MATHEMATICS AND STATISTICS PRELIMS COURSE

PATRICK WALLACE

Michaelmas Term 2005

I Course Convenor (Maths): Sujoy Mukerji (University College)

Course Convenor (Stats): Christine Greenhalgh (St Peter’s College)
I Lectures (Non AS): Thursday 11am. Gulbenkian Theatre.
Lectures (AS+): Friday 11am. Gulbenkian Theatre.
I Tutorials: Michaelmas Term and Trinity Term (Weeks 1–4 only)
Catz – Wednesday 2.30pm and 4.15pm (Room 3:14 St Catz)
LMH – Thursday 2.30pm and 4.15pm (Room 3:14 St Catz)
Mathematics and Statistics are an integral part of modern economics. A good understanding of
the underlying concepts of economics requires a sound mathematical knowledge, and for more
empirical economics a solid base of statistical method is an absolutely necessity. Yet these
areas are often overlooked when studying first year economics. As such, in parallel with your
microeconomics course this term there will also be a series of maths and stats classes.
Economics and Management students will be having classes which are held in and organised by
the economics department. These students have to sit a compulsory paper in maths and stats
at the end of their first year, which counts for a third of their mark. E&M–ers should keep
their eyes peeled for information on the economics department’s website for when and where
their classes will be held, and who will be their teacher. Feel free to read through this handout
as it will contain information of interest, however you should note the classes you have will be
different, and may contain different material from that which I teach to the PPE–ists.
Though their is no separate exam for the Politics, Philosophy and Economics students in math-
ematics, there is now a compulsory maths question in the prelim Economics paper. On top of
this the third part of the economics paper is a optional mathematics section; PPE students in
the past who have attempted questions in this section have tended to achieve higher grades than
those who did not. So not only will maths and stats help you further understand economics,
but they will also help you to pass, and give you a wider choice in the prelim exam.
PPE Class Structure
Initially the classes will be split into two groups dependant on mathematic ability and past
experience. Depending upon the spread of mathematical ability the classes may change size
and length and will travel at different speeds. Each week there will be one maths class for the

Date Printed. This Version Printed September 30, 2005.

c Patrick Wallace, Department of Economics, Oxford.
1
Maths for Economics Handout September 30, 2005 / Page 2 of 15

two groups. These will be on Wednesday (for Catz Students), and Thursday (for LMH
students) at 2.30pm-4pm and 4.15pm-5.45pm, in St Catz (3:14). Every week you will be
expected to hand in (approximately!) one exercise set for marking. Please can you make sure
these are in on time to my pidge at Catz by Sunday 6pm. The excercise sets can be found on
my webpage at Malroy (address below) or on the economics website, in case you lose the set
I have provided you with today (on my website there are an additional set of problems which
I have left up for revision and as an optional resource – these are from a previous years E&M
course).
A quick note on the exercises: You may find the exercises hard, however as you probably know,
the only way to learn maths and stats well is to practice questions. Even if you feel you can’t
answer a question fully, please attempt to do as much as you can, a half answer tells me much
more about what you are having particular difficulties with, rather than a blank (or worse yet
non-existant) sheet.
Again as in economics the classes will attempt to match the lectures, however some weeks we
may be ahead or behind, this makes personal study an absolute must. Obviously it goes without
saying attending all the lectures will help you immensily too. Even if you think you are a maths
wizz, or a hopeless mathematician the lectures are vital, as for those who are strong at maths
there will be additional topics covered that you almost certainly will have never seen before,
and if you are weaker then the lectures may help clarify points you didn’t understand from the
textbooks.
This is rough outline of how the tutorials will progress.

(1) Maths: Review of Algebra.

(2) Maths: Lines and Graphs.
(3) Maths: Sequences/Series, Finance, Functions.
(4) Maths: Differentiation, and Optimisation.
(5) Maths: Partial Differentiation.
(6) Maths: Partial Derivatives and Optimisation.
(7) Maths: Constrained Optimization.
(8) Maths: Integration.

