Unconstrained Optimization:

Multiple Variables

Basic Math for Economics – Refresher

Eric Dunaway epdunaway@gmail.com 1

 Introduction
 While working with just one variable is simple, it’s rare in
economics.
 Often, we must work with many variables all at the same
time.
 This complicates our optimization slightly, but the same rules
still apply.
 Let’s take a look at another unconstrained optimization
problem, but this time through the lens of a Cournot duopoly.
Recallthat in a Cournot duopoly, two firms simultaneously
choose their quantities, but face the same market price.

Eric Dunaway epdunaway@gmail.com 2

 Unconstrained Optimization
 Let’s use the same market as last time, but rather than there
being a monopolist, now there are two firms and they
compete in quantities.
 Both firms face the inverse demand function
𝑝 = 250 − 2𝑞1 − 2𝑞2
and face constant marginal costs of production of 𝑐 = 50.
 As before, we will set up our problem and then optimize.
 Note that we actually have two optimization problems here.
Each firm is maximizing their profits separately, so we
need to treat them as separate optimization decisions.
Eric Dunaway epdunaway@gmail.com 3
 Unconstrained Optimization
 Let’s start with firm 1.
 They want to maximize their profits, and the only thing
they can choose is their own quantity, 𝑞1 . Thus, we
have,
max
𝑞1
 Next, they want to maximize their own profits (they
don’t care about firm 2’s profits at all), but their inverse
demand function is also a function of firm 2’s quantity,
so we must include it.
max 250 − 2𝑞1 − 2𝑞2 𝑞1 − 50𝑞1
𝑞1

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 Unconstrained Optimization
max 250 − 2𝑞1 − 2𝑞2 𝑞1 − 50𝑞1
𝑞1
 From here, we can calculate a first-order condition as before
(remember to treat 𝑞2 as a constant),
𝜕𝜋1
= 250 − 4𝑞1 − 2𝑞2 − 50 = 0
𝜕𝑞1
 We can perform the same analysis for firm 2, obtaining the following
optimization problem,
max 250 − 2𝑞1 − 2𝑞2 𝑞2 − 50𝑞2
𝑞2
and first-order condition,
𝜕𝜋2
= 250 − 2𝑞1 − 4𝑞2 − 50 = 0
𝜕𝑞2

Eric Dunaway epdunaway@gmail.com 5

 Unconstrained Optimization
𝜕𝜋1
= 250 − 4𝑞1 − 2𝑞2 − 50 = 0
𝜕𝑞1
𝜕𝜋2
= 250 − 2𝑞1 − 4𝑞2 − 50 = 0
𝜕𝑞2
 This is just a system of two equations and two unknowns
and fairly easy to solve.
 Doing so yields 𝑞1∗ = 𝑞2∗ = 33.3, which is notable smaller
than what a monopolist produces (which is expected).
Westill need to check whether this is a maximum,
however.
Eric Dunaway epdunaway@gmail.com 6
 Unconstrained Optimization
𝜕𝜋1
= 250 − 4𝑞1 − 2𝑞2 − 50 = 0
𝜕𝑞1
𝜕𝜋2
= 250 − 2𝑞1 − 4𝑞2 − 50 = 0
𝜕𝑞2
 This is a bit harder, and requires the use of a matrix called the Hessian.
 To calculate the Hessian, we need to take a derivative of each of our
first-order conditions for each of our choice variables (4 derivatives
total in this case).
 The first row and first column of our Hessian is the derivative of our
first first-order condition for our first variable.
 Thefirst row and second column of our Hessian is the derivative of
our first first-order condition for our second variable.

Eric Dunaway epdunaway@gmail.com 7

 Unconstrained Optimization
 Calculating these derivatives,
𝜕 2 𝜋1 𝜕 2 𝜋1
2 = −4 𝜕𝑞1 𝜕𝑞2
= −2
𝜕𝑞1
𝐻=
𝜕 2 𝜋2 𝜕 2 𝜋2
= −2 2 = −4
𝜕𝑞2 𝜕𝑞1 𝜕𝑞2
 Or, reducing this matrix a little bit, we have
−4 −2
𝐻=
−2 −4
Our problem is maximized if this matrix is negative
semidefinite.
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 Unconstrained Optimization
−4 −2
𝐻=
−2 −4
 Negative semidefinite?
 Leaving out most of the math, it means that certain
elements of the Hessian must take certain values.
For a 2x2 matrix, if all the elements along the trace are
less than or equal to zero and the determinant is positive,
then the matrix is negative semidefinite.
First,
let’s check the trace. Both elements along the
trace are equal to −4, so they satisfy the requirement
that they are less than or equal to zero.
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 Unconstrained Optimization
−4 −2
𝐻=
−2 −4
 Now, let’s calculate the determinant.
𝐻 = −4 −4 − −2 −2 = 16 − 4 = 12
 Since the determinant of the Hessian is positive, that
along with all the elements of our trace being negative
means that our matrix is negative semidefinite and we
have a maximum rather than a minimum.
It’s
useful to check this when dealing with less
behaved functional forms.

Eric Dunaway epdunaway@gmail.com 10

 Unconstrained Optimization
 If you are looking for a minimum, rather than a maximum,
the Hessian needs to be positive semidefinite.
 For a 2x2 Hessian, all the elements along the trace must
be greater than or equal to zero while the determinant
is still positive.
 If we move beyond a 2x2 Hessian (i.e., we have more
than two choice variables), this becomes more
complicated.
 Our principal minors must have alternating signs based
upon which minor they are.
A linear algebra course would be helpful for this.
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