SCHOOL OF MATHEMATICAL AND NATURAL SCIENCES

DEPARTMENT OF MATHEMATICS AND APPLIED MATHEMATICS

LEARNING GUIDE

MODULE: MAT 1145 (BUSINESS MATHEMATICS I)

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1. FOREWORD

This module is intended for students in Management Sciences. It is designed to provide

students with a basic understanding of Business Mathematics.

It is important to realize that Mathematics is a life-long learning experience. From birth we

come across the concept of size, shape and form. Initially numbers are learned by
observation and during formal schooling these concepts are formalized into structures-
arithmetic, algebra, geometry, calculus etc. At tertiary level we continue to build on prior
knowledge, introducing and using additional techniques that are useful in solving real life
economic and business problems.

Welcome to the exciting World of Mathematics. It is our aim to provide you with the knowledge
of Basic Mathematics and techniques to enhance your abilities to integrate those techniques in
your personal life. We expect you to:

• attend all lectures and tutorial sessions,

• be punctual at all times,
• execute your tasks as required by your lecturers,
• study hard, regularly and honestly.

2. Lecturer’s information

2.1. Name of Lecturer: Dr. R.M Mukhodobwane

2.2. Office Number: G5 Old Science Building

2.3. Consultation Hours: Fridays (11H00-15H00)

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3. GENERAL INFORMATION OF THE MODULE

3.1. Module: MAT 1145

3.2. NQF Level: 5
3.3. NQF credits: 12
3.4. Type of module: 1st semester

3.5. Notional hours: 120 Hours

3.6. Prerequisite(s): MAT 0544/0644 or at least E (HG) or D (SG) or achievement level 4 in

Grade 12 Mathematics.

4. MODULE AIM

The principal aim of this module is to equip students with the skills required to analyze and
interpret economic and business situations under conditions of change. This involves primarily
the study of linear and quadratic functions, mathematics of finance and calculus (the
mathematics of change) and their applications to the construction and analysis of mathematical
models of economic and business phenomena.

5. LEARNING OUTCOMES

1. Construct and apply mathematical models of problems in economics, business and

finance using elementary mathematical functions.

2. Construct and interpret graphs of economic functions for specific classes of

mathematical functions, using differential calculus when required.

3. Validate mathematical statements relating to economics, business, and finance.

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6. CONTENT OF THE MODULE

1. Linear equations and applications in economics

• Solving simultaneous linear equations
• Demand and supply analysis
• Total, cost, total revenue, and profit functions analysis
• National income determination model

2. Non-linear functions and applications in economics

• Quadratic and other polynomial functions
• Total, revenue, and profit functions
• Exponential functions
• Logarithmic function
• Hyperbolic functions

3. Mathematics of Finance
• Simple interest, compound interest and annual percentage rate
• Investment appraisal using Net Present Value (NPV) and Internal Rate of
Return (IRR)
• Annuities, Debt repayment and sinking fund

4. Differentiation and application

• Rules for differentiation
• Marginal functions and average functions
• Optimization of the economic functions of one variable

7. TEACHING AND LEARNING

7.1. Teaching Methods

Lectures and tutorials.

7.2. Resources

7.2.1. Prescribed Textbook:

• Essential Mathematics for Economics and Business by Teresa Bradley (Six Edition).
• Mathematics for Economics and Business by Ian Jacques (Ninth Edition).

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7.2.2. Recommended Textbooks: Any other Business Mathematics Textbooks with
related topics.

7.2.3. Non-programmable scientific calculator.

7.3. Student support

Students will be assisted by student tutors and other full-time staff during tutorial sessions and
consultation hours.

8. ASSESSMENT

8.1. Methods of Assessment

Formative Assessment:

Students will be assessed continuously throughout the whole semester in the form of tutorial
tasks and written tests. At least two major tests and 2 assignments will be given in the duration
of the course.

Summative Assessment:

A three-hour examination paper out of 100 marks will be written at the end of the semester

8.2. ASSESMENT TIMETABLE

TEST NO TENTATIVE DATE SCOPE

1 22 MARCH 2025 CHAPTERS 1 & 2

2 03 MAY 2025 CHAPTERS 3 & 4

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 8.4. ENTRANCE REQUIREMENTS AND PASS REQUIREMENT FOR FINAL EXAMINATION

A student should obtain a semester mark of at least 40% in order to sit for an examination and
the minimum final mark to pass the module is 50%.

Final mark Compilation = Semester Mark (60%) + Examination Mark (40%)

9. AEGROTAT/ SPECIAL, TESTS AND OTHER FORMS OF ASSESSMENT

A student may be granted a special assessment opportunity if he/she applies within 5 working
days subsequent to the original date of assessment missed, this must be handed over to the
lecturer in person.

Reason for absence Documentation as proof

Illness Application letter and the medical

certificate from a registered medical
practitioner/Health institution is
submitted to the lecturer

Compassionate reasons Relevant documentation such as death

certificate etc. and a letter detailing
( for immediate family member only) circumstances and the student’s details
must accompany the application.

Legitimate reasons An affidavit signed and stamped by a

commissioner of oaths, accompanied

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 by a letter, detailing the specific
circumstances and the student’s details.

BUSINESS MATHEMATICS 1- MAT 1145 / MAT 1545

CHAPTER 1: Linear equations and functions

1.1 Linear Equations

Definition: Linear equations are first degree equations. Each variable in the equation is raised to
the first power.

Definition:
A linear equation involving two variables x and y has the standard form
𝑎𝑎𝑎𝑎 + 𝑏𝑏𝑏𝑏 = 𝑐𝑐
where a, b and c are constants and a and b cannot both equal zero.

Note: The presence of terms having power other than 1 or product of variables, e.g. (x y) would
exclude an equation from being linear.

Examples:
1. 3𝑥𝑥 + 4𝑦𝑦 = 7 is linear equation, where 𝑎𝑎 = 3, 𝑏𝑏 = 4, 𝑐𝑐 = 7
2. √𝑥𝑥 = 5 + 𝑦𝑦 is non-linear equation as power of 𝑥𝑥 is not 1.

Solution set of an equation

Given a linear equation 𝑎𝑎𝑎𝑎 + 𝑏𝑏𝑏𝑏 = 𝑐𝑐, the solution set for the equation is the set of all ordered
pairs (x, y) which satisfy the equation.
𝑆𝑆 = {(𝑥𝑥, 𝑦𝑦)|𝑎𝑎𝑎𝑎 + 𝑏𝑏𝑏𝑏 = 𝑐𝑐}
For any linear equation, S consists of an infinite number of elements.

Method
1. Assume a value of one variable
2. Substitute this into the equation
3. Solve for the other variable

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Example
Given the equation, 2𝑥𝑥 + 4𝑦𝑦 = 16 , determine the pair of values which satisfy the equation when
x=-2

Solution: Put x =-2 in given equation gives us 4y=16-4, i.e. y=3.

So, the pair (-2, 3) is a pair of values satisfying the given equation.

Linear equation with n variables

Definition
A linear equation involving n variables x1, x2, . . ., xn has the general form:
𝑎𝑎1 𝑥𝑥1 + 𝑎𝑎2 𝑥𝑥2+ . . . + 𝑎𝑎𝑛𝑛 𝑥𝑥𝑛𝑛 = 𝑏𝑏
where 𝑎𝑎1 , 𝑎𝑎2 , ⋯ , 𝑎𝑎𝑛𝑛 are non-zero.

Definition:
The solution set S of a linear equation with n variables as defined above is the collection of
n-tuples (𝑥𝑥1 , 𝑥𝑥2 , ⋯ , 𝑥𝑥𝑛𝑛 ) such that 𝑆𝑆 = {(𝑥𝑥1 , ⋯ , 𝑥𝑥𝑛𝑛 )| 𝑎𝑎1 𝑥𝑥1 + ⋯ + 𝑎𝑎𝑛𝑛 𝑥𝑥𝑛𝑛 = 𝑏𝑏}.

As in the case of two variables, there are infinitely many values in the solution set.

Example
Given an equation
4𝑥𝑥1 − 2𝑥𝑥2 + 6𝑥𝑥3 = 0, what values satisfy the equation when 𝑥𝑥1 = 2 and 𝑥𝑥3 = 1.

Solution: Put the given values of 𝑥𝑥1 and 𝑥𝑥3 in the above equation gives 𝑥𝑥2 = 7. Thus (2,7,1) is a
solution of the above equation.

1.2 Systems of Linear Equations

Definition
A system of equations is a set consisting of more than one equation.

Dimension: One way to characterize a system of equations is by its dimensions. If system of

equations has ‘m’ equations and ‘n’ variables, then the system is called an “m by n system”. In
other words, it has 𝑚𝑚 × 𝑛𝑛 dimensions. In solving systems of equations, we are interested in
identifying values of the variables that satisfy all equations in the system simultaneously.

After studying this section, you will be able to:

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 • solve simultaneous linear equations by substitution
• solve simultaneous linear equations by elimination
• solve simultaneous linear equations using straight line graphs

If an equation has two unknowns, such as 2𝑦𝑦 + 𝑥𝑥 = 20, it cannot have unique solutions.
Two unknowns require two equations which are solved at the same time (simultaneously) −
but even then, two equations involving two unknowns do not always give unique solutions.

Solution by substitution.
It involves what it says − substitution − using one of the equations to get an expression of the
form ‘y = …’ or ‘x = …’ and substituting this into the other equation. This gives an equation
with just one unknown, which can be solved in the usual way. This value is then substituted
in one or other of the original equations, giving an equation with one unknown.
Example

Solve the two simultaneous equations:

2𝑦𝑦 + 𝑥𝑥 = 8 [1]
1 + 𝑦𝑦 = 2𝑥𝑥 [2]

From [2]
𝑦𝑦 = 2𝑥𝑥 − 1 [3]

Substituting this value for y into [1] gives:

(2𝑥𝑥 – 1) + 𝑥𝑥 = 84𝑥𝑥 – 2 + 𝑥𝑥 = 8
5𝑥𝑥 = 10
𝑥𝑥 = 2

Substitute the value of x into [3] gives

𝑦𝑦 = 4 − 1 = 3

So 𝑥𝑥 = 2 and 𝑦𝑦 = 3

Solution by elimination.
The object is to manipulate the two equations so that, when combined, either the x term or
the y term is eliminated (hence the name) − the resulting equation with just one unknown can
then be solved:
Here we will manipulate one of the equations so that when it is combined with the other
equation either the x or y terms will drop out. In this example the x term will drop out giving
a solution for y. This is then substituted into one of the original equations.

Label your equations so you know which one you are working with at each stage.

2𝑦𝑦 + 𝑥𝑥 = 8 [1]

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 1 + 𝑦𝑦 = 2𝑥𝑥 [2]

Rearrange one equation so it is similar to the other.

