Tutorial 3: Optimisation

ECO4112F 2011
1. Find and classify the extrema of the cubic cost function C = C (Q) = 2Q
3
5Q
2
+2.
2. Find and classify the extreme values of the following functions
(a) y = x
2
1
+ 3x
2
2
3x
1
x
2
+ 4x
2
x
3
+ 6x
2
3
(b) y = x
1
x
3
+x
2
1
x
2
+x
2
x
3
+x
2
2
+ 3x
2
3
3. State whether each of the following functions are concave, strictly concave, convex,
strictly convex or neither:
(a) y = x
2
(b) y = 2x
2
xz +z
2
(c) y = x
2
(d) y = xz
4. Find the extreme values of the function z = 8x
3
+ 2xy 3x
2
+y
2
+ 1 and show that
only one of the two extrema can be characterised as a local minimum and neither
of the extrema can be characterised as a local maximum. If x

= 0, how would you

characterise the curvature of z at x

?
5. Identify the stationary point of the function
f (x
1
, x
2
, x
3
) = 2x
2
1
21x
1
3x
1
x
2
+ 3x
2
2
2x
2
x
3
+x
2
3
and show that this stationary point is a unique global minimum.
6. Identify the stationary point of the function
f (x
1
, x
2
, x
3
) = 2x
1
x
2

1
2
x
2
1
3x
2
2
+x
2
x
3
1.5x
2
3
+ 10x
3
and determine if it represents a maximum or minimum.
7. Find the extremum of the following functions
(a) z = xy subject to x + 2y = 2
(b) z = x 3y xy subject to x +y = 6
(c) y = x
2
+ 2xz + 4z
2
subject to x +z = 8
(d) y = 3x
2
+z
2
2xz subject to x +z = 1
(e) y = ln 2x + 2 ln z subject to z = 16 4x
1
8. Find the optimal values of each of the choice variables in the functions below, and
solve for the Lagrangian multiplier too.
(a) U(x, z) = x
2
+ 2x + 3z
2
6z +x subject to 2x + 2z = 32.
(b) U(a, b, c) =
1
2
a
2
+ 4b
2
4a + 8c
2
subject to
1
2
a + 3b +c.
9. Let A, , be positive constants. Show that the Cobb-Douglas production function
Q = AK

is concave if and only if + 1.