(9) Stats: Decision Analysis.

(10) Stats: Normal and Binomial Probabilities.
(11) Stats: Simple Tests.
(12) Stats: Simple Regression.

These are only rough outlines and the schedule may change depending upon how things are
progressing throughout term. There will be definitely eight tutorials in Michaelmas in mathe-
matics. The remaining tutorials in statistics will either be held in late Hilary or early Trinity
terms. At the end of each class I will provide you with the problem set, or selection of exercises
I expect you to complete for the next class.
2
Maths for Economics Handout September 30, 2005 / Page 3 of 15

Mathematics and Statistics: Course Specifics

The Economics website is an excellent source of information, a brief summary of which is given
here. To get to the required pages simply browse to http://www.economics.ox.ac.uk/, and
follow links as follows:

Intranet → Undergraduate Courses → PPE → Introduction to Mathematics and Stats

The lectures this year take on a new format in that there are now lectures provided for PPE
students who have not taken AS or A Level Mathematics or Statistics. The two lecture streams
will be held on separate days: the AS+ (obligatory for E&M students) on Fridays, and the
non-AS on Thursdays. They will progress as follows

Dates Non AS AS+ Notes:

MT
Weeks 1–8 Hilary Lamaison (Maths) Sujoy Mukerji (Maths)
HT
Week 1 Anke Hoeffler (IT Project) For all PPE students
Weeks 1–2 Hilary Lamaison (Maths) Sujoy Mukerji (Maths)
Weeks 3–8 Anke Hoeffler (Stats) Christine Greenhalgh & Non AS 1 lecture a week
Adeel Malik (Stats) AS+ 2 lectures a week
TT
Weeks 1–2 Hilary Lamaison (Maths) CG and AM (Stats) Stats may be E&M only
Weeks 3–5 HL (Revision) Anthony Murphy
(Lin Algebra) E&M only
Week 6 HL (!!! )
PPE students: The Introductory Economics paper consists of an essay section (Part A) and
a problem section (Part B). In addition there is a section (Part C) consisting of a compulsory
mathematics question carrying 20% of the total marks for the paper. Candidates will be
required to answer the Part C question and three other questions, of which no more than one
may be from Part B. This course prepares students for Parts B and C.

The relevant part of the rubric for the Introductory Economics paper is:

Elementary Mathematical Economics: applications of functions and graphs, dif-

ferentiation, partial differentiation, maxima and minima, maximization subject
to constraints.
Economic Statistics: presentation of statistics, descriptive statistics, index num-
bers, elementary sampling and significance, simple correlation and regression.

E&M students. The Mathematics and Statistics paper consists of a Mathematics section
(Part A) and a Statistics section (Part B). Candidates are required to answer four questions,
of which at least one must be from each part.
3
Maths for Economics Handout September 30, 2005 / Page 4 of 15

The relevant part of the rubric for the Mathematics and Statistics paper is:

Mathematics: multivariate calculus (total and partial differentiation and inte-

gration of functions of one or more variables), constrained and unconstrained
optimization, linear algebra (basic vector and matrix operations), applications
to economics (including utility and profit maximization), applications to man-
agement (including planning, scheduling and production).
Statistics: descriptive statistics (presentation of data, measures of central ten-
dency and dispersion), statistical inference (elementary probability theory and
probability distributions, sampling estimation and hypothesis testing), correla-
tion and regression (correlation coefficients, correlation and causality, ordinary
least squares regression, statistical inference of simple regression equations), ap-
plications of the above topics in economics or management, further application
in statistics for management (including methods for categorical variables and
analysis of variance).

