6 7 10 7 6 5:9078 7
6 7 6 7
6 41 50 7 6 32:847 7
6 7 6 7
6 10 3 7 0:5514 6 6:1284 7
Y =6
^
6
7 6
7 0:2048 = 6
7:
7
6 75 860 7 6 217:48 7
6 21 62 7 6 24:277 7
6 7 6 7
6 77 107 7 6 64:371 7
6 7 6 7
4 21 10 5 4 13:627 5
71 45 48:365

Problem 134 Prove that e^ and Y^ are always orthogonal. Is this the case in
the above example?

Answer
We have:
Y^ = P Y; e^ = (I P ) Y
1 T
where P = X X T X X and (I P ) are symmetric and idempotent. There-
fore:
e^T Y^ = ((I P ) Y )T (P Y )
= Y T (I P )T P Y
= Y T (I P ) P Y since I P is symmetric
= Y T (P P P ) Y
= Y T (P P ) Y since P is idempotent
= Y T 0Y
= 0 =) e^ and Y^ are orthogonal.
For this particular example we have:
2 3T 2 3
3:994 25:994
6 1:511 7 6 86:489 7
6 7 6 7
6 1:0922 7 6 5:9078 7
6 7 6 7
6 3:8474 7 6 32:847 7
6 7 6 7
6 1:8716 7 6 6:1284 7
e^ Y = 6
T ^
6 :483
7
7
6
6
7
7
6 7 6 217:48 7
6 10:723 7 6 24:277 7
6 7 6 7
6 3:3714 7 6 64:371 7
6 7 6 7
4 2:6274 5 4 13:627 5
3:6346 48:365
= 3:3454:
CHAPTER 3. MATRIX ALGEBRA 113

Note that it is not numerically equal to zero even though we proved it must be
zero!! The reason for this is that we have rounded the decimal expansion of the
numbers we have used (we have only worked with numbers up to one decimal
place) so that rounding error is the cause of the discrepancy.

3.3 Systems of Equations, Cramers Rule


The following three problems are based on the following system of equations:
3X1 + 5X2 = 7 + 2X3
X1 2X2 + 3X3 = 4 + 2X2
X1 X2 + X3 = 10
Problem 135 Writing this system as AX = b; what is A; what is X and what
is b? Is A or b symmetric? Calculate det [A] : Is A nonsingular? Is it invertible?
What is its rank? Solve AX = 0 for X:

Answer
Putting the X 0 s on the left-hand side we can rewrite the equations as:
3X1 + 5X2 2X3 = 7
X1 4X2 + 3X3 = 4
X1 X2 + X3 = 10
or in matrix notation as:
2 32 3 2 3
3 5 2 X1 7
4 1 4 3 5 4 X2 5 = 4 4 5 :
1 1 1 X3 10
Neither A nor b is symmetric since:
2 3T 2 3T
3 5 2 7
AT = 4 1 4 3 5 6= A; bT = 4 4 5 = 7 4 10 6= b:
1 1 1 10
We have:
2 3
3 5 2
4 3 1 3 1 4
det 4 1 4 3 5 = 3 det 5 det + 2 det
1 1 1 1 1 1
1 1 1
= 1:
Since det [A] 6= 0; it follows that A is invertible, has full rank, that is rank [A] =
3; and that AX = 0 =) X = 0; that is X1 = 0; X2 = 0 and X3 = 0:
1
Problem 136 Calculate A1 using determinants. Calculate AT : Calcu-
late A1 b: Solve the above system of equations using Cramers rule. The last
two answers you give should be identical. What is b1 ?
CHAPTER 3. MATRIX ALGEBRA 114

Answer
The adjoint of A is given by:
2 3T
4
3 1 3 1 4
2 3 6 det det det 7
3 5 2 6 1
1 1 1 1 1 7
6 25 3 2 3 5 7
4
adj 1 4 3 5 = 6
6 det det det 7
7
6 11 1 1 1 1 7
1 1 1 4 5
25 3 2 3 5
det det det
43 1 3 1 4
2 3
1 3 7
= 4 2 5 11 5 :
3 8 17
1
Since A1 = det[A] adj [A] and det [A] = 1 it follows that for this matrix A1 =
adj [A] so that:
2 3
1 3 7
A1 = 4 2 5 11 5 :
3 8 17

Therefore:
2 32 3 2 3
1 3 7 7 51
X = A1 b = 4 2 5 11 5 4 4 5 = 4 76 5
3 8 17 10 117

so that X1 = 51; X2 = 76 and X3 = 117: Using Cramers rule we nd that:


2 3
7 5 2
det 4 4 4 3 5
10 1 1 51
X1 = = = 51;
det [A] 1
2 3
3 7 2
det 4 1 4 3 5
1 10 1 76
X2 = = = 76;
det [A] 1
2 3
3 5 7
det 4 1 4 4 5
1 1 10 117
X3 = = = 117:
det [A] 1

Problem 137 Consider the system of equations Y AT = bT where Y is an


unknown 1 3 row vector and A and b are the same as in the problem above.
What is Y ?
CHAPTER 3. MATRIX ALGEBRA 115

Answer
Taking transposes of both sides of Y AT = bT we obtain:

AY T = b

so that Y T = X or

Y = XT = 51 76 117 :

Problem 138 Consider the following system of linear equations:

4x1 + 2x2 = 3
5x1 + 6x2 = 7:

Write these in matrix notation in the form Ax = b: Calculate det [A] and based
on this determine how many, if any, solutions to this model exist and whether
A1 exists. Calculate x1 and x2 using Cramers rule.

Answer
We have:


4 2 x1 3
=
5 6 x2 7

4 2
det [A] = det = 14:
5 6

Since det [A] = 14 6= 0 it follows that exactly one solution to these equations
exists and that A1 exists. Using Cramers rule we nd that:

3 2 4 3
det det
7 6 2 5 7 13
x1 = = ; x2 = = :
4 2 7 4 2 14
det det
5 6 5 6

Problem 139 If Ax = b where:


2 3 2 3 2 3
1 2 4 x1 1
A = 4 2 3 2 5 ; x = 4 x2 5 ; b = 4 5 5
3 1 3 x3 3

write this out as three linear equations with three unknowns. Find x using the
value of A1 you calculated in the previous problem. Now calculate x2 and x3
using Cramers rule.
CHAPTER 3. MATRIX ALGEBRA 116

Answer
We have:

x1 + 2x2 + 4x3 = 1
2x1 + 3x2 + 2x3 = 5
3x1 + x2 + 3x3 = 3

Thus x = A1 b or:
2 3 2 7 2 8
32 3 2 27 3
x1 13 13 13 1 13
4 x2 5 = 4 12 9 10 5 4 5 5 = 4 63 5
13 13 13 13
11 5 7
x3 13 13 13 3 35
13

27 63
so that x1 = 13 ; x2 = 13 and x3 = 35
13 : Using Cramers rule we nd that:
2 3
1 1 4
det 4 2 5 2 5
3 3 3 63
x2 = = ;
13 13
2 3
1 2 1
det 4 2 3 5 5
3 1 3 35
x3 = = :
13 13
Problem 140 Consider the following system of linear equations:

8x1 + 4x2 = 6
5x1 + 3x2 = 15

Write these in matrix notation as Ax = b: Calculate det [A] and based on this
determine how many, if any, solutions to this model exist and whether A1
exists. Calculate x1 and x2 using A1 . Solve the following equations for y1 and
y2
4
e6 y12 y2 = 1
15 5 3
e (y1 ) (y2 ) = 1:

Answer
We have:

8 4 x1 6
=
5 3 x2 15

8 4
det [A] = det = 4:
5 3
CHAPTER 3. MATRIX ALGEBRA 117

Since det [A] = 4 6= 0 it follows that exactly one solution to these equations
exists and that A1 exists. Using Cramers rule we nd that:

6 4
det
15 3 42 21
x1 = = = ;
8 4 4 2
det
5 3

8 6
det
5 15 90 45
x2 = = = :
8 4 4 2
det
5 3
Taking ln () of both sides of
4
e6 y12 y2 = 1
15 5 3
e (y1 ) (y2 ) = 1
we nd that:
4
ln e6 y12 y2 = ln (1) =) 8 ln (y1 ) + 4 ln (y2 ) = 6

5 3
ln e15 (y1 ) (y2 ) = ln (1) =) 5 ln (y1 ) + 3 ln (y2 ) = 15:

Setting x1 = ln (y1 ) and x2 = ln (y2 ) we nd that:


3x1 + 4x2 = 6
5x1 + 6x2 = 15
which is identical to the linear system of equations we just solved so that:
21 45
ln (y1 ) = x1 = ; ln (y2 ) = x2 =
2 2
which implies that
21 45
y1 = e 2 ; y2 = e 2
Problem 141 Consider the following system of linear equations:
3x1 + 4x2 = 6
5x1 + 6x2 = 15
Write these in matrix notation as Ax = b: Calculate det [A] and based on this
determine how many, if any, solutions to this model exist and whether A1 ex-
ists. Calculate x1 and x2 using Cramers rule. Find the solution to the following
nonlinear system of equations:
(w1 )3 (w2 )4 = e6
(w1 )5 (w2 )6 = e15
CHAPTER 3. MATRIX ALGEBRA 118

Answer
We have:

3 4 x1 6
=
5 6 x2 15

3 4
det [A] = det = 2:
5 6

Since det [A] = 2 6= 0 it follows that exactly one solution to these equations
exists and that A1 exists. Using Cramers rule we nd that:

6 4 3 6
det det
15 6 24 5 15 15
x1 = = = 12; x2 = = :
3 4 2 3 4 2
det det
5 6 5 6

Taking ln ( ) of both sides of

(w1 )3 (w2 )4 = e6
(w1 )5 (w2 )6 = e15

we nd that:

ln (w1 )3 (w2 )4 = ln e6 =) 3 ln (w1 ) + 4 ln (w2 ) = 6

5 6
ln (w1 ) (w2 ) = ln e15 =) 5 ln (w1 ) + 6 ln (w2 ) = 15:

Setting x1 = ln (w1 ) and x2 = ln (w2 ) we nd that:

3x1 + 4x2 = 6
5x1 + 6x2 = 15

which is identical to the linear system of equations we just solved so that:


ln (w1 ) = x1 = 12 and ln (w2 ) = x2 = 15
2 which implies that w1 = e
12
and
15
w2 = e 2 :

Problem 142 Given the two equations:

4x1 3x2 = 7
5x1 + 2x2 = 1;

if these are written as Ax = b; then what are A; x and b? Calculate A1 :


Calculate x1 and x2 using Cramers rule.
CHAPTER 3. MATRIX ALGEBRA 119

Answer

4 3 x1 7
=
5 2 x2 1
2 3

A1 = 23 23
5 23 4
2317

x1 23
= :
x2 31
23

3.4 Quadratic Forms, Eigenvalues and Eigenvec-


tors
Problem 143 Consider the matrix:

9 3
A= :
3 5
If x is given by:

x1
x=
x2
then write out the quadratic form: xT Ax in scalar notation. Find the eigen-
values of A and use these to determine whether A is positive denite, positive
semi-denite, negative denite or negative semi-denite. Now use determinants
to nd out if A is positive denite or negative denite.

Answer

9 3 x1
xT Ax = x1 x2
3 5 x2
= 9x21 + 6x1 x2 5x22 :
To nd the eigenvalues of A note that:

9 3 1 0
det [A I] = det
3 5 0 1
= 36 + 14 + 2 = 0
p
=) 1 = 7 + 13 = 3:3944 < 0
p
=) 2 = 7 13 = 10:606 < 0:
Since 1 < 0 and 2 < 0 it follows that A is negative denite.
Using determinants or leading principal minors we nd that:
M1 = det [9] = 9 < 0

9 3
M1 = det = 36 > 0:
3 5
CHAPTER 3. MATRIX ALGEBRA 120

Since they alternate in sign with the rst being negative, it follows that A is
negative denite.

Problem 144 Any symmetric matrix A can be written as: A = CC 1 where


C T = C 1 and is a diagonal matrix with eigenvalues: 1 ; 2 ; : : : n along the
diagonal. Use this to show that det [A] is the product of the eigenvalues and tr [A]
is the sum of the eigenvalues. If A is positive denite, show that A1 is positive
denite. If A is idempotent, show that A is positive semi-denite. Suppose
another matrix B can be written as B = CC 1 where is a diagonal matrix
with eigenvalues: 1 ; 2 ; : : : n and suppose A and B are negative denite. Show
that the matrix AB is positive denite.

Answer
We have:

det [A] = det CC 1

= det [C] det [] det C 1 since det [ABC] = det [A] det [B] det [C]

= det C 1 det [C] det [] since the determinant is a scalar
1 1
= det [C] det [] since det B 1 =
det [C] det [B]
= det [] = 1 2 n since is a diagonal matrix.

Similarly:
2 E F 3
z}|{z}|{
T r [A] = T r 4 C C 5

= T r C 1 C since T r [EF ] = T r [F E]
= T r []
= 1 + 2 + + n :

If A is positive denite then all the eigenvalues of A are positive. But:

A1 = C1 C 1

since

C1 C 1 A = C1 C 1 CC 1
= C1 C 1
= CC 1
= I:

Therefore the eigenvalues of A1 are 1


i > 0 and so A
1
is positive denite.
CHAPTER 3. MATRIX ALGEBRA 121

Another proof that A1 is positive denite is as follows:

xT A1 x = y T Ay 0

where y = A1 x with equality only when y = 0 =) x = 0 since A1 is


nonsingular.
If A = CC 1 and B = CC 1 then:

AB = CC 1 CC 1
= CC 1 :

Note that is a diagonal matrix with the ith diagonal element equal to i i > 0
which are the eigenvalues of AB: Therefore AB is positive denite. Note that
in general the product of two positive denite matrices is not positive denite.

Problem 145 Prove that the eigenvalues of A and AT are identical.

Answer
The eigenvalues of A are the roots of the equation:

det [A I] = 0:
T
We know that det [B] = det B so that:
h i
T
det [A I] = 0 , det (A I) = 0:

However since is a scalar:

(A I)T = AT I T = AT I

so that:

det [A I] = 0 , det AT I = 0:

Thus is an eigenvalue of A if and only if is an eigenvalue of AT : Note A and


AT will not in general have the same eigenvectors.

Problem 146 If a matrix A is nonsingular, what are the eigenvalues of A1 ?