𝑦𝑦 – 2𝑥𝑥 = −1 [2]

[1] 𝑥𝑥 2: 4𝑦𝑦 + 2𝑥𝑥 = 16 [3]

______________________
[1]+[3]: 5𝑦𝑦 = 15

𝑦𝑦 = 3

Substituting 𝑦𝑦 = 3 into [1] gives

1 + (3) = 2𝑥𝑥
2𝑥𝑥 = 4
𝑥𝑥 = 2

Hence
𝑥𝑥 = 2 and 𝑦𝑦 = 3

1.3 Linear Functions

A function is a relation between two sets such that to each element of the domain (input) there
corresponds exactly one element of the range (output) or a function is a rule which assign each
incoming number, x a uniquely defined outgoing number y.
A linear function has the general (slope-intercept) form
𝑦𝑦 = 𝑓𝑓 (𝑥𝑥 ) = 𝑚𝑚𝑚𝑚 + 𝑐𝑐

where 𝑚𝑚 is slope and 𝑐𝑐 is 𝑦𝑦-intercept.

Definition: The domain of a function is the set consisting of all possible input values.

Definition: The range of a function is the set of all possible output values.

The input variable is called the independent variable, and the output variable is called the
dependent variable.

Some examples
1. The fare of taxi depends upon the distance and the day of the week.
2. The fee structure depends upon the program and the type of education (on campus/off

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 campus) you are admitting in.
3. The house prices depend on the location of the house.

Note: The variable 𝑥𝑥 is not always the independent variable, 𝑦𝑦 is not always the dependent
variable and 𝑓𝑓 is not always the rule relating 𝑥𝑥 and 𝑦𝑦. Once the notation of function is clear then,
from the given notation, we can easily identify the input variable, output variable and the rule
relating them, for example 𝑢𝑢 = 𝑔𝑔(𝑣𝑣) has input variable 𝑣𝑣, output variable 𝑢𝑢 and 𝑔𝑔 is the rule
relating 𝑢𝑢 and 𝑣𝑣.

Example 1 (Weekly Salary Function)

A person gets a job as a salesperson and his salary depends upon the number of units he sells
each week. Then, dependency of weekly salary on the units sold per week can be represented
as
𝑦𝑦 = 𝑓𝑓(𝑥𝑥), where 𝑓𝑓 is the name of the salary function. Suppose your employer has given you the
following equation for determining your weekly salary: 𝑦𝑦 = 100 𝑥𝑥 + 5000

Given any value of x will result in the value of y with respect to the function f. If x = 5, then y =
5500. We write this as, y = f(5) = 5500.

Example 2
Given the functional relationship.
f(x) = 5x − 10,
Find f(0), f(−2) and f(a + b).

Solution: As 𝑓𝑓(𝑥𝑥 ) = 5𝑥𝑥 − 10, so

𝑓𝑓(0) = 5(0) − 10 = −10

𝑓𝑓(−2) = 5(−2) − 10 = −20

𝑓𝑓(𝑎𝑎 + 𝑏𝑏) = 5𝑎𝑎 + 5𝑏𝑏 − 10.

1.4 Graphing two variable equations

The following concepts must be taken into consideration when sketching linear functions:

x-intercept(s)
The x-intercept of an equation is the point where the graph of the equation crosses the x-axis, i.e.
𝑦𝑦 = 0.

y-intercept

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The y-intercept of an equation is the point where the graph of the equation crosses the y-axis, i.e.
𝑥𝑥 = 0

Note: Equations of the form x=k has no y-intercept and equations of the form 𝑦𝑦 = 𝑘𝑘 has no x-
intercept

Slope
Any straight line with the exception of vertical lines can be characterized by its slope. Slope
represents the inclination of a line or equivalently it shows the rate at which the line raises and fall
or how steep the line is.

Explanation: The slope of a line may be positive, negative, zero or undefined.

The line with slope
1. Positive then the line rises from left to right
2. Negative then the line falls from left to right
3. Zero then the line is horizontal line
4. Undefined if the line is vertical line

Note: The sign of the slope represents whether the line is decreasing or increasing.
.

We can use the following methods to sketch linear graphs:

• Plotting
• Gradient intercept
• Intercepts

Solving simultaneous equations graphically

Simultaneous equations can also be solved graphically. If the graphs of each linear
equation are drawn, then the solution to the system of simultaneous equations is the
coordinates of the point at which the two graphs intersect.

For example:

𝑥𝑥 = 2𝑦𝑦……………………… (1)

𝑦𝑦 = 2𝑥𝑥 − 3………………. (2)

The graphs of the two equations are shown below.

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The intersection of the two graphs is (2; 1). So the solution to the system of
simultaneous equations is 𝑥𝑥 = 2 and𝑦𝑦 = 1. We can also check the solution using
algebraic methods.

Exercise

Use the same system of axes to solve the following system of equations:

3𝑥𝑥 + 2𝑦𝑦 = 12

4𝑥𝑥 − 3𝑦𝑦 = −1

1.5 Linear functions, Applications

Recall that a linear function f involving one independent variable x and a dependent variable y
has the general form
𝑦𝑦 = 𝑓𝑓(𝑥𝑥 ) = 𝑚𝑚𝑚𝑚 + 𝑐𝑐,

where 𝑚𝑚 ≠ 0 and 𝑐𝑐 are constants.

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1.5.1. Linear cost function

The organizations are concerned with the costs as they reflect the money flowing out of the
organisation. The total cost usually consists of two components: total variable cost and total fixed
cost. These two components determine the total cost of the organisation.

The total cost function is given by

TC = FC + TVC
∴TC = FC + (VC )Q

where

𝑄𝑄 denotes quantity

𝐹𝐹𝐹𝐹 denotes fixed cost (in the short-run all costs are fixed),

𝑉𝑉𝑉𝑉 denotes variable costs (in the long run all costs are variable),

𝑇𝑇𝑇𝑇𝑇𝑇 denotes total variable costs (variable cost per unit of output).

 𝑇𝑇𝑇𝑇𝑇𝑇 = (𝑉𝑉𝑉𝑉)𝑄𝑄

Average cost function is given by;

TC
AC =
Q
FC + (VC )Q
=
Q
FC
= + VC
Q

1.5.2 Linear Revenue function

Revenue: The money which flows out into an organisation from either selling or providing services
is often referred to as revenue.

Total revenue function is given by

𝑇𝑇𝑇𝑇 = 𝑃𝑃𝑃𝑃

Where P and q denote the price of a good and number of units, respectively.

Suppose a firm sells product. Let PI and Q I be the price of the product and number of units per
product respectively. Then the revenue function is given by

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 𝑇𝑇R = P1 Q1 + ⋯ + Pn Q n .

1.5.3 Linear Profit function

Profit: The profit of an organisation is the difference between total revenue and total cost. In
equation form if total revenue is denoted by 𝑇𝑇R(Q) and Total cost is TC(Q), where Q is
quantity produced and sold, then profit P(Q) is defined as

𝜋𝜋(𝑄𝑄) = 𝑇𝑇𝑇𝑇(𝑄𝑄) − 𝑇𝑇𝑇𝑇(𝑄𝑄).

1. If total revenue exceeds total cost the profit is positive

2. In such case, profit is referred as net gain or net profit
3. On the other hand, the negative profit is referred to as a net loss or net deficit.

1.5.4 Break-Even Models

Break-even model is a set of planning tools which can be useful in managing organizations. One
significant indication of the performance of a company is reflected by how much profit is earned.
Break-even analysis focuses upon the profitability of a firm and identifies the level of operation or
level of output that would result in a zero profit.

The level of operations or output is called the break-even point. The break-even point represents
the level of operation at which total revenue equals to total cost. Any changes from the level of
operations will result in either a profit or a loss.

Break-even analysis is mostly used when:

1. Firms are offering new products or services.
2. Evaluating the pros and cons of starting a new business.

Method of performing break-even analysis

1. Formulate total cost as a function of 𝑄𝑄 , the level of output.
2. Formulate total revenue as a function of 𝑄𝑄.
3. As break-even conditions exist when total revenue equals total cost, so we set 𝑇𝑇𝐶𝐶 (𝑄𝑄)
equals 𝑇𝑇𝑅𝑅(𝑄𝑄) and solve for 𝑄𝑄. The resulting value of is the break-even level of output and
denoted by 𝑥𝑥𝑥𝑥𝐵𝐵𝐵𝐵 .
An alternate, to step 3 is to construct the profit function 𝜋𝜋(𝑄𝑄) = 𝑇𝑇𝑇𝑇(𝑄𝑄) − 𝑇𝑇𝑇𝑇(𝑄𝑄), set 𝜋𝜋(𝑄𝑄) equal
to zero and solve to find 𝑥𝑥𝑥𝑥𝐵𝐵𝐵𝐵 .

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Example

A store can purchase goods for 𝑅𝑅7 each. It has fixed costs of 𝑅𝑅2,500. Each good is sold for 𝑅𝑅18.

Let 𝑄𝑄 represents the of goods

1. Write a linear equation for both cost and revenue.

Total cost is given by the equation

𝑇𝑇𝑇𝑇 = 𝐹𝐹𝐹𝐹 + 𝑉𝑉𝑉𝑉 × 𝑄𝑄

𝑇𝑇𝑇𝑇 = 7𝑄𝑄 + 2 500

Total revenue function is given by the equation

𝑇𝑇𝑇𝑇 = 𝑃𝑃 × 𝑄𝑄

𝑇𝑇𝑇𝑇 = 18𝑄𝑄

2. Graph both total cost and total revenue lines are given below in purple and green
respectively.

Graphing these:

The two graphs intersect at approximately 𝑄𝑄 = 227.

3. Determine the break-even point.

At break-even occurs when 𝑇𝑇𝑇𝑇 = 𝑇𝑇𝑇𝑇 or 𝜋𝜋 = 0 and solve for Q to find the exact break-even
point.

18𝑄𝑄 = 7𝑄𝑄 + 2500

18𝑄𝑄 − 7𝑄𝑄 = 2500

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 11𝑄𝑄 = 2500

𝑄𝑄 = 227.3

4. If the store wants to make a profit of more than 𝑅𝑅2 000, how many goods must it sell?

Profit function is given by the equation

𝜋𝜋 = 𝑇𝑇𝑇𝑇 − 𝑇𝑇𝑇𝑇

18𝑄𝑄 − (7𝑄𝑄 + 2500) = 2000; 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑓𝑓𝑓𝑓𝑓𝑓 𝑄𝑄

18𝑄𝑄 – 7𝑄𝑄 − 2500 = 2000
18𝑄𝑄 – 7𝑄𝑄 = 2000 + 2500
11𝑄𝑄 = 4500
𝑄𝑄 = 4500/11
𝑄𝑄 = 409.1

This can be rounded to the nearest unit 410 since the firm can’t sell a fraction good. This means
that the firm should sell 410 goods to make a profit which is more than 𝑅𝑅2 000

Exercise 1
A Group of engineers is interested in forming a company to produce smoke detectors. They have
developed a design and estimated that variable costs per unit, including materials, labor, and
marketing costs are R22.50. Fixed costs associated with the formation, operation, management
of the company and purchase of the machinery costs R250,000. They estimated that the selling
price will be 30 rands per detector.
a) Determine the number of smoke detectors which must be sold for the firm to break-even
on the venture.
b) Preliminary marketing data indicate that the firm can expect to sell approximately 30,000
smoke detectors over the life of the project if the detectors are sold at R30 per unit.
Determine expected profits at this level of output.

