Mathematical Methods for Economics:

The Derivative

1. Definition, Notation and Interpretations. The derivative of a

function f (x), is the function defined by the limit

f (x + h) f (x)
f 0 (x) = lim ,
h0 h
at each point x where the limit exists.
In practice, we rarely compute derivatives using the definition above because there is a
list of differentiation formul that enables us to find the derivatives of all of the most
common functions and their combinations. This list is given in 2.
There are several different ways to denote the derivative of a function y = f (x). These
include
d df dy
f 0 (x), y0, (f (x)) , , and .
dx dx dx

What does the derivative of a function tell us? From a geometric point of view, f 0 (x0 )
may be seen to be the slope of the line tangent to the graph of y = f (x), at the point
(x0 , f (x0 )). The equation of this tangent line is given by

y f (x0 ) = f 0 (x0 )(x x0 ).

More generally, the derivative, dy/dx, may be thought of as the instantaneous rate
of change of y with respect to x. For example, if h(t) is the position of a particle in
motion at time t, then dh/dt is the velocity of the particle at time t.
There are many applications of this concept to Economics. These include, (but are not
limited to),
dc
Marginal Cost, : This is the rate at which the cost of production, c,
dq
changes with respect to the amount produced, q.
dr
Marginal Revenue, : This is the rate at which the revenue, r, changes
dq
with respect to the amount sold, q.
dr
Marginal Revenue Product, : This is the rate at which the revenue of
dm
a firm, r, changes with respect to the number of employees of the firm, m.
dS dC
Marginal Propensity to Save and Consume, , and : These are the
dI dI
rates at which saving, S, and consumption, C, change with respect to income,
I.
p/q
Point Elasticity of Demand, = : This is a measure of how changes
dp/dq
in the price of a product affect the demand for that product.

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2. Rules of Differentiation. To calculate the derivatives of the most
common functions and their various combinations, we make use of the following rules.

0. The derivative of a constant function:

d
c = 0.
dx
1. The derivatives of power functions: for any real number s,
d s
x = sxs1 .
dx
2. The derivatives of exponential functions: for any positive number a,
d x
a = (ln a)ax .
dx
Note the special case: [ex ]0 = ex .
3. The derivatives of logarithm functions: for any positive number b,
d 1
logb x = .
dx x ln b
Note the special case: [ln x]0 = 1/x.
4. The derivative of a sum or a difference of functions:
d
[f (x) g(x)] = f 0 (x) g 0 (x).
dx
5. The derivative of a constant times a function:
d
[c f (x)] = c f 0 (x).
dx
6. The product rule:
d
[f (x) g(x)] = f 0 (x) g(x) + f (x) g 0 (x).
dx
7. The quotient rule:
f 0 (x)g(x) g 0 (x)f (x)
 
d f (x)
= .
dx g(x) (g(x))2

8. The chain rule:

d
[f (g(x))] = f 0 (g(x))g 0 (x).
dx
Using some of the other notation for derivatives, if we write u = g(x) and y =
f (u), then the chain rule may be written as
dy dy du
= .
dx du dx

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3. Examples. Here we calculate the derivatives of various functions, mainly to
see the rules of 2 in action. Some of these examples are important in their
own right, e.g., f., h. and i.
a. Calculating a derivative from the definition:

d x+h x
[ x] = lim
dx h0 h
 
( x + h x) ( x + h + x)
= lim
h0 h( x + h + x)
x+hx
= lim
h0 h( x + h + x)
h 1 1
= lim = lim = .
h0 h( x + h + x) h0 x + h + x 2 x

b. The derivative of a polynomial, (Using formul 1, 4 and 5):

[2x7 3x5 + 3x4 + x3 7x2 + 3x 1]0 = 14x6 15x4 + 12x3 + 3x2 14x + 3.

c. To
make differentiation easier, remember to write roots and quotients as powers.
E.g., 3 x = x1/3 and 1/x7 = x7 . Then you can apply formula number 1, (and any
other formul that you may need):

d 5 d 1/2 1 35
[ u
4
]= [u 5u7/4 ] = u1/2 + u11/4 .
du u 7 du 2 4

d. The quotient rule:

d x2 + 3x + 1 (2x + 3)(2x3 2x + 7) (x2 + 3x + 1)(6x2 2)

 
=
dx 2x3 2x + 7 (2x3 2x + 7)2
2x4 12x3 2x2 + 14x + 23
= .
(2x3 2x + 7)2

Check to see that the arithmetic is correct!

e. Product rule:

[3x (x2 + 3x + 1)]0 = (ln 3)3x (x2 + 3x + 1) + 3x (2x + 3).

