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Monotone Comparative Statics

Econ 2100 Fall 2015

Lecture 10, October 5

Outline
1 Comparative Statics Without Calculus
2 Supermodularity
3 Single Crossing
4 Topkisand Milgrom & Shannons Theorems
5 Midterm
Comparative Statics Without Calculus
Remark
Using the implicit function theorem, one can show that if there are
complementarities between choice variable x and parameter q, the optimum
increases in q.
First Order Condition: fx (x; q) = 0. Second Order Condition: fxx < 0.
By IFT
fxq (x; q)
xq (q) = :
fxx (x; q)
Then
xq (q) 0 if and only if fxq (x; q) 0

Here g is the derivative of g with respect to .


Issues with implicit function theorem:
1 IFT needs calculus.
2 The conclusion holds only in a neighborhood of the optimum.
3 The results are dependent on the functional form used for the objective
function.
1 In particular, IFT gives cardinal results that depend on the assumptions on f .
Monotone Comparative Statics
Objectives
With monotone comparative statics, we seek results about changes that:
do not need calculus
are not necessarily only local (around the optimum).
are ordinal in the sense of being robust to monotonic transformations.

The objective is to get a similar result without calculus.


The downside is that the results are not as strong.

Main Idea: Complementarities


We want to generalize the notion of complementarities between endogenous
variable and parameters.
With calculus, this is the assumption that fxq (x; q) 0.

We would also like to account for the possibility that the optimum is not
unique so that x (q) is not a function.
What does it mean for a correspondence to be increasing?
Strong Set Order

When can we say that one set is larger?

Denition
For two sets of real numbers A and B, dene the binary relation s as follows:
for any a 2 A and b 2 B
A sB if
minfa; bg 2 B and maxfa; bg 2 A
A s B reads A is greater than or equal to B in the strong set order.

Generalizes the notion of greater than from numbers to sets of numbers.


According to this denition f1; 3g is not greater than or equal to f0; 2g.
This denition reduces to the standard denition when sets are singletons.
Non-Decreasing Correspondences
Denition
We say a correspondence g : Rm ! 2R is non-decreasing in q if and only if
q0 > q implies g (q 0 ) s g (q)

This says that q 0 > q implies that for any x 0 2 g (q 0 ) and x 2 g (q):
minfx 0 ; xg 2 g (q) and maxfx 0 ; xg 2 g (q 0 ).
Generalizes the notion of increasing function to correspondences.

Exercise
Prove that if g ( ) is non-decreasing and min g (q) exists for all q, then min g (q) is
non-decreasing.

Exercise
Prove that if g ( ) is non-decreasing and max g (q) exists for all q, then max g (q) is
non-decreasing.
Monotone Comparative Statics: Simplest Case

Set up
Suppose the function f : R2 ! R is the objective function; this is not
necessarily concave or dierentiable, and the optimizer could be set valued.

Let
x (q) arg max f (x; q); subject to q 2 ; x 2 S(q)
Notice that for any strictly increasing g ( ), this problem is equivalent to
x (q) arg max g (f (x ; q)); subject to q 2 ; x 2 S (q)
but g ( ) may destroy smoothness or concavity properties of the objective
function.
For now, assume S( ) is independent of q and both x and q are real variables.
Also, assume existence of a solution but not uniqueness.
Supermodularity

Denition
The function f : R2 ! R is supermodular in (x; q) if
for all x 0 > x f (x 0 ; q) f (x; q) is non-decreasing in q:

If f is supermodular in (x; q), then the incremental gain to a higher x is


greater when q is higher.
This is the idea that x and q are complements.

Question 1, Problem Set 6.


Show that supermodularity is equivalent to the property that
q0 > q implies f (x; q 0 ) f (x; q) is non-decreasing in x:
Dierentiable Version of Supermodularity

When f is smooth, supermodularity has a characterization in terms of


derivatives.

Lemma
A twice continuously dierentiable function f : R2 ! R is supermodular in (x; q) if
and only if D12 f (x; q) 0 for all (x; q).

The inequality in the denition of supermodularity is just the discrete version


of the mixed-partial condition in the lemma.
q0 > q implies f (x ; q 0 ) f (x ; q) is non-decreasing in x
TopkisMonotonicity Theorem

Theorem (Easy TopkisMonotonicity Theorem)


If f is supermodular in (x; q), then x (q) arg max f (x; q) is non-decreasing.

Proof.
Question 2, Problem Set 6 (do not use later results).