Answer
Since A1 exists all eigenvalues are nonzero. We have:

Ax = x
1
=) A1 x = x

CHAPTER 3. MATRIX ALGEBRA 122

1
so that is an eigenvalue of A if and only if is an eigenvalue of A1 : For
example given the matrix:

5 1
A=
2 4

you can verify that the eigenvalues are 1 = 3 and 2 = 6 while:


1 2 1

1 5 1 9 18
A = =
2 4 19 5
18

1
has eigenvalues: 1 = 3 and 2 = 16 :

Problem 147 Given an n n symmetric matrix A; what does it mean to say


that A is positive denite (that is, what is the denition of a positive denite
matrix)? Comment on the statement: If A is positive denite but not positive
semi-denite then det [A] = 0. If A is given by:

5 3
A=
3 4

what is xT Ax equal to (where x is a 2 1 vector)? Show that A is positive


denite using determinants. Calculate the eigenvalues of A and use these to
show that A is positive denite.

The following three problems are based on the following information:


Let A be an n n matrix with eigenvalues i ; i = 1; 2; : : : n: Assume that A
can be written as A = CC 1 (this is almost always true) where is an n n
diagonal matrix with the individual eigenvalues along the diagonal (and zeros
on the o-diagonals).

Problem 148 Show that = 2 where 2 is a diagonal matrix with 2i


i = 1; 2; :::n along the diagonal. Similarly, show that r is a diagonal matrix
with ri i = 1; 2; :::n along the diagonal. Now show that A2 = A A = C2 C 1
and that Ar = Cr C 1 : Use this to show that if j i j< 1 ; i = 1; 2; : : : n (i.e.
each eigenvalue has an absolute value less than one) that:

lim Ar = 0:
r!1

Answer
If is diagonal then:
2 3
1 0 0
6 0 2 0 7
6 7
=6 .. .. .. .. 7
4 . . . . 5
0 0 n
CHAPTER 3. MATRIX ALGEBRA 123

and
2 32 3
1 0 0 1 0 0
6 0 2 0 76 0 2 0 7
6 76 7
= 6 .. .. .. .. 76 .. .. .. .. 7
4 . . . . 54 . . . . 5
0 0 n 0 0 n
2 3
21 0 0
6 0 22 0 7
6 7
= 6 .. .. .. .. 7
4 . . . . 5
0 0 2n
by multiplying each row and column one sees that only the diagonal elements
are non-zero. Using mathematical induction, we see that the result is true for
r = 1: Assume it is true for r 1 so that:
2 r1 3
1 0 0
6 0 r1 0 7
6 2 7
r1 = 6 . .. .. .. 7
4 .. . . . 5
0 0 r1
n

then:
r = r1
2 r1 32 3
1 0 0 1 0 0
6 0 r1 0 76 0 2 0 7
6 2 76 7
= 6 . .. .. .. 76 .. .. .. .. 7
4 .. . . . 54 . . . . 5
0 0 r1
n 0 0 n
2 3
r1 0 0
6 0 r2 0 7
6 7
= 6 .. .. .. .. 7:
4 . . . . 5
0 0 rn
Thus the result is true for all r:
If j i j< 1 ; i = 1; 2; : : : n then clearly ri ! 0 as r ! 1 so that: r ! 0 as
r ! 1 and hence:
lim Ar = C lim r C 1
r!1 r!1
= C0C 1
= 0:
Problem 149 What will the matrices (I ) and (I )1 be equal to? Show
1
that I A = C (I ) C 1 ; dene the matrix B = C (I ) C 1 and show
1
that B = (I A) : Why do you have to assume that no eigenvalue of A is
equal to one?
CHAPTER 3. MATRIX ALGEBRA 124

Answer
2 3 2 3
1 0 0 1 0 0
6 0 1 0 7 6 0 2 0 7
6 7 6 7
(I ) = 6 .. .. .. .. 76 .. .. .. .. 7
4 . . . . 5 4 . . . . 5
0 0 1 0 0 n
2 3
1 1 0 0
6 0 1 2 0 7
6 7
= 6 .. .. .. .. 7:
4 . . . . 5
0 0 1 n
Since (I ) is diagonal its inverse is simply the inverse of its diagonal elements
so that:
2 31
1 1 0 0
6 0 1 2 0 7
6 7
(I )1 = 6 .. .. .. . 7
4 . . . .. 5
0 0 1 n
2 1 3
11 0 0
6 0 1
0 7
6 12 7
= 6 .. .. .. .. 7 :
4 . . . . 5
1
0 0 1n

If i = 1 then 1
1i = 1
11 = 1 and so (I )1 would not be dened.
Now:
I A = I CC 1
= CC 1 CC 1
= C (I ) C 1
1
If B = C (I ) C 1 then:
BA = C (I )1 C 1 (I A)
=I
z }| {
1
= C (I ) C 1 C (I ) C 1
= C (I )1 (I ) C 1
= CC 1
= I
so that: B = (I A)1 :
Problem 150 The geometric series says that for j j< 1 that
1
= 1 + + 2 + 3 + :
1
CHAPTER 3. MATRIX ALGEBRA 125

Assuming that j i j< 1 ; i = 1; 2 : : : n , use the results in your answers to a)


and b) to show that:

(I A)1 = I + A + A2 + A3 + :

Answer
Since
2 1 3
11 0 0
6 0 1
0 7
6 12 7
(I )1 = 6 .. .. .. .. 7
4 . . . . 5
1
0 0 1n
2 3
1 + 1 + 21 + 0 0
6 0 1 + 2 + 22 + 0 7
6 7
= 6 .. .. .. .. 7
4 . . . . 5
0 0 1 + n + 2n +
= I + + 2 + :
1
Since (I A) = C (I )1 C 1 we have:
1
(I A) = C (I )1 C 1

= C I + + 2 + C 1
= CC 1 + CC 1 + C2 C 1 +
= I + A + A2 + :

Problem 151 Let X and Y be two random variables. Let 2x be the variance of
X; let 2y be the variance of Y; and let xy be the covariance between X and Y:

The correlation coecient is then dened as: = xxy y : The variance covariance
matrix for X and Y is then dened to be:
2
x xy
= :
xy 2y

Using the fact that this matrix is positive semi-denite, show that 1 1
and that the matrix is positive denite as long as 6= 1:

Answer
Recall that det [] = 1 2 where 1 and 2 are the eigenvalues of : Since
is positive semi-denite, det [] = 1 2 0 since the determinant is the
CHAPTER 3. MATRIX ALGEBRA 126

product of the eigenvalues which are greater than equal to zero. Thus:
2
x xy
det [] = det
xy 2y
= 2x 2y ( xy )2
!
2 2 (xy )2
= xy 1 2 2
x y
0 1
B 2 C
B xy C
= 2x 2y B1 C
@ xy A
| {z }
=

= 2x 2y
1 2 0

=) 1 2 0
=) 2 1
=) 1 1:

If 6= 1 then

det [] = 1 2 = 2x 2y 1 2 > 0

and hence 1 > 0 and 2 > 0 so that is positive denite.

Problem 152 Recall that any symmetric matrix A can be written as A =


CC T where C T = C 1 and is a diagonal matrix with the eigenvalues
along the diagonal. Prove that A2 = C2 C T and that if A is nonsingular then
A1 = C1 C T . Find C ; and C T for the matrix A below by multiplying out
the right-hand side:
" p1 # " 1 #
5 2 2
p12 3 0 p
2
p1
2
A= = p1 p1
:
2 5 2 2
0 7 p12 p12

Verify that C T = C 1 : What are the eigenvalues of A? Calculate A1 without


using determinants. Show that the two columns of C T are eigenvectors of A;
that they are orthogonal to each other and that they have a length of 1:

Answer
First multiply the three matrices together to verify the result. Now:
" #
p1 p1
C = p12 p1
2
2 2
CHAPTER 3. MATRIX ALGEBRA 127

so that: det [C] = 1 and hence:


" #
1 p1 p1
1 2 2
C =
det [C] p12 p1
2
" #
p1 p1
= 2 2 = CT :
p12 p1
2

The eigenvalues of A are the diagonal elements of the matrix in the middle;
i.e., 1 = 3 and 2 = 7:
The columns of C are orthogonal since if c1 is the rst column and c2 is the
second as:
" # " #
p1 p1
c1 = p12 ; c2 = p1
2
2 2

then:
" #
h i p1
cT1 c2 = p1 p1 2 = 0:
2 2 p12

They each have a length of 1 since:


q
jjc1 jj = cT1 c1
v " #
uh i
u p1
= t p12 p1
2 p1
2
2

= q
1
jjc2 jj = cT2 c2
v " #
uh i
u p1
= t p1 p12 2
2 p12
= 1:
Taking the rst column of C and multiplying by A as Ac1 we nd that:
Ac1 = 3c1
" p1 # " p3 # "
p1
#
5 2 2 2 2
p1
= p3 = 3 p1
2 5 2 2 2

so that this column is an eigenvector corresponding to the eigenvalue 1 = 3:


Taking the second column we nd: Ac2 = 7c2 since:
" p1 # " p 7
# "
p1
#
5 2 2 = p72 = 7 2
2 5 p12 2
p12

so that this column is an eigenvector corresponding to the eigenvalue 2 = 7:


CHAPTER 3. MATRIX ALGEBRA 128

Problem 153 Consider the matrix:



9 3
A=
3 4

Find the eigenvalues of A and determine whether it is positive denite or not.


Find its inverse using the adjoint matrix.

Answer
Problem 154 If
2 3
1 1
X = 4 1 2 5
1 3

then calculate A = X T X: Calculate the eigenvalues of A and show from these


eigenvalues that A is positive denite. Use determinants to show that A is
positive denite. Calculate A1 using the adjoint matrix.

Problem 155 If X is an nxp matrix, show that A = X T X is p p; symmetric


and positive semi-denite. Show that if rank [X] = p then X T X is positive
denite.

Problem 156 We have just seen that A = X T X = X T IX is positive semi-


denite where I is positive denite. Consider generalizing this result. Assuming
that B is positive semi-denite, show that X T BX is positive semi-denite. If
B is positive denite and rank [X] = p show that X T BX is positive denite.

Problem 157 If A is positive denite and B is positive denite, show that AB


is not necessarily positive denite. Show that A + B is positive denite.

Problem 158 Show that for symmetric


n n A and any n m X that A is
positive denite if and only if tr AXX T > 0 for all X 6= 0:

Problem 159 If tr [A] 0 can A be positive denite?

Problem 160 If
2 3
1 1
X = 4 1 2 5
1 3

then calculate A = X T X: Calculate the eigenvalues of A and show from these


eigenvalues that A is positive denite. Calculate A1 using the adjoint matrix.

Problem 161 If X is any np matrix and A = X T BX where B is symmetric,


show that A is symmetric and that P = XA1 X T B is idempotent.
CHAPTER 3. MATRIX ALGEBRA 129

Problem 162 If A is given by:



5 3
A=
3 4
show that A is positive denite by 1) using principal minors and 2) calculating
the eigenvalues of A:
Problem 163 Suppose that A is symmetric and positive semi-denite or A 0:
Consider the problem of calculating the square root of A or nding a matrix B
such that A = BB: This turns out to be an important problem in econometrics.
Show that such a matrix B exists and that is also symmetric and positive semi-
denite.

Answer
Since A is symmetric we can write A as:
A = CC T
where C is orthogonal or C T = C 1 and is diagonal with the eigenvalues of
A along the diagonal or:
2 3
1 0 0
6 0 2 0 7
6 7
=6 . .. .. .. 7:
4 .. . . . 5
0 0 0 n
and where i 0 since A is positive semi-denite. Since i 0 we can take the
positive square root of each of the eigenvalues. Therefore dene B by:
1
B = C 2 C T
where:
2 1 3
12 0 0
6 1 7
6
1 0 n2 0 7
=6
2
6 .. .. .. ..
7:
7
4 . . . . 5
1
0 0 0 n2
You can then verify that B is symmetric, positive semi-denite and that:
1 1 1 1
BB = C 2 C T C 2 C T = C 2 2 C T = CC T = A:
Problem 164 We have for the matrix A below the representation A = CC T
given by:
" p1 # " p1 #
5 2 2
p12 3 0 2
p1
2
A= = p1 p1
:
2 5 2 2
0 7 p12 p12

Calculate B from the question above.


CHAPTER 3. MATRIX ALGEBRA 130

Answer
We have:
" # p " p1 #
p1 p123 p0 p1
B = 2 2 2
p1
p1 0 7 p1 p1
22 2 2
1p 1
p 1
p 1
p
2p3 + 2p 7 2p 3 2p 7
= 1 1 1 1 :
2 3 2 7 2 3+ 2 7

We then have with a little work:


1p 1
p 1
p 1
p 1
p p p p
2 p 3 + 2 p 7 2 p3 2 p7 2 p3 + 12 p7 1
2 p3 12 p7
BB = 1 1 1 1 1
3 7 3 + 2 7 2 3 12 7 1
2 3 + 12 7
2 2
2
5 2
= :
2 5
Problem 165 Suppose that A is positive semi-denite or A 0: Consider the
problem of calculating the square root of A but now we nd a matrix B such
that A = BB T : Show that such a matrix B exists.

Answer
Since A is symmetric we can write A as:
A = CC T

where C is orthogonal or C T = C 1 and is diagonal with the eigenvalues of


A along the diagonal or:
2 3
1 0 0
6 0 2 0 7
6 7
=6 . .. .. .. 7:
4 .. . . . 5
0 0 0 n
and where i 0 since A is positive semi-denite. Since i 0 we can take the
positive square root of each of the eigenvalues. Therefore dene B by:
1
B = C 2
1
from which it follows that B T = 2 C T : It follows then that:
1 1
BB T = C 2 2 C T = CC T = A:

Problem 166 We have for the matrix A below the representation A = CC T


given by:
" p1 # " p1 #
5 2 2
p12 3 0 2
p1
2
A= = p1 p1
:
2 5 2 2
0 7 p12 p12

Calculate B from the question above.