Reading
The core textbook for this maths course is Anthony and Biggs (1996). This is an excellent
guide, and covers the majority of the material very well, as well as some extra stuff. For
the stats course an excellent book is Newbold (1994), though the core textbook is Wonnacott
and Wonnacott (1990). I personally find Newbold (1994) more helpful but Wonnacott and
Wonnacott (1990) is still a good reference book.
Other maths/stats books you might find helpful are:

• Chiang (1985)
• Jacques (1998)
• Pemberton and Rao (2001)
• Simon and Blume (1994)
• Agresti and Finlay (1997) (Stats)

The economics website also lists some additional textbooks and useful references.
Questions
If you have any questions about this handout, or anything about economics/maths at St Catz
please don’t hesitate to contact me. My details are below. If you wish to see me outside of
tutorials just e-mail me, or simply pop along to my office hour, details of which are given below.
If you have any worries about the work, or Oxford life in general, please get in touch with me
as soon as these problems arise.

4
Maths for Economics Handout September 30, 2005 / Page 5 of 15

Department of Economics:
Desk A12, Second Floor
Manor Road Building
Manor Road,
Oxford OX1 3UQ
– (This is my usual haunt if you need to find me in an emergency!)
Office Hours:
Wednesday 6pm – 7pm
St Catz Office (3:14).
Mailing address
P R Wallace
St Catherine’s College, Oxford University
Manor Road
Oxford OX1 3UJ
email address
patrick.wallace@economics.ox.ac.uk
Websites
http://malroy.econ.ox.ac.uk/paddy/
http://www.econ.ox.ac.uk/Intra/Under/UGInfo.htm

References

Agresti, A., and B. Finlay (1997): Statistical Methods for the Social Sciences. Third Edition.
Prentice Hall, New Jersey.
Anthony, M., and N. Biggs (1996): Mathematics for Economics and Finance. Cambridge
University Press, Cambridge.
Chiang, A. (1985): Fundamental Methods of Mathematical Economics. Third Edition.
McGraw-Hill.
Jacques, I. (1998): Mathematics for Economics and Business. Fifth Edition. Addison-Wesley,
Harlow.
Newbold, P. (1994): Statistics for Business and Economics, Fourth Edition. Prentice Hall,
New Jersey.
Pemberton, M., and N. Rau (2001): Mathematics for Economists. Manchester University
Press.
Simon, C., and L. Blume (1994): Mathematics for Economists. Norton, New York.
Wonnacott, T., and R. Wonnacott (1990): Introductory Statistics, Fifth Edition. Wiley,
New York.

5
 1. REVIEW OF ALGEBRA 21

 

Worksheet 1: Review of Algebra 

(1) For a firm, the cost of producing q units of output is C = 4 + 2q + 0.5q 2 . What is
the cost of producing (a) 4 units (b) 1 unit (c) no units?

(2) Evaluate the expression x3 (y + 7) when x = −2 and y = −10.

(3) Simplify the following algebraic expressions, factorising the answer where possible:
(a) x(2y + 3x − 12) − 3(2 − 5xy) − (3x + 8xy − 6) (b) z(2 − 3z + 5z 2 ) + 3(z 2 − z 3 − 4)
p
(4) Simplify: (a) 6a4 b × 4b ÷ 8ab3 c (b) 3x3 y ÷ 27xy (c) (2x3 )3 × (xz 2 )4
p

2y 4y x + 1 2x − 1
(5) Write as a single fraction: (a) + (b) −
3x 5x 4 3
(6) Factorise the following quadratic expressions:
(a) x2 − 7x + 12 (b) 16y 2 − 25 (c) 3z 2 − 10z − 8
3
(7) Evaluate (without using a calculator): (a) 4 2 (b) log10 100 (c) log5 125

(8) Write as a single logarithm: (a) 2 loga (3x) + loga x2 (b) loga y − 3 loga z

(9) Solve the following equations:

6
(a) 5(2x − 9) = 2(5 − 3x) (b) 1 + = −1 (c) z 0.4 = 7 (d) 32t−1 = 4
y−8
(10) Solve these equations for x, in terms of the parameter a:
x
(a) ax − 7a = 1 (b) 5x − a = (c) loga (2x + 5) = 2
a
r
a
(11) Make Q the subject of: P =
Q2 + b
(12) Solve the equations: (a) 7 − 2x2 = 5x (b) y 2 + 3y − 0.5 = 0 (c) |1 − z| = 5

(13) Solve the simultaneous equations:

(a) 2x − y = 4 and 5x = 4y + 13
(b) y = x2 + 1 and 2y = 3x + 4

(14) Solve the inequalities: (a) 2y − 7 ≤ 3 (b) 3 − z > 4 + 2z (c) 3x2 < 5x + 2
 2. LINES AND GRAPHS 35

 

Worksheet 2: Lines and Graphs 

(1) Find the gradients of the lines AB, BC, and CA where A is the point (5, 7), B is
(−4, 1) and C is (5, −17).

