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Learning objectives
After completing this chapter students should be able to:
12.1 Overview
In this chapter, some techniques are introduced that can be used to differentiate functions that
are rather more complex than those encountered in Chapters 8, 9, 10 and 11. These are the
chain rule, the product rule and the quotient rule. As you will see in the worked examples, it
is often necessary to combine several of these methods to differentiate some functions. The
concept of integration is also introduced.
To differentiate y with respect to x in this type of function we use the chain rule which
states that
dy
dy dz
=
dx
dz dx
One economics example of a function within a function occurs in the marginal revenue
productivity theory of the demand for labour, where a rms total revenue depends on output
which, in turn, depends on the amount of labour employed. An applied example is explained
later. However, we shall rst look at what is perhaps the most frequent use of the chain
rule, which is to break down an awkward function articially into two components in order
to allow differentiation via the chain rule. Assume, for example, that you wish to nd an
expression for the slope of the non-linear demand function
p = (150 0.2q)0.5
(1)
The basic rules for differentiation explained in Chapter 8 cannot cope with this sort of
function. However, if we dene a new function
z = 150 0.2q
(2)
(3)
(Note that in both (1) and (3) the functions are assumed to hold for p 0 only, i.e. negative
roots are ignored.)
Differentiating (2) and (3) we get
dz
= 0.2
dq
dp
= 0.5z0.5
dz
Thus, using the chain rule and then substituting equation (2) back in for z, we get
dp
dp dz
0.1
0.1
=
= 0.5z0.5 (0.2) = 0.5 =
dq
dz dq
z
(150 0.2q)0.5
Some more examples of the use of the chain rule are set out below.
Example 12.1
The present value of a payment of 1 due in 8 years time is given by the formula
PV =
1
(1 + i)8
where i is the given interest rate. What is the rate of change of PV with respect to i?
1993, 2003 Mike Rosser
Solution
If we let
z=1+i
(1)
1
= z8
z8
(2)
dPV
= 8z9
dz
Therefore, using the chain rule, the rate of change of PV with respect to i will be
dPV
dPV dz
8
=
= 8z9 =
di
dz di
(1 + i)9
Example 12.2
If y = (48 + 20x 1 + 4x + 0.3x 2 )4 , what is dy/dx?
Solution
Let
z = 48 + 20x 1 + 4x + 0.3x 2
(1)
and so
dz
= 20x 2 + 4 + 0.6x
dx
(2)
(3)
dTR
dL
MCL =
dTCL
dL
where TR is total sales revenue (i.e. pq) and TCL is the total cost of labour. If a rm is a
monopoly seller of a good, then we effectively have to deal with two functions in order to
derive its MRPL function since total revenue will depend on output, i.e. TR = f(q), and
output will depend on labour input, i.e. q = f(L). Therefore, using the chain rule,
MRPL =
dTR dq
dTR
=
dL
dq dL
(1)
dq
= MPL
dL
Example 12.3
A rm is a monopoly seller of good q and faces the demand schedule p = 200 2q, where p
is the price in pounds, and the short-run production function q = 4L0.5 . If it can buy labour
at a xed wage of 8, how much L should be employed to maximize prot, assuming other
inputs are xed?
1993, 2003 Mike Rosser
Solution
Using the chain rule we need to derive a formula for MRPL in terms of L and then set it equal
to 8, given that MCL is xed at this wage rate. As
MRPL =
dTR dq
dTR
=
dL
dq dL
(1)
(2)
(3)
(4)
Substituting the production function q = 4L0.5 into (4), as we are trying to derive a formula
in terms of L, gives
400 8(4L0.5 ) = 8L0.5
400 32L0.5 = 8L0.5
400 = 40L0.5
10 = L0.5
100 = L
which is the optimal employment level.
In the example above the idea of a short-run production function was used to simplify
the analysis, where the input of capital (K) was implicitly assumed to be xed. Now that
you understand how an MRPL function can be derived we can work with full production
functions in the format Q = f(K, L). The effect of one input increasing while the other is
held constant can now be shown by the relevant partial derivative.
1993, 2003 Mike Rosser
Thus
MPL =
Q
L
The same chain rule can be used for partial derivatives, and full and partial derivatives can
be combined, as in the following examples.
Example 12.4
A rm operates with the production function q = 45K 0.7 L0.4 and faces the demand function
p = 6,980 6q. Derive its MRPL function.
Solution
By denition MRPL = TR/L, where K is assumed xed.
We know that
TR = pq = (6,980 6q)q = 6,980q 6q 2
Therefore
dTR
= 6,980 12q
dq
(1)
q
= 18K 0.7 L0.6
L
(2)
dTR q
TR
=
= (6,980 12q)18K 0.7 L0.6
L
dq L
(3)
Example 12.5
Find point elasticity of demand when q = 10 if p = (120 2q)0.5 .
Solution
Point elasticity is dened as
e = (1)
p 1
q dp
dq
(1)
Create a new variable z = 120 2q. Thus p = z0.5 and so, by differentiating:
dz
= 2
dq
dp
= 0.5z0.5
dz
Therefore
dp dz
dp
=
dq
dz dq
= 0.5z0.5 (2)
= 0.5(120 2q)0.5 (2)
=
1
(120 2q)0.5
10
(1)(120 2q)0.5 = (120 20)0.5 = 1000.5 = 10
10
Example 12.6
Differentiate the function y = (6 + 4x)2 .
Solution
(i) By multiplying out
y = (6 + 4x)2 = 36 + 48x + 16x 2
Therefore
dy
= 48 + 32x
dx
(ii) Using the chain rule, let z = 6 + 4x so that y = z2 . Thus
dy dz
dy
=
= 2z 4 = 2(6 + 4x)4 = 48 + 32x
dx
dz dx
2.
3.
A rm operates in the short run with the production function q = 2L0.5 and faces
the demand schedule p = 60 4q where p is price in pounds. If it can employ
labour at a wage rate of 4 per hour, how much should it employ to maximize
prot?
If a supply schedule is given by p = (2 + 0.05q)2 show (a) by multiplying out,
and (b) by using the chain rule, that its slope is 2.2 when q is 400.
The return R on a sum M invested at i per cent for 3 years is given by the formula
R = M(1 + i)3
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