CHAPTER 3. MATRIX ALGEBRA 131

Answer
We have:
" # p
p1 p12 3 p0
B = 2
p1 p1 0 7
2 2
" p p #
p3 p72
= p2 p :
p3 p7
2 2

We have:
" p p #" p p #T
p3 p72 p3 p72
T p2 p2
BB = p p
p3 p7 p3 p7
2 2 2 2

5 2
= :
2 5

Problem 167 For scalars a and b is a b 0 then 1b a1 0: For example if


a = 5 and b = 3 then ab = 2 0 =) 13 15 0: Now consider generalizing this
to matrices (this turns out to be important for econometrics). Thus suppose that
A and B are positive denite if and only if B 1 A1 is positive semi-denite.
Hint: prove that A B is positive semi-denite if and only if: det [A B] =
0 =) 1:

Answer
Since B is positive denite we can write it as B = DDT : We then have:

det [A B] = det [A B ( 1) B]

= det A B ( 1) DDT
h 1 i
= det D D1 (A B) DT ( 1) I DT
h T i
= det [D] det D1 (A B) D1 ( 1) I det DT
h T i
= det DDT det D1 (A B) D1 ( 1) I
h T i
= det [B] det D1 (A B) D1 ( 1) I

where det [B] > 0: Therefore det [A B] = 0 if and only if 1 is an eigenvalue


of the matrix
T
E = D1 (A B) D1 :

Now suppose that A B is positive semi-denite. It follows then that


T
E = D1 (A B) D1 is positive semi-denite since E has the form: CC T
CHAPTER 3. MATRIX ALGEBRA 132

where = A B is positive semi-denite and C = D1 : Therefore the eigen-


values of E are non-negative so that det [A B] = 0 implies that: 1 0
or 1:
Now suppose that det [A B] = 0 implies that: 1: It follows that E is
positive semi-denite. Therefore:
T
xT (A B) x = xT DD1 (A B) D1 DT x
= yT Ey 0

where y = DT x: It follows then that A B is positive semi-denite.


We then have:

det [A B] = det A B 1 A1 B

= det [A] det B 1 A1 det [B]

so that det [A B] = 0 , det B 1 A1 = 0: Therefore

A B is positive semi-denite , det [A B] = 0 =) 1



, det B 1 A1 =) 1
, B 1 A1 is positive semi-denite.
Chapter 4

Multivariate Calculus

4.1 Unconstrained Optimization


Problem 168 Consider the function:

f (x1 ; x2 ) = 3x21 6x1 x2 + 5x22 4x1 2x2 + 8:

Calculate
@f (x1 ; x2 ) @f (x1 ; x2 )
; ;
@x1 @x2
@ 2 f (x1 ; x2 ) @ 2 f (x1 ; x2 ) @ 2 f (x1 ; x2 ) @ 2 f (x1 ; x2 )
; ; and :
@x21 @x1 @x2 @x2 @x1 @x22

Find the Hessian and use this to determine if f (x1 ; x2 ) is concave or convex.
Find the x1 and x2 which solve the rst-order conditions using Cramers rule
and decide if this is a global minimum or maximum.

Answer
We have for 3x21 6x1 x2 + 5x22 4x1 2x2 + 8 that:

133
CHAPTER 4. MULTIVARIATE CALCULUS 134

@f (x1 ; x2 )
= 6x1 6x2 4
@x1
@f (x1 ; x2 )
= 6x1 + 10x2 2
@x2
@ 2 f (x1 ; x2 ) @
= (6x1 6x2 4) = 6
@x21 @x1
2
@ f (x1 ; x2 ) @
= (6x1 + 10x2 2) = 10
@x22 @x2
2
@ f (x1 ; x2 ) @ 2 f (x1 ; x2 ) @
= = (6x1 6x2 4) = 6
@x2 @x1 @x1 @x2 @x2
@
= (6x1 + 10x2 2) = 6 ( i.e., Youngs theorem).
@x1
Therefore the Hessian is given by:

6 6
H (x1 ; x2 ) = :
6 10
Since:
M1 = det [6] = 6 > 0

6 6
M1 = det = 24 > 0
6 10
it follows that H (x) is positive denite for all x and hence f (x1 ; x2 ) is globally
convex. This is illustrated in the plot below:

1600
1400
1200
1000
800
600
400
200
0
-5
0
5
-5
10 0
5
15 15 10
:
f (x1 ; x2 ) = 3x21 6x1 x2 + 5x22 4x1 2x2 + 8
The rst-order conditions then are:
@f (x1 ; x2 )
= 6x1 6x2 4 = 0
@x1
@f (x1 ; x2 )
= 6x1 + 10x2 2 = 0
@x2
CHAPTER 4. MULTIVARIATE CALCULUS 135

so that in matrix notation:



6 6 x1 4
= :
6 10 x2 2
Using Cramers rule we nd that:

4 6 6 4
det det
2 10 13 6 2 3
x1 = = ; x2 = = :
6 6 6 6 6 2
det det
6 10 6 10

Since f (x1 ; x2 ) is globally convex, it follows that x = 13 3
6 ; 2 is a global mini-
mum.
Problem 169 Given the function:
f (x1 ; x2 ) = 2 ln (x1 ) + 3 ln (x2 ) + ln (1 x1 x2 )

show that f (x1 ; x2 ) has a global maximum at x1 = 13 ; x2 = 12 :

Answer
The rst order conditions are:
@f (x1 ; x2 ) 2 1
= =0
@x1 x1 1 x1 x2
@f (x1 ; x2 ) 3 1
= = 0:
@x2 x2 1 x1 x2
These can be rewritten as:
2 (1 x1 x2 ) = x1
3 (1 x1 x2 ) = x2
or:
3x1 + 2x2 = 2
3x1 + 4x2 = 3
so that in matrix notation:

3 2 x1 2
= :
3 4 x2 3
Using Cramers rule we nd that:

2 2 3 2
det det
3 4 1 3 3 1
x1 = = ; x2 = = :
3 2 3 3 2 2
det det
3 4 3 4
CHAPTER 4. MULTIVARIATE CALCULUS 136

The Hessian is found from the second derivatives:



@ 2 f (x1 ; x2 ) @ 2 1
=
@x21 @x1 x1 1 x1 x2
2 1
= 2 ;
x1 (1 x1 x2 )2

@ 2 f (x1 ; x2 ) @ 3 1
=
@x22 @x2 x2 1 x1 x2
3 1
= 2
x2 (1 x1 x2 )2

@ 2 f (x1 ; x2 ) @ 2 1
=
@x1 @x2 @x2 x1 1 x1 x2
1
=
(1 x1 x2 )2
as:
" #
x22 (1x 1x )2 (1x 1x )2
H (x1 ; x2 ) = 1 1 2 1 2
:
(1x 1x )2 x2 (1x 1x
3
2
1 2 2 1 2)

To see that this is negative denite for all (x1 ; x2 ) we calculate the leading
principle minors and show that M1 < 0 and M2 > 0 as:
" #
2 1 2 1
M1 = det 2 2 = 2 <0
x1 (1 x1 x2 ) x1 (1 x1 x2 )2
" #
x22 (1x 1x )2 (1x 1x )2
M2 = det 1 1 2 1 2
(1x 1x )2 x32 (1x 1x )2
1 2 1 2
! 2 !
2 1 3 1
= 2 2
x1 (1 x1 x2 )2 x2 (1 x1 x2 )2
!2
1

(1 x1 x2 )2
6 2 1 3 1
= + + > 0:
x21 x22 x21 (1 x1 x2 )2 x22 (1 x1 x2 )2

Note. It is not clear that the second line of M2 is positive. The key part of the
derivation which shows that M2 > 0 is to show that the negative term
!2
1

(1 x1 x2 )2

drops out in the simplication leading to the last line.


CHAPTER 4. MULTIVARIATE CALCULUS 137

Therefore H is negative denite for all x so that f (x1 ; x2 ) is globally concave


(see the graph below) and so x1 = 13 ; x2 = 12 is a global maximum.

-6.3
-6.4
-6.5
-6.6
-6.7
-6.8
-6.9
0.46 0.3
0.48 0.32
0.5 0.34
0.52 0.36
0.54 0.38
0.4

f (x1 ; x2 )
The following 3 problems are based on the function:
1=4 1=2
f (x1 ; x2 ) = x1 x2 3x1 2x2 ;
where x1 > 0 and x2 > 0:
Problem 170 Calculate the gradient of f (x1 ; x2 ) and from this nd the rst
order conditions for a minimum or maximum. Using the ln ( ) function, convert
the rst-order conditions into a system of two equations with unknowns y1 =
ln (x1 ) and y2 = ln (x2 ) : Solve this system of equations using Cramers rule and
calculate x1 and x2 :

Answer
We have:
@f (x1 ; x2 ) 1 3=4 1=2
= x x2 3
@x1 4 1
@f (x1 ; x2 ) 1 1=4 1=2
= x x 2
@x2 2 1 2
so that the rst-order conditions are:
@f (x1 ; x2 ) 1 3=4 1=2
= (x ) (x2 ) 3 = 0
@x1 4 1
@f (x1 ; x2 ) 1 1=4 1=2
= (x ) (x2 ) 2=0
@x2 2 1
so that:
3=4 3 1
(x1 ) (x2 )1=2 = 12 =) ln (x1 ) + ln (x2 ) = ln (12)
4 2
1=4 1 1
(x1 ) (x2 )1=2 = 4 =) ln (x1 ) ln (x2 ) = ln (4)

4 2
CHAPTER 4. MULTIVARIATE CALCULUS 138

so that:
3 1
y1 + y = ln (12)
4 2 2
1 1
y y = ln (4)
4 1 2 2
or in matrix notation:

34 1
2 y1 ln (12)
1 1 =
4 2 y2 ln (4)
Since

34 1
2
1
det [A] = det 1 1 = 6= 0:
4 2 4
it follows that exactly one solution to these equations exists and that A1 exists.
Using Cramers rule we nd that:
1

ln (12) 2
det
ln (4) 12
ln (x1 ) = y1 = 3 1
= 2 ln (12) 2 ln (4) ;
4 2
det 1
12
34
4 ln (12)
det 1
ln (4)
ln (x2 ) = y2 = 43 1
= 3 ln (4) ln (12) :
4 2
det 1
4 12

1 1
Thus x1 = ey1 = e2 ln(12)2 ln(4) = 2304 and x2 = ey2 = e3 ln(4)ln(12) = 768 :
The function is plotted below:

0
-0.005
-0.01
-0.015
-0.02
-0.025
-0.03
0 0
0.002 0.002
0.004 0.004
0.006 0.006
0.008 0.008
0.01 0.01
:
1=4 1=2
f (x1 ; x2 ) = x1 x2 3x1 2x2
Problem 171 Calculate the Hessian. Solve for the numerical value of the
eigenvalues of the Hessian, and use this to show that x is a local maximum.
Now show that the Hessian is negative denite for all x using determinants and
use this to show that f (x) is globally concave and that x is a global maximum.
CHAPTER 4. MULTIVARIATE CALCULUS 139

Answer
1=4 1=2
To nd the Hessian we need to calculate second derivatives of x1 x2
3x1 2x2 as:
@ 2 f (x1 ; x2 ) 3 7=4 1=2
= x x2
@x21 16 1
@ 2 f (x1 ; x2 ) 1 1=4 3=2
= x1 x2
@x22 4
2
@ f (x1 ; x2 ) 1 3=4 1=2
= x x2
@x1 @x2 8 1
so that the Hessian is given by:
" #
3 7=4 1=2 1 3=4 1=2
16 x1 x2 8 x1 x2
H (x1 ; x2 ) = 1 3=4 1=2 1=4 3=2 :
x
8 1 x2 14 x1 x2
1 1
Thus substituting x1 = 2304 and x2 = 768 into H (x1 ; x2 ) we nd that:

1 1
H (x1 ; x2 ) = H ; =
2304 768
" 1 7=4 1 1=2 1 1 3=4 1 1=2 #
3
16
= 1
12304
3=4 1768
1=2 8 1 2304
1 1=4 768
1 5=2
8 2304 768 4 2304 768

5184 1152
=
1152 58982
which has eigenvalues of 1 = 5159:3 < 0 and 2 = 59007 < 0 found by
calculating the roots of:
2 + 64166 + 304435 = 0
1 1

so that H (x1 ; x2 ) is negative denite and hence 2304 ; 768 is a local maximum.
We can in fact prove that H (x1 ; x2 ) is negative denite for all x using
determinants since if
" #
3 7=4 1=2 1 3=4 3=2
16 x1 x2 x
8 1 x 2
H (x1 ; x2 ) = 1 3=4 3=2 1=4 3=2
8 x1 x2 14 x1 x2
then:

3 7=4 1=2 3 7=4 1=2
M1 = det x1 x2 = x1 x2 < 0
16 16
" #
3 7=4 1=2 1 3=4 1=2
16 x1 x2 x
8 1 x2
M2 = det 1 3=4 1=2 1=4 3=2
8 x1 x2 14 x1 x2
3 3=2 1 1 3=2
= x1 x2 x1 x1 2
64 64
2 3=2 1
= x x2 > 0
64 1
CHAPTER 4. MULTIVARIATE CALCULUS 140
1 1

so that f (x1 ; x2 ) is globally concave so that 2304 ; 768 is a global maximum.
This is illustrated in the plot of f (x1 ; x2 ) below:

0.001
0
-0.001
-0.002
-0.003
-0.004
-0.005
-0.006
0 0
0.0005 0.0005
0.001 0.001
0.0015 0.0015
0.002 0.002
:
1=4 1=2
f (x1 ; x2 ) = x1 x2 3x1 2x2
Problem 172 Consider the function:

1 1
f (x1 ; x2 ) = exp ln (x1 ) + ln (x2 ) 3eln(x1 ) 2eln(x2 ) :
4 2
@f (x1 ;x2 )
Simplify the function so there are no exp0 s or ln0 s: Calculate @x1 and
@f (x1 ;x2 )
@x2 and write down the rst-order conditions for a minimum or maximum.
Using the ln ( ) function convert the rst-order conditions into a system of two
equations with unknowns w1 = ln (x1 ) and w2 = ln (x2 ) : Solve this system of
equations using Cramers rule and calculate x1 and x2 :

Answer
Simplifying we have:

1 1
f (x1 ; x2 ) = exp ln (x1 ) + ln (x2 ) 3eln(x1 ) 2eln(x2 )
4 2

1 1
= exp ln (x1 ) exp ln (x2 ) 3x1 2x2
4 2
1 1
= exp ln x14 exp ln x22 3x1 2x2
1 1
= x14 x23 3x1 2x2
which is the identical function considered in the previous two questions and so
there is no need to repeat the work we did there.

