Intermediate Macroeconomics: Econ 2102/2220 1

Math For Econ 2102/2220 B

1 Shifts of a Curve vs. Movement along a Curve

1.1 Parameter and variable
Suppose y is a function of x, and
y = f (x, a) (1)

where a is a parameter, which represents the impact of other exogenous variables. Given
a certain value of a, we can plot the function y = f (x, a) as a curve in a two-dimension
graph. A change in x implies a movement along the curve, while a change in a means
a shift of the curve.

1.2 An example
Suppose the firms daily output, Y , depends on both the number of workers that the firm
employs, N , and the number of machines that the firm uses, K. The relation between
input and output is specified as the following,

Y =2 K N (2)

Output Y is a function of both the number of machines, K, and the number of workers,

N . For example, if there are 100 machines and 4 workers, the output Y = 2 100 4 =
2 10 2 = 40.
Now suppose we are concerned with the relation between output and the number of
workers employed. That means that we hold the number of machines constant and study
the relation between Y and N . Graphically, we plot Y against N , where N is on the
horizontal axis.
If we hold K constant at 100, the relation reduces to

Y = 2 100 N = 20 N (3)

It is shown as the solid curve in Figure 1. If the firm increases the number of work-
ers employed from 4 to 9, the output would increase from 40 to 60. In the graph, the
combination of Y and N moves along the solid curve from point C to point D.
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Figure 1: Shifts of a Curve vs. Movement along a Curve

Now suppose that the firm increases the number of machines used in the production
from 100 to 225. The relation becomes

Y = 2 225 K = 30 K (4)

It is the dashed curve in Figure 1. Note that the increase in K has shifted the curve up.
That is, for any number of workers, N , the amount of output, Y , has risen. For example,
from point D to point J when the number of workers is 9.

1.3 Summary
1. To graph a function of several variables in two dimensions, we hold all but one of the
right-side variables constant.

2. The one right-side variable that isnt held constant (N in the above example) appears
on the horizontal axis. Changes in this variable dont shift the graph of the function.
Instead, changes in the variable on the horizontal axis represent movements along
the curve that represents the function.
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3. The right-side variables held constant for the purpose of drawing the graph (K in
the above example) dont appear on either axis of the graph. If the value of one of
these variables is changed, the entire curve shifts. In the example above, for any
number of workers, N , the increase in machines, K, means that more output, Y , can
be produced. Thus the curve shifts up, from the solid curve to the dashed curve.

2 Slope and Derivative

Suppose that two variables, N and Y , are related by a function, Y = G(N ). To define the
slope precisely, we suppose that the current value of N is a specific number, N1 , so that
the current value of Y equals G(N1 ). Now consider what happens if N is increased by an
amount of N . The value of N is now N1 + N , so the value of Y becomes G(N1 + N ).
The change in Y is
Y = G(N1 + N ) G(N1 ).

The slope of the function G, for an increase in N from N1 to N1 + N , is

Y G(N1 +N )G(N1 )
slope= N = (N1 +N )N1

Figure 2 and 3 show graphically how to determine slopes for functions. Figure 2 shows the
graph of the function Y = 5N . Suppose we start from point E in Fig. 2, where N = 6
and Y = 30. If N is increased by 4, we move to point F on the graph, where N = 10
and Y = 50. Between E and F , N = 10 6 = 4 and Y = 50 30 = 20, so the slope
Y /N = 20/4 = 5.

For a nonlinear function, such as Y = 20 N , the slope depends on both the initial
value of N and the size of the change in N . These results are illustrated in Fig. 3, which

displays the graph of the function Y = 20 N . Suppose that we are initially at point G,
where N = 1 and Y = 20. If we increase N by 8 units, we are at point D, where N = 9
and Y = 60. Thus the slope of the function between G and D is 5. If we increase N by 3
units, we are at point C, where N = 4 and Y = 40. Thus the slope of the function between
G and C is 6.67.
In Fig. 3 we have also drawn a line that touched but not cross the graph of the function
at point G; this line is tangent to the graph of the function at point G. For small values
of N the slope of a function at any point is closely approximated by the slope of the line
tangent to the function at that point. Especially, we define the slope of a function of one
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Figure 2: Slope and Derivative

Figure 3: Slope and Derivative

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variable at any point as the derivative of the function at that point:

G(N1 + N ) G(N1 )
G0 (N )|N =N1 = G0 (N1 ) = lim (5)
N 0 (N1 + N ) N1
which is the slope of the line tangent to the function at any point N1 .
Similarly, we can also define a slope for a function of multiple variables. Take Y =

F (K, N ) = 20 K N for an example, we define the slope of the function, Y , along the
direction of N , at any point (N1 , K1 ) as the partial derivative of the function with respect
to N at that point.

F (N, K) F (N1 , K1 ) F (K1 , N1 + N ) F (K1 , N1 )

|K=K1 ,N =N1 = = lim . (6)
N N N 0 (N1 + N ) N1
Note that partial derivative with respect to N , gives the change of Y in response to the
change in N at N1 , holding K constant at K1 .