Supermodularity is su cient to draw comparative statics conclusions in


optimization problems without other assumptons.
TopkisTheorem follows from the IFT whenever the standard full-rank
condition in the IFT holds.
At a maximum, if D11 f (x ; q) 6= 0, it must be negative (by the second-order
condition), hence the IFT tells you that x (q) is strictly increasing.
Example

Prot Maximiization Without Calculus


A monopolist chooses output q to solve max p(q)q c(q; ).
p( ) is the demand (price) function
c( ) is the cost function
costs depend on the existing technology, described by some parameter .

Let q ( ) be the monopolists optimal quantity.


Suppose c(q; ) is supermodular in (q; ); then the entire objective function
is also supermodular in (q; ).
this follows because the rst term of the objective does not depend on .
Notice that supermodularity says that for all q 0 > q, c(q 0 ; ) + c(q; ) is
nondecreasing in .
in other words, the marginal cost is decreasing in .
Conclusion: by Topkistheorem q is nondecreasing as long as the marginal
cost of production decreases in the technological progress parameter .
A Useful Trick

Sometimes one can invent an objective function in order to apply the


theorem.

Compare the Optima of Dierent Optimization Problems


Suppose one wishes to compare the solutions to two dierent maximization
problems,
max g (x) and max h(x)
x 2S x 2S
Apply the theorem to an articial function, f
(
g (x) if = 0
f (x; ) =
h(x) if = 1
If h(x) g (x) is nondecreasing, f is supermodular and therefore the solution
to the second problem is greater than the solution to the rst.
Single-Crossing
In constrained maximization problems we have x 2 S(q), and supermodularity
is not enough to establish Topkistheorem.

Denition
The function f : R2 ! R satises the single-crossing condition in (x; q) if for all
x 0 > x, q 0 > q
f (x 0 ; q) f (x; q) 0 implies f (x 0 ; q 0 ) f (x; q 0 ) 0
and
f (x 0 ; q) f (x; q) > 0 implies f (x 0 ; q 0 ) f (x; q 0 ) > 0:

As a function of the second argument, the marginal return can cross 0 at most
once; whenever it crosses 0, as the second argument continues to increase, the
marginal return is going to remain positive.

Theorem
If f satises single crossing in (x; q), then x (q) = arg maxx 2S (q) f (x; q) is
nondecreasing. Moreover, if x (q) is nondecreasing in q for all constraint choice
sets S, then f satises single-crossing in (x; q).
Monotone Comparative Statics
n-dimensional choice variable and m-dimensional parameter vector

Before we had a function of a real number and a parameter.


Next, we generalize to functions of vectors where the parameter is also a
vector.

Denitions
Suppose x; y 2 Rn .
The join of x and y is dened by
x _ y = (maxfx1 ; y1 g; maxfx2 ; y2 g; : : : ; maxfxn ; yn g):
The meet of x and y is dened by
x ^ y = (minfx1 ; y1 g; minfx2 ; y2 g; : : : ; minfxn ; yn g):

Draw a picture.
A Simple Result
Lemma

(i) : x _y =x ,x y , and
(ii) : x ^y =x ,x y

Proof.
Let x; y 2 Rn . Note that
x _ y = x , (maxfx1 ; y1 g; : : : ; maxfxn ; yn g) = (x1 ; : : : ; xn )
, maxfxi ; yi g = xi 8i 2 f1; : : : ; ng
, xi yi 8i 2 f1; : : : ; ng
,x y:
Similarly,
x ^ y = x , (minfx1 ; y1 g; : : : ; maxfxn ; yn g) = (x1 ; : : : ; xn )
, minfxi ; yi g = xi 8i 2 f1; : : : ; ng
, xi yi 8i 2 f1; : : : ; ng
,x y
Strong Set Order

Denition (Strong set order in Rn )


The binary relation s on subsets of Rn is dened as follows: for A; B Rn ,
for any a 2 A and b 2 B
A sB if
a^b 2B and a _ b 2 A

This is the same as the previous denition.


We can use this to talk about non-decreasing Rn -valued correspondences.
Quasi-Supermodularity
Denition
Let f : Rn Rm ! R. Then f (x; q) is quasi-supermodular in x if, for all x; y 2 Rn
and q 2 Rm :
1
f (x; q) f (x ^ y; q) ) f (x _ y; q) f (y; q);
2
f (x; q) > f (x ^ y; q) ) f (x _ y; q) > f (y; q):

This is a generalization of the mixed second partial derivatives typically used


to make statements about complementarities or substitutability.
Quasi-supermodularity is an ordinal property, and for dierentiable functions
there is a su cient condition for quasi-supermodularity.

