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Chapter 2

Review of Some Important


Concepts and Math
Materials that will be
Covered/Reviewed
• Overview of a Market
• Economic/Accounting Profits
• Math
– Functions
– Derivatives
• How to find derivatives
• How to solve maximization & minimization problems
– Marginal Analysis
What is a Market?
• Consumers
– Some people want to buy something
• Suppliers
– Some people want to sell something
• Market
– In old times, people get together to make
trades
– Modern days, a “market” can be anywhere, in
any forms
Why does Managerial
Economics still Start with
Demand and Supply?

• Profits, Profits, Profits!!!


– Profit = Total Revenue – Total Cost
– Total revenue vs. Demand
– Total cost vs. Supply
Markets
Basics of supply and demand
• Demand curve--amount of some good
consumers are willing to buy at
various prices
• Supply curve--amount of some good
sellers are willing to offer at various
prices
Interaction of supply and demand
yields a market-clearing price
How does the Equilibrium Price Move
when the Demand Curve Shifts?
How does the Equilibrium Price Move
when the Supply Curve Shifts?
The Concept of Profits
• Accounting Profit
– Revenue minus cost
• However, to economists the “cost”
means far beyond the “tangible” cost
occurred
Economic Profits

• Economic Profits
– Accounting profits minus
opportunity cost
– Opportunity cost: forgone benefits
generated by alternative uses of
the capital or labor
The nature of opportunity costs
Example
Suppose you are a full-time student
and your favorite professor offers
you a research assistantship
• What do you gain?
• What do you lose?
• What are the opportunity costs?
Calculation
Operating a self-owned store

Total revenue 90,000

Total Cost 30,000

Salary if worked elsewhere 40,000

Yields if invested elsewhere 24,000

Accounting Profit 90,000 - 30,000

Economic Profit 60,000 - 40,000 - 24,000


Why do I Need to learn
Math?
• What are economists doing?
– Develop models and derive the results
mathematically…and yet…interpret the
results intuitively and economically
• How do you convince people about
your idea?
– “Number” speaks for itself!!!!!!!!
Functions
• Economists like to use a function to summarize
the relationship between two or more variables
Y = f (X )
Y = f (X 1 , X 2 , X 3 ,  , Xn )

(Y1 ,Y2 ,Y3 ,  ,Yn ) = f (X1 , X2 , X3 ,  , Xn )

• Y: profit; sales; stock price; cost; annual return


• X: advertising expense; R&D expense; production
technology; pricing strategy; relationship
between employers and employees
A Linear Function
• Y = a + bX, a straight line
• Example
Q = 200 – 5P

P Q
10 ?
20 ?
30 ?
Draw the function in a
Diagram
A non-linear function

• Example
Y = −50 + 100X − 5X 2

X Y
0 ?
10 ?
20 ?
Draw the function in a
Diagram
Slope
• Often times we are interested in how Y
moves as X changes
– Slope
change in Y Δ Y Y2 − Y1
= =
change in X Δ X X2 − X1

– Linear function: the slope is a constant


– Non-linear function: the slope will be
different for every pair of (X,Y)
Derivatives
• The derivative of Y with respect to X is
defined as
dY ΔY
= lim
dX ΔX→0 ΔX

The ratio of ΔY ΔX when ΔX approaches


zero

The slope of a “point”!!


Derivatives
• Each pair of (X,Y) has a derivative, which equals to the slope
of the tangent line M
Derivatives

– Linear function: Every pair of (X,Y) has


the same derivative
– Non-linear function: Every pair of (X,Y)
has a different derivative
How to find a derivative
• Case 1: Y is a constant
Case 2:
Y is a power function
Y = a⋅X b

dY
= b⋅a⋅X b-1

dX
dY
Exercise I : Y = 3X, find
dX
dY
Exercise II : Y = 2X , find
2

dX
Case 3: Derivatives of
Sums and Differences
Y = g (X ) + h ( X )
dY d g(X) d h(X)
= + = g′(X) + h′(X)
dX dX dX

Y = g (X ) − h (X )

dY d g(X) d h(X)
= − = g′(X) − h′(X)
dX dX dX
dY
Exercise 1 : y = 3X + 4X , find
3 2

dX
dY
Exercise 2 : y = 8X − 9X , find
2

dX
Case 4:
Derivatives of Products
Y = g(X) ⋅ h(X)

dY d g(X) d h(X)
= ⋅ h(X) + g(X) ⋅
dX dX dX
= g′(X) ⋅ h(X) + g(X) ⋅ h′(X)

dY
Exercise : Y = 6X ⋅ (3 − X ), find
2

dX
Case 5: Derivatives of a
function of a function
Y = f (W), W = g(X)
dY dY dW
= ⋅ = f′(W) ⋅ g′(X)
dX dW dX

dY
Exercise : Y = 4W + W , W = 3X , find
3 2

dX
Using Derivatives to Solve
Max. & Min. Problems
• Given a function

Y = −50 + 100X − 5X 2

How do we find out the value of X


that maximizes Y?
Method 1:
Judging from the diagram
Method 2:
Using Derivatives
• Observation:
– At the maximum point, the derivative of
Y with respect to X is zero.
• To solve the maximization problem:
Find the value of X where dY/dX
equals zero!!!
Exercise
Y = −50 + 100X − 5X 2 , find (X * , Y * )
How to distinguish the max. point
from the min. point?
The Maximum & Minimum Points

• Look at the change in derivatives!!


d 2Y
– The derivative is decreasing (or < 0 ):
dX 2
the maximum point
d 2Y
– The derivative is increasing (or > 0 ):
dX 2
the minimum point
Marginal Analysis
• A simple application of calculus to
the firm’s profit maximization
problem
• Marginal Revenue: the change in total
revenue resulted form an one-unit
increase in output
• Marginal Cost: the change in total cost
resulted form an one-unit increase in
output
Numbers Total Marginal Total Cost Marginal
of units of Revenue Revenue Cost
output
0 0 - 50 -
1 100 100 100 50

2 250 150 200 100


3 600 350 550 350
4 800 200 800 250
Profit Maximization
• Profit = TR – TC = TR(Q) – TC(Q)
• What is the optimal level of output (Q*)
that maximizes the profit?
dπ dTR dTC
=0 ⇒ − =0
dQ dQ dQ
dTR dTC
⇒ =
dQ dQ
⇒ MR = MC
Intuition

• If MR > MC, why not produce


more?
• If MR < MC, why not produce
less?