LECTURE 1: CONSTRAINED OPTIMISATION AND QUASI-CONCAVITY

Reference: Pemberton & Rau Section 17.4

Consider the following problem:

maximise f ( x, y ) subject to g ( x, y )  0
We saw in ECON1004 how to solve this problem using the Lagrangian.
Define a function L of three variables by setting
L ( x , y ,  )  f ( x , y )  g ( x , y ) .
L is called the Lagrangian function for the problem, and its third argument λ is called
the Lagrange multiplier. The relationship between the function L and the constrained
maximisation problem is as follows:
If ( x*, y*) is a solution of the constrained maximisation problem
maximise f ( x, y ) subject to g ( x, y )  0 ,
then there is a real number λ* such that the Lagrangian L has a critical point at
( x*, y*,  *) .
The same method can be applied to the following problem:
minimise f ( x, y ) subject to g ( x, y )  0 .
Economic applications
(1) Utility maximisation
maximise U ( x1 , x 2 ) subject to p1 x1  p 2 x 2  m.
In the case where the solution has both components strictly positive, it occurs at a point of
tangency between the budget constraint and an indifference curve. We can therefore
introduce the Lagrangian
L( x1 , x 2 ,  )  U ( x1 , x 2 )   ( p1 x1  p 2 x 2  m)
and write down the first-order conditions in the usual way.
Provided the indifference curves are negatively sloped and convex, the first-order
conditions are sufficient for an optimum.
(2) Cost minimisation
minimise w1 x1  w2 x 2 subject to F ( x1 , x 2 )  q.
As in the consumer case, these conditions are sufficient for an optimum provided the
isoquants are negatively sloped and convex.
Quasi-concave functions
Here we investigate more closely the circumstances in which indifference curves and
isoquants will be convex.
A function f defined on R n is said to be quasi-concave if, for any real number c, the set
of n-vectors x for which f (x)  c is convex.
For utility functions with two arguments which are increasing in both arguments, quasi-
concavity of the utility function is equivalent to convexity of all the indifference curves.
All concave functions are quasi-concave but not all quasi-concave functions are concave
eg if the surface z  f ( x, y ) has the shape of the upward-sloping part of a bell, then f is
not concave but is quasi-concave.
The following proposition is useful when checking for quasi-concavity.
Proposition Suppose g (x)  H ( f (x)) , where H is a strictly increasing function. If the
function f is quasi-concave, so is g.

The main theorem relating quasi-concave functions to constrained optimisation is as

follows:

Theorem Suppose that f is a quasi-concave function, and we wish to

maximise f ( x, y ) subject to the constraint ax  by  c  0 ,

where a, b, c are constants. Suppose the Lagrangian has a critical point where x  x * and
y  y * , and that either at least one of the partial derivatives of f is nonzero at ( x*, y*) ,
or f is a concave function or both. Then f ( x, y ) attains a constrained maximum at
( x*, y*) .

This theorem may be extended to more than two variables, more than one linear
constraint and, with obvious modifications, to minimisation problems.

Note that the first of the either/or conditions must be satisfied if at least one of the partial
derivatives of f is always positive. This is why the theorem is applicable to consumer
theory. It does not cover the cost-mimimisation case but we can check by geometrical
means that the first-order conditions do give the optimum.

Exercises: Pemberton & Rau 17.4.1-17.4.2