OPTIMIZATION

PROBLEM IV
Optimization with More than
One Choice Variable
Chapter 11
OUTLINE
The Differential Version of Optimization Conditions
Extreme Values: 1st -Order Condition
Extreme Values: 2nd-Order Sufficient Condition
Two Variable Case
n-Variable Case
Extreme Values: 2nd-Order Necessary Condition
Characteristic-Root Test
Some Economic Applications

134
THE DIFFERENTIAL VERSION OF
OPTIMIZATION CONDITIONS

 Derivative conditions:  Differential conditions

 First-order condition:  First-order condition:
dz
 f ( x)  0 dz  0
dx
 Second-order condition:  Second-order condition
d 2z
 f ( x )
0 d 2 z  0
dx 2 

135
EXTREME VALUES:
1ST -ORDER CONDITION

 Two-Variable Case: z = f(x, y)

dz  f x dx  f y dy  0 fx  f y  0

 n-Variable Case: z = f(x1, x2 , x3 ,…,xn)

dz  f1dx1  f 2 dx2  ....  f n dxn  0

f1  f 2  ...  f n  0

136
EXTREME VALUES:
2ND -ORDER SUFFICIENT CONDITION
 Two-Variable Case: z = f(x1, x2)

d 2 z  f11dx1  2 f12dx1dx2  f 22dx2 


2 2
0

2z 2 z 2 z 2z
 f 21 
x1 x1x2 x2x1 x 2
2 2

??? What are the requirements for f11, f12, and

f22 so that d 2z is satisfied?

137
 EXTREME VALUES:
2ND -ORDER SUFFICIENT CONDITION
 Two-Variable Case: z = f(x1, x2)
d 2 z  f11dx1  2 f12dx1dx2  f 22dx2  0
2 2

q  d11u1  2d12u1u2  d 22u2  0

2 2

=
d 21
2 2
d d
q  d11u1  2d12u1u2  d 22u2  12 u2  12 u2  0
2 2 2 2

d11 d11
 2 2d12 d12
2
2  d12  2 
2
Completing  d11 u1  u1u2  2 u2    d 22  u2  0
the square  d11 d11   d11 
2
 d12   d11d 22  d12  2 
2
 d11 u1  u2    u2  0

 d11   d11 
138
EXTREME VALUES:
2ND -ORDER SUFFICIENT CONDITION
 Two-Variable Case: z = f(x1, x2)
2
 d12   d11d 22  d12  2 
2
q  d11 u1  u2    u2  0

 d11   d11 

positive definite d11 > 0

q is iff and d11.d22 – d122 > 0
negative definite d11 < 0

positive (min.z) f11 > 0

d2z is iff and f11. f22 – f122 > 0
negative (max.z) f11 < 0

139
EXTREME VALUES:
2ND -ORDER SUFFICIENT CONDITION
 Two-Variable Case: z = f(x1, x2)
In MATRIX form:
positive definite
q is negative definite
q  d11u1  d12u1u2
2

d11  0 d11 d12

 d 21u2u1  d 22u2 0
2
iff and
d11  0 d 21 d 22
 d11 d12   u1 
q  u1 u2    u  Discriminant  Hessian Determinant
 21
d d 22   2 
positive (min.z)
d2z is negative (max.z)
f11  0 f11 f12
iff and 0
f11  0 f 21 f 22

140
 EXTREME VALUES:
2ND -ORDER SUFFICIENT CONDITION
 n-Variable Case: z = f(x1, x2, x3)
n n
q   dijui u j [ where d ij  d ij ]
i 1 j 1
q  u D u
(1n ) ( nn ) ( n1)

q is positive definite (min.z) q is negative definite (max.z)

d11 d12 d11 d12
iff D1  d11  0 ; D2  0; iff D1  d11  0 ; D2  0;
d 21 d 22 d 21 d 22
d11 d12 ... d1n d11 d12 ... d1n
d 21 d 22 ... d 2n d d 22 ... d 2n
Dn  0 Dn  (1) n 21
0
... ... ... ... ... ... ... ...
d n1 d n 2 ... d nn d n1 d n 2 ... d nn
141
EXTREME VALUES:
2ND -ORDER SUFFICIENT CONDITION

In terms of Discriminant:

Di  H i
H = Hessian
Determine wether q  u1  6u2  3u3  2u1u2  4u2u3
2 2 2

is either positive or negative definite!

