Jing-Woei Chien

Chapters 1,2,3 and 4

Chapter 1
Nature of Mathematical Economics
Approach to economic analysis.
Econometrics is typically concerned with the
measurement of economic data.
Use of mathematical theorems and statements to
express findings and conclusions.
Application of maths to purely theoretical aspects of
economic analysis with little concern about problems
involving statistics.
Chapter 2
Economic Models

Theoretical framework. Not necessarily mathematical.

Relates the number of variables to one another in
certain ways.

A mathematical model consists of a set of equations
designed to describe the structure of a model.

Mathematical Models
Variables
Endogenous Variables whose solution we seek in our
model. E.g. Prices, quantities.
Exogenous Variables that are taken as given.
Determined by external sources.
Note that status of variables are determined by the
context of the model.
Constants
Coefficients Joined with variables.
Parameters Constant that can take on many different
values (Parametric Constant).

Equations and Identities
Describes variables that can be related with each other.
We typically deal with three kinds of equations:
Definitional Sets up an identity between two alternate
expressions that have exactly the same identity. =R-C

Behavioural Specifies the manner in which a variable
behaves in response to changes in other variables. E.g. C=2+Q

Conditional States the requirement that needs to satisfied
in order to compute a relation. E.g. Equilibrium Qs=Qd or
MR=MC
Real Number System
Integers
Whole Numbers either positive or negative
Fractions
Ratio of integers.
Rational Numbers
Any number that can be expressed as a ratio of 2 integers.
Terminating or repeating decimal. E.g. 0.333333333.
Irrational Numbers
The opposite of rational numbers. E.g. Square root of 2.
Complex (We dont deal with these)
Do not exist in the real number system. E.g. square root of
negative numbers.
Sets
Collection of distinct objects.
Objects in a set are elements.
Notation:
Enumeration: S={5,6}.
Description: I={x|x is positive}.
Finite Set: Elements are finite
Infinite Set: Infinite elements
Countable Set: Elements can be counted

Venn Diagrams
Diagrammatic representations of sets:









Area encompassed by black box defines the universal set. All
elements not contained in either A or B still fall in the box but are
said to mutually exclusive to sets A and B.
Important Sets

N = {0,1,2,3,}, the set of natural numbers, non negative
integers, (occasionally IN)

Z = { , -2, -1, 0, 1, 2,3, ), the set of integers

Z
+
= {1,2,3,} set of positive integers

Q = {p/q | p Z, q Z, and q0}, set of rational numbers

R, the set of real numbers

Note: Set notation is not order sensitive. It does not matter in
which order you write your numbers. However, convention
typically favours arranging in ascending order.

Note on Complements
A = U A, where U is the universal set.
A set fixed within the framework of a theory and consisting
of all objects considered in the theory.
If A = {x : x is bored}, then

A = {x : x is not bored}
A
U
= U
And
U =
General Notational Info
More on Sets

x S means x is an element of set S.
x S means x is not an element of set S.

A B means A is a subset of B.
A
B
More comprehensive analysis
Examples:
Set Operations
Commutativity:


Associativity:


Distributivity:


B U A
B A
(A U B) U C =
(A B) C =
A U (B U C)
A (B C)
A U (B C) =
A (B U C) =
(A U B) (A U C)
(A B) U (A C)
A B =
A U B =
Some useful extensions
Identity:


Domination:


Idempotent:

A U = A
A U = A
A U = U
A =
A A = A
A A = A
Ordered Pairs
Pair of numbers whose order in a set matters.
Most commonly applied to functions where one plots
points on the Cartesian coordinate plane.
The Cartesian coordinate plane is an infinite set of
points each of which is an ordered pair with a first
value x and second value y.
Associates a y value with an x value.
Functions
If a relation (ordered pair) is such that for each x value
there is a unique y value, then relation described is a
function. However, the converse is not necessarily
true! (Think of a circle and semi-circle).
Easy way to think of it is the ruler test/vertical line
test.
Functions are also called mapping/transformations
and hence: y=f(x) where y is the value and x is the
argument.
Exercises:
Functions Contd.
The y value is the image of the x value under f(x).
Set over which x is defined is the DOMAIN of f(x).
Set of images(y) of x under f is the RANGE of f(x).
Relating to econometrics, x is referred to the
independent variable whilst y is referred to as the
dependent variable.