Exercise 2
The company that sells chickens snack boxes for R3.50 has fixed cost of R800 per day and
variable costs of R1.50 for each chicken snack box.
(a) Write down the equation for profit function.
(b) Calculate the number of chicken snack boxes that must br produced and sold if the
company is to break even.
(c) Graph the profit function. From the graph estimate the break-even quantity.

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1.6 Demand and supply analysis
1.6.1 Linear demand function

A demand function is a mathematical relationship expressing the way in which the quantity
demanded of an item varies with the price charged for it. The relationship between these two
variables, quantity demanded and price per unit, is usually inversely proportional, i.e. a decrease
in price results in increase in demand.

Most demand functions are nonlinear, but there are situations in which the demand relationship
either is or can be approximated by a linear function.

In microeconomics the quantity demanded, Q of a good depends on the market price, P and is
given by

Quantity demanded= Q D = f(price per unit)

𝑄𝑄 = 𝑓𝑓(𝑃𝑃)

And conversely

𝑓𝑓 = 𝑓𝑓(𝑄𝑄)

The linear demand function is given by

𝑃𝑃 = 𝑎𝑎𝑎𝑎 + 𝑏𝑏

where the parameters a, b are constants, 𝑎𝑎 < 0 and 𝑏𝑏 > 0. Since 𝑎𝑎 < 0, P is said to be a
decreasing function.

Example

Given the demand function

𝑃𝑃 = −2𝑄𝑄 + 50,

Determine the following value of:

(a) P when 𝑄𝑄 = 9
(b) Q when 𝑃𝑃 = 10

Solution

(a) When 𝑸𝑸 = 𝟗𝟗
𝑷𝑷 = −𝟐𝟐𝟐𝟐 + 𝟓𝟓𝟓𝟓
𝑷𝑷 = −𝟐𝟐(𝟗𝟗) + 𝟓𝟓𝟓𝟓
= −𝟏𝟏𝟏𝟏 + 𝟓𝟓𝟓𝟓
= 𝟑𝟑𝟑𝟑

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(b)When 𝑷𝑷 = 𝟏𝟏𝟏𝟏

𝑷𝑷 = −𝟐𝟐𝟐𝟐 + 𝟓𝟓𝟓𝟓

𝟏𝟏𝟏𝟏 = −𝟐𝟐𝟐𝟐 + 𝟓𝟓𝟓𝟓

− 𝟐𝟐𝟐𝟐 + 𝟓𝟓𝟓𝟓 = 𝟏𝟏𝟏𝟏

𝟐𝟐𝟐𝟐 = 𝟏𝟏𝟏𝟏 − 𝟓𝟓𝟓𝟓

− 𝟐𝟐𝟐𝟐 = −𝟒𝟒𝟒𝟒

−𝟐𝟐𝟐𝟐 −𝟒𝟒𝟒𝟒
=
−𝟐𝟐 −𝟐𝟐

𝑸𝑸 = 𝟐𝟐𝟐𝟐

Note: The number of quantities that a consumer purchase does not depend on the price, P only,
but depends on other factors as well, namely

• i.e., income of consumers, Y

• Price of substitutable good, PS
• Price of complementary good, PC
• Advertising expenditure, A
• Consumer taxes, T

Exercise:
Define the following terms:

(a) Substitutable good

(b) Complementary good
(c) Superior good
(d) Inferior good.

1.6.2 Linear Supply and demand Function

A supply function relates market price to the quantities that suppliers are willing to produce or sell.
The supply function implicates that what is brought to the market depends upon the price people
are willing to pay.

In contrast to the demand function, the quantity which suppliers are willing to supply usually varies
directly with the market price. The higher the market price, the more a supplier would like to

19
produce and sell. The lower the price, the less a supplier would like to produce and sell.

Quantity supplied= 𝑄𝑄𝑠𝑠 = 𝑓𝑓(𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝)

A linear supply function is given by

𝑃𝑃 = 𝑎𝑎𝑎𝑎 + 𝑐𝑐

where the parameters a, b are constants, 𝑎𝑎 > 0 and 𝑐𝑐 > 0. Since a> 0, P is said to be an
increasing function of Q.

A linear demand function is given by

𝑃𝑃 = 𝑎𝑎𝑎𝑎 + 𝑐𝑐

where the parameters a, b are constants, 𝑎𝑎 < 0 and 𝑐𝑐 > 0. Since a> 0, P is said to be a
decreasing function of Q.

1.6.3 Market Equilibrium

Given supply and demand functions of a product, market equilibrium exits if there is a price at
which the quantity demanded is equal to the quantity supplied.

Example

Suppose demand is governed by:

𝑄𝑄 𝑑𝑑 = −3𝑃𝑃 + 24

and supply is governed by:

𝑄𝑄 𝑠𝑠 = 2𝑃𝑃 + 4

Find the equilibrium price algebraically and hence sketch the graphs on the same syatem of
axis

Solution

We know that at equilibrium, quantity demanded must equal quantity supplied, that is:

𝑄𝑄𝑄𝑄 = 𝑄𝑄𝑄𝑄 = 𝑄𝑄

20
−3𝑃𝑃 + 24 = 2𝑃𝑃 + 4

24 − 4 = 2𝑃𝑃 + 3𝑃𝑃

20 = (2 + 3)𝑃𝑃

20 = 5𝑃𝑃

𝑃𝑃 = 4.

The corresponding value of Q is found by substituting 𝑃𝑃 = 4 into demand or supply equation.

𝑄𝑄 = −3 (4) + 24 = 12

or

𝑄𝑄 = 2(4) + 4 = 12

Note: In practice, you don't have to repeat it. Just pick one or the other equation to solve for
quantity.

Sketch the graph of example 1 on the same system of axes.

Exercise 1

Given the supply function

3𝑃𝑃 − 𝑄𝑄 = 34

and the demand function

2𝑃𝑃 = −𝑄𝑄 + 56,

Sketch the graphs of the two functions and hence determine the co-ordinates of the intersection
point.

Exercise 2

The demand and supply functions of a good are given by

𝑃𝑃 = −2𝑄𝑄𝐷𝐷 + 50

1
𝑃𝑃 = 𝑄𝑄 + 25
2 𝑆𝑆

Where P, and Q denote the price and quantity respectively.

21
 (a) Determine the equilibrium price and quantity.
(b) Determine the effect on the equilibrium point, if the government decides to impose a
fixed tax of R5 on each good.

Exercise 3

Suppose demand and supply functions have been estimated for two competing products.

𝑄𝑄𝐷𝐷1 = 100 − 2𝑃𝑃1 + 3𝑃𝑃2 (Demand, Product 1)

𝑄𝑄𝐷𝐷2 = 150 + 4𝑃𝑃1 − 𝑃𝑃2 (Demand, Product 2)

𝑄𝑄𝑆𝑆1 = 2𝑃𝑃1 − 4(Supply, Product 1)

𝑄𝑄𝑆𝑆2 = 3𝑃𝑃2 − 6(Supply, Product 2)

1.7 NATIONAL INCOME DETERMINATIOM

Economy is divided into sectors, households and firms. Firms use factors of production. National
income determination represents the flow of money from firms to households as payments.
Households spend this money in one of two ways. i.e. consumption of food produced by firm or it
can be put into savings.

Consumption, C, and savings, S are functions of income, Y

𝐶𝐶 = 𝑓𝑓 (𝑌𝑌)

𝑆𝑆 = 𝑔𝑔(𝑌𝑌)

for some consumption function, f, and savings function, g.

Consumption is given by the equation

𝐶𝐶 = 𝑎𝑎𝑎𝑎 + 𝑏𝑏

Where a, b∈ 𝑅𝑅 , 𝑎𝑎 > 0 and 𝑏𝑏 > 0

The intercept b is the level of consumption when 𝑦𝑦 = 0 and is known as autonomous

consumption.

a is the slope and it is the change in c brought about by one unit increase in y. It is known as the
marginal propensity to consume (MPC)

Since income is used up in consumption and savings

This implies that 𝑌𝑌 = 𝐶𝐶 + 𝑆𝑆

22
Example 1

Given the consumption function

𝐶𝐶 = 0.6𝑌𝑌 + 10

Determine the corresponding savings fund and hence sketch the graphs of consumption and
savings.

For the general consumption function:

𝐶𝐶 = 𝑎𝑎𝑎𝑎 + 𝑏𝑏

We have

𝑆𝑆 = 𝑌𝑌 – 𝐶𝐶

= 𝑌𝑌 – (𝑎𝑎𝑎𝑎 + 𝑏𝑏)

= (1 − 𝑎𝑎) 𝑌𝑌 – 𝑏𝑏

where (1 − 𝑎𝑎) is a slope of the savings function and Marginal propensity to save is denoted by
MPS.

𝑀𝑀𝑀𝑀𝑀𝑀 = 1 – 𝑎𝑎 = 1 – 𝑀𝑀𝑀𝑀𝑀𝑀

when 𝑌𝑌 = 0, 𝑆𝑆 = − 𝑏𝑏 which is the autonomous savings.

Note: If the economy is equilibrium

𝑌𝑌 = 𝐶𝐶 + 𝐼𝐼 ∗

where I* is the fixed planned investment

Example

Find the equilibrium level of income and consumption if the consumption function is:

𝐶𝐶 = 0.6𝑌𝑌 + 10

and the planned investment is 𝐼𝐼 = 14

Solution

In equilibrium 𝒀𝒀 = 𝑪𝑪 + 𝑰𝑰, substituting C and I we get

𝒀𝒀 = 𝟎𝟎. 𝟔𝟔𝟔𝟔 + 𝟏𝟏𝟏𝟏 + 𝟏𝟏𝟏𝟏

23
𝒀𝒀 = 𝟎𝟎. 𝟔𝟔𝟔𝟔 + 𝟐𝟐𝟐𝟐

𝒀𝒀 − 𝟎𝟎. 𝟔𝟔𝟔𝟔 + 𝟐𝟐𝟐𝟐

𝟎𝟎. 𝟒𝟒𝟒𝟒 = 𝟐𝟐𝟐𝟐

𝟎𝟎. 𝟒𝟒𝟒𝟒/𝟎𝟎. 𝟒𝟒 = 𝟐𝟐𝟐𝟐/𝟎𝟎. 𝟒𝟒

𝒀𝒀 = 𝟔𝟔𝟔𝟔

TWO SECTOR MODEL

Consider the following two-sector model:

Y =C + I
C = aY + b

where I is a constant (planned investment.) and depends on the rate of interest, r.

Planned investment is given by

I = cr + d,

where 𝑐𝑐 < 0 and 𝑑𝑑 > 0

NOTE: When r rises investment falls.