10. A monopolist can produce quantities x and y of two products X and Y at cost
4x
2
+xy + 2y
2
. The inverse demand functions are
p
X
= 150 5x +y
p
Y
= 30 + 2x 2y
where p
X
and p
Y
are the prices charged for X and Y .
(a) Find the values of x, y, p
X
and p
Y
which maximise prot, and the maximal
prot.
(b) Conrm that your answer to (a) represents a maximum.
11. Find the extrema of
z = 2x
2
21x + 8xy +y
3
2y
2
+ 6y
and classify the extrema as minima or maxima, and as global (unique or not unique)
or local.
12. Billy has a Cobb-Douglas utility function
U(x
1
, x
2
) = x
3/4
1
x
1/4
2
where x
1
, x
2
denote the consumption of cars and jets respectively. The prices of the
goods are p
1
, p
2
and Billys income is m.
(a) Find the demand functions for cars and jets that maximise Billys utility.
(b) Conrm that your answer to (a) represents a constrained maximum.
(c) What is the economic interpretation of the Lagrangian multiplier in this case?
2
13. The production of Jimmy Choo shoes (Q) requires two inputs, capital (K) and labour
(L):
Q = f(K, L) = 9K
1/3
L
2/3
A unit of capital costs R4 and a unit of labour costs R16.
(a) Does the production function exhibit increasing, decreasing or constant returns
to scale? Explain your answer.
(b) Show that the production function exhibits diminishing returns to each factor
of production.
(c) What is the cost minimising bundle of capital and labour to produce any xed
Q = Q?
(d) Conrm that your answer to (a) represents a constrained minimum.
(e) What is the economic interpretation of the Lagrangian multiplier in this case?
14. Solve the following maximisation problem by applying the Kuhn-Tucker theorem:
max
x,y
4x
2
2xy 4y
2
subject to x + 2y 2
2x y 1
15. Solve the following maximisation problem by applying the Kuhn-Tucker theorem:
max
x,y
3.6x 0.4x
2
+ 1.6y 0.2y
2
subject to 2x +y 10
x 0
y 0
16. Consider the issue of optimal time allocation:
Suppose that you have a utility function dened over two goods, x
1
and x
2
, such that
your utility function is u(x
1
, x
2
).
Suppose it takes t
1
units of time to consume x
1
units of Swiss chocolate and t
2
units
of time to consume x
2
units of champagne.
The total time available for consumption is T.
Your challenge is to maximize your utility subject to your income constraint
p
1
x
1
+p
2
x
2
m and time constraint t
1
x
1
+t
2
x
2
T.
Assume that both x
1
and x
2
are strictly positive at the optimum and u
1
and u
2
are
positive, reecting non-satiation.
3
(a) Set up a Lagrangian function in which utility is maximized subject to both
the time and income constraint and specify the rst order conditions for the
optimum.
(b) Consider the four solution possibilities to this problem based on the four possible
ways in which the complementary slackness conditions might be met. Which is
most likely to yield the optimal solution?
> 0 and > 0
> 0 and = 0
= 0 and > 0
= 0 and = 0
4
Tutorial 3: Optimisation
SELECTED SOLUTIONS
ECO4112F 2011
1. Q = 0 is a maximum
Q =
10
6
is a minimum
2.
(a) j = 0 : minimum
(b) j =
11
40
: minimum
3.
(a) strictly convex
(b) strictly convex
(c) strictly concave
(d) neither
4. FOC
.
x
= 24r
2
+ 2j 6r = 0
.
y
= 2r + 2j = 0
Solve simultaneously to get the extrema: r

= j

= 0 and r

= j

=
1
3
.
SOC:
H =
_
.
xx
.
xy
.
yx
.
yy
_
=
_
48r 6 2
2 2
_
jH
1
j = j48r 6j = 48r 6 < 0 when r <
6
48
0 when r
6
48
Thus, the Hessian cannot be everywhere positive or negative denite and so neither
of our extrema can be global.
1
We evaluate the Hessian at each critical point. Consider r

= j

= 0 :
H =
_
6 2
2 2
_
jH
1
j = j6j = 6 < 0
jH
2
j = jHj = 16 < 0
Thus, H is indenite at r

= j

= 0.
Consider r

= j

=
1
3
:
H =
_
10 2
2 2
_
jH
1
j = j10j = 10 0
jH
2
j = jHj = 16 0
Thus, H is positive denite at r

= j

=
1
3
and so this point is a local minimum.
5. FOC:
0)
0r
1
= 4r
1
21 3r
2
= 0
0)
0r
2
= 3r
1
+ 6r
2
2r
3
= 0
0)
0r
3
= 2r
2
+ 2r
3
= 0
Solve these simultaneously to get the stationary point.
SOC:
H =
_
_
)
11
)
12
)
13
)
21
)
22
)
23
)
31
)
32
)
33
_
_
=
_
_
4 3 0
3 6 2
0 2 2
_
_
jH
1
j = j4j = 4 0
jH
2
j =

4 3
3 6

= 15 0
jH
3
j = jHj = 46 0
The Hessian matrix is everywhere positive denite, and so the stationary point rep-
resents a unique global minimum.
2
6. r

1
= 4, r

2
= 2, r

3
= 4. This is a unique global maximum.
7.
(a) .

=
1
2
when `

=
1
2
, r

= 1, j

=
1
2
.

H
2

= 4 0 and so this is a constrained maximum.

(b) .

= 19 when `

= 4, r

= 1, j

= 5.

H
2

= 2 < 0 and so this is a constrained minimum.

(c) (r

, .

) = (8, 0) Constrained minimum

(d) (r

, .

) =
_
1
3
,
2
3
_
Constrained minimum
(e) (r

, .

) =
_
4
3
,
32
3
_
Constrained maximum
8.
(a) (r

, .