3 Growth Rate Formulas and Ratio Scale

3.1 Growth Rate
Suppose the variable X takes the value of Xt at time t, then the growth rate of X in a
single period from t to t + 1 is defied as the change of X divided by the initial value, Xt :
Xt+1 Xt Xt
gt = = . (7)
Xt Xt
where Xt = Xt+1 Xt . The equation can also be rewritten as follows:

Xt+1 = Xt (1 + gt ). (8)

Similarly,
Xt+2 = Xt+1 (1 + gt+1 ). (9)

Combine the Equation (8) and (9), we have

Xt+2 = Xt (1 + gt ) (1 + gt+1 ). (10)

Suppose the average growth rate is g, then we have the following between Xt+2 and Xt

Xt+2 = Xt (1 + g)2 . (11)

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Similarly, suppose the average growth rate of X in n multiple periods from time t to time
t + n is g, then
Xt+n = Xt (1 + g)n . (12)

Thus, given Xt+n and Xt , the average growth rate, g, can be calculated as
Xt+n 1
g=( ) n 1. (13)
Xt

3.2 Linear Scale vs. Ratio Scale

1. To graph data on variables that grow over time we can use a ratio scale (or logarithmic
scale).

2. On a ratio scale, equal space on the vertical axis correspond to equal proportional
differences in the variable being graphed.

3. For example, the vertical gap between X = 1 and X = 10 is the same as the vertical
gap between X = 10 and X = 100 (when using a ratio scale).

4. By contrast on the more common linear scale, equal spaces on the vertical axis cor-
respond to equal differences in levels of the variable being graphed.

5. A linear line with ratio scale corresponds to constant growth rate.

Figure 4 shows the effect of using a ratio scale. Figure 5 and 6 give two examples of
plotting economic data using ratio scales.

3.3 Growth Rate Formulas Approximation

It is useful to start with the following approximation. If is sufficient small, then

ln(1 + ) .

In Figure 7, we show that the straight line y = is tangent to the function y = ln(1 + )
at point (0, 0). If is sufficiently close to 0, the difference between the two lines is very
small. For example, if = 0.1, ln(1 + 0.1) = 0.0953.
Let X and Z be any two variables, not necessarily related by a function, that are
changing over time. Let X/X and Z/Z represent the growth rates (percentage changes)
of X and Z, respectively. Then the following rules provide useful approximations.
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Figure 4: A linear line with ratio scale corresponds to a constant growth rate

Figure 5: GDP per Capita in the United States

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Figure 6: GDP per Capita in the U.S., UK and Japan

Figure 7: y = ln(1 + ) is approximated by y = around the point of = 0

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3.3.1 Growth Rate of the Product of X and Z

Denote
Yt = Xt Zt . (14)

Taking logarithm of both side of (14), we have

ln(Yt ) = ln(Xt ) + ln(Zt ). (15)

And the relation holds true for the year t + 1.

ln(Yt+1 ) = ln(Xt+1 ) + ln(Zt+1 ). (16)

Combine Equ (15) and (16), we have

ln(Yt+1 ) ln(Yt ) = ln(Xt+1 ) ln(Xt ) + ln(Zt+1 ) ln(Zt )

Yt+1 Xt+1 Zt+1
ln( ) = ln( ) + ln( )
Yt Xt Zt
Yt+1 Yt Xt+1 Xt Zt+1 Zt (17)
ln(1 + ) = ln(1 + ) + ln(1 + )
Yt Xt Zt
Yt Xt Zt
ln(1 + ) = ln(1 + ) + ln(1 + ).
Yt Xt Zt
Recall the approximation where = ln(1 + ), we have

Yt Xt Zt
= + . (18)
Yt Xt Zt
Thus, the growth rate of the product XZ equals the sum of the growth rates of X and
Z.

3.3.2 Growth Rate of the Ratio of X and Z

Denote
Xt
Yt = . (19)
Zt
Taking logarithm of both side of (19), we have

ln(Yt ) = ln(Xt ) ln(Zt ). (20)

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Similarly, we have
ln(Yt+1 ) ln(Yt ) = ln(Xt+1 ) ln(Xt ) [ln(Zt+1 ) ln(Zt )]
Yt+1 Yt Xt+1 Xt Zt+1 Zt
ln(1 + ) = ln(1 + ) ln(1 + )
Yt Xt Zt
Yt Xt Zt (21)
ln(1 + ) = ln(1 + ) ln(1 + )
Yt Xt Zt
Yt Xt Zt
=
Yt Xt Zt
X
Thus, the growth rate of the ratio Z
equals the difference of the growth rates of X and
Z.

3.3.3 Growth Rate of X Raised to the Power .

Denote
Yt = Xt . (22)
Taking logarithm of both side of (22), we have

ln(Yt ) = ln(Xt ). (23)

Similarly,
ln(Yt+1 ) ln(Yt ) = [ln(Xt+1 ) ln(Xt )]
Yt+1 Yt Xt+1 Xt
ln(1 + ) = ln(1 + )
Yt Xt
Yt Xt (24)
ln(1 + ) = ln(1 + )
Yt Xt
Yt Xt
=
Yt Xt

Thus, the growth rate of X equals times the growth rate of X.
Exercise: Suppose the production function takes the following form, Y = AK N .
Show that the following holds:
Y A K N
= + + .
Y A K N

4 Elasticity
4.1 Definition
Elasticities indicate how one variable responds when a second variable changes. Suppose
that there is a function relating Y to N , so that when N changes, Y changes as well. The
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elasticity of Y with respect to N is defined to be the percentage change in Y , Y /Y ,

divided by the percentage change in N , N/N , that is
Y /Y
elasticity of Y with respect to N = N/N

4.2 Examples
The Price Elasticity of Demand is a measure of the responsiveness of the quantity
demanded of a good, Q, to a change in the price of that good, P . Formally, it is the
percentage change in the quantity demanded that results from a 1 percent change in
its price.

Q/Q
P/P

The price of pork falls by 2% and the quantity demanded increases by 6%, then the
price elasticity of demand for pork is

6%
= 3.
2%
If a 1 percent rise in the price of shelter caused a 2 percent reduction in the quantity
of shelter demanded, the price elasticity of demand for shelter would be

2%
= 2.
1%