Methods of Economic Nalysis II

EC115 - Methods of Economic Analysis
Lecture 2
Functions with more than one variable
Renshaw - Chapter 14 & Chapter 17
University of Essex - Department of Economics
Week 17
Domenico Tabasso (University of Essex - Department of Economics) Lecture 2 Week 17 1 / 38
Topics for this week
Denition of a function with more than one variable
Graphs of functions with two variables: level curves
Linear functions
Leontief functions
The Cobb-Douglas function
Homogeneous functions and and returns to scale
Denition
A function of several variables is a relation between
some independent variables x
1
, x
2
, x
3
, ...x
n
and some
dependent variable z such that
z = f (x
1
, x
2
, x
3
, ...x
n
)
species the value of z given the values of
x
1
, x
2
, x
3
, ...x
n
.
For example, we might encounter functions of the
following form
z = 100 2x
1
+ 5x
2
+ 3x
3
57x
4
z = 3x
2
1
9x
2
x
3
+ 10x
3
4
z = e
2x
1
+3x
2
A few examples - 1
A few examples - 2
A few examples - 3
A few examples - 4
Graph of a function
How can we graph these functions?
Only functions of at most TWO independent variables
can be graphed!
Consider any function
z = f (x, y)
This type of function can be graphed in a three
dimensional space.
Hence we have to extend the techniques we learned
about functions of the form z = f (x) and try to use
them for this new set of functions.
Three-dimensional graph: z = f (x, y)
Example:
Consider the following linear function
z = f (x, y) = 3x + 2y 10
This is an example of a plane or a at surface.
This is the extension of a straight line into three
dimensions or R
3
.
Example of coordinates:
(x
1
, y
1
, z
1
), (1,1,-5);
(x
2,
y
2
, z
2
), (2,-0.5,-5);
(x
3
, y
3
, z
3
), (10,-12.5,-5).
Here is the graph: z = 3x + 2y 10
Sections (slices) through the surface of a function
Three dimensional graphs sometimes are very hard to
graph and could lead to confusion.
In Economics we normally analyze these functions by
looking at their sections.
To obtain a particular section of the function we should
ask the following question:
What are the values of x, y such that z = a, where a is
a constant?
Why is this useful?
For instance, consider the previous equation:
z = 3x + 2y 10
and assume z = a. Then we have:
a = 3x + 2y 10
but since a is a constant we can rewrite our equation as:
y =
3
2
x +
a + 10
2
So what we have here is our old friend y = f (x), which
can be graphed on a x, y plan!
All we have to do now is to impose some values for a so
that we can see how the relation between x and y changes
when a changes. So, for example if a = 0 we get
y =
3
2
x + 5
while if we impose a = 10 what we get is:
y =
3
2
x + 10
and so on.
z = 3x + 2y 10 A two dimensional graph
14
16
Y
12
14
a=20
8
10
a 0
6
8
a=10
2
4
0
2
a=0
2
0 1 2 3 4 5
X
4
Holding constant x or y
So holding z constant we can nd the underlined
relation between x and y. Of course we can repeat the
procedure holding any of the three variables constant.
What are the values of z, y such that x = b, where b is
a constant? These can be represented in the y, z plane
by
y =
1
2
z +
10 3b
2
for example if x = 0,
y =
1
2
z + 5
What are the values of x, z such that y = c,where c is
a constant? These can be represented in the x, z plane
by
x =
1
3
z +
10 2c
3
for example if y = 0,
x =
1
3
z +
10
3
Level curves - 1
Hence, by holding constant a variable (x, y or z) we
have reduced a three dimensional function into a two
dimensional function (a function of one-variable).
Here these are represented by straight lines since the
original function was linear in a two dimensional space.
In general, we call level curves any two dimensional
representations of z = f (x, y) when holding a variable
constant.
Level curves - 2
Can we hold z constant?
Sure! Thats exactly what we do for drawing the
indierence curves of a utility function.
Imagine:
U = 100xy
Indierence curves? Fix U = U where U is a constant and
the solve for y
y =
U
100x
As U varies we obtain a map of indierence curves.
Level curves: z = x
2
+ y
2
holding z constant
Level curves: z = x
2
+ y
2
holding z constant
Economic Applications:
Consumer Theory and the Utility Function
= u = U(x, y) (indierence curves)
Producer Theory and the Production Function
= y = F(L, K) (isoquants)
The typical functions we encounter in economics are:
1
Cobb-Douglas functions
2
Linear Functions
3
Quasi-linear Functions
4
Leontief Functions
Cobb-Douglas function:
u = Ax
Utility function
y = AL
Production function
where A, and are usually positive constants.
u = 100x
1/2
y
1/2
y =
z
2
100x
u = 100x
7
y
3
y =
z
100x
7
1/3
Cobb-Douglas functions level curves - u = 100x
1/2
y
1/2
90
100
70
80
90
50
60
30
40
0
10
20
0
1 2 3 4 5 6 7 8 9 101112131415161718192021222324252627282930
Linear Function:
u = ax + by,
y = aL + bK,
where a and b are usually positive constants.
Quasi-Linear function:
u = Ay + v(x),
y = AK + v(L),
where A is usually a positive constant and v() is a
function of one variable.
Quasi-linear function, an example: z = 100x + y
3
3.5
4
2
2.5
3
1
1.5
2
0
0.5
1 4 7 10 13 16 19 22 25 28
Leontief or Fixed Proportions function:
u = Amin(ax
, by
),
y = Amin(aL
, bK
)
where A, a, b, and are usually a positive constants
and the word min simply means minimum, i.e. the the
smallest between the two inputs
This function is also called: function with Complementary
Inputs
Leontief functions, examples
In order to produce 1 mobile phone (P) we need 1 keyboard
(K) and 1 software (S). The production function is:
P = min {K, S}
In order to produce 1 bike (B) we need 1 frame (F) and 2
tyres (T). So the production function is:
B = min
F,
1
2
T