The following 2 problems are based on the following function:


f (x1 ; x2 ) = 5x21 6x1 x2 + 4x22 2x1 3x2 :
CHAPTER 4. MULTIVARIATE CALCULUS 141

Problem 173 Write this function using matrix notation as f (x) = aT x+xT Ax
where x and a are 2 1 vectors and A is a symmetric 2 2 matrix. Calculate
@f (x1 ;x2 )
@x1 and @f (x1 ;x2 )
@x2 and write down the rst-order conditions. Solve the rst-
order conditions using Cramers rule to nd x1 and x2 :

Answer
We can write f (x) as:

x1 5 3 x1
f (x) = 2 3 + x1 x2 :
x2 3 4 x2

Now:
@f (x1 ; x2 )
= 10x1 6x2 2
@x1
@f (x1 ; x2 )
= 6x1 + 8x2 3:
@x2
The rst-order conditions then are:
@f (x1 ; x2 )
= 10x1 6x2 2 = 0
@x1
@f (x1 ; x2 )
= 6x1 + 8x2 3 = 0
@x2
so that in matrix notation:

10 6 x1 2
=
6 8 x2 3

so that:

2 6 10 2
det det
3 8 17 6 3 21
x1 = = ; x2 = = :
10 6 22 10 6 22
det det
6 8 6 8

Problem 174 Calculate the Hessian of f (x1 ; x2 ). Show that H (x1 ; x2 ) is al-
ways positive denite using determinants and using eigenvalues. Show that
f (x1 ; x2 ) is globally convex. Show that the solution to the rst-order conditions
x1 ; x2 is a global minimum.
CHAPTER 4. MULTIVARIATE CALCULUS 142

Answer

@ 2 f (x1 ; x2 ) @
= (10x1 6x2 2) = 10
@x21 @x1
2
@ f (x1 ; x2 ) @
= (6x1 + 8x2 3) = 8
@x22 @x2
@ 2 f (x1 ; x2 ) @ 2 f (x1 ; x2 ) @
= = (10x1 6x2 2) = 6
@x2 @x1 @x1 @x2 @x2
@
= (6x1 + 8x2 3) = 6 ( i.e., Youngs theorem).
@x1
Therefore the Hessian is given by:

10 6
H (x1 ; x2 ) = :
6 8
Since:
M1 = det [10] = 10 > 0

10 6
M1 = det = 44 > 0
6 8
it follows that H (x) is positive denite for all x and hence f (x1 ; x2 ) is globally
convex. This is illustrated in the plot below:

3000
2500
2000
1500
1000
500
0
-15
-10
-5
0
5 -10 -15
10 0 -5
10 5
15 15

f (x1 ; x2 ) = 5x21 6x1 x2 + 4x22 2x1 3x2



Since f (x1 ; x2 ) is globally convex, it follows that x = 17 21
22 ; 22 is a global
minimum.
Problem 175 Consider the following function:
f (x1 ; x2 ) = 3x1 + 2x2 + 4x21 + 6x22 + 4x1 x2 :
Using the appropriate rst order conditions nd any local maxima or minima.
From the appropriate second order conditions determine whether the solutions
are local maxima or minima. Determine whether any of the function is convex
or concave.
CHAPTER 4. MULTIVARIATE CALCULUS 143

Answer
We have

@f (x1 ; x2 )
= 3 + 8x1 + 4x2
@x1
@f (x1 ; x2 )
= 2 + 4x1 + 12x2
@x2
2
@ f (x1 ; x2 ) @
= (3 + 8x1 + 4x2 ) = 8
@x21 @x1
@ 2 f (x1 ; x2 ) @
= (3 + 4x1 + 12x2 ) = 12
@x22 @x2
@ 2 f (x1 ; x2 ) @ 2 f (x1 ; x2 ) @
= = (3 + 8x1 + 4x2 ) = 4
@x2 @x1 @x1 @x2 @x2
@
= (3 + 4x1 + 12x2 ) = 4 ( i.e., Youngs theorem).
@x1
Therefore the Hessian is given by:

8 4
H (x1 ; x2 ) = :
4 12

Since:

M1 = det [8] = 8 > 0



8 4
M1 = det = 80 > 0
4 12

it follows that H (x) is positive denite for all x and hence f (x1 ; x2 ) is globally
convex. This is illustrated in the plot below:

18
16
14
12
10
8
6
4
2
0
-1
-0.5
0
0.5 -1
-0.5
0
1 1 0.5
:
f (x1 ; x2 ) = 3x1 + 2x2 + 4x21 + 6x22 + 4x1 x2
CHAPTER 4. MULTIVARIATE CALCULUS 144

The rst-order conditions then are:


@f (x1 ; x2 )
= 3 + 8x1 + 4x2 = 0
@x1
@f (x1 ; x2 )
= 2 + 4x1 + 12x2 = 0
@x2
so that in matrix notation:

8 4 x1 3
=
4 12 x2 2

so that:

3 4 8 3
det det
2 12 7 4 2 1
x1 = = ; x2 = = :
8 4 20 8 4 20
det det
4 12 4 12
7 1
Since f (x1 ; x2 ) is globally convex, it follows that x1 = 20 ; x2 = 20 is a
global minimum.

Problem 176 Consider the following function:


6 5=6 1=6 1
f (x1 ; x2 ) = ln x1 x2 ln (x1 ) 5x1 4x2 :
5 5
Using the appropriate rst order conditions nd any local maxima or minima.
From the appropriate second order conditions determine whether the solutions
are local maxima or minima. Determine whether any of the function is convex
or concave.

Answer
First simplifying we have:
6 5=6 1=6 1
f (x1 ; x2 ) = ln x1 x2 ln (x1 ) 5x1 4x2
5 5
6 1
5=6 1=6
= ln x1 + ln x2 ln (x1 ) 5x1 4x2
5 5
6 5 1 1
= ln (x1 ) + ln (x2 ) ln (x1 ) 5x1 4x2
5 6 6 5
1 1
= ln (x1 ) ln (x1 ) + ln (x2 ) 5x1 4x2
5 5
4 1
= ln (x1 ) + ln (x2 ) 5x1 4x2 :
5 5
CHAPTER 4. MULTIVARIATE CALCULUS 145

Thus:
@f (x1 ; x2 ) 4 1
= 5
@x1 5 x1
@f (x1 ; x2 ) 1 1
= 4
@x2 5 x2

@ 2 f (x1 ; x2 ) @ 4 1 4 1
= 5 = 2
@x21 @x1 5 x1 5 x1
2

@ f (x1 ; x2 ) @ 1 1 1 1
= 4 = 2
@x22 @x2 5 x2 5 x2
2

@ f (x1 ; x2 ) @ 2 f (x1 ; x2 ) @ 4 1
= = 5 =0
@x2 @x1 @x1 @x2 @x2 5 x1

@ 1 1
= 4 = 0 ( i.e., Youngs theorem).
@x1 5 x2

The rst-order conditions then are:


@f (x1 ; x2 ) 4 1 4
= 5 = 0 =) x1 =
@x1 5 x1 25
@f (x1 ; x2 ) 1 1 1
= 4 = 0 =) x2 =
@x2 5 x2 20

Since the Hessian:


" #
45 x12 0
H (x1 ; x2 ) = 1
0 15 x12
2

is a diagonal matrix with negative elements on the diagonal, f (x1 ; x2 ) is globally


4 1
concave so that x1 = 25 ; x2 = 20 is a global maximum. This is illustrated in
the graph below:

-3.2
-3.4
-3.6
-3.8
-4
-4.2
0.02 0.02
0.04
0.04 0.06
0.08
0.06 0.1
0.12
0.08 0.14
0.16
0.18
0.1 0.2

4 1
f (x1 ; x2 ) = 5 ln (x1 ) + 5 ln (x2 ) 5x1 4x2
CHAPTER 4. MULTIVARIATE CALCULUS 146

Problem 177 For

f (x1 ; x2 ) = 3x1 x2 3x21 5x22 2x1 3x2 + 7

nd the solution to the rst-order conditions, determine if the function is con-


cave or convex and whether the solution to the rst-order conditions is a global
or local maximum or minimum.

Answer
We have

@f (x1 ; x2 )
= 3x2 6x1 2
@x1
@f (x1 ; x2 )
= 3x1 10x2 3
@x2
@ 2 f (x1 ; x2 ) @
= (3x2 6x1 2) = 6
@x21 @x1
2
@ f (x1 ; x2 ) @
= (3x1 10x2 3) = 10
@x22 @x2
2
@ f (x1 ; x2 ) @ 2 f (x1 ; x2 ) @
= = (3x2 6x1 2) = 3
@x2 @x1 @x1 @x2 @x2
@
= (3x1 10x2 3) = 3 ( i.e., Youngs theorem).
@x1
Therefore the Hessian is given by:

6 3
H (x1 ; x2 ) = :
3 10

Since:

M1 = det [6] = 6 < 0



6 3
M1 = det = 51 > 0
3 10
CHAPTER 4. MULTIVARIATE CALCULUS 147

it follows that H (x) is negative denite for all x and hence f (x1 ; x2 ) is globally
concave This is illustrated in the plot below:

8
6
4
2
0
-2
-4
-1
-0.5
0
0.5 -1
-0.5
0
1 1 0.5
:
f (x1 ; x2 ) = 3x1 x2 3x21 5x22 2x1 3x2 + 7

The rst-order conditions then are:


@f (x1 ; x2 )
= 3x2 6x1 2 = 0
@x1
@f (x1 ; x2 )
= 3x1 10x2 3 = 0
@x2
so that in matrix notation:

6 3 x1 2
=
3 10 x2 3

so that:

2 3 6 2
det det
3 10 29 3 3 8
x1 = = ; x2 = = :
6 3 51 6 3 17
det det
3 10 3 10

Since f (x1 ; x2 ) is globally concave it follows that x = 29 8
51 ; 17 is a global
maximum.

Problem 178 For


6
3 ln(x1 ) 5 ln(x2 ) 0 ln(x1 )
f (x1 ; x2 ) = ln e e e e x2 :

nd the solution to the rst-order conditions, determine if the function is con-


cave or convex and whether the solution to the rst-order conditions is a global
or local maximum or minimum.
CHAPTER 4. MULTIVARIATE CALCULUS 148

Answer
Simplifying we have:
6
f (x1 ; x2 ) = ln e3 ln(x1 ) e5 ln(x2 ) e0 eln(x1 ) x2

6
= ln e3 ln(x1 ) e5 ln(x2 ) + ln (1 x1 x2 )
= 3 ln (x1 ) + 5 ln (x2 ) + 6 ln (1 x1 x2 ) :

Thus the rst order conditions are:


@f (x1 ; x2 ) 3 6
= =0
@x1 x1 1 x1 x2
@f (x1 ; x2 ) 5 6
= = 0:
@x2 x2 1 x1 x2

These can be rewritten as:

3 (1 x1 x2 ) = 6x1
5 (1 x1 x2 ) = 6x2

or:

9x1 + 3x2 = 3
3x1 + 11x2 = 5

so that:

9 3 x1 3
=
3 11 x2 5

so that:

3 3 9 3
det det
5 11 1 3 5 2
x1 = = ; x2 = = :
9 3 5 9 3 5
det det
3 11 3 11

The Hessian is
" #
x32 (1x 6x )2 (1x 6x )2
1 1 2 1 2
(1x 6x )2 x52 (1x 6x 2
1 2 2 1 2)
CHAPTER 4. MULTIVARIATE CALCULUS 149

so that:
" #
3 6 3 6
M1 = det 2 2 = 2 <0
x1 (1 x1 x2 ) x1 (1 x1 x2 )2
" #
x32 (1x 6x )2 (1x 6x )2
M2 = det 1 1 2 1 2
(1x 6x )2 x52 (1x 6x )2
1 2 2 1 2
! !
3 6 5 6
= 2 2
x1 (1 x1 x2 )2 x2 (1 x1 x2 )2
!2
6

(1 x1 x2 )2
15 18 1 30 1
= + + > 0:
x21 x22 x21 (1 x1 x2 )2 x22 (1 x1 x2 )2
The key part of the derivation is that the negative term
!2
6

(1 x1 x2 )2
drops out in the simplication.
Therefore H is negative denite for all x so that f (x1 ; x2 ) is globally concave
and so x1 = 13 ; x2 = 12 is a global maximum. See the graph of f (x1 ; x2 ) below:

-15.5
-16
-16.5
-17
-17.5
-18
-18.5
0.36 0.1
0.38 0.15
0.4 0.2
0.42 0.25
0.44 0.3

f (x1 ; x2 )

4.2 Prot Maximization


The next 2 problems are based on the following information: Suppose
that a perfectly competitive rm faces a price P; a nominal wage W; a nominal
rental cost of capital R; and dene the real wage as w = WP and the real rental
R
cost of capital as r = P : The rms production function is given by:
1 1
Q = F (L; K) = L + K + L 2 K 4
CHAPTER 4. MULTIVARIATE CALCULUS 150

where L is labour and K is capital.


Problem 179 Show that the marginal products of labour and capital are pos-
itive and that the assumption of a diminishing marginal product of labour and
capital is satised. Show that an increase in labour increases the marginal prod-
uct of capital. Show that this production function is concave.

Answer
We have:
@F (L; K) 1 1 1 1 1
MPL (L; K) = =1+ L 2 K 4 > 0 since L 2 > 0; K 4 > 0
@L 2
@F (L; K) 1 1 3 1 3
MPK (L; K) = =1+ L 2 K 4 > 0 since L 2 > 0; K 4 > 0:
@K 4
@MPL (L;K)
Also there is a diminishing marginal product of labour and capital since: @L =
2 2
@ F (L;K) @MPK (L;K) @ F (L;K)
@L2 < 0 and @K = @K 2 < 0 since:
@M PL (L; K) @ 2 F (L; K) 1 3 1 3 1
= 2
= L 2 K 4 < 0 since L 2 > 0; K 4 > 0
@L @L 4
@MPK (L; K) @ 2 F (L; K) 3 1 7 1 7
= = L 2 K 4 < 0 since L 2 > 0; K 4 > 0:
@K @K 2 16
To show F (L; K) we need to calculate the Hessian. Since the diagonal
2 2
elements: @ F@L
(L;K)
2 and @ F@K(L;K)
2 have already been calculated we just need the
o-diagonal element:
@ 2 F (L; K) 1 1 3
= L 2 K 4 > 0:
@L@K 8
2
(Since @MP@K
L (L;K)
= @ @L@K
F (L;K)
> 0, and increase in capital increases the marginal
product of labour.) The Hessian is:
1 3 1 1 12 3
4L 2 K 4 8 L K 4
H (L; K) = 1 1 3 3 1 7 :
8L
2K 4 16 L 2 K 4
We need to show that H is negative denite for all L and K: Using principle
minors we nd that:
1 3 1
M1 = L 2 K 4 < 0
4
2
1 3 1 3 1
7 1 1
3
M2 = L 2K4 L2 K 4 L 2K 4
4 16 8
3 2 6 1 2 6
= L 2 K 4 L 2 K 4
64 64
3 2 6
= L 2K 4 > 0
64
1 1
so that H is negative denite and hence F (L; K) = L + K + L 2 K 4 is globally
concave.
CHAPTER 4. MULTIVARIATE CALCULUS 151

Problem 180 Find the rst order conditions for prot maximization. Show
that these require that: w > 1 and r > 1: Using the ln ( ) function, convert the
rst order conditions into a set of linear equations involving l = ln (L) and
k = ln (K ) and solve these equations using Cramers rule. Show that @l
@w < 0:
Will the second order conditions for prot maximization be satised?