(2) Draw (accurately), for values of x between −5 and 5, the graphs of:
(a) y − 2.5x = −5 (b) z = 14 x2 + 12 x − 1
Use (b) to solve the equation 14 x2 + 12 x = 1

(3) Find the gradient and y-intercept of the following lines:

(a) 3y = 7x − 2 (b) 2x + 3y = 12 (c) y = −x

(4) Sketch the graphs of 2P = Q+5, 3Q+4P = 12, and P = 4, with Q on the horizontal
axis.

(5) What is the equation of the line through (1, 1) and (4, −5)?

(6) Sketch the graph of y = 3x − x2 + 4, and hence solve the inequality 3x − x2 < −4.

(7) Draw a diagram to represent the inequality 3x − 2y < 6.

(8) Electricity costs 8p per unit during the daytime and 2p per unit if used at night. The
quarterly charge is £10. A consumer has £50 to spend on electricity for the quarter.
(a) What is his budget constraint?
(b) Draw his budget set (with daytime units as “good 1” on the horizontal axis).
(c) Is the bundle (440, 250) in his budget set?
(d) What is the gradient of the budget line?

(9) A consumer has a choice of two goods, good 1 and good 2. The price of good 2 is 1,
and the price of good 1 is p. The consumer has income M .
(a) What is the budget constraint?
(b) Sketch the budget set, with good 1 on the horizontal axis, assuming that p > 1.
(c) What is the gradient of the budget line?
(d) If the consumer decides to spend all his income, and buy equal amounts of the
two goods, how much of each will he buy?
(e) Show on your diagram what happens to the budget set if the price of good 1
falls by 50%.
 3. SEQUENCES, SERIES AND LIMITS 55

 
Worksheet 3: Sequences, Series, and

Limits; the Economics of Finance

Quick Questions
(1) What is the nth term of each of the following sequences:
(a) 20, 15, 10, 5, . . . (b) 1, 8, 27, 64, . . . (c) 0.2, 0.8, 3.2, 12.8, . . .

(2) Write out the series: n−1 2

P
r=0 (2r − 1) without using sigma notation, showing the first
four terms and the last two terms.

(3) For each of the following series, work out how many terms there are and hence find
the sum:
(a) 3+4+5+· · ·+20 (b) 1+0.5+0.25+· · ·+(0.5)n−1 (c) 5+10+20+· · ·+5×2n

(4) Express the series 3 + 7 + 11 + · · · + (4n − 1) + (4n + 3) using sigma notation.

(5) If you invest £500 at a fixed interest rate of 3% per annum, how much will you have
after 4 years:
(a) if interest is paid annually?
(b) if interest is paid monthly? What is the APR in this case?
(c) if interest is compounded continuously?
If interest is paid annually, when will your savings exceed £600?

(6) If the interest rate is 5% per annum, what is the present value of:
(a) An annuity that pays £100 a year for 20 years?
(b) A perpetuity that pays £50 a year?