Leontief functions level curves (isoquants)
Y
1
1
XX
Returns to Scale
This is an importan t economic concept that describes
some features of the production function.
It considers the scale of production the amount of
inputs used.
Returns how production changes when the scale is
changed
For instance, if we double the amount of input used we get:
double output = constant returns to scale
more than double = increasing returns to scale
less than double = decreasing returns to scale
NB important
inputs must increase in the same proportion
Otherwise we would be changing not only the scale of the
inputs but also the relative amounts of dierent inputs
used.
Cobb-Douglas functions level curves
Homogeneous Functions
Functions whose return to scale rate does not varies are
called homogeneous. A function f (x, y) is said to be
homogeneous of degree k if
f (tx, ty) = t
k
f (x, y)
for all x, y and all t > 0, where k is a scalar scalar.
In words:
a function is homogeneous of degree k if we obtain
the same result whether we multiply each
independent variable by t or if the whole function is
multiplied by t
k
Example 1
z = f (x, y) = x
2
y + 3xy
2
+ y
3
What is its degree of homogeneity?
f (tx, ty) = (tx)
2
(ty) + 3(tx)(ty)
2
+ (ty)
3
= t
2
x
2
ty + 3txt
2
y
2
+ t
3
y
3
= t
3
(x
2
y + 3xy
2
+ y
3
)
= t
3
f(x, y)
Example 2: Cobb-Douglas function
y = F(L, K) = AL
What is its degree of homogeneity?

F(tL, tK) = A(tL)
(tK)
= t
+
(AL
a
K
)
= t
+
F(L, K).
The degree of homogeneity is just = +
Returns to Scale of a Cobb-Douglas
If + = 1, the function is homogeneous of degree
1 = Constant Returns to Scale.
If + > 1,the function is homogeneous of a degree
> 1 = Increasing Returns to Scale.
If + < 1,the function is homogeneous of a degree
< 1 = Decreasing Returns to Scale.
Variable Returns to Scale
Partial Dierentiation
Consider a function z = f (x, y)
partial derivative of z wrt x
z
x
partial derivative of z wrt y
z
y
We use the usual rule of derivation, because when we do
the partial derivative wrt x we held the rest of the variables
xed.

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EC115 - Methods of Economic Analysis

Domenico Tabasso (University of Essex - Department of Economics) Lecture 2 Week 17 28 / 38

What is its degree of homogeneity?

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