APPLICATIONS

OF DIFFERENTIATION - I 3
Differentiation plays a vital role in Economics and Commerce.
Before we embark on demonstrating applications of differentiation
in these fields, we introduce a few Economic terminologies with
usual notations.
3.1 FUNCTIONS IN ECONOMICS AND COMMERCE
3.1.1 Demand Function
Let q be the demand (quantity) of a commodity and p
the price of that commodity. The demand function is defined as
q = f(p) where p and q are positive. Generally, p and q are
inversely related.
Observe the graph of the demand function q = f(p)
y
q = f(p)
Quantity

Demand curve

Price
x1 O Fig. 3.1 x
y
Following observations can be made from the graph (Fig 3.1)
(i) only the first quadrant portion of the graph of the demand
function is shown since p and q are positive.
(ii) slope of the demand curve is negative.
3.1.2 Supply Function
Let x denotes amount of a particular commodity that sellers
offer in the market at various price p, then the supply function is
given by x = f(p) where x and p are positive.
99
 Generally x and p are directly related
Observe the graph of the supply function, x = f (p)
y
x = f(p)

Unit price

Supply curve

x1 O Supply x
y Fig. 3.2
Following observations can be made from the graph (Fig 3.2)
(i) only the first quadrant portion of the graph of the supply
function is shown since the function has meaning only for non-
negative values of q and p.
(ii) slope of the supply function is positive.
3.1.3 Cost Function
Normally total cost consists of two parts.
(i) Variable cost and (ii) fixed cost. Variable cost is a single -
valued function of output, but fixed cost is independent of the level
of output.
Let f(x ) be the variable cost and k be the fixed cost
when the output is x units. The total cost function is defined as
C(x) = f(x) + k, where x is positive.
Note that f(x) does not contain constant term.
We define Average Cost (AC), Average Variable Cost
(AVC), Average Fixed Cost (AFC), Marginal Cost (MC), and
Marginal Average Cost (MAC) as follows.
f (x) + k
(i) Average Cost (AC) = = Total Cost
Output
x

100
 f (x) Variable Cost
(ii) Average Variable Cost (AVC) = x = Output

(iii) Average Fixed Cost (AFC) = k = Fixed Cost

Output
x
(iv) Marginal Cost (MC) = d C(x) = C′(x)
dx
(v) Marginal Average Cost (MAC) = d (AC)
dx
Note
If C(x) is the total cost of producing x units of some product
then its derivative C′(x) is the marginal cost which is the approximate
cost of producing 1 more unit when the production level is x units.
The graphical representation is shown here (Fig 3.3).
T
y c(x)
C(x+1)
A B
C(x)
Cost

O
xl x x+1 x
yl Production level
Fig. 3.3
A = C(x + 1) − C(x)
B = C′(x) = Marginal Cost

3.1.4 Revenue Function

Let x units be sold at Rs. p per unit. Then the total revenue
R(x) is defined as R(x) = px , where p and x are positive.
Average revenue (AR) = Total revenue = px = p.
quantity sold x
(i.e. Average revenue and price are the same)
Marginal revenue (MR) = d (R) = R′(x)
dx
101
Note
If R(x) be the total revenue gained from selling x units of
some product, then its derivative, R′(x) is the marginal revenue,
which is approximate revenue gained from selling 1 more unit when
the sales level is x units. The graphical representaion is shown
here (Fig 3.4)
y T
R(x)
R(x+1)
A B
Revenue

R(x)

O
x′ x x+1 x
y′ Sales level
Fig. 3.4
A = R(x+1) − R(x)
B = R′ (x) = marginal revenue
3.1.5 Profit Function
The profit function P(x) is defined as the difference between
the total revenue and the total cost. i.e. P(x) = R(x) − C(x).
3.1.6. Elasticity
The elasticity of a function y = f(x), with respect to x, is
defined as Äy
y
η = Ey = Lt ∆x
Ex ∆x→ 0
x
x dy
= y dx
Thus the elasticity of y with respect to x is the limit of the
ratio of the relative increment in y to the relative increment in x, as
the increment in x tends to zero. The elasticity is a pure number,
independent of the units in x and y.
102
3.1.7 Elasticity of Demand
Let q = f(p) be the demand function, where q is the demand
p dq
and p is the price. Then the elasticity of demand is ηd = q dp
y q = f(p)
(Fig 3.5)