(7) Find the limit, as n → ∞, of:

5n2 + 4n + 3
(a) 3(1 + (0.2)n ) (b) (c) 0.75 + 0.5625 + · · · + (0.75)n
2n2 + 1

Longer Questions
(1) Carol (an economics student) is considering two possible careers. As an acrobat, she
will earn £30000 in the first year, and can expect her earnings to increase at 1% per
annum thereafter. As a beekeeper, she will earn only £20000 in the first year, but
the subsequent increase will be 5% per annum. She plans to work for 40 years.
(a) If she decides to be an acrobat:
(i) How much will she earn in the 3rd year of her career?
(ii) How much will she earn in the nth year?
(iii) What will be her total career earnings?
(b) If she decides to be a beekeeper:
(i) What will be her total career earnings?
(ii) In which year will her annual earnings first exceed what she would have
earned as an acrobat?
(c) She knows that what matters for her choice of career is the present value of her
earnings. The rate of interest is i. (Assume that earnings are received at the
end of each year, and that her choice is made on graduation day.) If she decides
to be an acrobat:
 4. FUNCTIONS 75

 
 Worksheet 4: Functions 

Quick Questions
1
(1) If f (x) = 2x − 5, g(x) = 3x2 and h(x) = 1+x :
1


(a) Evaluate: h 3 and g(h(2))
(b) Solve the equation h(x) = 34
(c) Find the functions h(f (x)), f −1 (x), h−1 (x) and f (g(x)).

(2) A country’s GDP grows according to the equation Y (t) = Y0 egt .

(Y0 and g are parameters; g is the growth rate.)
(a) What is GDP when t = 0?
(b) If g = 0.05, how long will it take for GDP to double?
(c) Find a formula for the time taken for GDP to double, in terms of the growth
rate g.

(3) Consider the function: g(x) = 1 − e−x .

(a) Evaluate g(0), g(1) and g(2).
(b) Is it an increasing or a decreasing function?
(c) What is lim g(x)?
x→∞
(d) Use this information to sketch the function for x ≥ 0.

(4) The inverse supply and demand functions for a good are: P s (Q) = 1 + Q and
P d (Q) = a − bQ, where a and b are parameters. Find the equilibrium quantity, in
terms of a and b. What conditions must a and b satisfy if the equilibrium quantity
is to be positive?

(5) Are the following functions homogeneous?

√ If so, of what degree?
(a) g(z, t) = 2t2 z (b) h(a, b) = 3 a2 + b2

Longer Questions
(1) The supply and demand functions for beer are given by:
 
s d 12
q (p) = 50p and q (p) = 100 −1
p
(a) How many bottles of beer will consumers demand if the price is 5?
(b) At what price will demand be zero?
(c) Find the equilibrium price and quantity in the market.
(d) Determine the inverse supply and demand functions ps (q) and pd (q).
(e) What is lim pd (q)?
q→∞
(f) Sketch the inverse supply and demand functions, showing the market equilib-
rium.
The technology for making beer changes, so that the unit cost of producing a bottle
of beer is 1, whatever the scale of production. The government introduces a tax on
the production of beer, of t per bottle. After these changes, the demand function
remains the same, but the new inverse supply function is:
ps (q) = 1 + t
 5. DIFFERENTIATION 95

 
 Worksheet 5: Differentiation 

Quick Questions
(1) Differentiate:
(a) y = 9x3 − 7x2 + 15
3
(b) f (x) = 2
4x
(c) Y (t) = 100t1.3
1
(d) P (Q) = Q2 − 4Q 2

(2) Determine whether each of the following functions is concave, convex, or neither:
(a) y = 5x2 √− 8x + 7
(b) C(y) = 4y (for y ≥ 0)
1
(c) P (q) = q 2 − 4q 2 (for q ≥ 0)
(d) k(x) = x2 − x3
2
(3) Find the first and second derivatives of the production function F (L) = 100L+200L 3
(for L ≥ 0) and hence determine whether the firm has decreasing, constant, or in-
creasing returns to labour.

(4) Find and classify all the the stationary points of the following functions. Find the
global maxima and minima, if they exist, and sketch the functions.
(a) y = 3x − x2 + 4 for values of x between 0 and 4.
1
(b) g(x) = 6x 2 − x for x ≥ 0.
(c) f (x) = x4 − 8x3 + 18x2 − 5 (for all values of x)

(5) If a firm has cost function C(Q) = aQ(b + Q1.5 ) + c, where a, b and c are positive
parameters, find and sketch the marginal cost function. Does the firm have concave
or convex costs?

