The Mathematics of Optimization

Many economic theories begin with the

assumption that an economic agent is
seeking to find the optimal value of some
function
This chapter introduces the mathematics
common to these problems

THE MATHEMATICS OF
OPTIMIZATION

Maximization of a Function of
One Variable

Maximization of a Function of
One Variable

Simple example: Manager of a firm

wishes to maximize profits

The manager will likely try to vary q to see

where the maximum profit occurs

*
= f(q)

= f (q)

>0
q

*
= f(q)

2
1

q*

Quantity
3

q1

q2

q*

Quantity
4

Maximization of a Function of
One Variable
If output is increased beyond q*, profit will
decline

The derivative of = f(q) is the limit of

/q for very small changes in q
d df
f (q + h ) f (q1 )
=
= lim 1
dq dq h0
h

<0
q

*
= f(q)

Note that the value of this ratio depends

on the value of q1

q*

Quantity

q3

Value of a Derivative at a Point

The evaluation of the derivative at the
point q = q1 can be denoted

In our previous example,

d
=0
dq q = q *

First Order Condition for a

Maximum

df
=0
dq q = q *

d
<0
dq q =q

For a function of one variable to attain

its maximum value at some point, the
derivative at that point must be zero

d
dq q = q
d
>0
dq q =q

Derivatives

Second Order Conditions

Second Order Conditions

The first order condition (d/dq) is a

necessary condition for a maximum, but
it is not a sufficient condition

If the profit function was u-shaped,

the first order condition would result
in q* being chosen and would
be minimized

q*

This must mean that, in order for q* to

be the optimum,

d
d
> 0 for q < q * and
< 0 for q > q *
dq
dq
Therefore, at q*, d/dq must be
decreasing

Quantity
9

10

Second Derivatives

Second Order Condition

The derivative of a derivative is called a

second derivative
The second derivative can be denoted
by

The second order condition to represent

a (local) maximum is

d 2
d 2f
or
or f ' ' (q)
dq 2
dq 2
11

d 2
<0
dq 2 q = q *

12

Rules for Finding Derivatives

db
= 0.
dx
2. If a and b are constants and b 0,
dax b
then
= bax b 1.
dx
d ln x 1
3.
=
dx
x
x
da
4.
= a x ln a for any constant a.
dx
1. If b is a constant, then

13

Rules for Finding Derivatives

5.

d[f (x) + g(x)]

= f ' (x) + g ' (x)
dx

6.

d[f (x) g(x)]

= f (x)g ' (x) + f ' (x)g(x)
dx

( f (x) %
d&
#
g
(
x
)
$ = f ' (x)g(x) f (x )g ' (x ) provided
7. '
dx
[g(x )]2
that g(x ) 0.
14

Rules for Finding Derivatives

Example of Profit Maximization

8. If y = f (x ) and x = g(z) and if both f ' (x )

dy dy dx df dg
and g ' (z) exist, then
=

dz dx dz dx dz

Suppose that the relationship between

profit and output is
= 1,000q - 5q2
The first order condition for a maximum is
d/dq = 1,000 - 10q = 0
q* = 100
Since the second derivative is always -10,
q=100 is a global maximum.

This is called the chain rule. The chain rule

allows us to study how one variable (z) affects
another variable (y) through its influence on
some intermediate variable (x).
15

16

Important Points to Note:

Important Points to Note:

Using mathematics provides a convenient,

short-hand way for economists to develop
their models
Derivatives are often used in economics
because economists are often interested in
how marginal changes in one variable
affect another

The mathematics of optimization is an

important tool for the development of
models that assume that economic agents
rationally pursue some goal
Most economic optimization problems
involve constraints on the choices that
agents can make

17

Important Points to Note:

18

Important Points to Note:

The Lagrangian multiplier is used to help

solve constrained maximization problems
The implicit function theorem illustrates the
dependence of the choices that result from
an optimization problem on the parameters
of that problem

19

The envelope theorem examines how

optimal choices will change as the
problem s parameters change
First-order conditions are necessary but not
sufficient for ensuring a maximum or
minimum

20