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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?

– 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

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 )

• 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

– 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

zero

Derivatives

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

of the tangent line M

Derivatives

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

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

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

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

more?

• If MR < MC, why not produce

less?

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