Longer Questions
(1) The number of meals, y, produced in a hotel kitchen depends on the number of
n3
cooks, n, according to the production function y(n) = 60n −
5
(a) What is the marginal product of labour?
(b) Does the kitchen have increasing, constant, or decreasing returns to labour?
(c) Find:
(i) the output of the kitchen
(ii) the average output per cook
(iii) the marginal product of labour
when the number of cooks is 1, 5, 10 and 15.
(d) Is this a realistic model of a kitchen? Suggest a possible explanation for the
figures you have obtained.
(e) Draw a careful sketch of the production function of the kitchen.
(f) What is the maximum number of meals that can be produced?

(2) A manufacturer can produce economics textbooks at a cost of £5 each. The text-
book currently sells for £10, and at this price 100 books are sold each day. The
 6. MORE DIFFERENTATION, AND OPTIMISATION 115

 
Worksheet 6: More Differentiation

and Optimisation

Quick Questions
(1) Find the derivatives of the following functions:
y2 + 1
(a) f (x) = (2x + 1)(x + 3) (b) g(y) = (c) h(z) = (6z + 1)5
2−y
x+1
(2) For what values of the parameter a is y(x) = an increasing function of x?
x+a
3
(3) Differentiate: (a) e3x (b) ln(3x2 + 1) (c) ex (d) e2x (x + x1 )

(4) If the cost function of a firm is C(q) = q 2

p
1 + 2q, what is the marginal cost function?

(5) Does the production function F (L) = ln(2L + 5) have increasing or decreasing re-
turns to labour?

(6) Consider the function:

y (x) = 2x2 − 2x − 1 e2x

(a) Find and classify the stationary points.

(b) For what values of x is y positive?
(c) Sketch the graph of the function.

(7) Find the elasticity of demand when the demand function is q(p) = 120 − 5p. For
what values of p is demand inelastic?

(8) Suppose that a monopoly has cost function C (q) = q 2 , and a demand function
q (p) = 10 − p2 . Find (i) the inverse demand curve; (ii) the profit function; and (iii)
the profit-maximizing level of output, and corresponding price.

(9) The supply and demand functions in a market are

q s (p) = 16(p − t) q d (p) = 24 − 8p
where t is a per unit sales tax. Find the equilibrium price and quantity in the mar-
ket, and the total tax revenue for the government, in terms of the tax, t. What value
of t should the government choose if it wants to maximise tax revenue? How much
tax will then be raised?

Longer Questions
a
(1) Suppose that a monopolist faces the demand function: q D (p) =
p2 +1
where a is a positive parameter.

(a) Find the elasticity of demand (i) as a function of the price, and (ii) as a function
of the quantity sold.
(b) At what value of q is the elasticity of demand equal to 1?
(c) Sketch the demand curve, showing where demand is inelastic, and where it is
elastic.
(d) Find the firm’s revenue function, and its marginal revenue function.
 7. PARTIAL DIFFERENTIATION 133

 
 Worksheet 7: Partial Differentiation 

Quick Questions
(1) Obtain the first-order partial derivatives of each of the following functions:
x+y
f (x, y) = 4x2 y + 3xy 3 + 6x; g (x, y) = e2x+3y ; h (x, y) = .
x−y
(2) Show that the function
√x2
f (x, y) = xy +
y
is homogeneous of degree 1. Find both partial derivatives and hence verify that it
satisfies Euler’s Theorem.

(3) A firm has production function Q(K, L) = KL2 , and faces demand function P d (Q) =
120 − 1.5Q.
(a) Find the marginal products of labour and capital when L = 3 and K = 4.
(b) Write down the firm’s revenue, R, as a function of output, Q, and find its
marginal revenue.
(c) Hence, using the chain rule, find the marginal revenue product of labour when
L = 3 and K = 4.
1
(4) A consumer has a quasi-linear utility function u(x1 , x2 ) = x12 +x2 . Find the marginal
utilities of both goods and the marginal rate of substitution. What does the MRS
tell us about the shape of the indifference curves? Sketch the indifference curves.