, `

) = (12, 4, 15)
(b) (a

, /

, c

, `

) = (12, 6, 1, 16)
9. First order derivatives:
0Q
01
= c1
1
1

0Q
01
= ,1

1
1
Hessian:
H =
_
@
2
Q
@K
2
@Q
@K
@Q
@L
@Q
@L
@Q
@K
@
2
Q
@L
2
_
=
_
c(c 1) 1
2
1

c,1
1
1
1
c,1
1
1
1
, (, 1) 1

1
2
_
For production function to be concave, the Hessian must be negative denite, i.e. the
signs of the principal minors must alternate in sign, starting with a non-positive.
jH
1
j = c(c 1) 1
2
1

Since , 1 and 1 are positive

c(c 1) 0
) 0 c 1
3
jH
2
j =

c(c 1) 1
2
1

c,1
1
1
1
c,1
1
1
1
, (, 1) 1

1
2

=
_
c(c 1) 1
2
1

_ _
, (, 1) 1

1
2
_

_
c,1
1
1
1
_ _
c,1
1
1
1
_
= c(c 1) , (, 1)
2
1
22
1
22
c
2
,
2

2
1
22
1
22
=
2
1
22
1
22
_
c(c 1) , (, 1) c
2
,
2

Since , 1 and 1 are positive,

c(c 1) , (, 1) c
2
,
2
0
_
c
2
c
_ _
,
2
,
_
c
2
,
2
0
c
2
,
2
c
2
, c,
2
+c, c
2
,
2
0
c, (c , + 1) 0
) c +, 1
Therefore the function is concave i c +, 1.
10.
(a)
= rj
X
+jj
Y

_
4r
2
+rj + 2j
2
_
= r(150 5r +j) +j (30 + 2r 2j) 4r
2
rj 2j
2
= 150r 5r
2
+rj + 30j + 2rj 2j
2
4r
2
rj 2j
2
= 9r
2
+ 2rj + 150r 4j
2
+ 30j
FOC:
D (r, j) =
_
0,0r
0,0j
_
= 0
)
_
18r + 2j + 150
2r 8j + 30
_
= 0
Solving simultaneously:
r

= 9
j

= 6
Therefore:
j

X
= 150 5 (9) + 6 = 111
j

Y
= 30 + 2 (9) 2 (6) = 36
4
And:

max
= rj
X
+jj
Y

_
4r
2
+rj + 2j
2
_
= 9 (111) + 6 (36)
_
4 (9)
2
+ 9 (6) + 2 (6)
2
_
= 765
(b) SOC:
H = D
2
(r, j) =
_
0
2
,0r
2
0,0r0j
0,0j0r 0
2
,0j
2
_
=
_
18 2
2 8
_
jH
1
j = j18j < 0
jH
2
j =

18 2
2 8

= 140 0
Thus, H is negative denite and hence we have a maximum.
11.
D. =
_
0.,0r
0.,0j
_
=
_
4r 21 + 8j
8r + 3j
2
4j + 6
_
H = D
2
. =
_
0
2
.,0r
2
0
2
.,0r0j
0
2
.,0j0r 0
2
.,0j
2
_
=
_
4 8
8 6j 4
_
FOCs
4r 21 + 8j = 0 (1)
8r + 3j
2
4j + 6 = 0 (2)
5
Solve simultaneously:
From (1)
r = 2j
21
4
(3)
Substitute (3) into (2)
8
_
2j
21
4
_
+ 3j
2
4j + 6 = 0
)3j
2
+ 12j 36 = 0
)j
2
+ 4j 12 = 0
)(j + 6) (j 2) = 0
)j = 6, 2
Therefore, candidates for extrema are r =
69
4
, j = 6, . =
2169
8
and r =
5
4
, j = 2, . =
121
8
.
SOCs:
The deniteness of the Hessian matrix depends on the value of j, so the extrema
cannot be absolute (global) but only relative (local) extrema.
We must determine the deniteness of the Hessian matrix at the candidate extrema:
At r =
69
4
, j = 6 :
H =
_
4 8
8 40
_
jH
1
j = j4j = 4 < 0
jH
2
j =