Example

Suppose

𝐶𝐶 = 0.8𝑦𝑦 + 100 … … … … . (1)

𝐼𝐼 = 20𝑟𝑟 + 1000 … … … . … . (2)

The commodity market is in equilibrium when,

𝑌𝑌 = 𝐶𝐶 + 𝐼𝐼 … … … … … … . (3)

Substituting equations (1) and(2) into equation (3) we get

24
Y = 0.8 y + 100 + (20r + 1000)
= 0.8y + 100 - 20r + 1000
= 0.8y - 20r = 1100
y - 0.8y + 20r = 1100
0.2y + 20r = 11000................(4)

This equation is called the IS-Scheduled and is relating Y and r.

Money market is in equilibrium when

𝑀𝑀𝑆𝑆 = 𝑀𝑀𝐷𝐷 (demand) for money is equal to the supply of money

MS is controlled by the central bank.

MS = MS* [MS*-fixed]

Types of demands

1) Transaction demand –daily exchange

2) Precautionary demand – unforeseen circumstances.

Lump sum of (1) and (2) gives

𝐿𝐿1 = 𝐾𝐾1𝑌𝑌

where L1-denotes aggregate transaction - precautionary demands and 𝑘𝑘 > 0.

3) Speculative demand is given by

L 2 = K 2r + K 3
where L 2 − speculativedemand K 2 < 0 and K 3 > 0

The total demand is given by ;

MD = L1 + L 2
= K 1Y + K 2 r + K 3

If the money market is in equilibrium, then

MD = MS = MS *
⇒ MS = K 1Y + K 2 + K 3
*

NOTE : Equilibrium exist in both commodity and money market.

25
This equation is called the LM-Scheduled and is relating Y and r.

Example

Determine the equilibrium income and interest rate given the following information about the
commodity market:

C = 0.8 y + 100
I = −20r + 1000

and the money market

MS = 2375
L1 = 0.1Y
L 2 = −25r + 2000

CHAPTER 2: NON-LINEAR EQUATIONS

2.1 Quadratic Equations
Quadratic equations are equations of the second degree. The standard form of form is given by

𝑎𝑎𝑥𝑥 2 + 𝑏𝑏𝑏𝑏 + 𝑐𝑐 = 0,

where 𝑎𝑎, 𝑏𝑏, 𝑐𝑐 are constants and 𝑎𝑎 ≠ 0.

A solution of a quadratic equation can be found by using the following methods:

• Factorization
• Quadratic formula

26
 −𝑏𝑏 ± √𝑏𝑏 2 − 4𝑎𝑎𝑎𝑎
𝑥𝑥 =
2𝑎𝑎

Example

Solve for x:

1. 2 x 2 + 9 x + 5 = 0
2. x 2 − 4 x + 4 = 0
3. x 2 − 5 x + 6 = 0

2.2 QUADRATIC FUNCTIONS

Definition: A quadratic function involving the independent variable 𝑥𝑥 and the dependent variable
𝑦𝑦 has the general form

𝑦𝑦 = 𝑓𝑓 (𝑥𝑥 ) = 𝑎𝑎𝑥𝑥 2 + 𝑏𝑏𝑏𝑏 + 𝑐𝑐,

where 𝑎𝑎, 𝑏𝑏, 𝑐𝑐 are constants and 𝑎𝑎 ≠ 0.

Graphical Representation

All quadratic functions have graphs as curves called parabolas.

Consider the function 𝑦𝑦 = 𝑥𝑥 2 then we have

The graph of the function is given in the figure given below.

27
Properties of Parabolas
a) A parabola which opens “upward” is said to be concave up. The above parabola is
concave up.
b) A parabola which opens “downward” is said to be concave down.
c) The point at which a parabola either concaves up or down is called the vertex (turning
point) of the parabola.

Note: A quadratic function of the form

𝑦𝑦 = 𝑎𝑎𝑥𝑥 2 + 𝑏𝑏𝑏𝑏 + 𝑐𝑐

−𝑏𝑏 4𝑎𝑎𝑎𝑎−𝑏𝑏2
has the vertex coordinates � , �.
2𝑎𝑎 4𝑎𝑎

As we have discussed earlier, here are the results about concavity.

• If 𝑎𝑎 > 0; the function will graph as parabola which is concave up.

• If 𝑎𝑎 < 0; the function will graph as parabola which is concave down.

Sketching of Parabola
Parabolas can be sketched by using the following strategy:
1. Concavity of the parabola
2. Y-intercept, where graph meets y-axis.
3. X-intercept, where graph meets x-axis
4. Vertex or turning point

How to find intercepts

1) Algebraically, 𝑦𝑦-intercept is obtained when the value of 𝑥𝑥 is equal to zero in the given
function.
2) Algebraically, 𝑥𝑥-intercept is obtained when the value of 𝑦𝑦 is set equal to zero

28
Methods to find the x-intercept
The 𝑥𝑥-intercept of a quadratic equation is determined by finding the roots of an equation.

1) Finding roots by factorisation:

If a quadratic can be factored, it is an easy way to find the roots, e.g. 𝑥𝑥 2 − 3𝑥𝑥 + 2 = 0 can
be written as (𝑥𝑥 − 1)(𝑥𝑥 − 2) = 0, which gives 𝑥𝑥 = 1,2 as its roots..

2) Finding roots by using the quadratic formula

The quadratic formula will always identify the real roots of an equation if any exist.
The quadratic formula of an equation which has the general form

−𝑏𝑏±√𝑏𝑏2 −4𝑎𝑎𝑎𝑎
will be 𝑥𝑥 = .
2𝑎𝑎

Taking the same example, we get

−(−3) ± �(−3)2 − 4(1)(2)
𝑥𝑥 =
2

3+√1 3−√1
𝑥𝑥 = or
2 2

So we get 𝑥𝑥 = 1,2 as solutions of the equation.

3.3 Quadratic functions; Applications

3.3.1 Quadratic Revenue Function

Suppose that the demand function for the product is Q = f(P).
Here 𝑞𝑞 is the quantity demanded and p is the price in rands. The total revenue R from selling Q
units of price P is stated as the product of P and Q or TR = PQ.

Since the demand function 𝑄𝑄 is stated in terms of price 𝑃𝑃, total revenue, TR can be stated as a
function of price,
T𝑅𝑅 = 𝑃𝑃. 𝑓𝑓(𝑄𝑄) = 𝑃𝑃𝑃𝑃.

If we let, 𝑄𝑄 = 1500 − 50𝑃𝑃, then 𝑇𝑇𝑇𝑇 = 1500𝑃𝑃 − 50𝑃𝑃2 .

3. 3.2 Quadratic supply function

Example

Market surveys of suppliers of a particular product have resulted in the conclusion that the supply
function is approximately quadratic in form. Suppliers were asked what quantities they would be

29
willing to supply at different market prices. The results of the survey indicated that at market prices
of R25, R30 and R 40, the quantities which suppliers would be willing to offer to the market were
112.5, 250 and 600 (thousands) units, respectively. Determine the equation of the quadratic
supply function?

Solution: We determine the solution by substituting the three price-quantity combinations into the
general equation

𝑄𝑄𝑠𝑠 = 𝑎𝑎𝑃𝑃2 + 𝑏𝑏𝑏𝑏 + 𝑐𝑐.

The resulting system of equations is

625𝑎𝑎 + 25𝑏𝑏 + 𝑐𝑐 = 112.5

900𝑎𝑎 + 30𝑏𝑏 + 𝑐𝑐 = 250

1600𝑎𝑎 + 40𝑏𝑏 + 𝑐𝑐 = 600

By solving the above system of equations, we get 𝑎𝑎 = 0.5, 𝑏𝑏 = 0, and 𝑐𝑐 = −200. Thus, the
quadratic supply function is represented by 𝑄𝑄𝑠𝑠 = 𝑓𝑓(𝑃𝑃) = 0.5 𝑃𝑃2 − 200.

3.3.3 Quadratic demand function

Example 1

A consumer survey was conducted to determine the demand function for the same product as in
the previous example discussed for supply function. The researchers asked consumers if they
would purchase the product at various prices and from their responses constructed estimates of
market demand at various market prices. After sample data points were plotted, it was concluded
that the demand relationship was estimated best by a quadratic function. The researchers
concluded that the quadratic representation was valid for prices between R5 and R45. Three data
points chosen for fitting the curve were (5, 2025), (10, 1600) and (20, 900). Just like last example,
substituting these data points into the general equation for a quadratic function and solving the
resulting system simultaneously gives the demand function

𝑄𝑄𝐷𝐷 = 𝑃𝑃2 − 100𝑃𝑃 + 2500.

Here 𝑄𝑄𝐷𝐷 is the demand stated in thousands of units and 𝑃𝑃 equals the selling price in rands.

EXAMPLE 2

Given the supply and demand function

30
P = QS2 + 14QS + 22
P = −Q D2 − 10Q D + 150

Calculate the equilibrium price and quantity

3.4 REVENUE, COST AND PROFIT.

Example

A firm’s total cost function is given by the equation as 𝑄𝑄 = 65 − 5𝑃𝑃. Fixed costs are 𝑅𝑅30 and each
unit produced costs an additional 𝑅𝑅2.

(a) Write down the equation for profit function in terms of Q.

(b) Find the break – even point(s) algebraically.
(c) Graph profit function and hence estimate the break-even point(s).
(d)

2.6 EXPONENTIAL AND LOGARITHMIC FUNCTIONS

Properties of exponents and radicals

If 𝑎𝑎, 𝑏𝑏 are positive numbers and 𝑚𝑚, 𝑛𝑛 are real numbers then:

1. 𝑏𝑏 𝑚𝑚 . 𝑏𝑏 𝑛𝑛 = 𝑏𝑏 𝑚𝑚+𝑛𝑛

𝑏𝑏 𝑚𝑚
2. = 𝑏𝑏 𝑚𝑚−𝑛𝑛 , 𝑏𝑏 ≠ 0
𝑏𝑏 𝑛𝑛

𝑛𝑛
3. 𝑏𝑏 𝑚𝑚 = 𝑏𝑏 𝑚𝑚.𝑛𝑛

4. 𝑎𝑎𝑚𝑚 . 𝑏𝑏 𝑚𝑚 = (𝑎𝑎𝑎𝑎)𝑚𝑚
𝑚𝑚 𝑚𝑚
𝑛𝑛 𝑛𝑛
5. 𝑏𝑏 𝑛𝑛 = √𝑏𝑏 𝑚𝑚 = � √𝑏𝑏�

6. 𝑏𝑏 0 = 1
1
7. 𝑏𝑏 −𝑚𝑚 =
𝑏𝑏 𝑚𝑚

Exponential Function

Definition: A function of the form bx , where b > 0, b ≠ 1 and x is any real number is called an
exponential function to the base x. e.g., f(x) = 10x .