Answer
The prot function is:
1 1

(L; K) = P L + K + L 2 K 4 W L RK

so that the rst-order conditions are:



@ (L ; K ) 1 1 1
= 0 = P 1 + (L ) 2 (K ) 4 W
@L 2
1 12 1
=) w 1 = (L ) (K ) 4 > 0 (=) w > 1)
2
1 1
=) ln (2 (w 1)) = ln (L ) + ln (K )
2 4
@ (L ; K ) 1 1 3
= 0 = P 1 + (L ) 2 (K ) 4 R
@K 4
1 12 3
=) r 1 = (L ) (K ) 4 > 0 (=) r > 1)
4
1 3
=) ln (4 (r 1)) = ln (L ) ln (K ) :
2 4
Thus in matrix notation we have:
1 1

2 4 l ln (2 (w 1))
1 =
4 34 k ln (4 (r 1))

so that using Cramers rule we have:



ln (2 (w 1)) 14
det
ln (4 (r 1)) 34 12 4
l = 1 1
= ln (2 (w 1)) ln (4 (r 1)) ;
2 4
5 5
det 1 3

1 4 4

2 ln (2 (w 1))
det 1
4 ln (4 (r 1)) 8 4
k = = ln (4 (r 1)) ln (2 (w 1)) :
12 1
4
5 5
det 1
4 34

Thus using the chain rule we have:


@l 12
= <0
@w 5 (w 1)
CHAPTER 4. MULTIVARIATE CALCULUS 152

since w > 1:
The next 2 problems are based on the following information: Sup-
pose that a perfectly competitive has a production function given by:
2 1
Q = L5 K 5
where L is labour, K is capital and Q is output. The price of Q is P; the nominal
wage is W and the rental cost of capital is R: Prots are
2 1
(L; K) = P L 5 K 5 W L RK:
Problem 181 Calculate the marginal product of labour and capital. Prove there
is a positive and diminishing marginal product of labour and a positive and
diminishing marginal product of capital. Prove that the production function is
concave.

Answer
We have
@F (L; K) 2 3 1
MPL (L; K) = = L 5K5 > 0
@L 5
@F (L; K) 1 2 4
M PK (L; K) = = L5 K 5 > 0
@K 5
We have diminishing marginal products since:
@MPL (L; K) @ 2 F (L; K) 6 8 1
= = L 5 K 5 < 0
@L @L2 25
@M PK (L; K) @ 2 F (L; K) 4 2 9
= = L 5 K 5 < 0:
@K @K 2 25
To show F (L; K) is concave we need to calculate the Hessian. Since the
2 2
diagonal elements: @ F@L
(L;K)
2 and @ F@K(L;K)
2 have already been calculated we just
need the o-diagonal element:
@ 2 F (L; K) 2 3 4
= L 5 K 5 > 0:
@L@K 25
2
(Since @MP@K
L (L;K)
= @ @L@K
F (L;K)
> 0, an increase in capital increases the marginal
product of labour.) The Hessian is:
6 85 1 2 35 4
25 L K 5 25 L K 5
H (L; K) = 2 35 4 4 2 9 :
25 L K 5 25 L 5 K 5
Using principle minors we nd that:
6 8 1
M1 = L 5 K 5 < 0
25
2
6 8 1 4 2 9 2 3 4
M2 = L 5 K 5 L 5 K 5 L 5K 5
25 25 25
4 6 8
= L 5K 5 > 0
125
CHAPTER 4. MULTIVARIATE CALCULUS 153

and so the Hessian is negative denite and F (L; K) is concave.

Problem 182 Find the rst-order conditions for prot maximization letting
L and K denote the prot maximizing amount of labour and capital. Letting
l = ln (L ) and k = ln (K ) ; transform the rst-order conditions to obtain
two linear equations. Write these linear equations in matrix form, solve for l
using Cramers rule and show that:
@l
< 0:
@w

Answer
The rst-order conditions are:
@ (L ; K ) 2 2 1
= 0 = P (L ) 5 1 (K ) 5 W = 0
@L 5
5
3 1 5
=) (L ) (K ) 5 = w
2
3 1 5
=) ln (L ) + ln (K ) = ln

w
5 5 2

3 1 5
=) l + k = ln w
5 5 2
@ (L ; K ) 1 2 4
= 0 = P (L ) 5 (K ) 5 R = 0
@K 5
25 4
=) (L ) (K ) 5 = 5r
2 4
=) ln (L ) + ln (K ) = ln (5r)
5 5
2 4
=) l + k = ln (5r) :
5 5
Thus in matrix notation we have:
3 1
5
5 5 l ln 2 w
2 =
5 45 k ln (5r)
CHAPTER 4. MULTIVARIATE CALCULUS 154

so that using Cramers rule we have:




ln 52 w 1
5
det
ln (5r) 45
ln (L ) = l = 3 1

5 5
det 2
5 45

45 ln 52 w 15 ln (5r)
= 2
5 3
5 ln 52 w
det 2
ln (5r)
ln (K ) = k = 5 3 1

5 5
det 2
45
5

35 ln (5r) 25 ln 52 w
= 2 :
5
or:
4 2 1
L = el = w r 2
125
2 1 3
K = ek = w r 2:
125
Using the chain rule we have:
@L 4 3 1
= 2 w r 2 < 0:
@w 125
The next 2 problems are based on the following information: Sup-
pose that a perfectly competitive has a production function given by:
Q = L K
where L is labour, K is capital and Q is output. The price of Q is P; the nominal
wage is W and the rental cost of capital is R: Prots are
= P Q W L RK:
Problem 183 Calculate the marginal product of labour and capital. Under
what conditions will the marginal products of labour and capital be positive?
Prove that a positive and diminishing marginal product of labour and a positive
and diminishing marginal product of capital requires 0 < < 1 and 0 < < 1.
Prove that in order for the production function to be concave it must be that:
+ < 1:

Answer
We have
@F (L; K)
M PL (L; K) = = L1 K > 0 =) > 0 since L1 > 0 and K > 0
@L
@F (L; K)
MPK (L; K) = = L K 1 > 0 =) > 0 since L > 0 and K 1 > 0
@K
CHAPTER 4. MULTIVARIATE CALCULUS 155

@MPL (L;K) @ 2 F (L;K)


Diminishing marginal products in turn imply that: @L = @L2 <0
@MPK (L;K) @ 2 F (L;K)
and @K = @K 2 < 0 so that:

@M PL (L; K) @ 2 F (L; K)
= = ( 1) L2 K < 0
@L @L2
=) < 1 since > 0; L2 > 0 and K > 0
@M PK (L; K) @ 2 F (L; K)
= = ( 1) L K 2 < 0
@K @K 2
=) < 1 since > 0; L > 0 and K 2 > 0:

To show F (L; K) is concave we need to calculate the Hessian. Since the


2 2
diagonal elements: @ F@L
(L;K)
2 and @ F@K
(L;K)
2 have already been calculated we just
need the o-diagonal element:

@ 2 F (L; K)
= L1 K 1 > 0:
@L@K
2
(Since @MP@K
L (L;K)
= @ @L@K
F (L;K)
> 0, an increase in capital increases the marginal
product of labour.) The Hessian is:

( 1) L2 K L1 K 1
H (L; K) = :
L1 K 1 ( 1) L K 2

We need to show that if + < 1 then H is negative denite for all L and K:
Using principle minors we nd that:

M1 = ( 1) L2 K < 0 since > 0 and < 1


2
M2 = ( 1) L2 K ( 1) L K 2 L1 K 1
= ( 1) ( 1) L22 K 22 ()2 L22 K 22

= L22 K 22 ( 1) ( 1) ()2
= L22 K 22 (( 1) ( 1) )
= L22 K 22 (1 ( + )) > 0:
| {z }
+ since +<1

Problem 184 Find the rst-order conditions for prot maximization letting
L and K denote the prot maximizing amount of labour and capital. Letting
l = ln (L ) and k = ln (K ) ; transform the rst-order conditions to obtain
two linear equations. Write these linear equations in matrix form, solve for l
using Cramers rule and show that:
@l
< 0:
@w
CHAPTER 4. MULTIVARIATE CALCULUS 156

Answer
The prot function is:

(L; K) = P L K W L RK

so that the rst-order conditions are:


@ (L ; K )
= 0 = P (L )1 (K ) W = 0
@L
W w
=) (L )1 (K ) = =
P w
=) ( 1) ln (L ) + ln (K ) = ln
w

=) ( 1) l + k = ln

@ (L ; K )
= 0 = P (L ) (K )1 R = 0
@K
R r
=) (L ) (K )1 = =
P

r
=) ln (L ) + ( 1) ln (K ) = ln


r
=) l + ( 1) k = ln :

Thus in matrix notation we have:
" ln w #
( 1) l
=
( 1) k ln r

so that using Cramers rule we have:


" #
ln w

det r
ln ( 1)

ln (L ) = l =
( 1)
det
( 1)

( 1) ln w ln r

=
1
" #
( 1) ln w

det
ln r
ln (K ) = k =
( 1)
det
( 1)

( 1) ln r ln w
= :
1
CHAPTER 4. MULTIVARIATE CALCULUS 157

or:
(1)
w 1
l r 1
L = e =

1
(1)

k w 1 r
K = e = :

Using the chain rule we have:
@l ( 1) 1
= < 0 since 0 < < 1 and + < 1:
@w 1 w
Problem 185 Suppose the rms production function is given by:
p
Q = F (L; K) = L + K + 2 LK

where L is labour and K is capital.Show that the marginal product of labour


and capital is positive and that the marginal product of labour and capital is
diminishing. Show that an increase in labour increases the marginal product of
capital. Is this production function concave?

Answer
We have:
@F (L; K) 1 1 1 1
MPL (L; K) = = 1 + L 2 K 2 > 0 since L 2 > 0; K 2 > 0
@L
@F (L; K) 1 1 1 1
M PK (L; K) = = 1 + L 2 K 2 > 0 since L 2 > 0; K 2 > 0:
@K
Also there is a diminishing marginal product of labour and capital since: since:
@MPL (L; K) @ 2 F (L; K) 1 3 1 3 1
= 2
= L 2 K 2 < 0 since L 2 > 0; K 2 > 0
@L @L 2
@M PK (L; K) @ 2 F (L; K) 1 1 3 1 3
= = L 2 K 2 < 0 since L 2 > 0; K 2 > 0:
@K @K 2 2
To nd if F (L; K) is concave we need to calculate the Hessian. Since the
2 2
diagonal elements: @ F@L
(L;K)
2 and @ F@K
(L;K)
2 have already been calculated we just
need the o-diagonal element:
@ 2 F (L; K) 1 1 1
= L 2 K 2 > 0:
@L@K 2
2
(Since @MP@K
L (L;K)
= @ @L@K
F (L;K)
> 0, and increase in capital increases the marginal
product of labour.) The Hessian is:
1 3 1 1 1 1
L 2K2 L 2K 2
H (L; K) = 1 2 1 1 2 1 1 3 :
2L K 2L2 K 2
2 2
CHAPTER 4. MULTIVARIATE CALCULUS 158

We need to show that H is negative denite for all L and K: Using principle
minors we nd that:
1 3 1
M1 = L 2 K 2 < 0
2
2
1 3 1 1 1 3 1 1 1
M2 = L K 2 2 L K
2 2 L K
2 2
2 2 2
1 1 1 1 1 1
= L K L K
4 4
= 0:

Since M2 = 0 (and not M2 > 0 as required) the Hessian is not negative denite.
The next 3 problems are based on the following information: Sup-
pose that a rm has the following prot function:

(L; K) = 2L1=4 K 1=4 3L 4K

where L is the amount of labour and K the amount of capital the rm hires.

Problem 186 If L and K are the optimal levels of labour and capital, what
are the rst order conditions for prot maximization?

Answer
We have:
@ (L; K) 1 3=4 1=4
= L K 3
@L 2
@ (L; K) 1 1=4 3=4
= L K 4
@K 2
so that the rst-order conditions become:
@ (L ; K ) 1 3=4
= (L ) (K )1=4 3 = 0
@L 2
@ (L; K) 1 1=4
= (L ) (K )3=4 4 = 0:
@K 2
Problem 187 Using the ln ( ) function, transform the rst order conditions
in a) to obtain a system of 2 equations in 2 unknowns where the unknowns are
l = ln (L ) and k = ln (K ) : Solve for these using Cramers rule and give L
and K :
CHAPTER 4. MULTIVARIATE CALCULUS 159

Answer
We have from the rst rst-order condition:
1 3=4 1=4
(L ) (K ) 3 = 0
2
=) (L )3=4 (K )1=4 = 6
3 1
=) ln (L ) + ln (K ) = ln (6)
4 4
3 1
=) l + k = ln (6)
4 4
while the second yields:
1 1=4
(L ) (K )3=4 4 = 0
2
=) (L )1=4 (K )3=4 = 8
1 3
=) ln (L ) ln (K ) = ln (8)
4 4
1 3
=) l k = ln (8) :
4 4
Combining these two results and using matrix notation we nd that:
3 1

4 4 l ln (6)
1 =
4 34 k ln (8)

so that using Cramers rule:


1

ln (6) 4
det
ln (8) 34 3 1
ln (L ) = l = 3 1
= ln (6) ln (8)
4 4
2 2
det 1 3
4
34
4 ln (6)
det 1
ln (8) 3 1
ln (K ) = k = 43 1
= ln (8) ln (6)
4 4
2 2
det 1 3
4 4

so that:
p
3 1 3
L = el = e 2 ln(6) 2 ln(8) =
72
p
3 1 3
K = ek = e 2 ln(8) 2 ln(6) = :
96
Problem 188 Show that (L; K) is strictly concave and that the second order
conditions are satised.
CHAPTER 4. MULTIVARIATE CALCULUS 160

Answer
We have:
@ 2 (L; K) 3 @ 2 (L; K) 1
= L7=4 K 1=4 ; = L3=4 K 3=4
@L2 8 @L@K 8
2
@ (L; K) 3
= L1=4 K 7=4
@K 2 8
so that the Hessian is:

38 L7=4 K 1=4 1 3=4 3=4
8L K
H (L; K) = 1 3=4 3=4 :
8L K 38 L1=4 K 7=4
This is negative denite for all L and K since:

3 7=4 1=4 3
M1 = det L K = L7=4 K 1=4 < 0
8 8
3 7=4 1=4 1 3=4 3=4
L K L K
M2 = det 1 8 3=4 3=4 8 3 1=4 7=4
8 L K 8 L K
9 6=4 6=4 1
= L K L6=4 K 6=4
64 64
8 6=4 6=4
= L K > 0:
64
p p
3 3
Therefore F (L; K) is globally concave and L = 72 ; K

= 96 is a global
maximum. The prot function is plotted below:

0.1
0
-0.1
-0.2
-0.3
-0.4
0 0
0.02 0.02
0.04 0.04
L0.06 0.06K
0.08 0.08
0.1 0.1

(L; K) = 2L1=4 K 1=4 3L 4K


Problem 189 Suppose that a perfectly competitive rm faces a price P; a nom-
inal wage W; a nominal rental cost of capital R: The rms production function
is given by: Q = F (L; K) : The marginal products of labour and capital are pos-
itive and F (L; K) is concave. What does F (L; K) being concave mean? Derive
the rst order conditions for prot maximization. Show that the second order
conditions will be satised and that the solution to the rst order conditions will
be a global maximum.
CHAPTER 4. MULTIVARIATE CALCULUS 161

Answer
F (L; K) is concave if its Hessian given by:
" 2 2
#
@ F (L;K) @ F (L;K)
HF (L; K) = @L2 @L@K
@ 2 F (L;K) @ 2 F (L;K)
@L@K @K 2

is negative denite for all L and K:


The prot function is:

(L; K) = P F (L; K) W L RK

so that the rst-order conditions are:


@ (L ; K ) @F (L ; K )
= P W =0
@L @L
@ (L ; K ) @F (L ; K )
= P R = 0:
@K @K
The second-order conditions involve the Hessian of the prot function:
" 2 2
#
@ (L;K) @ (L;K)
H (L; K) = @L2 @L@K
@ 2 (L;K) @ 2 (L;K)
@L@K @K 2

where:
@ 2 (L; K) @ 2 F (L; K) @ 2 (L; K) @ 2 F (L; K)
= P ; =P
@L2 @L 2 @L@K @L@K
2
@ (L; K) @ 2 F (L; K)
= P
@K 2 @K 2
so that:
" #
@ 2 (L;K) @ 2 (L;K)
H (L; K) = @L2 @L@K
@ 2 (L;K) @ 2 (L;K)
@L@K @K 2
" 2 2
#
P @ F@L (L;K)
2 P @ @L@K
F (L;K)
= @ 2 F (L;K) @ 2 F (L;K)
P @L@K P @K 2
" 2 #
@ F (L;K) @ 2 F (L;K)
= P @L2 @L@K
@ 2 F (L;K) @ 2 F (L;K)
@L@K @K 2
= P HF (L; K) :

Since HF (L; K) is negative denite for all (L; K) (since F (L; K) is concave),
and since P > 0; it follows that H (L; K) is also negative denite for all (L; K).
Thus any (L ; K ) which solves the rst-order conditions is the unique prot
maximizing amount of labour and capital.
CHAPTER 4. MULTIVARIATE CALCULUS 162

4.3 Linear Regression


Problem 190 For the simple linear regression model: Yi = + Xi + ei ,
i = 1; 2; : : : n the least squares estimators ^ are the values of and
^ and
which minimize the sum of squares function:
n
X
S (; ) = (Yi Xi )2 :
i=1

Show that:
P Pn Pn Pn
( ni=1 Yi ) 2
i=1 Xi ( i=1 Xi ) ( i=1 Xi Yi )

^ = P P 2
n ni=1 Xi2 ( ni=1 Xi )
Pn Pn Pn
^ n i=1 Xi Yi ( i=1 Xi ) ( i=1 Yi )
= P P 2 :
n ni=1 Xi2 ( ni=1 Xi )
Show that S (; ) is globally convex as long as the Xi 0 s are not all identical.

Answer
We have using the sum and chain rules that:
n
X
@S (; )
= 2 (Yi Xi )
@ i=1
Xn
@S (; )
= 2 Xi (Yi Xi )
@ i=1

so that the rst-order conditions for a minimum are:


n !
@S ^
^; X n X Xn
= 2 Yi ^
^ Xi = 0 =) n^ + Xi ^= Yi
@ i=1 i=1 i=1
n ! n !
@S ^
^; X n X X Xn
= 2 Xi Yi ^ i = 0 =)
^ X Xi ^+ Xi2 ^= Xi Yi
@ i=1 i=1 i=1 i=1

or in matrix notation:
Pn Pn
Pnn Pn
i=1 Xi
^ Pn i=1 Yi
2 ^ = :
i=1 Xi i=1 Xi i=1 Xi Yi

Solving for ^ using Cramers rule we nd that:


^ and
P Pn Pn Pn
( ni=1 Yi ) 2
i=1 Xi ( i=1 Xi ) ( i=1 Xi Yi )

^ = P P 2
n ni=1 Xi2 ( ni=1 Xi )
Pn Pn Pn
^ = n i=1P

Xi Yi ( i=1 Xi ) ( i=1 Yi )
P :
2
n ni=1 Xi2 ( ni=1 Xi )
CHAPTER 4. MULTIVARIATE CALCULUS 163

The Hessian of S (; ) is given by:


P
P2n 2 P ni=1 Xi
H (; ) =
2 ni=1 Xi 2 ni=1 Xi2
= 2X T X

where X is a n 2 matrix given by:


2 3
1 X1
6 1 X2 7
6 7
X =6 .. .. 7:
4 . . 5
1 Xn

As long as the Xi0 s are not all identical the two columns of X are linearly
independent and hence the rank of X is 2: From this it follows that X T X is
positive denite and so S (; ) is globally convex. Thus ^ is a unique global
^;
minimum.

Problem 191 Let Y^i = ^ i be the tted value and let e^i = Yi
^ + X ^ i=
^ X
^
Yi Yi be the least squares residual. Show that:
n
X
e^i = 0; Y = ^X
^ +
i=1
n
X n
X
Xi e^i = 0; Y^i e^i = 0:
i=1 i=1

Use this to show that:


n
X n
X 2 X
n
2
Yi Y = Y^i Y + e^2i
i=1 i=1 i=1
n
X n
X

^2
= 2+
Xi X e^2i
i=1 i=1

and from this that 0 R2 1 where:


Pn 2
Y^i Y
i=1
R2 = Pn :
Y i Y 2
i=1
CHAPTER 4. MULTIVARIATE CALCULUS 164

Answer
From the rst-order conditions we have:
e^i
@S ^
^; X z
n }| { n
X
= 2 Yi ^
^ Xi = 0 =) e^i = 0
@ i=1 i=1
n ! n
X X
=) n^
+ ^=
Xi Yi =) Y = ^ X;
^ +
i=1 i=1
e^i
@S ^
^; n
X z
}| { n
X
= 2 Xi Yi ^ i = 0 =)
^ X Xi e^i = 0:
@ i=1 i=1

Therefore:
n
X n
X
Y^i e^i = ^ i e^i
^ + X
i=1 i=1
Xn n
X
=
^ ^
e^i + Xi e^i = 0:
i=1 i=1

Now:

Yi = Y^i + e^i =) Yi Y = Y^i Y + e^i


2 2
=) Yi Y = Y^i Y + e^2i + 2 Y^i Y e^i
n
X n
X 2 X
n n
X
2
=) Yi Y = Y^i Y + e^2i + 2 Y^i Y e^i :
i=1 i=1 i=1 i=1

But:
n
X n
X n
X
Y^i Y e^i = Y^i e^i Y e^i = 0
i=1 i=1 i=1

so that:
n
X n 2 X
n
2 X
Yi Y = Y^i Y + e^2i :
i=1 i=1 i=1

Therefore:
Pn 2
+ Pn e^2 Pn 2
^
i=1 Yi Y i=1 i e^
1= Pn 2 = R + Pn i=1 i 2
2

i=1 Yi Y i=1 Yi Y
CHAPTER 4. MULTIVARIATE CALCULUS 165

Pn ^ 2
0 and Pn Yi Y 2 > 0 we have:
so that since: i=1 Yi Y i=1

Pn 2
Y^i Y
i=1
R2 = Pn 0
2
i=1 Yi Y
Pn
and since ^2i
i=1 e 0 we have:
Pn
e^2
R = 1 Pn i=1 i 2 1:
2

i=1 Yi Y

Problem 192 Now consider the weighted sum of squares function given by:
n
X
SW (; ) = wi (Yi Xi )2
i=1
Pn ^ minimizes SW (; ) ;
where the weights wi satisfy: i=1 wi = n: Show that if
then:
P P P
^ n ni=1 wi Xi Yi ( ni=1 wi Xi ) ( ni=1 wi Yi )
= P P 2 :
n ni=1 wi Xi2 ( ni=1 wi Xi )

Answer
We have using the sum and chain rules that:
n
X
@S (; )
= 2 wi (Yi Xi )
@ i=1
Xn
@S (; )
= 2 wi Xi (Yi Xi )
@
i=1

so that the rst-order conditions for a minimum are:


=n
z }| !{
n !
@S ^
^; n
X Xn X n
X
= 2 wi Yi ^ i = 0 =)
^ X wi ^+ wi Xi ^= wi Yi
@ i=1 i=1 i=1 i=1
n ! n !
@S ^
^; n
X X X n
X
= 2 wi Xi Yi ^ i = 0 =)
^ X wi Xi
^+ ^=
wi Xi2 wi Xi Yi
@ i=1 i=1 i=1 i=1

or in matrix notation:
Pn Pn
Pn n Pni=1 wi X2i
^ P i=1 wi Yi
^ = n :
i=1 wi Xi i=1 wi Xi i=1 wi Xi Yi

^ using Cramers rule we nd that:


Solving for
Pn Pn Pn
^ = n i=1 wP

i Xi Yi ( i=1 wi Xi ) ( i=1 wi Yi )
P :
2
n ni=1 wi Xi2 ( ni=1 wi Xi )
CHAPTER 4. MULTIVARIATE CALCULUS 166

4.4 Maximum Likelihood


Problem 193 Suppose there are m parties in Quebec with pi being the unknown
proportion of the population who favour party i: Clearly:
p1 + p2 + + pm = 1:
You decide to conduct a survey of n people and ni is the number of people in
the survey who support party i: Clearly:
n1 + n2 + + nm = n:
The likelihood is then given by:
L (p) = pn1 1 pn2 2 pnmm
Find p^i ; the maximum likelihood estimator of pi

Answer
The log-likelihood is given by:
l (p1 ; p2 ; : : : pm ) = n1 ln (p1 ) + n2 ln (p2 ) + + nm ln (pm ) :
We need to maximize this but the proportions must sum to 1 so that we con-
struct the Lagrangian:
L (; p1 ; p2 ; : : : pm ) = n1 ln (p1 ) + n2 ln (p2 ) + + nm ln (pm )
+ (1 p1 p2 pm )
which leads to the rst order conditions:

@L ;^ p^1 ; p^2 ; : : : p^m
= 1 p^1 p^2 p^m
@
@L ;^ p^1 ; p^2 ; : : : p^m
n1 ^ ^ p1 = n1
= = 0 =) ^
@p1 p^1

@L ;^ p^1 ; p^2 ; : : : p^m
n2 ^ ^ p2 = n2
= = 0 =) ^
@p2 p^2
..
.
^
@L ; p^1 ; p^2 ; : : : p^m nm ^ ^ pm = nm :
= = 0 =) ^
@pm p^m
We therefore have:
^ pj =
^ nj for j = 1; 2; : : : m
0 1
^ @p^1 + p^2 + + p^m A = n1 + n2 + + nm
=)
| {z } | {z }
=1 =n
^=n
=)
CHAPTER 4. MULTIVARIATE CALCULUS 167

and so
nj
p^j = :
n
Thus if for n = 2000 people interviewed, n1 = 525 support the Blue party,
n2 = 1022 support the Green Party and n3 = 473 support the Red party then
the maximum likelihood estimates are:
525 1022
p^1 = = 0:263; p^2 = = 0:511;
2000 2000
453
p^3 = = 0:226
2000
so that an estimated 26% of the population support the Blue party, and esti-
mated 51% the Green party and an estimated 23% the Red party.

4.5 Multivariate Chain Rule


@U (Q1 ;Q2 )
Problem 194 Given a utility function: U (Q1 ; Q2 ) where @Q1 > 0 and
@U(Q1 ;Q2 )
@Q2 > 0; and if an indierence curve Q2 = h (Q1 ) is dened by U (Q1 ; h (Q1 )) =
c; where c is a constant, then show that h0 (Q1 ) < 0: Show that if U (Q1 ; Q2 ) is
concave then h00 (Q1 ) > 0:

Answer
Dierentiating both sides of

U (Q1 ; h (Q1 )) = c

with respect to Q1 and using the multivariate chain rule yields:

@U (Q1 ; h (Q1 )) @U (Q1 ; h (Q1 )) 0


+ h (Q1 ) = 0
@Q1 @Q2

so that replacing h (Q1 ) with Q2 yields


@U (Q1 ;Q2 )
0 @Q1
h (Q1 ) = @U (Q1 ;Q2 )
< 0:
@Q2

Dierentiating a second time with respect to Q1 yields:

@ 2 U (Q1 ; h (Q1 )) @ 2 U (Q1 ; h (Q1 )) 0


2 +2 h (Q1 ) +
@Q1 @Q1 @Q2
@ 2 U (Q1 ; h (Q1 )) 0 2 @U (Q1 ; h (Q1 )) 00
(h (Q1 )) + h (Q1 )
@Q22 @Q2
= 0
CHAPTER 4. MULTIVARIATE CALCULUS 168

so that:
" @2U @2 U
# T
0
@Q21 @Q1 @Q2 1
1 h (Q1 ) @2U @2 U h0 (Q1 )
00 @Q1 @Q2 @Q21
h (Q1 ) = @U
:
@Q2

The matrix in the middle is the Hessian of U (Q1 ; Q2 ) : Therefore if U (Q1 ; Q2 )


is concave then the Hessian would be negative denite so that xT Hx < 0 for
x 6= 0 where here:

1
x= :
h0 (Q1 )
Thus if U (Q1 ; Q2 ) is concave then h00 (Q1 ) > 0:

4.6 Lagrangians and Constrained Optimization


4.6.1 Utility Maximization
The next 3 problems are based on the following information:

Consider a household with the utility function:


1=3 1=3
U (Q1 ; Q2 ) = 3Q1 + 3Q2 :
The household has income Y; the price of good 1 is P1 and the price of good 2
is P2 so that the budget constraint is:
Y = P1 Q1 + P2 Q2 :
Based on this information answer the following:
Problem 195 What is the Lagrangian for the utility maximization problem that
the household faces? From this nd the rst-order conditions. Show that the
second-order conditions will be satised.

