EC400B Math for Micro Lecture 2 Taylor Expansion

EC400B Math for Micro: Lecture 2
Francesco Nava
September 2013
Nava (LSE)
EC400B Lecture 2
September 2013
1 / 25
Taylor Expansion
The rst order Taylor Expansion of a function f : R1 R1 is f (a + h) f (a) + f (a)h Dene the residual from the approximation as: R (h|a) = f (a + h) f (a) f (a)h Note that the approximation holds since by the denition of the derivative f (a), we have that: R (h|a) =0 h0 h lim
Nava (LSE)
EC400B Lecture 2
September 2013
2 / 25
Taylor Expansion
The rst order Taylor Expansion of a function f : R1 R1 is f (a + h) f (a) + f (a)h Dene the residual from the approximation as: R (h|a) = f (a + h) f (a) f (a)h Note that the approximation holds since by the denition of the derivative f (a), we have that: R (h|a) =0 h0 h lim
Nava (LSE)
EC400B Lecture 2
September 2013
2 / 25
Taylor Expansion
Geometrically: this is the formalization of the approximation of the graph of f (x ) by its tangent line at (a, f (a)).
Analytically: it describes the best approximation of f by a polynomial of degree 1.
Nava (LSE)
EC400B Lecture 2
September 2013
3 / 25
Higher Order Taylor Expansions

Denition
The k th order Taylor Polynomial of f (x ) at x = a is dened by: Pk (a|h) = f (a) + f (a)h + f (a) 2 f [k ] ( a ) k h + ... + h 2! k!
the corresponding k th order residual is dened by: Rk (h|a) = f (a + h) Pk (a|h) and satises (by Taylors Theorem): Rk (h|a) =0 h0 hk lim
Nava (LSE)
EC400B Lecture 2
September 2013
4 / 25
A Simple Example
Consider the rst and second order Taylor polynomial of the exponential function f (x ) = e x at x = 0. All the derivatives of f (x ) at x = 0 equal 1. Therefore: P1 (0|h) = 1 + h P2 (0|h) = 1 + h + For h = 0.2, then: P1 (0|0.2) = 1.2, P2 (0|0.2) = 1.22, f (0.2) = 1.22140275816017 h2 2
Nava (LSE)
EC400B Lecture 2
September 2013
5 / 25
A Simple Example
Consider the rst and second order Taylor polynomial of the exponential function f (x ) = e x at x = 0. All the derivatives of f (x ) at x = 0 equal 1. Therefore: P1 (0|h) = 1 + h P2 (0|h) = 1 + h + For h = 0.2, then: P1 (0|0.2) = 1.2, P2 (0|0.2) = 1.22, f (0.2) = 1.22140275816017 h2 2
Nava (LSE)
EC400B Lecture 2
September 2013
5 / 25
Taylor Expansion for Functions of Several Variables
First Order Taylor Polynomial: F (a + h) F (a) + F F (a)h1 + ... + (a)hn x1 xn
Alternatively, let R1 (h|a) denote the residual, to get: F (a + h) = F (a) + dF (a) h + R1 (h|a) where dF (a) = ( F / x1 , . . . , F / xn ) is the Jacobian of F at a. As before R1 (h|a)/||h|| 0 as h 0.
Nava (LSE)
EC400B Lecture 2
September 2013
6 / 25
First Order Taylor Polynomial: F (a + h) F (a) + F F (a)h1 + ... + (a)hn x1 xn
Alternatively, let R1 (h|a) denote the residual, to get: F (a + h) = F (a) + dF (a) h + R1 (h|a) where dF (a) = ( F / x1 , . . . , F / xn ) is the Jacobian of F at a. As before R1 (h|a)/||h|| 0 as h 0.
Nava (LSE)
EC400B Lecture 2
September 2013
6 / 25

Second order Taylor Polynomial: F (a + h) F (a) + dF (a)h + where d 2 F (a) is the Hessian matrix of 2F x1 x1 (a) ... d 2 F (a) = 2F x1 xn (a) 1 T 2 h d F (a)h 2!
F at a: ... ... ...