(5) For a firm with Cobb-Douglas production function Y (K, L) = aK α Lβ , show that the
marginal rate of technical substitution depends on the capital-labour ratio. Show
on a diagram what this means for the shape of the isoquants.

(6) The supply and demand functions in a market are

Qs = kp2 and Qd = D(p)
where k is a positive constant and the demand function slopes down: D0 (p) < 0.
(a) Write down the equation satisfied by the equilibrium price.
(b) Use implicit differentiation to find how the price changes if k increases.

Longer Questions
(1) A consumer’s demand for good 1 depends on its own price, p1 , the price of good 2,
p2 , and his income, y, according to the formula
y
x1 (p1 , p2 , y) = √ .
p1 + p1 p2
(a) Show that x1 (p1 , p2 , y) is homogeneous of degree zero. What is the economic
interpretation of this property?
(b) The own-price elasticity of demand is given by the formula
p1 ∂x1
11 (p1 , p2 , y) = .
x1 ∂p1
Show that |11 | is always less than 1.
150 8. UNCONSTRAINED OPTIMISATION PROBLEMS

 
Worksheet 8: Unconstrained
Optimisation Problems with One or
 More Variables 

(1) In a competitive industry, all firms have cost functions C(q) = 32 + 2q 2

(a) Write down the profit function for an individual firm when the market price is
P , and hence show that the firm’s supply curve is
P
q=
4
(b) Find the firm’s average cost function, and determine the price in long-run in-
dustry equilibrium.
The market demand function is Q = 3000 − 75P .
(c) In the short-run there are 200 firms. Find the industry supply function, and
hence the equilibrium price, and the output and profits of each firm.
(d) How many firms will there be in long-run equilibrium?
Suppose that a trade association could limit the number of firms entering the indus-
try.
(e) Find the equilibrium price and quantity, in terms of the number of firms, n.
(f) What upper limit would the trade association set if it wanted to maximise in-
dustry revenue?

(2) Find and classify the stationary points of the function: f (x, y) = x3 + y 3 − 3x − 3y

(3) Two competing toothpastes are produced by a monopolist. Brand X costs 9 pence
per tube to produce and sells at PX , with demand (in hundreds/day) given by:
X = 2 (PY − PX ) + 4. Brand Y costs 12 pence per tube to produce and sells at PY
pence, with demand given by: Y = 0.25PX − 2.5PY + 52. What price should she
charge for each brand if she wishes to maximize joint profits?

(4) A firm’s production function is given by

1 1
Q = 2L 2 + 3K 2
where Q, L and K denote the number of units of output, labour and capital. Labour
costs are £2 per unit, capital costs are £1 per unit, and output sells at £8 per unit.
(a) What is the firm’s profit function?
(b) Find the maximum profit and the values of L and K at which it is achieved.

(5) Suppose there are two firms, firm 1 which sells product X, and firm 2 which sells
product Y. The markets for X and Y are related, and the inverse demand curves for
X and Y are
pX = 15 − 2x − y, and
pY = 20 − x − 2y
respectively. Firm 1 has total costs of 3x and firm 2 has total costs of 2y.
(a) Are X and Y substitutes or complements?
(b) If the two firms are in Cournot competition (i.e. each maximizes its own profits
assuming the output of the other is fixed), how much should each produce?
 9. CONSTRAINED OPTIMISATION 171

 
Worksheet 9: Constrained

Optimisation Problems

Quick Questions
(1) A consumer has utility function u(x1 , x2 ) = 2 ln x1 + 3 ln x2 , and income m = 50.
The prices of the two goods are p1 = p2 = 1. Use the MRS condition to determine
his consumption of the two goods. How will consumption change if the price of good
1 doubles? Comment on this result.

(2) Repeat the first part of question 1 using the Lagrangian method and hence deter-
mine the marginal utility of income.

(3) Is the utility function u(x1 , x2 ) = x2 + 3x21 well-behaved? Explain your answer.