1 1 0
q  1 6  2 D1 , D2 , D3  0 q>0
0 2 3

142
EXTREME VALUES:
2ND -ORDER NECESSARY CONDITION
 Characteristic-Root Test
 To detect the 2nd-order necessary conditions (in case, for
example, H1  0) simultaneously with the sufficient conditions.
D x r x
( nn ) ( n1) ( n1)
characteristic root of matrix D
characteristic vector of matrix D, x  0
( Dx  rIx )  ( D  rI ) x  0

Must be a singular matrix,

since 0 is (n x 1) matrix

143
EXTREME VALUES:
2ND -ORDER NECESSARY CONDITION
 Characteristic-Root Test
d11  r d12 ... d1n
d 21 d 22  r ... d 2n
D  rI  0
... ... ... ...
d n1 dn2 ... d nn  r
Suppose
2 2  , then 2r 2
D    D  rI 
 2  1 2 1  r
 r2  r  6  0
r1  3 and r2  2

144
EXTREME VALUES:
2ND -ORDER NECESSARY CONDITION

 Characteristic-Root Test
positive definite ri > 0
q is iff
negative definite ri < 0

positive semidefinite ri  0
q is iff
negative semidefinite ri  0

145
WRAP UP
Optimization with >1 Choice Variable
• First-order condition:
To find the critical values  stationary value  st.point
The objective function
𝜕𝑧
=0 𝑥𝑖∗ → 𝑧 ∗ → (𝑥𝑖∗ , 𝑧 ∗ )
𝜕𝑥𝑖
The choice variables
• Second-order condition:
To find out: is the resulting stationary point relative
maximum/minimum? Find Hessian Determinant!
𝐻1 < 0, 𝐻2 > 0, 𝐻3 < 0 or 𝐻1 , 𝐻2 , 𝐻3 > 0
• Use characteristic root test if 𝐻1 = 0
 SOME ECONOMIC APPLICATIONS
Firm’s objective: to maximize profit 𝜋 , so 𝜋 is the objective function
1. Multiproduct Firm: firm produces >1 type of product
𝜋(𝑄1 , 𝑄2 , 𝑄3 ) = (𝑃1 𝑄1 + 𝑃2 𝑄2 + 𝑃3 𝑄3 ) − 𝐶(𝑄1 , 𝑄2 , 𝑄3 )
𝑄1 , 𝑄2 , 𝑄3 are different product  firm’s choice variables
1) Competitive Firm case: 𝑃𝑖 are given/constant (i.e. firm cannot change the price)
2) Monopolistic Firm case: 𝑄𝑖 = 𝑓 𝑃1 , 𝑃2 , 𝑃3 allwing us to have 𝑃𝑖 = 𝑓 𝑄1 , 𝑄2 , 𝑄3 by Cramer’s rule

2. Multiplant Firm: firm produces 1 type of product using different plant (or different cost functions)
𝜋(𝑄1 , 𝑄2 , 𝑄3 ) = 𝑃𝑄 − [𝐶1 𝑄1 + 𝐶2 (𝑄2 )+ 𝐶3(𝑄3 )]; [𝑄 = 𝑄1 + 𝑄2 + 𝑄3 ]
𝑄1 , 𝑄2 , 𝑄3 are firm’s product produced in different plant  firm’s choice variables
3. Price Discrimination (3rd degree): firm produces 1 type of product but sells it to different customers
𝜋(𝑄1 , 𝑄2 , 𝑄3 ) = (𝑃1 𝑄1 + 𝑃2 𝑄2 + 𝑃3 𝑄3 ) − 𝐶(𝑄1 , 𝑄2 , 𝑄3 ); [𝑄 = 𝑄1 + 𝑄2 + 𝑄3 ]
𝑄1 , 𝑄2 , 𝑄3 are firm’s levels of production sold to diff. consumers  firm’s choice variables
4. Input Decisions of Firm: firm is facing profit maximizing problem with input as its choice variable
𝜋(𝑎, 𝑏, 𝑐) = 𝑃𝑄(𝑎, 𝑏, 𝑐) − (𝑝𝑎 𝑎 + 𝑝𝑏 𝑏 + 𝑝𝑐 𝑐)
𝑎, 𝑏. 𝑐 are firm’s inputs used to produce its output  firm’s choice variables