Answer
We have:
1=3 1=3
L (; Q1 ; Q2 ) = 3Q1 + 3Q2 + (Y P1 Q1 P2 Q2 )
so that
@L (; Q1 ; Q2 )
= Y P1 Q1 P2 Q2
@
@L (; Q1 ; Q2 ) 2=3
= Q1 P1
@Q1
@L (; Q1 ; Q2 ) 2=3
= Q2 P2
@Q2
CHAPTER 4. MULTIVARIATE CALCULUS 169

the rst-order conditions are:


@L ( ; Q1 ; Q2 )
= Y P1 Q1 P2 Q2 = 0
@
@L ( ; Q1 ; Q2 ) 2=3
= Q1 P1 = 0
@Q1
@L ( ; Q1 ; Q2 ) 2=3
= Q2 P2 = 0:
@Q2
The Hessian is found from:
@ 2 L (; Q1 ; Q2 ) @ 2 L (; Q1 ; Q2 ) @ 2 L (; Q1 ; Q2 )
= 0; = P1 ; = P2 ;
@2 @@Q1 @@Q2
2
@ L (; Q1 ; Q2 ) @ 2=3 2 5=3
= Q1 P1 = Q1 ;
@Q21 @Q1 3
@ 2 L (; Q1 ; Q2 ) @ 2=3
= Q1 P1 = 0;
@Q1 @Q2 @Q2
@ 2 L (; Q1 ; Q2 ) @ 2=3 2 5=3
= Q2 P2 = Q2
@Q22 @Q2 3
so that:
2 3
0 P1 P2
6 5=3 7
H (; Q1 ; Q2 ) = 4 P1 23 Q1 0 5
2 5=3
P2 0 3 Q2

so that:
2 3
0 P1 P2
6 5=3 7
det [H (; Q1 ; Q2 )] = det 4 P1 23 Q1 0 5
5=3
P2 0 23 Q2
2 2 5=3 2 2 5=3
= P Q + P2 Q1 >0
3 1 2 3
so that the second order conditions are satised.

Problem 196 From the rst-order conditions nd Q1 , Q2 and (the La-


32 12
grange multiplier). (Hint: show that P1 Q1 = ( ) P1 and that P2 Q2 =
32 1
( ) P2 2 ) .

Answer
We have:
2=3 32
Q1 P1 = 0 =) Q1 = ( P1 )
3 12
=) P1 Q1 = 2 P1
CHAPTER 4. MULTIVARIATE CALCULUS 170

and
2=3 32
Q2 P2 = 0 =) Q2 = ( P2 )
3 12
=) P2 Q2 = 2 P2

so that combining this with the budget constraint:


3 1 3 12
Y P1 Q1 + P2 Q2 = 2 P1 2 + 2 P2
=
1
3 1
=) 2 P1 2 + P2 2 = Y
3 Y
=) 2 = 1 1
:
P1 + P2 2
2

Therefore:
3 32
Q1 = 2 P1
32
Y P1
= 1
1
P1 2 + P2 2

and
3 32
Q2 = 2 P2
32
Y P2
= 1 :
1
P1 2 + P2 2

Problem 197 Suppose the individual was thrown in prison. By law the prison
must insure that the individual obtain enough Q1 and Q2 to obtain Umin units
of utility. The cost of Q1 and Q2 will then be P1 Q1 + P2 Q2 which the prison
wishes to minimize. Write down the Lagrangian and the rst-order conditions
for this cost minimization problem. Solve for ; Q1 and Q2 from the rst-order
conditions.

Answer
The constraint is that
1=3 1=3
Umin = U (Q1 ; Q2 ) = 3Q1 + 3Q2

and the objective function is now expenditure or P1 Q1 +P2 Q2 ; which the warden
attempts to minimize subject to the constraint. The Lagrangian is therefore:

1=3 1=3
L (; Q1 ; Q2 ) = P1 Q1 + P2 Q2 + Umin 3Q1 3Q2
CHAPTER 4. MULTIVARIATE CALCULUS 171

so that
@L (; Q1 ; Q2 ) 1=3 1=3
= Umin 3Q1 3Q2
@
@L (; Q1 ; Q2 ) 2=3
= P1 Q1
@Q1
@L (; Q1 ; Q2 ) 2=3
= P2 Q2
@Q2
so that the rst-order conditions are:
@L ( ; Q1 ; Q2 ) 1=3 1=3
= Umin 3Q1 3Q2 =0
@
@L ( ; Q1 ; Q2 ) 2=3
= P1 Q1 =0
@Q1
@L ( ; Q1 ; Q2 ) 2=3
= P2 Q2 = 0:
@Q2
Thus:
2=3 3=2
P1 = Q1 =) Q1 = 3=2 P1
2=3 3=2
P2 = Q2 =) Q2 = 3=2 P2 :

Substituting these into the constraint yields:


1=3 1=3
Umin = 3Q1 + 3Q2
1=3 1=3
3=2 3=2
= 3 3=2 P1 + 3 3=2 P2

1=2 1=2
=) 31=2 P1 + P2 = Umin
Umin
=) 1=2 =
1=2 1=2
3 P1 + P2
U 2 1=2 1=2
2
=) = min P1 + P2 :
9
Once is found we can derive the optimal Q1 and Q2 as:
3=2
Q1 =3=2 P1
2 2 3=2
Umin 1=2 1=2 3=2
=) Q1 = P1 + P2 P1
9
(Umin )3 1=2 1=2
3
3=2
=) Q1 = P1 + P2 P1
27
CHAPTER 4. MULTIVARIATE CALCULUS 172

and:
3=2
Q2 = 3=2 P2
2 2 3=2
Umin 1=2 1=2 3=2
=) Q2 = P1 + P2 P2
9
(Umin )3 1=2 1=2
3
3=2
=) Q2 = P1 + P2 P2 :
27
The next 3 problems are based on the following information: Con-
sider a household with the utility function:
1=2 1=2
U (Q1 ; Q2 ) = 2Q1 + 2Q2 :

The household has income Y; the price of good 1 is P1 and the price of good 2
is P2 so that the budget constraint is:

Y = P1 Q1 + P2 Q2 :

Problem 198 What is the Lagrangian for the utility maximization problem that
the household faces? From this nd the rst order conditions. Show that the
second order conditions will be satised.

Answer
We have:
1=2 1=2
L (; Q1 ; Q2 ) = 2Q1 + 2Q2 + (Y P1 Q1 P2 Q2 )

so that
@L (; Q1 ; Q2 )
= Y P1 Q1 P2 Q2
@
@L (; Q1 ; Q2 )
= (Q1 )1=2 P1
@Q1
@L (; Q1 ; Q2 )
= (Q2 )1=2 P2
@Q2
the rst-order conditions are:
@L ( ; Q1 ; Q2 )
= Y P1 Q1 P2 Q2 = 0
@
@L ( ; Q1 ; Q2 )
= (Q1 )1=2 P1 = 0
@Q1
@L ( ; Q1 ; Q2 )
= (Q2 )1=2 P2 = 0:
@Q2
CHAPTER 4. MULTIVARIATE CALCULUS 173

The Hessian is found from:


@ 2 L (; Q1 ; Q2 ) @ 2 L (; Q1 ; Q2 ) @ 2 L (; Q1 ; Q2 )
= 0; = P1 ; = P2 ;
@2 @@Q1 @@Q2
@ 2 L (; Q1 ; Q2 ) @ 1 3=2
= (Q1 )1=2 P1 = Q1 ;
@Q21 @Q1 2
@ 2 L (; Q1 ; Q2 ) @
= (Q1 )1=2 P1 = 0;
@Q1 @Q2 @Q2
2
@ L (; Q1 ; Q2 ) @ 1 3=2
= (Q2 )1=2 P2 = Q2
@Q22 @Q2 2

so that:
2 3
0 P1 P2
6 1 3=2 7
H (; Q1 ; Q2 ) = 4 P1 2 Q1 0 5
3=2
P2 0 12 Q2

so that:
2 3
0 P1 P2
6 3=2 7
det [H (; Q1 ; Q2 )] = det 4 P1 12 Q1 0 5
1 3=2
P2 0 2 Q2
1 2 3=2 1 2 3=2
= P Q + P2 Q1 >0
2 1 2 2
so that the second order conditions are satised.
1
Problem 199 From the rst-order conditions show that P1 Q1 = ( )2 P1
and
1
that P2 Q2 = ( )2 P2
. Now use this to nd Q1 , Q2 and (the Lagrange
multiplier). Show that the budget share of Q1 will be P1P+P
2
2
:

Answer
We have:
2 1
(Q1 )1=2 P1 = 0 =) Q1 = ( P1 ) = 2
( ) P12
1
=) P1 Q1 = 2
( ) P1

and
2 1
(Q2 )1=2 P2 = 0 =) Q2 = ( P2 ) = 2
( P2 )
1
=) P2 Q2 = 2
( ) P2
CHAPTER 4. MULTIVARIATE CALCULUS 174

so that combining this with the budget constraint:


1 1
Y = P1 Q1 + P2 Q2 = 2
+ 2
( ) P1 ( ) P2

1
1 1
=) 2 + =Y
( ) P1 P2
1 Y
=) 2
=
( ) 1 1
P1 + P2
1
12 1 1 2
=) = Y + :
P1 P2

Therefore:
1 1 Y 1
Q1 = 22 =

P
( ) 1 1
+ 1 P12
P1 P2
P1 Q1 1 1
=) =
Y 1
+ 1 P1
P1 P2
1 P2
= =
P1
1 + P2 P1 + P2

and
1 1 Y 1
Q2 = 22 =

P
( ) 2 1
+ 1 P22
P1 P2
P2 Q1 1 1
=) =
Y 1
+ 1 P2
P1 P2
1 P1
= = :
P2
1 + P1 P1 + P2

Problem 200 Consider a Cobb-Douglas utility function with n goods:

U = 1 ln (Q1 ) + 2 ln (Q2 ) + + n ln (Qn )

where: i 0,

1 + 2 + + n = 1

and the budget constraint is:

Y = P1 Q1 + P2 Q2 + + Pn Qn :

Find the utility maximizing values of Qi :


CHAPTER 4. MULTIVARIATE CALCULUS 175

Answer
The Lagrangian is:
L (; Q1 ; Q2 ; : : : Qn ) = 1 ln (Q1 ) + 2 ln (Q2 ) + + n ln (Qn )
+ (Y P1 Q1 P2 Q2 Pn Qn )
so that the rst-order conditions are:
@L ( ; Q1 ; Q2 ; : : : Qn )
= 0 = Y P1 Q1 P2 Q2 Pn Qn
@
@L ( ; Q1 ; Q2 ; : : : Qn ) 1
= 0= P1 =) 1 = P1 Q1
@Q1 Q1

@L ( ; Q1 ; Q2 ; : : : Qn ) 2
= 0 = P2 =) 2 = P2 Q2
@Q2 Q2
..
.
@L ( ; Q1 ; Q2 ; : : : Qn ) n
= 0 = Pn =) n = Pn Qn :
@Qn Qn
Adding up the last n rst-order conditions we have:
1 + 2 + + n = P1 Q1 + P2 Q2 + + Pn Qn
=) 1 + 2 + + n = (P1 Q1 + P2 Q2 + + Pn Qn )
| {z } | {z }
=1 =Y
1
=) = :
Y
It then follows that:
i = Pi Qi
Pi Qi
=
Y
i Y
=) Qi = :
Pi
Problem 201 The indirect utility function is dened as:
U (P1 ; P2 : : : ; Pn ; Y ) = U (Q1 ; Q2 ; : : : Qn ) :
Find the indirect utility function for the Cobb-Douglas utility function using
your answer from the previous problem. Verify that:
@U (P1 ; P2 : : : ; Pn ; Y )
=
@Y
so that the Lagrange multiplier is the marginal utility of income (this is always
true for all utility functions, not just Cobb-Douglas!) and that:
@U (P1 ;P2 ::: ;Pn ;Y )
@Pi
Qi = @U (P1 ;P2 ::: ;Pn ;Y )
@Y
CHAPTER 4. MULTIVARIATE CALCULUS 176

which is known as Roys identity (again, this is always true!). Roys identity
allows you to calculate the demand curve from the indirect utility function.

Answer
We have:

U (P1 ; P2 : : : ; Pn ; Y ) = 1 ln (Q1 ) + 2 ln (Q2 ) + + n ln (Qn )



1 Y 2 Y n Y
= 1 ln + 2 ln + + n ln
P1 P2 Pn
= 1 (ln (1 ) + ln (Y ) ln (P1 )) + + n (ln (n ) + ln (Y ) ln (Pn ))
= ln (Y ) 1 ln (P1 ) + 2 ln (P2 ) + + n ln (Pn ) c

where the coecient on ln (Y ) is one since the i 0 s sum to 1 and the constant
c:

c = 1 ln (1 ) + 2 ln (2 ) + + n ln (n )

is not important for most applications.