f. The Power Rule This is a special case of the chain rule,

d
[(f (x))s ] = s(f (x))s1 f 0 (x).
dx
For example: [(x2 + 3x 8)3 ]0 = 3(x2 + 3x 8)2 (2x + 3), and
 
d 3

5
= 3[(x3 2x + 9)1/5 ]0
dx 3
x 2x + 9
3 3(3x2 2)
= (x3 2x + 9)6/5 (3x2 2) = .
5 5(x3 2x + 9)6/5

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(See how the comment of example c. was used here too.)
h 3 i0
g. More chain rule: Lets find ex 3x+2 . If we write y = eu and u = x3 3x + 2,
then the chain rule says
h 3 i0 dy dy du
ex 3x+2 = = .
dx du dx
Now, dy/du = eu and du/dx = 3x2 3, so
h 3 i0 3
x 3x+2
e = eu (3x2 3) = ex 3x+2 (3x2 3).

More generally, if u = f (x) is any function, then the chain rule gives
0
ef (x) = ef (x) f 0 (x).


h. Even more chain rule. Lets calculate [ln(t4 t2 + 1)]0 . We write u = t4 t2 + 1 and
y = ln u, then dy/dt = (dy/du) (du/dt). Now, dy/du = 1/u and du/dt = 4t3 2t, so

d 4t3 2t
[ln(t4 t2 + 1)] = 4 .
dt t t2 + 1
More generally, for any function, u = f (t), and with y = ln u, the chain rule gives
dy/dt = (dy/du)(du/dt) = (1/u) f 0 (t). In other words

f 0 (t)
[ln(f (t))]0 = .
f (t)

This quotient, f 0 (t)/f (t), is called the logarithmic derivative of f . Some of you may
recognize this as the relative rate of change of f .
i. Logarithmic Differentiation. How do we differentiate y = xx ? Rule 1. seems to
indicate that y 0 = x xx1 = xx , while rule 2. says that y 0 = xx ln x. In fact, neither
one is correct! The point is that both the base and the exponent depend on x, so those
rules do not apply! The trick here is to take natural logarithms:

ln y = x ln x.

Differentiating both sides with respect to x gives

y0 1
= (x ln x)0 = 1 ln x + x = ln x + 1.
y x

If we now multiply both sides by y we obtain y 0 = y (x ln x)0 , in other words,

d x
x = xx (ln x + 1).
dx
This method, called logarithmic differentiation, works for any function. I.e., since
(ln y)0 = y 0 /y, it follows that
y 0 = y (ln y)0 .

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Logarithmic differentiation is useful when the function (ln f (x)) is easier to differentiate
case of y = xx .
than the original function, f (x), as in the
Another example: if y = (x + 3)3 (x 5)7 / x + 11 then

ln y = 3 ln(x + 3) + 7 ln(x 5) ln(x + 11)/2,

which is much easier to differentiate than y. Indeed

3 7 1
(ln y)0 = + ,
x + 3 x 5 2(x + 11)
so
(x + 3)3 (x 5)7
 
0 0 3 7 1
y = y(ln y) = + .
x + 11 x + 3 x 5 2(x + 11)

4. Applications.1 In this set of examples we study several different applications of

the derivative to Economics.
A. A manufacturer of aluminum widgets calculates her weekly average cost of pro-
duction to be
1500
c = 0.001q 2 0.03q + 50 + ,
q
where q is the number of widgets produced in a week, and c is measured in dollars.
Find the marginal cost when q = 100.
The marginal cost is dc/dq, so we first need to find the cost function c. Since c = c/q,
it follows that
dc
c = c q = 0.001q 3 0.03q 2 + 50q + 1500, and = 0.003q 2 0.06q + 50.
dq
So

dc 
= 0.003 1002 0.06 100 + 50 = 74
dq q=100


Interpretation: Recall that dc/dq|q=q0 gives a good approximation to the cost of

producing the (q0 + 1)st unit. In our example this means that the cost of producing
the 101st widget in a week will be $74.00.
B. The same manufacturer knows that the demand equation for her product is

p = 100 0.07q,

where q is the number of widgets sold in a week, and p is measured in dollars. What
is the marginal revenue when q = 100?
To find the marginal revenue, dr/dq, we first need the revenue function:

r = p q = 100q 0.07q 2 .
1
The text referred to in later footnotes is Introductory Mathematical Analysis for Business,
Economics, etc., 9th edition, by Haeussler and Paul, published by Prentice Hall.