2F xn x1 (a)
...
xn xn (a) 2F
The extension for order k then trivially follows.
Nava (LSE)
EC400B Lecture 2
September 2013
7 / 25

Second order Taylor Polynomial: F (a + h) F (a) + dF (a)h + where d 2 F (a) is the Hessian matrix of 2F x1 x1 (a) ... d 2 F (a) = 2F x1 xn (a) 1 T 2 h d F (a)h 2!
F at a: ... ... ...

2F xn x1 (a)
...
xn xn (a) 2F
The extension for order k then trivially follows.
Nava (LSE)
EC400B Lecture 2
September 2013
7 / 25
Denition Extreme Points

Denition
The ball B (x, ) centred at x of radius is the set of all vectors y in Rn whose distance from x is less than : B (x, ) = {y Rn | > ||y x||}
Denition
Let f (x) be a real valued function dened on a subset C of Rn . A point x in C is: a global maximizer for f (x) on C if f (x ) f (x) for all x C a strict global maximizer for f (x) on C if f (x ) > f (x) for all x C such that x = x
Nava (LSE) EC400B Lecture 2 September 2013 8 / 25

Denition
The ball B (x, ) centred at x of radius is the set of all vectors y in Rn whose distance from x is less than : B (x, ) = {y Rn | > ||y x||}
Denition
Let f (x) be a real valued function dened on a subset C of Rn . A point x in C is: a global maximizer for f (x) on C if f (x ) f (x) for all x C a strict global maximizer for f (x) on C if f (x ) > f (x) for all x C such that x = x

Denition
Let f (x) be a real valued function dened on a subset C of Rn . A point x in C is: a local maximizer for f (x) if > 0 exists such that: f (x ) f (x) for all x C B (x , ) a strict local maximizer for f (x) if > 0 exists such that: f (x ) > f (x) for all x C B (x , ) such that x = x a critical point for f (x) if rst partial derivatives exist at x and if: f (x ) = 0 for i = 1, 2, ..., n df (x ) = 0 xi
Example: Critical Points
Consider the function : F (x , y ) = x 3 y 3 + 9xy
Set the rst partial derivatives to zero: F = 3x 2 + 9y = 0 and x F = 3y 2 + 9x = 0 y
To nd the two critical points: (0, 0) and (3, 3).
Nava (LSE)
EC400B Lecture 2
September 2013
10 / 25
Do Extreme Points Exist?
Theorem (Extreme Value Theorem)

Let C be a compact (closed and bounded) subset of Rn . Let f (x ) be a continuous function dened on C . If so, there exists a point x in C , which is a global maximizer of f , and there exists a point x in C , which is a global minimizer of f . That is: f (x ) f (x ) f (x ) for all x C
Nava (LSE)
EC400B Lecture 2
September 2013
11 / 25
Functions of One Variable: FOC

First Order Necessary Conditions for a maximum in R : Let f (x ) be a continuous dierentiable function on an interval I . If x is a local maximizer of f (x ) then: either x is an end point of I or f (x ) = 0
Nava (LSE)
EC400B Lecture 2
September 2013
12 / 25
Functions of One Variable: SOC

Second Order Sucient Conditions for a maximum in R: Suppose that f (x ), f (x ), f (x ) are all continuous on an interval in I and that x is a critical point of f (x ) then: if f (x ) 0 for all x I , then x is a global maximizer of f (x ) on I . if f (x ) < 0 for all x I such that x = x , then x is a strict global maximizer of f (x ) on I . if f (x ) < 0, then x is a strict local maximizer of f (x ) on I .
Nava (LSE)
EC400B Lecture 2
September 2013
13 / 25
Functions of Several Variables: FOC