4 8
8 40

= 96 0
At this point, H is negative denite. So this point is a local maximum.
At r =
5
4
, j = 2 :
H =
_
4 8
8 8
_
jH
1
j = j4j = 4 < 0
jH
2
j =

4 8
8 8

= 96 < 0
6
At this point, H is neither positive nor negative denite. So this point is neither a
local minimum nor a local maximum.
12.
(a)
max
x
1
;x
2
L = r
3=4
1
r
1=4
2
+`(:j
1
r
1
j
2
r
2
)
FOCs:
0L
0r
1
=
3
4
r
1=4
1
r
1=4
2
`j
1
= 0
0L
0r
2
=
1
4
r
3=4
1
r
3=4
2
`j
2
= 0
0L
0`
= :j
1
r
1
j
2
r
2
= 0
Solving simultaneously:
r

1
=
3:
4j
1
r

2
=
:
4j
2
(b) SOC:
BH =
_

_
0 j
1
j
2
j
1

3
16
r
5=4
1
r
1=4
2
3
16
r
1=4
1
r
3=4
2
j
2
3
16
r
1=4
1
r
3=4
2

3
16
r
3=4
1
r
7=4
2
_

_
jBH
2
j =

0 j
1
j
2
j
1

3
16
r
5=4
1
r
1=4
2
3
16
r
1=4
1
r
3=4
2
j
2
3
16
r
1=4
1
r
3=4
2

3
16
r
3=4
1
r
7=4
2

=
1
16
r
5=4
1
r
7=4
2
_
3j
2
1
r
2
1
+ 6j
1
j
2
r
1
r
2
+ 3j
2
2
r
2
2
_
0
Therefore bordered Hessian is negative denite, and we have a constrained max-
imum.
(c) It is the marginal utility of money.
7
13.
(a) Constant returns to scale.
9 (`1)
1=3
(`1)
2=3
= `91
1=3
1
2=3
) constant returns to scale.
OR Sum the exponents
1
3
+
2
3
= 1 ) constant returns to scale.
(b)
)
K
= 31
2=3
1
2=3
)
KK
= 21
5=3
1
2=3
< 0 ) diminishing returns to capital
)
L
= 61
1=3
1
1=3
)
LL
= 21
1=3
1
4=3
< 0 ) diminishing returns to labour
(c) Problem: min
K;L
41 + 161 subject to Q = 91
1=3
1
2=3
Lagrangian:
L = 41 + 161 +`
_
Q91
1=3
1
2=3
_
FOCs:
0L
01
= 4 `31
2=3
1
2=3
= 0 (1)
0L
01
= 16 `61
1=3
1
1=3
= 0 (2)
0L
0`
= Q91
1=3
1
2=3
= 0 (3)
(1) (2)
1
4
=
11
21
)1 =
1
2
1 (4)
Sub (4) into (3)
Q91
1=3
_
1
2
1
_
2=3
= 0
9
2
2=3
1 = Q
1

=
2
2=3
9
Q
= 0.176Q
8
1

=
1
2
_
2
2=3
9
Q
_
=
1
9
_
2
1=3
_Q
= 0.088Q
4 `31
2=3
1
2=3
= 0
)`

=
4
3
1
2=3
1
2=3
=
4
3
_
2
2=3
9
Q
_
2=3
_
1
9
_
2
1=3
_Q
_
2=3
=
4
3
_
2
4=9
9
2=3
_
_
9
2=3
2
2=9
_
=
4
3
_
2
7=9
_
=
2
25=9
3
= 2.286
(d) SOC:
H =
_
_
0 31
2=3
1
2=3
61
1=3
1
1=3
31
2=3
1
2=3
2`1
5=3
1
2=3
2`1
2=3
1
1=3
61
1=3
1
1=3
2`1
2=3
1
1=3
2`1
1=3
1
4=3
_
_