31
Characteristics of function 𝒇𝒇(𝒙𝒙) = 𝒃𝒃𝒙𝒙 , 𝒃𝒃 > 𝟏𝟏

1. Each function 𝑓𝑓 is defined for all values of 𝑥𝑥. The domain of 𝑓𝑓 is the set of real numbers.
2. The graph of 𝑓𝑓 is entirely above the x-axis. The range of 𝑓𝑓 is the set of positive real
numbers.
3. The 𝑦𝑦-intercept occurs at (0,1). There is no 𝑥𝑥-intercept.
4. The value of 𝑦𝑦 approaches but never reaches zero as 𝑥𝑥 approaches negative infinity.
5. Function 𝑦𝑦 is an increasing function of 𝑥𝑥, i.e., for
𝑥𝑥1 < 𝑥𝑥2 , 𝑓𝑓(𝑥𝑥1 ) < 𝑓𝑓(𝑥𝑥2 ).
6. The larger the magnitude of the base 𝑏𝑏, the greater the rate of increase in 𝑦𝑦 as 𝑥𝑥 increases
in value.

Characteristics of function 𝒇𝒇(𝒙𝒙) = 𝒃𝒃𝒙𝒙 , 𝒃𝒃 < 𝟏𝟏

1. Each function 𝑓𝑓 is defined for all values of 𝑥𝑥. The domain of 𝑓𝑓 is the set of real numbers.
2. The graph of 𝑓𝑓 is entirely above the x-axis. The range of 𝑓𝑓 is the set of positive real
numbers.
3. The 𝑦𝑦-intercept occurs at (0,1). There is no 𝑥𝑥-intercept.
4. The value of 𝑦𝑦 approaches but never reaches zero as 𝑥𝑥 approaches positive infinity.
5. Function 𝑦𝑦 is a decreasing function of 𝑥𝑥, i.e. for
𝑥𝑥1 < 𝑥𝑥2 , 𝑓𝑓(𝑥𝑥1 ) > 𝑓𝑓(𝑥𝑥2 ).
6. The smaller the magnitude of the base 𝑏𝑏, the greater the rate of decrease in 𝑦𝑦 as 𝑥𝑥
increases in value.

Base 𝒆𝒆 exponential functions

A special class of exponential functions is of the form y = aemx , where e is an irrational number
approximately equal to 2.7183.

1. Base 𝑒𝑒 exponential functions also called as natural exponential functions and are
particularly appropriate in modelling continuous growth and decay process, continuous
compounding of interest.
2. Base 𝑒𝑒 exponential functions are more widely applied than any other class of functions.

The two special exponential functions are ex and e−x . The graph of ex is given by the following
figure.

32
Conversion to base 𝒆𝒆
There are instances where base e exponential functions are preferred to those having another
base. Exponential functions having a base other than 𝑒𝑒 can be transformed into equivalent base
𝑒𝑒 functions. For example, if we take 𝑒𝑒 𝑛𝑛 = 3𝑥𝑥 , then we have 𝑒𝑒 1.1 = 3. Thus 𝑒𝑒 1.1𝑥𝑥 = 3𝑥𝑥 = 𝑓𝑓(𝑥𝑥 ).
Any positive number 𝑥𝑥 can be expressed equivalently as some power of the base 𝑒𝑒, or we can
find an exponent 𝑛𝑛 such that 𝑒𝑒 𝑛𝑛 = 𝑥𝑥.

Applications of exponential functions

1. When a growth process is characterized by a constant per cent increase in value, it is
referred as an exponential growth process.
2. Decay processes: When a growth process is characterized by a constant per cent
decrease in value, it is referred as an exponential decay process.

Exponential functions have particular application to growth processes and decay processes.
Growth processes include population growth, appreciation in the value of assets, inflation,
growth in the rate at which some resources (like energy) are used. Decay processes include
declining value of certain assets such as machinery, decline in the efficiency of machine,
decline in the rate of incidence of certain diseases with the improvement of medical
research and technology. Both processes are usually stated in terms of time.

Example 1 (Population Growth Process)

This function characterized by a constant percentage of increase in the value over time. Such
process may be described by the general function; 𝑉𝑉 = 𝑓𝑓(𝑡𝑡) = 𝑉𝑉0 𝑒𝑒 𝑘𝑘𝑘𝑘 ,

where
𝑉𝑉 = value of function at time 𝑡𝑡,
𝑉𝑉0 =value of function at time 𝑡𝑡 = 0,
𝑘𝑘 = percentage rate of growth,
𝑡𝑡= time measured in the appropriate units (hours, days, weeks, years, etc).

The population of a country was 100 million in 1990 and is growing at the constant rate of 4 per
cent per year. The size of populations is
𝑃𝑃 = 𝑓𝑓(𝑡𝑡) = 100𝑒𝑒 0.04 𝑡𝑡 .

33
The projected population for 2015, will be

𝑃𝑃 = 𝑓𝑓(25) = 100 𝑒𝑒 0.04(25) = 271.83 Million.

Example 2 (Decay functions: Price of a machinery)

The general form of the exponential decay function is

𝑉𝑉 = 𝑓𝑓(𝑡𝑡) = 𝑉𝑉0 𝑒𝑒 −𝑘𝑘𝑘𝑘 .

The resale value 𝑉𝑉 of certain type of industrial equipment has been found to behave according to
the function
𝑉𝑉 = 𝑓𝑓(𝑡𝑡) = 100,000𝑒𝑒 −0.1𝑡𝑡
then
a) Find original value of the price of equipment.
b) its value after 5 years.
Solution: a) We need to find 𝑓𝑓 at 𝑡𝑡 = 0, so

𝑓𝑓(0) = 100,000𝑒𝑒 0 = 100,000.

Thus, the original price is R100,000.

b) After 5 years the value will be

𝑓𝑓(5) = 100,000 𝑒𝑒 0.1(5) = 𝑅𝑅60,650.

Example 3 (Homogenous function)

The output, Q of any production process depends on inputs (factors of production)

i.e. land. Capital, labour, enterprise etc.

1. Capital – k

2. Labour - L

Q depends of K and L

i.e. 𝑄𝑄 = 𝑓𝑓(𝐾𝐾, 𝐿𝐿) – production function

We need to determine the effect of Q when K and L (inputs) are scaled in some way.

34
 1 1
If Q = 100k 3 L2 and k = 27 and L = 100, then
1 1
Q = 100(27) 3 (100) 2
1 1

= 100(33 ) 3 (10 2 )
2

= 100(3)(10)
= 3000

If K and L are scaled

K = 2K and L= 2L

1 1
⇒ Q = 100(2 K ) (2 L) 3 2

1 1 1 1
= 100 • 2 • k • 2 • L 3 3 2 2

 1 1
 1 1

=  2 3 • 2 2 100 K 3 L2 
  
1 1
= 1.78(100k 3 L2 )
1.78 < 2
⇒ Scale factor =
Replace K and L by λk and λL respectively
1 1
Q = 100k L becomes
3 2

1 1
= 100(λk) (λL) 3 2


1 1 1 1

= (λ λ )100K 3 L2 
3 2

 
5
=λ 6
<λ
⇒ the production funnction exhibits decreasing returns to scale.

Generally, a production function

𝑄𝑄 = 𝑓𝑓 (𝐾𝐾; 𝐿𝐿) is homogenous if:

𝑓𝑓 (𝜆𝜆𝜆𝜆, 𝜆𝜆𝜆𝜆) = 𝜆𝜆 n 𝑓𝑓 (𝐾𝐾; 𝐿𝐿) some number, n.

Where n is the degree of homogeneity.

35
If the degree of homogeneity, n statistics

1) 𝒏𝒏 < 𝟏𝟏, the function is said to display decreasing return to scale.

2) 𝒏𝒏 = 𝟏𝟏, the function is said to display constant return to scale.
3) 𝒏𝒏 > 𝟏𝟏, the function is said to display increasing return to scale.

Example

Given: Q = 2 K 1 / 2 L3 / 2

Show that the production function is homogeneous and find its degree of homogeneity..

Solution

f ( K , L) = 2 K 1 / 2 L3 / 2

Replacing K and L by 𝜆𝜆𝜆𝜆 and 𝜆𝜆𝜆𝜆 respectively, we get,

f ( λ K ; λ L ) = 2( λ K ) 1 / 2 ( λ L ) 3 / 2
= 2λ1 / 2 K 1 / 2 λ3 / 2 L3 / 2
= (λ1 / 2 λ3 / 2 )(2 K 1 / 2 L3 / 2 )
= λ2 (2 K 1 / 2 L3 / 2 )

⇒ degree of homogeneity is 2.
Since 2 > 1 ⇒ the function has increase return to scale.

CHAPTER 3: MATHEMATICS OF FINANCE

36
Definition 1: The interest is a fee which is paid for having the use of money.

We pay interest on loans for having the use of bank’s money. Similarly, the bank pay us interest
on money invested in savings accounts because the bank has temporary access to our money.
Note

1. Interest is usually paid in proportion to the principal amount and the period of time
over which the money is used.
2. The interest rate specifies the rate at which the interest accumulates.
3. It is typically stated as a percentage of the principal amount per period of time, e.g.
18 % per year, 12 % quarterly or 13.5 % per month.

Definition 2: The amount of money that is lent or invested is called the principal.

3.1. Simple Interest

Definition 3: Interest that is paid solely on the amount of the principal is called simple interest.

Simple interest is usually associated with loans or investments which are short-term in nature,
computed as
𝐼𝐼 = 𝑃𝑃 × 𝑖𝑖 × 𝑡𝑡.
𝐼𝐼 = simple interest
𝑃𝑃 = principal
𝑖𝑖 = interest rate per time period
𝑡𝑡 = number of time periods

While calculating the interest 𝐼𝐼, it should be noted that both 𝒊𝒊 and 𝒕𝒕 are consistent with each
other, i.e. expressed in same duration.

Example
A credit union has issued a 3-year loan of R5 000. Simple interest is charged at the rate of 10%
per year. The principal plus interest is to be repaid at the end of the third year. Compute the
interest for the 3-year period. What amount will be repaid at the end of the third year?

Solution: Here 𝑃𝑃 = 5,000, = 0.1, 𝑡𝑡 = 3. therefore by using the above formula, we get the simple
interest

𝐼𝐼 = (5,000)(0.1)(3) = 𝑅𝑅1,500.

3.2 Compound Interest

In compound interest, the interest earned each period is reinvested, i.e. added to the principal for
purposes of computing interest for the next period. The amount of interest computed using this

37
procedure is called the compound interest.

To get a general formula, we let

𝑃𝑃 = principal,
𝑖𝑖 = interest rate per compounding period
𝑡𝑡= number of compounding periods (number of periods in which the principal has earned interest)
𝑆𝑆= compound amount after 1 period
𝑆𝑆 = 𝑃𝑃(1 + 𝑖𝑖 ).

Compound amount after 2 periods

= 𝑃𝑃 (1 + 𝑖𝑖 ) + 𝑖𝑖[𝑃𝑃(1 + 𝑖𝑖)] = 𝑃𝑃 (1 + 𝑖𝑖 )2

Similarly, compound amount after 3 periods = 𝑃𝑃(1 + 𝑖𝑖 )3 .