Demand curve
Quantity

∆q

∆p

x1 O p p+∆p x
y Price
Fig. 3.5
∆q
q p dq
Elasticity of demand = Lt ∆p = q
∆p→0 dp
p
Since the slope of the demand curve is negative and elasticity
is a positive quantity the elasticity of demand is given by
p dq
ηd = - q dp

3.1.8. Elasticity of Supply

Let x = f(p) be the supply function, where x is the supply
and p is the price. The elasticity of supply is defined as
ηs = p d x
x dp
3.1.9 Equilibrium Price
The price at which quantity demanded is equal to quantity
supplied is called equilibrium price.
3.1.10 Equilibrium Quantity
The quantity obtained by substituting the value of equilibrium
price in any one of the given demand or supply functions is called
equilibrium quantity.
103
3.1.11 Relation between Marginal Revenue and Elasticity of
Demand
Let q units be demanded at unit price p so that p = f(q)
where f is differentiable. The revenue is given by
R(q) = qp
R(q) = q f(q) [ p = f(q)]
Marginal revenue is obtained by differentiating R(q) with
respect to q.
∴ R′(q) = q f ′(q) + f(q)
dp dp
=q +p [Œ = f ′(q)]
dq dq
q dp
R′(q) = p(1 + )
p dq
 
= p 1 + p dq 
 1
 
 q dp 
  
1 +  −1 
=p  p dq 
  − q dp 
p dq
Since ηd = − ,
q dp
 
Marginal Revenue = R′(q) = p 1 − 1 
 ηd 
Example 1
A firm produces x tonnes of output at a total cost
C(x) = 1 x3 - 4x2 + 20x + 5
10
Find (i) Average cost (ii) Average Variable Cost
(iii) Average Fixed Cost (iv) Marginal Cost and
(v) Marginal Average Cost.
Solution :
C(x) = 1 x 3 - 4x 2 + 20x + 5
10
104
 Total cost
(i) Average Cost = output
=( 1 x 2 − 4x + 20 + 5 )
10 x
(ii) Average Variable Cost = Variable cost
output

= 1 x 2 − 4x + 20
10
(iii) Average Fixed Cost = Fixed cost
output
= 5
x
(iv) Marginal Cost = d C(x)
dx
= d ( 1 x 3 − 4x 2 + 20x +5)
dx 10
= ( 3 x 2 − 8x + 20)
10
(v) Marginal Average Cost = d (AC)
dx
= d ( 1 x 2 − 4x + 20 + 5 )
dx 10 x
5
=( 1 x−4− 2)
5 x
Example 2
The total cost C of making x units of product is
C = 0.00005x3 − 0.06x2 + 10x + 20,000. Find the marginal cost
at 1000 units of output.
Solution :
C = 0.00005x 3 − 0.06x 2 + 10x + 20,000
Marginal Cost dC = (0.00005) (3x 2) − (0.06) 2x + 10
dx
= 0.00015 x 2 − 0.12x + 10
when x = 1000
dC
= (0.00015)(1000)2 − (0.12)(1000) + 10
dx
= 150 − 120 + 10 = 40
At x = 1000 units, Marginal Cost is Rs. 40
105
Example 3
Find the elasticity of demand for the function
x = 100 − p − p2 when p = 5.
Solution :
x = 100 − p − p2
dx
dp = −1−2p.
p
Elasticity of demand ηd = − dx
x dp
p( − 1 − 2 p) p +2p2
=− =
100 − p − p 2 100 − p − p 2
When p = 5, ηd = 5 + 50
100 − 5 − 25
= 55 = 11
70 14
Example 4
Find the elasticity of supply for the supply function
x = 2p2+8p+10
Solution :
x = 2p2+8p+10
dx
dp = 4p+8
p dx
Elasticity of supply ηs =
x dp
4 p2 +8 p 2 p 2 +4 p
= =
2 p2 +8 p+10 p2 + 4 p+ 5
Example 5
For the function y = 4x-8 find the elasticity and also
obtain the value when x = 6.
Solution :
y = 4x−8
dy
=4
dx
106
 dy
Elasticity η = xy
dx
η = x (4) = x
4 x −8 x−2
when x = 6, η = 6 = 3
6− 2 2
Example 6
1−2x Ey
If y = 2 + 3 x find Ex . Obtain the values of η when
x = 0 and x = 2.
Solution :
1− 2x
We have y = 2 + 3 x
Differntiating with respect to x, we get
dy ( 2 + 3 x)( −2 ) − (1 − 2 x )(3)
=
dx ( 2 + 3 x )2
− 4 − 6x − 3 + 6x −7
= =
( 2 + 3 x) 2 (2 + 3 x ) 2
Ey x dy
η = Ex = y dx
x ( 2 + 3 x) −7
= (1 − 2 x ) x
(2 + 3 x) 2
− 7x
η = (1 − 2 x )( 2 + 3x )
when x = 0, η = 0
when x = 2, η = 7
12
Example 7
A demand function is given by xp n = k, where n and k
are constants. Calculate price elasticity of demand.
Solution :
Given x pn = k
⇒ x = k p−n
107
 dx
dp = − nk p
−n−1