H
2

= 0 31
2=3
1
2=3
_
6`1
1=3
1
2=3
+ 12`1
1=3
1
2=3
_
+61
1=3
1
1=3
_
6`1
4=3
1
1=3
12`1
4=3
1
1=3
_
= 31
2=3
1
2=3
_
18`1
1=3
1
2=3
_
+ 61
1=3
1
1=3
_
18`1
4=3
1
1=3
_
= 54`1
1
108`1
1
= 162`1
1
=
162`
1
9
At 1

, `

H
2

=
162`
1
< 0
Therefore, the point is a constrained minimum.
(e) It is the marginal cost.
14. Rewrite the constraints so they are in the form q
i
(x) 0 :
r + 2j 2 0
2r j + 1 0
(a) Set up the Lagrangian
L = 4r
2
2rj 4j
2
`(r + 2j 2) j(2r j + 1)
The Kuhn-Tucker conditions are:
0L
0r
= 8r 2j ` 2j = 0 (1)
0L
0j
= 2r 8j 2` +j = 0 (2)
` 0, r + 2j 2 and `(r + 2j 2) = 0
j 0, 2r j 1 and j(2r j + 1) = 0
Consider the possible cases in turn:
(a) Case 1: ` 0, j 0
If ` 0, then complementary slackness implies r + 2j 2 = 0.
If j 0, then complementary slackness implies 2r j + 1 = 0.
Solving these equations simultaneously gives r = 0, j = 1.
Substituting r = 0, j = 1 into equations (1) and (2) gives
2 ` 2j = 0
8 2` +j = 0
Solving simultaneously gives ` =
18
5
, j =
4
5
which violates ` 0.
Case 2: ` 0, j = 0
If ` 0, then complementary slackness implies r + 2j 2 = 0.
Substituting j = 0 into equations (1) and (2) gives
8r 2j ` = 0
2r 8j 2` = 0
10
Solving these three equations simultaneously gives r =
1
4
, j =
7
8
, ` =
15
4
which
violates ` 0.
Case 3: ` = 0, j 0
If j 0, then complementary slackness implies 2r j + 1 = 0.
Substituting ` = 0 into equations (1) and (2) gives
8r 2j 2j = 0
2r 8j +j = 0
Solving these three equations simultaneously gives r =
3
8
, j =
1
4
, j =
5
4
which
satises all conditions.
Case 4: ` = 0, j = 0
Substituting ` = 0, j = 0 into equations (1) and (2) gives
8r 2j = 0
2r 8j = 0
which is satised if and only if r = 0, j = 0 which violates 2r j + 1 0. So
no solution candidates here.
Therefore:
The Kuhn Tucker necessary conditions for a maximum are satised under Case
3 where r =
3
8
, j =
1
4
, ` = 0, j =
5
4
.
(This point also satises the sucient conditions for a maximum and so is the
optimum point.)
15. Two possible Lagrangians and associated FOCs:
(a)
L = 3.6r 0.4r
2
+ 1.6j 0.2j
2
+`(10 2r j)
FOCs:
0L
0r
= 3.6 0.8r 2` 0, r 0, (r) (3.6 0.8r 2`) = 0
0L
0j
= 1.6 0.4j ` 0, j 0, (j) (1.6 0.4j `) = 0
` 0, 2r +j 10, (`) (2r +j 10) = 0
OR
11
(b)
L = 3.6r 0.4r
2
+ 1.6j 0.2j
2
+`
1
(10 2r j) +`
2
(r) +`
3
(j)
FOCs:
0L
0r
= 3.6 0.8r 2`
1
+`
2
= 0
0L
0j
= 1.6 0.4j `
1
+`
3
= 0
`
1
0, 2r +j 10, (`
1
) (2r +j 10) = 0
`
2
0, r 0, (`
2
) (r) = 0
`
3
0, j 0, (`
3
) (j) = 0
Consider the various cases (Working now with the Lagrangian and FOCs from (a)):
(I) : 2r +j = 10, r = 0, j = 0
(II) : 2r +j < 10, r = 0, j = 0
(III) : 2r +j = 10, r 0, j = 0
(IV) : 2r +j = 10, r = 0, j 0
(V) : 2r +j < 10, r 0, j = 0
(VI) : 2r +j < 10, r = 0, j 0
(VII) : 2r +j = 10, r 0, j 0
(VIII) : 2r +j < 10, r 0, j 0
Case (I): 2r +j = 10, r = 0, j = 0
Inconsistent, since r = 0, j = 0 violates 2r +j = 10
Case (II): 2r +j < 10, r = 0, j = 0
2r +j < 10 )` = 0 (from complementary slackness condition)
Substituting ` = 0, r = 0, j = 0 into:
0L
0r
= 3.6 0 and
0L
0j
= 1.6 0
So no solution here.
Case (III): 2r +j = 10, r 0, j = 0
2r +j = 10, j = 0 )r = 5
12
r 0 )3.6 0.8r 2` = 0 (from complementary slackness condition)
Sub in r = 5 : 3.6 0.8 (5) 2` = 0
)` = 0.2
violates ` 0
Case (IV): 2r +j = 10, r = 0, j 0
2r +j = 10, r = 0 )j = 10
j 0 )1.6 0.4j ` = 0 (from complementary slackness condition)
Sub in j = 10 : 1.6 0.4 (10) ` = 0
)` = 2.4
violates ` 0
Case (V): 2r +j < 10, r 0, j = 0
2r +j < 10 )` = 0 (from complementary slackness condition)
Sub in ` = 0, j = 0 into
0L
0j
= 1.6 0.4j ` = 1.6 0
So no solution here
Case (VI): 2r +j < 10, r = 0, j 0
2r +j < 10 )` = 0 (from complementary slackness condition)
Sub in ` = 0, r = 0 into
0L
0r
= 3.6 0.8r 2` = 3.6 0
So no solution here
Case (VII): 2r +j = 10, r 0, j 0
r 0 )3.6 0.8r 2` = 0 (from complementary slackness condition)
j 0 )1.6 0.4j ` = 0 (from complementary slackness condition)
2r +j = 10
13
This gives the augmented matrix:
_
_
0.8 0 2
0 0.4 1
2 1 0