Types of Functions
Constant Functions
A function whose range consists of only one element.
Polynomial Functions
Consists of many terms in which each term contains a
coefficient as well as a nonnegative-integer.
Rational Functions
Function in which y is expressed as a ratio of two
polynomials in the variable x.
Nonalgebraic Functions (Transcendental Functions)
Any function expressed in terms of polynomials and/or
roots of polynomials.

Examples:
Of Particular Interest
Exponents

Indicators of the power to which a variable (or
number) is to be raised.

Often used as part of a function and has a number of
properties that are useful to keep in mind at all times.

Exponent Rules
A Final Note on Functions

Functions can have more than 2 independent
variables. E.g. z=g(x,y).

A typical example is the Cobb-Douglas production
function: Y= F(K,L)
Chapter 3
Equilibrium
Given a set of equations, the equilibrium is obtained
when we solve for the endogenous variables that are
equivalent to the function of exogenous variables and
parameters.
If exogenous variables/ parameters change we will
observe a new equilibrium which leads us to classify
equilibrium as static analysis.
In Economics, people frequently analyse partial
equilibrium in an isolated market.
Market Model
Given Qd, Qs and P.
Assume Qd=a-bP and Qs=-c+dP where a,b,c,d >0
We know from Economics that equilibrium is defined
at the point where Qd=Qs.
Therefore, we proceed to elliminate Qs and Qd by
renaming a single variable Q in equilibrium.
The system of equations then yield the following
expression: Q=a-bP=-c+dP in equilibrium.
However, not all calculations and equations can be
manipulated so easily.
2-Commodity Case
Given:

1
= 10 2
1
+
2


1
= 2 + 3
1


2
= 15 +
1

2


2
= 1 + 2
2


Now we have to solve this system of equations to get
equilibrium price and quantities in equilibrium.
Make use of simultaneous equations.

From this, we see that
the quantity demanded
of each good is
dependent on the prices
of both goods. Realistic?
Non-linear Models
Economics, however, is not restricted to linear
relationships.
For example: Given

= 4
2

= 4 1
We again assume Qd=Qs in equilibrium to yield:
4
2
= 4 1which, when simplified, results to

2
+4 5 = 0
How do we solve this?
The Quadratic Formula
This is a useful formula to remember/memorise, however,
this will be provided on your test/exam formula sheet. An
important to note is that when
2
4 = 0, xs will be
equal. Furthermore, when
2
4 < 0, there will be no
real roots to the equation under consideration.
Application
Higher-Degree Polynomials
We have seen how to deal with polynomials of degree 2
by making use of the quadratic equation. However,
what happens when we encounter higher-degree
polynomials?
It turns out that there is a relatively intuitive method
to obtain the roots of higher-degree polynomials.
If a system reduces to an Nth degree polynomial
equation, it will probably have N roots.
Can be found on Page 38-40 of textbook.
Dealing with Higher-degree
Polynomials
Given polynomial equation with integer coefficients:

+
1

1
++
1

1
+
0

0
= 0

If there exist rational roots r/s where r, s are integers with
no common divisor except unity, then r is a divisor of
0

and s is a divisor of

.

Note there are three theorems listed in the textbook.
Theorem 1 is just a subset of theorem 2 whilst theorem 3 is
simply a special case scenario.