First Order Necessary Conditions for a maximum in Rn : Let f (x) be a continuous real valued function for which all rst partial derivatives exist and are continuous on a subset C Rn . If x is both an interior point of C and a local maximizer of f (x ), then x is a critical point of f (x ), that is: f (x ) = 0 for i = 1, 2, ..., n xi
Nava (LSE)
EC400B Lecture 2
September 2013
14 / 25
Functions of Several Variables: SOC
How can we determine whether a critical point is a local maximum or a local minimum in this more general setup?
To this end we have to consider the Hessian of the map f (ie the matrix of the second order partial derivatives).
Note that the Hessian is always a symmetric matrix, since cross-partial derivatives are equal (Clairaut-Schwarz Theorem).
Nava (LSE)
EC400B Lecture 2
September 2013
15 / 25

Second Order Sucient Conditions for a local maximum in Rn Let f (x) be a continuous real valued function for which all rst and second partial derivatives exist and are continuous on a subset C Rn . If x is critical point of f then: if d 2 f (x ) is negative denite, x is a strict local maximizer of f . if d 2 f (x ) is positive denite, x is a strict local minimizer of f .
Nava (LSE)
EC400B Lecture 2
September 2013
16 / 25

It is also true that if x is an interior point and: a global maximum of f , then d 2 f (x ) is negative semidenite. a global minimum of f , then d 2 f (x ) is positive semidenite. But, it is not true that if x is a critical point and d 2 f (x ) is negative (positive) semidenite, then x is a local maximum (minimum). A counterexample is f (x ) = x 3 : which has a critical point at x = 0 in which d 2 f (0) = 0 is semidenite. But x = 0 is not a maximum or minimum, its a saddle point.
Back to the Example

Consider again F (x , y ) = x 3 y 3 + 9xy . The Hessian satises: d 2 F (x , y ) = 6x 9 9 6y
The rst order leading principle minor is 6x and the second order leading principal minor is 36xy 81. At (0, 0) the two minors are 0 and 81. Hence the Hessian is indenite and (0, 0) is not an extreme point, it is a saddle point. At (3, 3) these two minors are positive. Hence, (3, 3) is a strict local minimum of F . However, (3, 3) is not a global minimum of F (to see why this is the case consider (x , y ) (0, inf)).
Back to the Example

Back to the Example

Sketch of the Proof

Consider the Taylor Expansion: 1 F (x + h) = F (x ) + dF (x )h + hT d 2 F (x ) h + R (h) 2 Ignore R (h), set dF (x ) = 0, and observe that: F (x + h) F (x ) 1 T 2 h d F (x ) h 2
If d 2 F (x ) is negative denite, then for all small enough h = 0, the right hand side is negative. This in turn implies that for small enough h: F (x + h) < F (x ) Hence, x is a strict local maximizer of F .
Concavity and Convexity

Denition
A set U is convex if for all x U and y U , then for all t [0, 1] : t x + (1 t )y U
Denition
A real valued function f dened on a convex subset U of Rn is concave, if for all x, y in U and for all t [0, 1] : f (t x + (1 t )y) t f (x) + (1 t ) f (y)
Denition
A real valued function g dened on a convex subset U of Rn is convex, if for all x, y in U and for all t [0, 1] : g (t x + (1 t )y) t g (x) + (1 t ) g (y)

Denition
Denition
Denition

Denition
Denition
Denition

Observations: f is concave if and only if f is convex. linear functions are convex and concave. concave and convex functions must to have convex sets as their domains for the denitions to apply.
Theorem
Let f be a continuous dierentiable function on a convex subset U of Rn . If so, f is concave on U if and only if for all x, y in U: f (y) f (x) df (x) (y x) = f (x) f (x) = (y1 x1 ) + ... + (yn xn ) x1 xn