3.6
1.6
10
_
_
Solving yields:
_
_
r
j
`
_
_
=
_
_
3.5
3
0.4
_
_
This satises all conditions and is a possible solution.
Case (VIII): 2r +j < 10, r 0, j 0
r 0 ) 3.6 0.8r 2` = 0 (from complementary slackness condition)
j 0 ) 1.6 0.4j ` = 0 (from complementary slackness condition)
2r +j < 10 ) ` = 0 (from complementary slackness condition)
Solving:
3.6 0.8r 2 (0) = 0 )r = 4.5
1.6 0.4j 0 = 0 )j = 4
But then:
2r +j = 2 (4.5) + 4 = 13 10
So no solution here.
Therefore, the only solution is
_
_
r
j
`
_
_
16.
(a)
L = n(r
1
, r
2
) `(j
1
r
1
+j
2
r
2
:) j(t
1
r
1
+t
2
r
2
T)
The solution that provides the maximum value must satisfy:
0L
0r
1
= n
1
`j
1
jt
1
= 0
0L
0r
2
= n
2
`j
2
jt
2
= 0
` 0, j
1
r
1
+j
2
r
2
: and `(j
1
r
1
+j
2
r
2
:) = 0
j 0, t
1
r
1
+t
2
r
2
T and j(t
1
r
1
+t
2
r
2
T) = 0
14
(b) It will not be the case that ` = 0 and j = 0 because complementary slackness
implies that j
1
r
1
+j
2
r
2
< : and t
1
r
1
+t
2
r
2
< T and then more of one or both
of the goods can be consumed, which would raise utility.
It is also unlikely that both ` 0 and j 0 since this would mean that both
constraints would be binding, i.e. j
1
r
1
+j
2
r
2
= : and t
1
r
1
+t
2
r
2
= T.
It is more likely that either ` 0 and j = 0, in which case the budget constraint
is binding, or ` = 0 and j 0 in which case the time constraint is binding.
15