We therefore have:
@U (P1 ; P2 : : : ; Pn ; Y ) 1
= =
@Y Y
@U (P1 ; P2 : : : ; Pn ; Y ) i
=
@Pi Pi
so that:
@U (P1 ;P2 ::: ;Pn ;Y )
@Pi i
Pi i Y
@U (P1 ;P2 ::: ;Pn ;Y )
= 1 = = Qi :
Y
Pi
@Y

Problem 202 The Cobb-Douglas utility function is sometimes written as:

~ = AQ1 Q 2 Qnn
U 1 2

where A > 0 and i 0 and i > 0 for at least one i: Show that this is
equivalent to maximizing the Cobb-Douglas utility function given in the previous
two questions where:

U = 1 ln (Q1 ) + 2 ln (Q2 ) + + n ln (Qn )

with i 0 and

1 + 2 + + n = 1:
CHAPTER 4. MULTIVARIATE CALCULUS 177

Answer
Dene as the sum of the i 0 s or:

= 1 + 2 + + n > 0:

Now since f (x) = x is monotonically increasing (i.e., f 0 (x) = x1 > 0 ) it


~ is equivalent to maximizing U
follows that maximizing U ^ =U ~ 1 or
1
^ = U
U ~ 1 = AQ1 Q2 Qnn
1 2
2 2 n
1
= A Q1 Q2 Qn
= BQ 2
1 Q2 Qn
1 n

1 i
where B = A > 0 and i = : We then have: i 0 and

1 + 2 + + n
1 + 2 + + n =

1 + 2 + + n
= = 1:
1 + 2 + + n
1
Now since g (x) = ln (x) ln (B) is monotonically increasing (i.e., g0 (x)
= x >
~ is equivalent to maximizing U = ln U
0 ) it follows that maximizing U ^ where:

U ^ ln (B)
= ln U
= ln (BQ 2 n
1 Q2 Qn ) ln (B)
1

= 1 ln (Q1 ) + 2 ln (Q2 ) + + n ln (Qn ) :

Problem 203 The CES utility function (constant elasticity of substitution) is


given by:
! ! 1
Q1
1 1 Q1
2 1 Qn 1
U = 1 + 2 + + n
1 1 1

where > 0; i > 0 and

1 + 2 + + n = 1

This includes the Cobb-Douglas as a special case where = 1 since from LHpitals
rule it follows that:

Q1
i 1
lim = ln (Qi ) :
!1 1
(This mathematical fact is the basis for the Box-Cox transformation often used
in econometrics). Calculate the demand functions Qi for the CES utility func-
tion.
CHAPTER 4. MULTIVARIATE CALCULUS 178

Answer
The Lagrangian is:
! !
Q1
1 1 Q1
2 1 Q1
n 1
L (; Q1 ; Q2 ; : : : Qn ) = 1 + 2 + + n
1 1 1
+ (Y P1 Q1 P2 Q2 Pn Qn )

so that the rst-order conditions are:


@L ( ; Q1 ; Q2 ; : : : Qn )
= 0 = Y P1 Q1 P2 Q2 Pn Qn
@
@L ( ; Q1 ; Q2 ; : : : Qn ) 1 1
1 1
= 0 = 1 Q
1 P1 =) P1 Q1 = 1 P1
@Q1
@L ( ; Q1 ; Q2 ; : : : Qn ) 1 1
1 1
= 0 = 2 (Q2 ) P2 =) P2 Q2 = 2 P2
@Q2
..
.
@L ( ; Q1 ; Q2 ; : : : Qn ) 1 1
1 1
= 0 = n Q
n Pn =) Pn Qn = n Pn :
@Qn
Adding up the implications of the last n rst-order conditions we have:

Y = P1 Q1 + P2 Q2 + + Pn Qn
1
1 1 1 1 1
1 1 1 1
1 1
= 1 P1 + 2 P2 + + n Pn
1
1 1 1 1
1 1 1
1 1
= 1 P1 + 2 P2 + + n Pn
1 Y
=) = 1
1 1 1
1 1 1
1 1
1 P1

+ 2 P2

+ + n Pn
0 1
Y
=) = @ 1
1 1 1
1 1 1
1 1
A :
1 P1

+ 2 P2

+ + n Pn

Once we have the Lagrange multiplier we can calculate the demand curves using:
1
1 1
i (Qi ) Pi = 0 =) Qi = i Pi
1
1
i Pi Y
=) Qi = 1
1 1 1
1 1 1 1 :
(1 ) (P1 )
+ (2 ) (P2 )
+ + (n ) (Pn )1

4.6.2 Cost Minimization


Problem 204 Suppose the rms production function is given by:
p
Q = F (L; K) = L + K + 2 LK
CHAPTER 4. MULTIVARIATE CALCULUS 179

where L is labour and K is capital. Suppose that the wage is W; and the rental
cost of capital is R: Set up the Lagrangian for the problem of nding that amount
of labour L and that amount of capital K which minimizes the cost of pro-
ducing Q units of output. Find the rst-order conditions from this Lagrangian
(you do not have to actually solve them) . Write down what the second order
conditions require.

Answer
We have:
p
L (; L; K) = W L + RK + Q L K 2 LK

so that:
@L (; L; K) p
= Q L K 2 LK
@
@L (; L; K) 1 1

= W 1 + L 2 K 2
@L
@L (; L; K) 1 1

= R 1 + L 2 K 2
@K
so that the rst-order conditions are:
@L ( ; L ; K ) p
= Q L K 2 L K = 0
@
@L ( ; L ; K ) 1 1

= W 1 + (L ) 2 (K ) 2 = 0
@L
@L ( ; L ; K ) 1 1

= R 1 + (L ) 2 (K ) 2 = 0
@K
The second-order conditions require that we calculate the second derivatives
of the Lagrangian as:
@ 2 L (; L; K) @ 2 L (; L; K) @ 2 L (; L; K)
12 1 1 1
2 K 2
= 0; = 1 + L K 2 ; = 1 + L ;
@2 @@L @@K
@ 2 L (; L; K) 1 3 1 @ 2 L (; L; K) 1 1 1

2
= L 2 K 2 ; = L 2 K 2
@L 2 @L@K 2
@ 2 L (; L; K) 1 1 3
2
= L 2 K 2
@K 2
so that the Hessian of L (; L; K) evaluated at ; L ; K is:
2 1 1
1 1
3
0 1 + L 2 K 2 1 + L 2 K 2
6 7
6 1 1 1 32 12 1 12 12 7
H ( ; L ; K ) = 6 1 + L 2 K 2 2 L K 2 L K 7
4 1 1
1 1 1 3
5

1 + L 2 K 2 12 L 2 K 2 1
2 L K
2 2

2 3
0 W R
= 4 W 12 L 2 K 2 5
1 3 1 1 1
2
2 L K 2
R 1 12 12 1 12 32
2 L K 2 L K
CHAPTER 4. MULTIVARIATE CALCULUS 180

which the second equality follows from the rst-order conditions


1 1
1 1 W
W 1 + (L ) 2 (K ) 2 = 0 =) 1 + (L ) 2 (K ) 2 =

1 1
1 1 R

R 1 + (L ) 2 (K ) 2 = 0 =) 1 + (L ) 2 (K ) 2 = :

The second-order conditions for a local minimum are satised since:
2 3
0 W R
det [H ( ; L ; K )] = det 4 W 12 L 2 K 2 5
1 23 1 1 1
2 L K 2
R 1 12 12 1 12 32
2 L K 2 L K
1 (W L + RK )2 L 2 K 2
3 3

= <0
2
(this takes some work!) where > 0 since again from the rst-order conditions:

W 1
2
1

= 1 + (L ) (K ) 2 > 0:

Problem 205 Suppose the rms production function is given by:
p
Q = F (L; K) = L + K + 2 LK

where L is labour and K is capital. Suppose you wanted to prove that increasing
W would reduce the cost minimizing amount of labour L (W ). Show how this
could be done by dierentiating the rst order conditions, obtaining a system
of 3 equations in 3 unknowns and using Cramers rule to solve these equations
for the appropriate partial derivative (you dont have to actually evaluate the
determinants or prove the result).

Answer
Using the multivariate version of the chain rule on the rst-order conditions
and dierentiating both sides of the rst-order conditions with respect to W;
and remembering that (W ) ; L (W ) and K (W ) are all functions of W we
nd that:
2 3
1
0 1 + L 2 K 2
1 1
1 + L 2 K 2
1
2 @ 3 2 3
6 7 @W 0
6 7
K 2 7 4 @L 5 = 4 1 5
1 1 3 1 1 1
6 1 + L 2 K 2 12 L 2 K 2 1
2 L
2
@W
4 1 1
1 1 1 3
5 @K 0
1 2
1 + L 2 K 2 2 L K 2 12 L 2 K 2 @W
CHAPTER 4. MULTIVARIATE CALCULUS 181

so that using Cramers rule:


2 1 1
3
0 1 + L 2 K 2
0
6 7
6 1 1 1 12 1 7
det 6 1 + L 2 K 2 1 2 L K 2 7
4 1 1
1 3
5
@L 1 + L 2 K 2 0 12 L 2 K 2
=
@W det [H ( ; L ; K )]
1 1
2
1 + L 2 K 2
= <0
det [H ( ; L ; K )]

since det [H ( ; L ; K )] < 0 by the second-order conditions and the term in


the numerator is squared and hence positive.

4.6.3 Eigenvectors, Eigenvalues and Constrained Optimiza-


tion
Problem 206 Let A be a symmetric 2 2 matrix and let x be a 2 1 vector
as:

a11 a12 x1
A= ; x= :
a12 a22 x2

Consider the problem of maximizing f (x) = xT Ax or:

f (x1 ; x2 ) = a11 x21 + 2a12 x1 x2 + a22 x22


2
subject to the constraint that jjxjj = xT x = 1 or:

1 = x21 + x22 :

Find x and f (x ) :

Answer
The Lagrangian for this problem is:

L (; x1 ; x2 ) = a11 x21 + 2a12 x1 x2 + a22 x22 + 1 x21 x22

which leads to the rst-order conditions:


@L ( ; x1 ; x2 )
= 1 x2 2
1 x2 = 0
@
@L ( ; x1 ; x2 )
= 2a11 x1 + 2a12 x2 2 x1 = 0
@x1
@L ( ; x1 ; x2 )
= 2a12 x1 + 2a22 x2 2 x2 = 0:
@x2
CHAPTER 4. MULTIVARIATE CALCULUS 182

Writing the last two conditions in matrix notation after cancelling the 20 s we
nd that:

a11 a12 x1 x1
=
a12 a22 x2 x2
or:

Ax = x :

It follows that x is an eigenvector of A and is an eigenvalue! Since A has


two eigenvalues from the roots of:

2 (a11 + a22 ) + a11 a22 a212 = 0

the question is which eigenvalue? Since we are maximizing f (x1 ; x2 ) it is the


largest eigenvalue. This is because:

f (x ) = (x )T Ax

but we have just shown that Ax = x so that:

f (x ) = (x )T x :
T
However the constraint require that jjx jj = (x ) x = 1 so that:

f (x ) = :

Thus if we choose x corresponding to the largest eigenvalue then f (x) will be


maximized with a maximized value of :

Problem 207 Let A be a symmetric 2 2 matrix and let x be a 2 1 vector


as:

10 7 x1
A= ; x= :
7 6 x2

Consider the problem of maximizing f (x) = xT Ax or:

f (x1 ; x2 ) = 10x21 + 14x1 x2 + 6x22


2
subject to the constraint that jjxjj = xT x = 1 or:

1 = x21 + x22 :

Find x and f (x ) :
CHAPTER 4. MULTIVARIATE CALCULUS 183

Answer
The Lagrangian for this problem is:

L (; x1 ; x2 ) = 10x21 + 14x1 x2 + 6x22 + 1 x21 x22

which leads to the rst-order conditions:


@L ( ; x1 ; x2 )
= 1 x2 2
1 x2 = 0
@
@L ( ; x1 ; x2 )
= 20x1 + 14x2 2 x1 = 0
@x1
@L ( ; x1 ; x2 )
= 14x1 + 13x2 2 x2 = 0:
@x2
Writing the last two conditions in matrix notation after cancelling the 20 s we
nd that:

10 7 x1 x1
=
7 6 x2 x2
or:

Ax = x :

It follows that x is an eigenvector of A and is an eigenvalue! Since A has


two eigenvalues from the roots of:

2 16 + 11 = 0

or:
p
1 = 8 + 53 = 15:28
p
2 = 8 53 = 0:72:

Since we are maximizing f (x1 ; x2 ) it turns out that is the largest eigen-
value so that: = 15:28: Thus:

f (x ) = = 15:28:

Thus if we choose x corresponding to the largest eigenvalue then f (x) will be


maximized with a maximized value of :
To calculate x note that if x is any solution of

Ax = x

then so is x where is a scalar. Because of this we can normalize x2 = 1 by


picking = x1 if x2 6= 1:
2
CHAPTER 4. MULTIVARIATE CALCULUS 184

From the rst rst-order condition we then have:

20x1 + 14x2 2 x1 = 0
p
=) 20 2 8 + 53 x1 = 14x2 = 14

so that:
14
x1 = p = 1:3257:
20 2 8 + 53

We thus have:

x1 1:3257
x = =
x2 1

as a solution to Ax = x :
This is not the x which we are looking for since the constraint requires that
jjx jj = 1 but for the above x :

q
jjx jj = (1:3257)2 + 12 = 1:6606:

This problem can easily be remedied by dividing x by jjx jj = 1:6606 so


that:

1 1:3257 0:79833
x = =
1:6606 1 0:60219

which does satisfy the constraint since:


q
jjx jj = (0:79833)2 + (0:60219)2 = 1:

Thus x1 = 0:79833 and x2 = 0:60219: Note that:

f (x ) = f (0:79833; 0:60219)
T
0:79833 10 7 0:79833
=
0:60219 7 6 0:60219
= 15:28 = :

Problem 208 Suppose that A is a symmetric matrix and x is an n 1 vector.


Consider the problem of maximizing (minimizing)

xT Ax

subject to the constraint that:

xT x = 1:

Show, both with and without calculus that x is the eigenvector of A associated
with the maximum (minimum) eigenvalue of A; normalized so that kx k = 1:
CHAPTER 4. MULTIVARIATE CALCULUS 185

Answer
With calculus: The Lagrangian for this problem is:

L (; x) = xT Ax + 1 xT x

from which we obtain the rst-order conditions:


@L ( ; x )
= 1 (x )T x = 0
@
@L ( ; x )
= 2Ax 2 x = 0 =) Ax = x :
@x
From the second rst-order condition it follows that x is an eigenvector of A
and is the associated eigenvalue. If x is any eigenvector of A; we can always
satisfy the constraint by using x = kx k : Furthermore:

Ax = x =) xT Ax = Ax = (x )T x =

so to maximize (minimize ) xT Ax we pick the maximum (minimum) eigenvalue


and its associated eigenvector.
Without calculus: Writing A as A = CC T where C T = C 1 is orthogonal
and is a diagonal matrix with eigenvalues along the diagonal, we have

xT Ax = xT CC T x = y T y = y12 1 + y22 2 + + yn2 n

and where y = C T x satises:

yT y = xT CC T x = xT x = 1
=) y12 + y22 + + yn2 = 1

since xT x = 1. Let i+ and i be the indices of the maximum and minimum


T T
eigenvalues. It follows then that xTi+ Axi+ = i+ (xi+ ) xi+ = i+ xTi Axi = i (xi ) xi = i
and since yi2 0 that for all x such that xT x = 1 :

xT Ax = y12 1 + y22 2 + + yn2 n i+


xT Ax = y12 1 + y22 2 + + yn2 n i :