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This means that dr/dq = 100 0.14q, and

dr 
= 100 0.14 100 = 86.
dq q=100

Interpretation: Recall that dr/dq|q=q0 gives a good approximation to the revenue

generated by the sale of the (q0 + 1)st unit. In our example this means that the
revenue generated by the sale of the 101st widget in a week is $86.00.
C. According to examples A. and B., producing and selling the 101st widget will incur
a cost of $74.00 and will generate a revenue of $86.00. This seems to indicate that
our friendly widget manufacturer should certainly go ahead and produce and sell that
extra widget to earn an additional profit of $12.00, all else being equal. This leads,
naturally, to the question: What level of production maximizes profit?
Lets denote the profit function by , for which we have the simple relationship profit
equals total revenue minus total cost:

= r c.

Mathematically speaking, we want to find the value of q for which (q) attains its
maximum. The underlying mathematical principle we will use here is that the maxi-
mum, (and/or minimum), values of any function occur at the critical points2 of the
function. In the case of the profit function, (q), we find the critical points by setting3
d/dq = 0 and solving for q.
Returning to the widgets, we use the cost and revenue functions from examples A. and
B. to get the profit function:

= r c = (100q 0.07q 2 ) (0.001q 3 0.03q 2 + 50q + 1500)

= 0.0001q 3 0.04q 2 + 50q 1500.

Differentiating gives 0 (q) = 0.0003q 2 0.08q + 50. Setting 0 (q) = 0 and using the
quadratic formula to solve for q gives the critical points

0.08 0.0064 + 0.06 0.08 + 0.0064 + 0.06
q1 = = 296.137 and q2 = = 562.803.
0.0006 0.0006

Since our intrepid widget maker cannot produce and sell a negative number of widgets,
the only critical point to consider is q1 = 296.137. To verify that q1 does indeed give a
maximum, we use the second derivative test4 and note that

00 (q1 ) = 0.0006q1 .08 = 0.2577 < 0.

Strictly speaking, this only guarantees that (296) is a relative maximum. On the
other hand, it is easy to see that 00 (q) < 0 for all positive values of q, so that the
2
Recall that a critical point is a point where the derivative is 0 or does not exist. For more details
see section 14.1 in the text.
3
In principle, the maximum of (q) can also occur at a point q0 where d/dq is undefined, but in
practice that usually wont be the case.
4
See section 14.3 in the text.

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graph of (q) is concave down throughout the interval [0, ). This means that (296)
is an absolute maximum on the interval [0, ).
This means that profit is maximized when 296 widgets, (rounded to the nearest whole
number of widgets), are produced and sold each week. The weekly profit at this level
of production is

(296) = 0.0001 2963 0.04 2962 + 50 296 1500 = $12, 388.79.

Lets take one more look at the profit maximization problem in general. Since = r c,
it follows that d/dq = dr/dq dc/dq. Now, to find the level of production that
maximizes profit we set d/dq = 0 and solve for q. But this means that profits are
maximized when
dr dc
= .
dq dq
This is nothing other than the familiar principle from Economics: profit is maximized
when marginal revenue equals marginal cost.
D. Lets take another look at the demand equation from example B., p = 100 0.07q.
Assume that the current price of a widget is $90.00, and our friend the widget maker
wants to lower the price by 90 cents: how will that affect the demand for widgets and
the weekly revenue? For this we consider the Elasticity of Demand5 for the widgets.
Remember that, roughly speaking,
% change in demand
Elasticity of Demand = .
% change in price
This can sometimes be messy to compute, so instead we compute the Point Elasticity
of Demand:
p
q
= ,
dp
dq
which gives a good approximation to the elasticity: Elasticity . For the purposes
of answering the question with which we began, we rewrite this approximate identity
like this

(% change in price) (% change in demand).

If the current price of $90.00 per widget is lowered by 90 cents, this means that

% change in price = 1%.

To compute the corresponding % change in demand, we need to compute when

p = 90, and multiply this by 1%. From the demand equation, we see that
dp
= 0.07.
dq
5
For more details see section 15.3 in the text.

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Next, we solve for q, (from the demand equation): 90 = 100 0.07q, so
10
q= = 142.857 143.
0.07
Thus, when p = 90 the point elasticity of demand is

90/143
= = 8.99.
0.07
So the 1% decrease in price will generate an 8.99% increase in demand, because

(8.99)(1%) = +8.99%.

How will revenue be affected? To answer this question we rely on the identity6
 
dr 1
=p 1+ .
dq

In our example, p = 90 and = 8.99 so

 
dr 1
= 90 1 = 79.99.
dq 8.99

Thus, when p = 90 the marginal revenue is $79.99.

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See section 15.3 in the text.