Example
Given:
4
+
5
2

3

11
2

2
10 +6 = 0
First, get rid of the fractions:

2
4
+5
3
11
2
20 +12 = 0

r={1;-1;2;-2;3;-2;4;-4;6;-6;12;-12}
s={1;-1;2;-2}
r/s={1;-1;1/2;-1/2;2;-2;3;-3;3/2;-3/2;4;-4;6;-6;12;-12}

Once you have calculated each root, sub each into the
original equation and observe which roots satisfy the
equation.


Final note on polynomials

If 2 is a root, then (x-2) is a term. Similarly, if -6 was a root, then
(x+6) would also be a term. Since the polynomial is of degree 3,
we should typically have 3 roots. However, this does not preclude
the same roots occurring twice in our final answer.

Note, in the special case that the coefficients add to zero, 1 is a
root.

Do the example yourselves and check that you get the following
answer:
(
1
2
)( 2)( + 2)( +3) = 0

Unique Solution?
There are a few issues that can confound the
obtainment of a unique solution.
We can have inconsistency:
X+Y=2 and X+Y=3
Functional dependence:
X+Y=2 and 2X+2Y=4

What Next?
So, we have dealt with a system of equations and
shown how to solve them. This has been relatively easy
up to now.

However, consider a very large system of equations.
Writing the whole system out and solving via the
simultaneous equation method can become very
messy very quickly.

So, how would we approach this?
Chapter 4
Matrices
A matrix is an array of elements.
Matrices are a useful tool to summarise a system of
equations when it seems too tedious to write out.
For example: 2X+5Y=39 & 11X-3Y=1

It turns out that we
are also able to solve
the system of
equations via
matrices too. We will
discuss this later.
Matrices Contd.
Convention dictates that notation be written with the rows
expressed first followed by the column dimension. For
example: A (2 x 3) Matrix would have 2 rows and 3
columns.



In general, a matrix with m rows and n columns is an (m
x n) matrix.
Square matrices have the same number of rows as columns.

Matrices - General Form
Matrices Contd.
A matrix containing only one row or one column are
sometimes referred to as row and column vectors
respectively.

General Notation: A=[

]
Note that the row component always comes first in
matrices. Therefore, the i subscript relates to the row
element whereas, j subscript refers to the column
element.
A=[
21
] would refer to the element that corresponds to
the second row and and first column.
Matrix Operations - Addition
Matrix Operations - Subtraction
Scalar Matrix Multiplication
Matrix Operations - Multiplication

Much more sophisticated than usual multiplication of
scalars.

In matrices, compatibility issues arise. One needs to
check that the dimensions of the matrices allow for the
matrix multiplication operation to take place.

Therefore, matrices are order sensitive!

Matrix Multiplication Operation
NOTE: Always Check Dimensions!
A Nifty Trick for Multiplication
A
B
AB
Matrix Operations - Division
While matrices are able to perform the normal
operations that one is typically used to, but it cannot
undergo division.

HOWEVER, there are other operations such as
Inverses or Reciprocal that takes its place.

1
.

Aside for later: Transposes are also frequently used.
A note on Summation
Summation is self-explanatory in the sense that we
simply the different terms of interest.
Some people get confused with the shorthand
notation for summation though.

For example:

5
=0

This simply indicates that the variable must be
summed from zero to five. Simply replace i with the
range of numbers in the summation operator.
Linear Dependence
In words: A set of vectors is said to be linearly
dependent if and only if any one of them can be
expressed as a linear combination of the remaining
vectors; otherwise they are linearly independent.

=1
= 0
If this equation can be satisfied only when

= 0 for
all , then these vectors are said to be linearly
independent.

Identity Matrix
Square Matrix with 1s in its principal diagonal and os
everywhere else.
Plays a role similar to 1. In other words, any matrix
multiplied by the identity matrix will yield the same
matrix given that they are conformable.

Null Matrix
A matrix all of whose elements are zero.
Plays the role of the number zero for matrices. Any
matrix multiplied by the null matrix will yield the null
matrix.
Note: This matrix does not have to be a square matrix.