(4) A firm has production function F (K, L) = 8KL. The wage rate is 2 and the rental
rate of capital is 1. The firm wants to produce output y.
(a) What is the firm’s cost minimisation problem?
(b) Use the Lagrangian method to calculate its demands for labour and capital, in
terms of output, y.
(c) Evaluate the Lagrange multiplier and hence determine the firm’s marginal cost.
(d) What is the firm’s cost function C(y)?
(e) Check that you obtain the same expression for marginal cost by differentiating
the cost function.

Longer Questions
1 1
(1) A rich student, addicted to video games, has a utility function given by U = S 2 N 2 ,
where S is the number of Sega brand games he owns and N is the number of Nin-
tendo brand games he possesses (he owns machines that will allow him to play games
of either brand). Sega games cost £16 each and Nintendo games cost £36 each. The
student has disposable income of £2, 880 after he has paid his battels, and no other
interests in life.
(a) What is his utility level, assuming he is rational?
(b) Sega, realizing that their games are underpriced compared to Nintendo, raise
the price of their games to £36 as well. By how much must the student’s father
raise his son’s allowance to maintain his utility at the original level?
(c) Comment on your answer to (b).

(2) George is a graduate student and he divides his working week between working on his
research project and teaching classes in mathematics for economists. He estimates
that his utility function for earning £W by teaching classes and spending R hours
on his research is:
3 1
u (W, R) = W 4 R 4 .
He is paid £16 per hour for teaching and works for a total of 40 hours each week.
How should he divide his time between teaching and research in order to maximize
his utility?

(3) Maggie likes to consume goods and to take leisure time each day. Her utility function
CH
is given by U = C+H where C is the quantity of goods consumed per day and H is
 10. INTEGRATION 189

 
Worksheet 10: Integration, and

Further Optimisation Problems

Integration
(1) Evaluate the following integrals:
Z Z 1 Z
−5y 2z + 3
(a) (x − 3)(x + 1)dx (b) e dy (c) dz
0 z2
(2) Evaluate the following integrals, using a substitution if necessary:
Z 1
y−3 z3
Z Z
9
(a) (3x + 1) dx (b) dy (c) √ dz
y 2 − 6y + 1 0 z2 + 1

(3) A competitive firm has inverse supply function p = q 2 + 1 and fixed costs F = 20.
Find its total cost function.

(4) An investment will yield a continuous profit flow π(t) per year for T years. Profit
at time t is given by:
π(t) = a + bt
where a and b are constants. If the interest rate is r, find the present value of the
investment. (Hint: you can use integration by parts.)

(5) The inverse demand and supply functions in a competitive market are given by:
72
pd (q) = and ps (q) = 2 + q
1+q
(a) Find the equilibrium price and quantity, and consumer surplus.
(b) The government imposes a tax t = 5 on each unit sold. Calculate the new
equilibrium quantity, tax revenue, and the deadweight loss of the tax.

Further Problems
(1) An incumbent monopoly firm Alpha faces the following market demand curve:
Q = 96 − P,
where Q is the quantity sold per day, and P is the market price. Alpha can produce
output at a constant marginal cost of £6, and has no fixed costs.
(a) What is the price Alpha is charging? How much profit is it making per day?
(b) Another firm, Beta, is tempted to enter the market given the high profits that
the incumbent, Alpha, is making. Beta knows that Alpha has a cost advantage:
if it enters, its marginal costs will be twice as high as Alpha’s, though there will
be no fixed costs of entry. If Beta does enter the market, is expects Alpha to act
as a Stackelberg leader (i.e. Beta maximizes its profits taking Alpha’s output
as given; Alpha maximizes its profits taking into account that Beta will react
in this way). Show that under these assumptions, Beta will find it profitable to
enter, despite the cost disadvantage. How much profit would each firm earn?
(c) For a linear demand curve of the form Q = a−bP, show that consumers’ surplus
1 2
is given by the expression CS = 2b Q . Evaluate the benefit to consumers of
increased competition in the market once Beta has entered.