Exercise
1 Prove that if f is quasi-supermodular in x, then h f is quasi-supermodular in
x for any strictly increasing h : f (Rn Rm ) ! R.
@2 f
2 Suppose f (x; q) is twice dierentiable in x and @xi xj > 0 for all i; j = 1; : : : ; n
with i 6= j. Then f is quasi-supermodular in x.
Single-Crossing Property
Denition
Let f : Rn Rm ! R. Then f (x; q) satises the single-crossing property if, for all
x; y 2 Rn and q; r 2 Rm such that x y and q r:
1
f (x; r) f (y; r) ) f (x; q) f (y; q);
2
f (x; r) > f (y; r) ) f (x; q) > f (y; q):

The marginal return f (x; ) f (y; ) as a function of the second argument


can cross 0 at most once.
The single-crossing property is an ordinal property, and for dierentiable
functions there is a su cient condition for single-crossing.

Exercise
1 Prove that if f satises the single-crossing property, then h f satises the
single-crossing property for any strictly increasing h : f (Rn Rm ) ! R.
2
@ f
2 Suppose f (x; q) is twice dierentiable and @x i xj
> 0 for all i = 1; : : : ; n and
j = 1; : : : ; m. Then f satises the single-crossing property.
Hint: Use induction on dimensions.
Increasing Dierences and Supermodularity
Denition
Let f : Rn Rm ! R. We say that f (x; q) satises the increasing dierences if, for
all x; x0 2 Rn and q; q0 2 Rm such that x0 x and q0 q:
f (x0 ; q0 ) f (x; q0 ) f (x0 ; q) f (x; q)

Strict increasing dierences has a strict inequality.


Similar to single crossing, but stronger. The marginal return f (x0 ; ) f (x; )
is increasing in the second argument.
@2 f
If f (x; q) is twice dierentiable and @x i xj
> 0 for all i and j, then f has
increasing dierences in (x; q).
Denition
f (x; q) is supermodular in x if, for all x; y 2 Rn and q 2 Rm :
f (x _ y; q) + f (x ^ y; q) f (x; q) + f (y; q);

Similar to quasi-supermodularity, but stronger.


@2 f
If f (x; q) is twice dierentiable in x and @x i xj
> 0 for all i; j = 1; : : : ; n with
i 6= j, then f is supermodular in x.
Unlike quasi-supermodularity and single-crossing, increasing dierences and
Monotone Comparative Statics
Theorem (easy Milgrom and Shannon)
Let f : Rn Rm ! R. Dene x (q) = arg maxx 2Rn f (x; q). Suppose jx (q)j = 1
for all q and f (x; q) is quasi-supermodular in x and satises the single-crossing
property. Then
q r ) x (q) x (r ):

This is easysince it assume the optimum is unique (the proof does not use
the strictpart of the denitions of quasi-supermodularity and single-crossing).
Proof.
Suppose q r . Then:
f (x (r ); r ) f (x (q) ^ x (r ); r ) by denition of x (q)
) f (x (q) _ x (r ); r ) f (x (q); r ) by quasi-supermodularity in x
) f (x (q) _ x (r ); q) f (x (q); q) by Single Crossing
) x (q) _ x (r ) = x (q) since jx (q)j equals 1
) x (q) x (r ) by the earlier Lemma

This result can be extended to constrained optimization problems (Question 3,


Problem Set 6).
Problem Set 6 (Incomplete)
Due Monday, 13 October, at the beginning of class
1 Assume the function f : R2 ! R is supermodular in (x; q) and show that
supermodularity is equivalent to the property that
q0 > q implies f (x; q 0 ) f (x; q) is non-decreasing in x:
2 Without using Milgrom and Shannons theorem, prove that if f : R2 ! R is
supermodular in (x; q), then x (q) arg max f (x; q) is non-decreasing.
3 Consider the following extension of the monotone comparative statics results allowing
for constrained optimization. Suppose f : Rn Rm ! R is quasi-supermodular in x and
satises the single crossing property. Suppose ' : Rm ! Rn is a correspondence such
that '(q 0 ) s '(q) for every q 0 > q. Set
x (q) = arg max f (x; q)
x 2'(q)

and assume jx (q)j = 1 for each q. Prove that x (q 0 ) x (q) for every q 0 > q.
4 Suppose a rm purchases two inputs x1 and x2 at unit costs w1 and w2 to produce a
single product with production function f (x1 ; x2 ) to sell at a unit market price of p. Its
prot is therefore:
(x1 ; x2 ; p; w1 ; w2 ) = pf (x1 ; x2 ) w1 x1 w2 x2 :
2
Suppose f is C 2 and @x@ 1 fx2 > 0, i.e. x1 and x2 are complements. Assume that
x (p; w1 ; w2 ) = arg max (x1 ; x2 ; p; w1 ; w2 ) is unique. Use monotone comparative
statics to prove that if p 0 p, w10 w1 , and w20 w2 , then
x (p 0 ; w10 ; w20 ) x (p; w1 ; w2 ). (Hint: you will have to do some change of variables.)