Thus after 𝑛𝑛 periods the compound amount 𝑆𝑆 = 𝑃𝑃(1 + 𝑖𝑖 )𝑛𝑛 .

Note: The compound amount 𝑆𝑆 is an exponential function of the number of compounding

periods 𝑛𝑛,

so 𝑆𝑆 = 𝑓𝑓(𝑛𝑛).

Definition 4: The expression (1 + 𝑖𝑖 )𝑛𝑛 is called a compound amount factor or scale factor.

3.2.1. Compounding daily, monthly, quarterly and semi-annually

Example
Assume that we have deposited R1 000 in a credit union which pays interest of 8% per year
compounded
a) annually
b) semi-annually
c) quarterly
d) monthly
e) weekly.

Compare the returns on the investment as the number of frequency increases.

3.2.2. Continuous compounding

The continuous compounding can be thought of as occurring infinite number of times. It can be
computed by the following formula.

Continuous compounding formula is given by

𝑆𝑆 = 𝑃𝑃𝑒𝑒 𝑖𝑖𝑖𝑖 ,

38
where

𝑖𝑖 = rate of interest, 𝑡𝑡 = time period, 𝑃𝑃 = principal.

Exercise

1. A principal of R2 000 is invested at 10% interest compounded continuously. After how

many days will the investment first exceed R2 100?

2. Determine the rate of interest required for a principal of R1 000 to produce a future value
of R 4 000 after 10 years compounded continuously

Note: The value of an investment increases with increased frequency of compounding. If we

compute the interest by using different frequency, we get the following.
1. Simple interest in 10 years will raise the amount to 𝑅𝑅20,000.
2. Annual compounding in 10 years will raise the amount to 𝑅𝑅25,937.
3. Semi-annual compounding in 10 years will raise the amount to 𝑅𝑅26,533.
4. Quarterly compounding in 10 years will raise the amount to 𝑅𝑅26,830.

3.3. Effective Interest Rates

The stated annual interest rate is usually called nominal rate. We know that when interest is
compounded more frequently, then interest earned is greater than earned when compounded
annually. When compounding is done more frequently than annually, then effective annual
interest rates can be determined.

Let 𝑟𝑟 equals the effective annual interest rate, 𝑖𝑖 is the nominal annual interest rate and 𝑚𝑚 is the
number of compounding periods per year. The equivalence between the two rates suggests that
if a principal 𝑃𝑃 is invested for 𝑛𝑛 years, the two compound amounts would be the same, or
𝑖𝑖 𝑛𝑛𝑛𝑛
𝑃𝑃(1 + 𝑟𝑟)𝑛𝑛 = 𝑃𝑃 �1 + �
𝑚𝑚
Solving for 𝑟𝑟, we get
𝑖𝑖 𝑚𝑚
𝑟𝑟 = �1 + � −1
𝑚𝑚

• When the nominal rate is compounded m times per year,

𝑖𝑖 𝑚𝑚
𝐴𝐴𝐴𝐴𝐴𝐴 = �1 + � −1
𝑚𝑚

• When the nominal rate is compounded continuously,

39
 𝐴𝐴𝐴𝐴𝐴𝐴 = 𝑒𝑒 𝑖𝑖 − 1

3.4. Depreciation

This is an allowance made for wear and tear of equipment during the production process. This
involves the deduction of money from the original asset value, A, each year There are two
depreciation techniques namely straight–line and reducing balance depreciation

3.4.1. Straight-line depreciation

This is the converse of simple interest with equal amounts being subtracted from the original asset
value

3.4.2. Reducing-balance depreciation

Reducing balance is the converse of compound interest with large amount being subtracted from
the original asset value each year. It can be calculated from the formula

𝑆𝑆 = 𝑃𝑃(1 − 𝑖𝑖)𝑡𝑡

where

S = value of the asset after t years taking account of depreciation

P = original value of the asset

i = depreciation rate expressed as a percentage

t = number of time periods usually in years.

Example

A machine costing R30 000 depreciates by 15% compounded annually. Calculate the value of
the machine after five years. What is the total amount of depreciation?

3.5. Present Value Computation (Discounting)

The compound amount formula
𝑆𝑆 = 𝑃𝑃 (1 + 𝑖𝑖 )𝑛𝑛
is an equation involving four variables, .i.e. 𝑆𝑆, 𝑃𝑃, 𝑖𝑖, 𝑛𝑛.
Thus knowing the values of any of the 3 variables, we can easily find the 4th one.

If the compounding formula is transpose to P, the new formula will be written as:
𝑆𝑆
𝑃𝑃 = = 𝑆𝑆(1 + 𝑖𝑖)−𝑛𝑛
(1 + 𝑖𝑖 )𝑛𝑛
For continuous compounding the formula is

40
 𝑃𝑃 = 𝑆𝑆𝑒𝑒 −𝑟𝑟𝑟𝑟

The process of calculating the original principal is called discounting and the principal, P is called
the present value. The rate of interest is called the discount rate.

Example

Find the present value of R 1000 in 4 years’ time if the discount rate is 10% compounded

a) Semi-annually
b) Continuously.
1
Definition 4 The factor (1+𝑖𝑖)𝑛𝑛 or (1 + 𝑖𝑖 )−𝑛𝑛 is called the present value factor.

3.5.1 Investment Appraisal

Present values are very much useful in appraising investments projects. This is done by
quantifying the profit which is found by calculating the difference between the present value and
the initial outlay and is given by

𝑁𝑁𝑁𝑁𝑁𝑁 = 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣 – 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜

The project is considered to be worthwhile if the net present value is positive. If a decision is to
be made between two projects, the project with the higher NPV is preferred.

The alternative method of assessing investments projects is the internal rate of return (IRR)
method. The project is considered to be worthwhile, if the IRR exceeds the market rate.

Example

A project requiring an initial outlay of R15 000 is guaranteed to produce a return of R20 000 in 3
years, time. Use the

1. Net present value

2. Internal rate of return

methods to decide whether this investment is worthwhile if the prevailing market rate is 5%
compounded annually. Would your decision be affected if the interest rate was 12%?

3.6. ANNUITIES
3.6.1. Annuities and their Future value

41
An annuity is a series of periodic payments, e.g. monthly car payment, regular deposits to savings
accounts, insurance payments.
• We assume that an annuity involves a series of equal payments.
• All payments are made at the end of a compounding period, e.g. a series of
payments 𝐴𝐴0 , each of which equals 𝑅𝑅1000 at the end of each period, earn full
interest in the next period and does not qualify for the interest in the previous
period.

Example 1
A person plans to deposit R1000 in a tax-exempt savings plan at the end of this year and an equal
sum at the end of each year following year. If interest is expected to be earned 6 % per year
compounded annually, to what sum will the investment grow at the time of the 4th deposit?

Solution:
We can determine the value of 𝑆𝑆4 by applying the compound amount formula to each deposit,
determining its value at the time of the 4-th deposit. These compound amounts may be summed
for the four deposits to determine S4 .

First deposit earns interest for 3 years, 4th deposit earns no interest. The interest earned on first
3 deposits is R 374.62. Thus S4 = 4374.62.

Formula
In general to compute the sum 𝑆𝑆𝑛𝑛 , we use the following formulae.

[(1+𝑖𝑖)𝑛𝑛 −1]
𝑉𝑉𝐴𝐴𝐴𝐴𝐴𝐴,𝑇𝑇 = 𝐴𝐴0
𝑖𝑖

or

𝑎𝑎[(𝑟𝑟)𝑛𝑛 − 1]
𝑆𝑆𝑛𝑛 =
𝑟𝑟 − 1

where

𝑆𝑆𝑛𝑛 is the sum of n terms, 𝑎𝑎 is the first term, 𝑟𝑟 denotes geometric ratio and 𝑛𝑛 denotes the number
of terms.

Example 1

To provide for the future education costs, a family considers various methods of saving. Assume
saving will continue for a period of 10 years at an interest rate of 7.5% per annum.

1. Calculate the value of the fund at the end of 10 years when a single deposit of R2 000 is
made annually.
2. How much should be deposited each year if the final value of the fund is R40 000?

42
EXERCISE

1. A boy plans to deposit R50 in a savings account at the end of each year for the next 6
years. Interest is earned at the rate of 8% per year compounded quarterly. What should
her account balance be 6 years from now? How much interest will he earn?

2. A corporation wants to establish a fund beginning at the end of this year. Annual deposits will
be made at the end of this year and for the following 9 years. If deposits earn interest at the
rate of 8 % per year compounded semi-annually, how much money must be deposited each
year in order to have R 12 million at the time of the 10th deposit? How much interest will be
earned?

3. Assume in example 2 that the corporation is going to make monthly deposits and that the
interest is earned at the rate of 8 % per year compounded monthly. How much money should
be deposited each month?

3.6.2. Annuities and their Present value

There are applications which relate an annuity to its present value. e.g. we may be interested in
knowing the size of a deposit which will generate a series of payments (an annuity) for college,
retirement years, or given that a loan has been made, we may be interested in knowing the series
of payments (annuity) necessary to repay the loan with interest.

The present value of an annuity is an amount of money today which is equivalent to a series of
equal payments in the future. An assumption is that: the final withdrawal would deplete the
investment completely.

The present value of an annuity can be calculated from the formula

1 − [(1 + 𝑖𝑖 )−𝑡𝑡 ]
𝑉𝑉0 = 𝐴𝐴0
𝑖𝑖

Example 1
A person recently won a state lottery. The terms of the lottery are that the winner will receive
annual payments of R 20 000 at the end of this year and each of the following 3 years. If the
winner could invest money today at the rate of 8 % per year compounded annually, what is the
present value of the four payments?

Solution: If 𝑉𝑉0 defines the present value of the annuity, we might determine the value by
computing the present value of each 20000 payment. Here 𝑆𝑆 = 20000, 𝑖𝑖 = 0.08 then using 𝑃𝑃 =
𝑆𝑆
(1+𝑖𝑖)𝑛𝑛
For 𝑛𝑛 = 1 => 𝑃𝑃 = 𝑅𝑅18 518.6

43
For 𝑛𝑛 = 2 => 𝑃𝑃 = 𝑅𝑅17 146.8

For 𝑛𝑛 = 3 => 𝑃𝑃 = 𝑅𝑅15 876.6

For 𝑛𝑛 = 4 => 𝑃𝑃 = 𝑅𝑅14 700.6

Solution: If A defines the present value of the annuity, we might determine the value of A by
computing the present value of each 20000 payment. Here 𝑆𝑆 = 20000, 𝑖𝑖 = 0.08 then using 𝑃𝑃 =
𝑆𝑆
(1+𝑖𝑖)𝑛𝑛
For 𝑛𝑛 = 1 => 𝑃𝑃 = 𝑅𝑅18 518.6

For 𝑛𝑛 = 2 => 𝑃𝑃 = 𝑅𝑅17 146.8

For 𝑛𝑛 = 3 => 𝑃𝑃 = 𝑅𝑅15 876.6

For 𝑛𝑛 = 4 => 𝑃𝑃 = 𝑅𝑅14 700.6

Calculating the sum we get 𝐴𝐴 = 𝑅𝑅66 242.6.