p dx
Elasticity of demand ηd = − x dp
p
= − − n (−nk p−n−1)
kp
= n, which is a constant.
Example 8
Show that the elasticity of demand at all points on the
curve xy 2 = c (c is constant), where y represents price will be
numerically equal to 2.
Solution :
We have xy 2 = c
c
x = 2
y
Differentiating with respect to y,
dx 2c
=− 3
dy y
y dx −y  − 2c 
Elasticity of demand ηd = − = c
 3  = 2
x dy 2  y 
y
Example 9
The demand curve for a monopolist is given by x = 100−− 4p
(i) Find the total revenue, average revenue and marginal
revenue.
(ii) At what value of x, the marginal revenue is equal to zero?
Solution :
We have x = 100−4p
p = 100 − x
4
Total revenue R= px
=  100 − x  x = 100x−x
2

 4  4
108
 Average revenue = p = 100 − x
4
Marginal revenue = d (R)
dx
 
= d  100 x − x 
2

dx  4 
= 1 [100−2x] = 50 − x
4 2
(ii) Marginal revenue is zero implies
50 − x
= 0 ⇒ x = 50
2
∴ Marginal revenue is zero when x = 50.
Example 10
If AR and MR denote the average and marginal revenue
at any output level, show that elasticity of demand is equal to
AR . Verify this for the linear demand law p = a + bx.
AR – MR
where p is price and x is the quantity.
Solution :
Total Revenue R = px
Average Revenue AR = p
Marginal Revenue MR = d (R) = d (px)
dx dx
dp
=p+x
dx
Now,
AR p
=
(AR − MR) dp
p −( p+ x )
dx
p dx
=−
x dp
= Elasticity of demand ηd
AR
∴ (AR − MR) = ηd

109
 Given p = a + bx
Differentiating with respect to x,
dp
=b
dx
R = px = ax + bx 2
AR = a+bx ( AR = price)
MR = d (ax + bx 2)
dx
= a + 2bx.
AR a + bx ( a + bx )
∴ (AR − MR) = =− -----(1)
a + bx−a−2bx bx
p dx
ηd =−
x dp
( a + bx ) 1 ( a + bx )
= − = − ---------(2)
x b bx
AR
from (1) and (2) we get that = ηd
(AR − MR)
Example 11
Find the equilibrium price and equilibrium quantity for
the following demand and supply functions, Qd = 4-0.06p and
Qs = 0.6+0.11p
Solution :
At the equilibrium price
Qd = Qs
⇒ 4-0.06p = 0.6 + 0.11p
⇒ 0.17p = 3.4
⇒ p = 3.4
0.17
p = 20
when p = 20, Qd = 4 − (0.06)(20)
= 4−1.2 = 2.8
∴ Equilibrium price = 20 and Equilibrium quantity = 2.8
110
Example 12
p
The demand for a given commodity is given by q =
p−5
(p>5), where p is the unit price. Find the elasticity of demand
when p =7. Interpret the result.
Solution :
p
Demand function q =
p −5
Differentiating with respect to p, we get
dq (p−5 ) (1 ) − p(1) −5
= 2 =

{− }
dp (p-5 ) (p−5 )2

p dq − p(p− 5 ) 5
Elasticity of demand ηd = − = 2
q dp p (p−5)
5
=
p −5
when p =7, ηd = 5 = 2.5
7 −5
This means that if the price increases by 1% when p = 7, the
quantity demanded will decrease by approximately 2.5%. Also if
the price decreases by 1% when p = 7, the quantity demanded will
increase by approximately 2.5%.
Example 13
The demand for a given commodity is q = - 60p + 480,
(0 < p < 7) where p is the price. Find the elasticity of demand
and marginal revenue when p = 6.
Solution :
Demand function q = −60p + 480
Differentiating with respect to p, we get
dq
= −60
dp
p dq −p p
Elasticity of demand ηd = − = (−60) =− p −8
q dp −60 p + 480
when p = 6, ηd = − 6 = 3
6−8
111