Observations: f is concave if and only if f is convex. linear functions are convex and concave. concave and convex functions must to have convex sets as their domains for the denitions to apply.
Theorem
Let f be a continuous dierentiable function on a convex subset U of Rn . If so, f is concave on U if and only if for all x, y in U: f (y) f (x) df (x) (y x) = f (x) f (x) = (y1 x1 ) + ... + (yn xn ) x1 xn
Proof for R1
Since f is concave, then t f (y ) + (1 t ) f (x ) f (ty + (1 t )x ) f (x ) + t (f (y ) f (x )) f (x + t (y x )) f (x + t (y x )) f (x ) f (y ) f (x ) t f (x + h) f (x ) f (y ) f (x ) (y x ) h where the latter holds for h = t (y x ). The limit the last expression when h 0 gives: f (y ) f (x ) f (x )(y x )
Nava (LSE)
EC400B Lecture 2
September 2013
22 / 25
Theorem
If f is a continuous, dierentiable, concave function on a convex set U and if x0 U, then: df (x0 )(y x0 ) 0 f (y) f (x0 ) and if this holds for all y U, then x0 is a global maximizer of f .
Theorem
Let f be a twice continuously dierentiable function whose domain is a convex open subset U of Rn . If f is a concave function on U and df (x0 ) = 0 for some x0 , then x0 is a global maximum of f on U.
Theorem
A twice continuously dierentiable function f on an open convex subset U of Rn is concave on U if and only if the Hessian d 2 f (x) is negative semidenite for all x in U. The function f is a convex function if and only if d 2 f (x) is positive semidenite for all x in U.
Second Order Conditions

Second order sucient conditions for global maximum (minimum) in Rn : Suppose that x is a critical point of a function f (x) with continuous rst and second order partial derivatives on Rn . Then x is: a global maximizer (minimizer) for f (x) if d 2 f (x) is negative (positive) semidenite on Rn . a strict global maximizer (minimizer) for f (x) if d 2 f (x) is negative (positive) denite on Rn .
Nava (LSE)
EC400B Lecture 2
September 2013
24 / 25
Why Care about Concavity?

The property that critical points of concave functions are global maximizers is an important one in economic theory. For example, many economic principles, such as marginal rate of substitution equals the price ratio, or marginal revenue equals marginal cost are simply the rst order necessary conditions of the corresponding maximization problems (as we will see). Ideally, such conditions should also be sucient to identify optimizing behavior. But this will indeed be the case when the objective functions are concave.
Nava (LSE)
EC400B Lecture 2
September 2013
25 / 25

EC400B Math for Micro Lecture 2 Taylor Expansion

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EC400B Math for Micro Lecture 2 Taylor Expansion

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EC400B Math for Micro: Lecture 2

Analytically: it describes the best approximation of f by a polynomial of degree 1.

Higher Order Taylor Expansions

Taylor Expansion for Functions of Several Variables

First Order Taylor Polynomial: F (a + h) F (a) + F F (a)h1 + ... + (a)hn x1 xn

Taylor Expansion for Functions of Several Variables

First Order Taylor Polynomial: F (a + h) F (a) + F F (a)h1 + ... + (a)hn x1 xn

Taylor Expansion for Functions of Several Variables

F at a: ... ... ...

The extension for order k then trivially follows.

Taylor Expansion for Functions of Several Variables

F at a: ... ... ...

The extension for order k then trivially follows.

Denition Extreme Points

Denition Extreme Points

Denition Extreme Points

Example: Critical Points

Consider the function : F (x , y ) = x 3 y 3 + 9xy

Set the rst partial derivatives to zero: F = 3x 2 + 9y = 0 and x F = 3y 2 + 9x = 0 y

To nd the two critical points: (0, 0) and (3, 3).

Do Extreme Points Exist?

Theorem (Extreme Value Theorem)

Functions of One Variable: FOC

Functions of One Variable: SOC

Functions of Several Variables: FOC

Functions of Several Variables: SOC

Functions of Several Variables: SOC

Functions of Several Variables: SOC

Back to the Example

Back to the Example

Back to the Example

Sketch of the Proof

Concavity and Convexity

Concavity and Convexity

Concavity and Convexity

Concavity and Convexity

Concavity and Convexity

Second Order Conditions

Why Care about Concavity?

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