Example 2
Parents of a teenager girl want to deposit a sum of money which will earn interest at the rate of 9
% per year compounded semi-annually. The deposit will be used to generate a series of 8 semi-
annual payments of R 2500 beginning 6 months after the deposit. These payments will be used
to help finance their daughter’s college education. What amount must be deposited to achieve
their goal? How much interest will be earned?

0.09
Solution: Here 𝐴𝐴 = 2500, 𝑖𝑖 = = 0.045, 𝑛𝑛 = 8.
2
Thus we find 𝑉𝑉 = 𝑅𝑅16 489.73
Since R16 489.73 will generate eight payments totalling R20 000, interest earned will be 20 000
– 16 489.73 = R3 510.27.

3.7. LOAN REPAYMENT/AMORTIZATION

A loan is said to be amortised if:

• both the principal and interest are to be repaid by a series of equal payments
• the payments are made at equal interval of time,
• an interest rate is fixed throughout the loan repayment period.

In order to repay the loan, the following formula can be used:

𝑖𝑖
𝐴𝐴0 = 𝐿𝐿
1 − [(1 + 𝑖𝑖 )−𝑡𝑡 ]

where

44
L is the loan amount, A0 is the monthly payment i and t are the interest rate and time respectively.

Example 1

A loan of R5 000 is to be paid in four equal payments at the end of each quarter. Assuming that
an interest rate of 20%, calculate:

a) the amount of each payment

b) the present value of the loan
c) the total amount of interest paid
d) the amount of interest paid each quarter.

Example 2

For example given a loan of R10 000 which is received today, what quarterly payments must be
made to repay the loan in 5 years if interest is charged at the rate of 10 % per year, compounded
quarterly? How much interest will be paid on the loan?

0.1
Solution: Here 𝐿𝐿 = 10,000, 𝑖𝑖 = = 0.025, 𝑛𝑛 = 20.
4

There will be 20 payments totalling to R12 830, thus interest will be equal to R2 830 on the loan.

3.8 Sinking Fund

The value of a sinking fund, payment, 𝐴𝐴0 made at the beginning of each year, and can be
calculated from the formula

[(1 + 𝑖𝑖 )𝑡𝑡 − 1]
𝑉𝑉𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆,𝑇𝑇 = 𝐴𝐴0 (1 + 𝑖𝑖)
𝑖𝑖

Example

A taxi service must replace cars every five years at a cost of R450 000. At an *% rate of interest,
calculate:

a) the size of the fund if R4 000 is deposited at the beginning of each months.
b) the size of each quarterly payment to meet this target

`CHAPTER 4: DIFFERENTIATION
This chapter examines the calculus and its application to business, economics, and other areas
of problem solving. Two major areas of study within the calculus are differential calculus and

45
integral calculus. Differential calculus focuses on rates of change in analyzing a situation.
Graphically, differential calculus solves of following problem: Given a function whose graph is a
smooth curve and given a point in the domain of the function, what is the slope of the line tangent
to the curve at this point.

4.1.Limits
Two concepts are important in the theory of differential and integral calculus are the limit of a
function and continuity.

Limits of Functions
In calculus, there is often an interest in the limiting value of a function as the independent variable
approaches some specific real number. This limiting value, when it exists, is called limit. The
notation
lim 𝑓𝑓(𝑥𝑥 ) = 𝐿𝐿
𝑥𝑥→𝑎𝑎
is used to express the limiting value of a function. When investigating a limit, one is asking
whether 𝑓𝑓(𝑥𝑥) approaches a specific value 𝐿𝐿 as the value of 𝑥𝑥 gets closer and closer to 𝑎𝑎.

Notation of Limits
The notation
lim− 𝑓𝑓(𝑥𝑥 ) = 𝐿𝐿
𝑥𝑥→𝑎𝑎
represents the limit of 𝑓𝑓(𝑥𝑥) as 𝑥𝑥 approaches ‘𝑎𝑎’ from the left (left-hand limit).
The notation
lim+ 𝑓𝑓(𝑥𝑥 ) = 𝐿𝐿
𝑥𝑥→𝑎𝑎

represents the limit of 𝑓𝑓(𝑥𝑥) as 𝑥𝑥 approaches ‘𝑎𝑎’ from the right (right-hand limit).
If the value of the function approaches the same number 𝐿𝐿 as 𝑥𝑥 approaches ‘𝑎𝑎’ from either
direction, then the limit is equal to 𝐿𝐿.

Test For Existence Of Limit

If lim 𝑓𝑓(𝑥𝑥) = 𝐿𝐿= lim+ 𝑓𝑓(𝑥𝑥) then

𝑥𝑥→𝑎𝑎− 𝑥𝑥→𝑎𝑎

lim 𝑓𝑓(𝑥𝑥) = 𝐿𝐿
𝑥𝑥→𝑎𝑎

If the limiting values of 𝑓𝑓(𝑥𝑥) are different when 𝑥𝑥 approaches 𝑎𝑎 from each direction, then the
function does not approach a limit as 𝑥𝑥 approaches 𝑎𝑎.

Example
Determine whether the lim 𝑥𝑥 3 exists or not?
𝑥𝑥→2

Solution: In determine the limit

46
let’s construct a table of assumed value for x and corresponding values for f(x).
The following table indicates these values.

Note that the value of 𝑥𝑥 = 2 has been approached from both the left and the right. From either
direction, f(x) is approaching the same value, 8.

Properties Of Limits and Continuity

1. If 𝑓𝑓(𝑥𝑥) = 𝑐𝑐, where is real, then

lim 𝑓𝑓(𝑥𝑥 ) = 𝑐𝑐
𝑥𝑥→𝑎𝑎

2. If 𝑓𝑓(𝑥𝑥) = 𝑥𝑥 𝑛𝑛 , where 𝑛𝑛 is a positive integer, then

lim 𝑥𝑥 𝑛𝑛 = 𝑎𝑎𝑛𝑛
𝑥𝑥→𝑎𝑎

3. If f(x) has a limit as 𝑥𝑥 → 𝑎𝑎 and c is any real number, then

lim 𝑐𝑐. 𝑓𝑓(𝑥𝑥 ) = 𝑐𝑐. lim 𝑓𝑓(𝑥𝑥 )
𝑥𝑥→𝑎𝑎 𝑥𝑥→𝑎𝑎

4. If lim 𝑓𝑓(𝑥𝑥 ) and lim 𝑔𝑔(𝑥𝑥 ) exist, then

𝑥𝑥→𝑎𝑎 𝑥𝑥→𝑎𝑎
lim [𝑓𝑓(𝑥𝑥 ) ± 𝑔𝑔(𝑥𝑥 )] = lim 𝑓𝑓 (𝑥𝑥 ) ± lim 𝑔𝑔(𝑥𝑥 )
𝑥𝑥→𝑎𝑎 𝑥𝑥→𝑎𝑎 𝑥𝑥→𝑎𝑎

5. If lim 𝑓𝑓(𝑥𝑥 ), lim 𝑔𝑔(𝑥𝑥 )exist, then

𝑥𝑥→𝑎𝑎 𝑥𝑥→𝑎𝑎
lim [𝑓𝑓(𝑥𝑥 ). 𝑔𝑔(𝑥𝑥 )] = lim 𝑓𝑓(𝑥𝑥 ) . lim 𝑔𝑔(𝑥𝑥 )
𝑥𝑥→𝑎𝑎 𝑥𝑥→𝑎𝑎 𝑥𝑥→𝑎𝑎

6. If lim 𝑓𝑓(𝑥𝑥 ) and lim 𝑔𝑔(𝑥𝑥 ) exist, then

𝑥𝑥→𝑎𝑎 𝑥𝑥→𝑎𝑎
lim 𝑓𝑓(𝑥𝑥 )
𝑓𝑓(𝑥𝑥 ) 𝑥𝑥→𝑎𝑎
lim =
𝑥𝑥→𝑎𝑎 𝑔𝑔 (𝑥𝑥 ) lim 𝑔𝑔(𝑥𝑥 )
𝑥𝑥→𝑎𝑎

Limits and Infinity

47
Frequently there is an interest in the behavior of a function as the independent variable becomes
large without limit (“approaching” either positive or negative infinity).

Horizontal Asymptote

The line 𝑦𝑦 = 𝑎𝑎 is a horizontal asymptote of the graph of 𝑓𝑓 if and only if

lim 𝑓𝑓(𝑥𝑥 ) = 𝑎𝑎
𝑥𝑥→∞

Vertical Asymptote
The line 𝑥𝑥 = 𝑎𝑎 is a vertical asymptote of the graph of 𝑓𝑓 if and only if
lim 𝑓𝑓(𝑥𝑥 ) = ∞
𝑥𝑥→𝑎𝑎

4.2.Continuity

In an informal sense, a function is described as continuous if it can be sketched without lifting

your pen or pencil from the paper (i.e., it has no gaps, no jumps, and no breaks). A function that
is not continuous is termed as discontinuous.

Continuity at a Point
A function f is said to be continuous at 𝑥𝑥 = 𝑎𝑎 if

1- the function is defined at 𝑥𝑥 = 𝑎𝑎, and

2- lim 𝑓𝑓(𝑥𝑥 ) = 𝑓𝑓(𝑎𝑎)
𝑥𝑥→𝑎𝑎

Examples
Determine that 𝑓𝑓(𝑥𝑥) = 𝑥𝑥 3 is continuous at 𝑥𝑥 = 2.
Solution: Since
lim 𝑥𝑥 3 = 𝑓𝑓(2) = 8.
𝑥𝑥→2
Thus 𝑓𝑓 is continuous at 𝑥𝑥 = 2.

Average Rate of Change and the Slope

The slope of a straight line can be determined by the two-point formula
∆y y 2 − y1
m = =
∆x x 2 − x1
The slope provides an exact measure of the rate of change in the value of y with respect to a
change in the value of x.

48
With nonlinear functions the rate of change in the value of y with respect to a change in x is not
constant. One way of describing nonlinear functions is by the average rate of change over some
interval.
In moving from point A to point B, the change in the value of x is (x + Δx) – x, or Δx. The
associated change in the value of y is
Δy = f(x + Δx) – f(x)
The ratio of these changes is.
Δ𝑦𝑦 𝑓𝑓(𝑥𝑥 + Δ𝑥𝑥) − 𝑓𝑓(𝑥𝑥 )
=
Δ𝑥𝑥 Δ𝑥𝑥
The above equation is sometimes referred to as the difference quotient.

