Managerial Economics

Optimization Techniques and New Management Tools

Managerial Economics

Prof. M. El-Sakka

CBA. Kuwait University

OPTIMIZATION Managerial economics is concerned with the ways in which managers should make decisions in order to maximize the effectiveness or performance of the organizations they manage. To understand how this can be done we must understand the basic optimization techniques. Functional relationships: relationships can be expressed by graphs:
P

Managerial Economics

Prof. M. El-Sakka

CBA. Kuwait University

Quick Differentiation Review

Name Function Derivative dY/dX = 0 Example Y=5 dY/dX = 0 Y = 5X dY/dX = 5 Constant Y = c Functions A Line

Y = c X dY/dX = c

Power Y = cXb Functions

Managerial Economics

dY/dX = bcX b-1 Y = 5X2 dY/dX = 10X

Prof. M. El-Sakka CBA. Kuwait University

Quick Differentiation Review

Sum of Y = G(X) + H(X) Functions example Y = 5X + 5X2 dY/dX = dG/dX + dH/dX

dY/dX = 5 + 10X

Product of Y = G(X) H(X) Two Functions dY/dX = (dG/dX)H + (dH/dX)G example Y = (5X)(5X2 ) dY/dX = 5(5X2 ) + (10X)(5X) = 75X2

Managerial Economics

Prof. M. El-Sakka

CBA. Kuwait University

Quick Differentiation Review

Quotient of Two Y = G(X) / H(X) Functions dY/dX = (dG/dX)H - (dH/dX)G H2 Y = (5X) / (5X2) dY/dX = 5(5X2) -(10X)(5X) (5X2)2 = -25X2 / 25X4 = - X-2 Chain Rule Y = G [ H(X) ] dY/dX = (dG/dH)(dH/dX) Y = (5 + 5X)2 dY/dX = 2(5 + 5X)1(5) = 50 + 50X
Managerial Economics Prof. M. El-Sakka CBA. Kuwait University

 USING DERIVATIVES TO SOLVE MAXIMIZATION AND MINIMIZATION PROBLEMS Maximum or minimum points occur only if the slope of the curve equals zero. Look at the following graph

Managerial Economics

Prof. M. El-Sakka

CBA. Kuwait University

Max of x y Slope = 0

the function Y = -50 + 100X - 5X2

value of x

i.e.,
10 20 x

dy/dx

Value of Dy/dx when y is max 0

dY = 100 - 10X dX dY = 0 if dX
X = 10 i.e., Y is maximized when the slope equals zero.

Value of dy/dx which Is the slope of y curve

10

20

Note that this is not sufficient for maximization or minimization problems.

Managerial Economics Prof. M. El-Sakka CBA. Kuwait University

Optimization Rules
Maximization conditions: 1-

2-

dY = 0 dX d 2Y = < 0 dX 2

Minimization conditions: 1-

2Managerial Economics

dY = 0 dX d 2Y = > 0 dX 2
Prof. M. El-Sakka CBA. Kuwait University

Applications of Calculus in Managerial Economics

maximization problem:
A profit function might look like an arch, rising to a peak and then declining at even larger outputs. A firm might sell huge amounts at very low prices, but discover that profits are low or negative. At the maximum, the slope of the profit function is zero. The first order condition for a maximum is that the derivative at that point is zero. If = 50Q - Q2, then d/dQ = 50 - 2Q, using the rules of differentiation. Hence, Q = 25 will maximize profits where 50 - 2Q = 0.
Managerial Economics Prof. M. El-Sakka CBA. Kuwait University

More Applications of Calculus

minimization problem: Cost minimization supposes that there is a least cost point to produce. An average cost curve might have a U-shape. At the least cost point, the slope of the cost function is zero. The first order condition for a minimum is that the derivative at that point is zero. If TC = 5Q2 60Q, then dC/dQ = 10Q - 60. Hence, Q = 6 will minimize cost Where: 10Q - 60 = 0.
Managerial Economics Prof. M. El-Sakka CBA. Kuwait University

More Examples
Competitive Firm: Maximize Profits
where = TR - TC = P Q - TC(Q) Use our first order condition:

d/dQ = P - dTC/dQ = 0. Decision Rule: P = MC.

a function of Q

Max = 100Q - Q2
First order = 100 -2Q = 0 implies Q = 50 and; = 2,500

Managerial Economics

Prof. M. El-Sakka

CBA. Kuwait University

Second Order Condition: one variable

If the second derivative is negative, then its a maximum If the second derivative is positive, then its a minimum

Problem 1

Problem 2

Max = 100Q - Q2
First derivative

Max= 50 + 5X2
First derivative

100 -2Q = 0 second derivative is: -2 implies Q =50 is a MAX

10X = 0 second derivative is: 10 implies Q = 10 is a MIN

Managerial Economics

Prof. M. El-Sakka

CBA. Kuwait University

Extra examples
e.g.; Y = -1 + 9X - 6X + X first condition
2 3

X=

(12) 122 4(9 3) 6

=2 1

therefore Y = 0 at X=3 the second condition or X = 1

dY dX

= 9 - 12X + 3X2 = 0

Quadratic Function Y = aX + bX + c
2

d 2Y dX 2
at X = 3

= -12 + 6X

X=

b b2 4ac 2a

d 2Y dX 2
at X = 1

= -12 + 6(3) = 6 >0 ( minimum point)

a=3 b = -12 c=9

Managerial Economics

d 2Y dX 2

= -12 + 6(1) = - 6 <0 (maximum point)

Prof. M. El-Sakka

CBA. Kuwait University