4.3.The Derivative

Given a function of the form y = f(x), the derivative of the function is defined as
𝑑𝑑𝑑𝑑 Δ𝑦𝑦 𝑓𝑓(𝑥𝑥 + Δ𝑥𝑥) − 𝑓𝑓 (𝑥𝑥 )
= lim = lim
𝑑𝑑𝑑𝑑 Δ𝑥𝑥→0 Δ𝑥𝑥 Δ𝑥𝑥→0 Δ𝑥𝑥

If this limit exists.

Comments About the Derivative

i. The above equation is the general expression for the derivative of the function f.
ii. The derivative represents the instantaneous rate of change in the dependent variable
given a change in the independent variable. The notation 𝑑𝑑𝑑𝑑/𝑑𝑑𝑑𝑑 is used to represent the
instantaneous rate of change in y with respect to a change in 𝑥𝑥. This notation is
distinguished from 𝛥𝛥𝑦𝑦/𝛥𝛥𝑥𝑥 which represents the average rate of change.
iii. The derivative is a general expression for the slope of the graph of 𝑓𝑓 at any point 𝑥𝑥 in the
domain.

The process of finding the derivative is called differentiation.

4.4. Rules of Differentiation

Rule 1: Constant Function

If 𝑓𝑓(𝑥𝑥) = 𝑐𝑐, where 𝑐𝑐 is any constant then
𝑓𝑓′(𝑥𝑥 ) = 0.

49
Rule 2: Power Rule
𝑑𝑑𝑑𝑑
If 𝑓𝑓(𝑥𝑥 ) = 𝑥𝑥 𝑛𝑛 → = 𝑛𝑛𝑥𝑥 𝑛𝑛−1 ,
𝑑𝑑𝑑𝑑
where 𝑛𝑛 is a real number.

Algebra Flashback
𝑚𝑚
1 𝑛𝑛
Recall that = 𝑥𝑥 −𝑛𝑛 , √𝑥𝑥 𝑚𝑚 = 𝑥𝑥 𝑛𝑛 .
𝑥𝑥 𝑛𝑛

Rule 3: Constant Times Function

If 𝑓𝑓(𝑥𝑥) = 𝑐𝑐. 𝑔𝑔(𝑥𝑥), where 𝑐𝑐 is a constant and 𝑔𝑔 is a differentiable function then
′(𝑥𝑥 ) = 𝑐𝑐. 𝑔𝑔′ (𝑥𝑥 )

Rule 4: Sum or Difference of Functions

If 𝑓𝑓(𝑥𝑥) = 𝑢𝑢(𝑥𝑥) ± 𝑣𝑣(𝑥𝑥), where 𝑢𝑢 and 𝑣𝑣 are differentiable,
𝑓𝑓′(𝑥𝑥) = 𝑢𝑢′(𝑥𝑥) ± 𝑣𝑣′(𝑥𝑥),

Rule 5: Product Rule

If 𝑓𝑓(𝑥𝑥) = 𝑢𝑢(𝑥𝑥) . 𝑣𝑣(𝑥𝑥), where 𝑢𝑢 and 𝑣𝑣 are differentiable,

𝑓𝑓′(𝑥𝑥) = 𝑢𝑢′(𝑥𝑥). 𝑣𝑣(𝑥𝑥) + 𝑣𝑣′(𝑥𝑥). 𝑢𝑢(𝑥𝑥)

Rule 6: Quotient Rule

𝑢𝑢(𝑥𝑥)
If 𝑓𝑓(𝑥𝑥) = , where u and v are differentiable and 𝑣𝑣(𝑥𝑥) ≠ 0, then
𝑣𝑣(𝑥𝑥)
v ( x ).u ' ( x ) − u ( x ).v ' ( x )
f ' ( x) =
[v ( x )]2
Rule 7: If 𝑓𝑓(𝑥𝑥 ) = [𝑢𝑢(𝑥𝑥 )]𝑛𝑛 then
𝑓𝑓 ′ (𝑥𝑥) = 𝑛𝑛 ∙ [𝑢𝑢(𝑥𝑥 )]𝑛𝑛−1 ∙ 𝑢𝑢′(𝑥𝑥)

RULE 8: Base-e Exponential Functions

If 𝑓𝑓(𝑥𝑥 ) = 𝑒𝑒 𝑢𝑢(𝑥𝑥) , where 𝑢𝑢 is differentiable, then

𝑓𝑓 ′ (𝑥𝑥) = 𝑢𝑢′ (𝑥𝑥 )𝑒𝑒 𝑢𝑢(𝑥𝑥)

Rule 9: Natural Logarithm Functions

If𝑓𝑓(𝑥𝑥 ) = 𝑙𝑙𝑙𝑙 𝑢𝑢(𝑥𝑥) , where 𝑢𝑢 is differentiable, then

𝑢𝑢′(𝑥𝑥)
𝑓𝑓 ′ (𝑥𝑥) =
𝑢𝑢(𝑥𝑥)

50
Rule 10: Chain Rule
If 𝑦𝑦 = 𝑓𝑓(𝑢𝑢), is a differentiable function and 𝑢𝑢 = 𝑔𝑔(𝑥𝑥) is a differentiable function, then

𝑑𝑑𝑑𝑑 𝑑𝑑𝑑𝑑 𝑑𝑑𝑑𝑑

= ∙
𝑑𝑑𝑑𝑑 𝑑𝑑𝑑𝑑 𝑑𝑑𝑑𝑑

Exercise
Find the derivative of the following functions:
1. 𝑌𝑌 = 5𝑥𝑥 7
2
2. 𝐶𝐶 = 5 +
𝑄𝑄
2
3. 𝑌𝑌 =
3√𝑋𝑋
2
4. 𝑄𝑄 = 𝑃𝑃 + 𝑃𝑃 + 1
5. 𝑇𝑇𝑇𝑇 = 50𝑄𝑄 − 3𝑄𝑄2
6. 𝑄𝑄 = 10√10
7. 𝜋𝜋 = −2𝑄𝑄3 + 15𝑄𝑄2 − 24𝑄𝑄 − 3

4.4.The higher order derivatives

If a function, 𝑦𝑦 = 𝑓𝑓(𝑥𝑥) is differentiated for the first time, we get a function which can be
differentiated for the second time. The second order derivative is written as

𝑑𝑑 2 𝑦𝑦
𝑓𝑓 ′′ (𝑥𝑥 ) 𝑜𝑜𝑜𝑜 .
𝑑𝑑𝑥𝑥 2

The Second Derivative:

As the first derivative is a measure of the instantaneous rate of change in the value of 𝑦𝑦 with
respect to a change in 𝑥𝑥, the second derivative is a measure of the instantaneous rate of change
in the value of the first derivative with respect to the change in 𝑥𝑥. The second order derivative is
used to find and confirm maximum and minimum point, and point of inflection.

Determine the first and second derivatives of the following functions

1. 𝑃𝑃 = 25𝑄𝑄4 − 10𝑄𝑄2 + 20𝑄𝑄

𝑄𝑄 3 5𝑄𝑄
2. 𝑇𝑇𝑇𝑇 = − 8𝑄𝑄2 + + 180
5 2

51
4.5. Marginal Functions

The derivatives of certain economic variables such as total revenue, total cost, production
consumption and savings are called marginal functions.

4.5.1. Total Revenue Function

The marginal revenue is the rate of chance in total revenue per unit increase in output,Q and is
given by
𝑑𝑑𝑑𝑑𝑑𝑑
𝑀𝑀𝑀𝑀 = .
𝑑𝑑𝑑𝑑

Example

Given the demand function, 𝑃𝑃 = 6 − 0.5𝑄𝑄, find the value of MR for 1 ≤ 𝑄𝑄 ≤ 7 using the
∆𝑇𝑇𝑇𝑇
definition 𝑀𝑀𝑀𝑀 = .
∆𝑄𝑄

4.5.2. Total Cost

The marginal cost is the rate of chance in total cost per unit increase in output, Q and is given by
𝑑𝑑𝑑𝑑𝑑𝑑
𝑀𝑀𝑀𝑀 = .
𝑑𝑑𝑑𝑑

.Example

Given the total cost function, 𝑇𝑇𝑇𝑇 = 10 + 4𝑄𝑄:

a) Derive an equation for MC. Does MC vary with output?

b) Show that the derivative of total cost and variable cost with respect to output provides the
same answer.
c) Estimate the change in TC as output, Q increases from 15 to 16

4.5.3. Production function and the average and average product of labour.

If the short-run production function is

𝑄𝑄 = 15𝐿𝐿2 − 0.5𝐿𝐿3

52
where Q denotes output and L denotes the size of the workforce,

a) Deduce the equation for the marginal product of labour and hence calculate value of
MPL when
b) 𝐿𝐿 = 1
c) 𝐿𝐿 = 10
d) 𝐿𝐿 = 100

and discuss the implication of these results.

Note: The law of diminishing marginal labour.

4.5.4 Marginal and average propensity to consume and save.

Recall that income can be defined as consumption plus savings:

𝑌𝑌 = 𝐶𝐶 + 𝑆𝑆. (1)

The marginal propensity to consume is defined as the change in consumption per unit change in
income and on the other hand, the marginal propensity to save, 𝑀𝑀𝑀𝑀𝑀𝑀 is defined as the change in
savings per unit change in income.

If we differentiate both sides of the equation (1) with respect to Y we get

𝑑𝑑𝑑𝑑 𝑑𝑑 𝐶𝐶 𝑑𝑑𝑑𝑑
= +
𝑑𝑑𝑑𝑑 𝑑𝑑𝑑𝑑 𝐷𝐷𝐷𝐷

Hence

1 = 𝑀𝑀𝑀𝑀𝑀𝑀 + 𝑀𝑀𝑀𝑀𝑀𝑀

Example

Given the consumption function

𝐶𝐶 = 20 + 2𝑌𝑌 0.4

a) Write down the equation for 𝑀𝑀𝑀𝑀𝑀𝑀 and 𝑀𝑀𝑀𝑀𝑀𝑀.

b) Write down the equation for 𝐴𝐴𝐴𝐴𝐴𝐴 and 𝐴𝐴𝐴𝐴𝐴𝐴.
c) Show that 𝐴𝐴𝐴𝐴𝐴𝐴 > 𝑀𝑀𝑀𝑀𝑀𝑀 and 𝑀𝑀𝑀𝑀𝑀𝑀 > 𝐴𝐴𝐴𝐴𝐴𝐴 when 𝑌𝑌 = 10.

4.6. OPTIMIZATION OF ECONOMIC FUNCTIONS

The strategy for finding and classifying stationary points of a function, 𝑓𝑓(𝑥𝑥) is as follows:

53
Step 1: Finding the stationary points

Solve the equation 𝑓𝑓′(𝑥𝑥) = 0 in order to find the stationary points, 𝑥𝑥 = 𝑎𝑎 and find 𝑓𝑓′′(𝑥𝑥)

Step 2: Classification of the point(s)

If

• 𝑓𝑓’’(𝑎𝑎) > 0, then the function has a minimum at 𝑥𝑥 = 𝑎𝑎

• 𝑓𝑓’’(𝑎𝑎) < 0, then the function has a maximum at 𝑥𝑥 = 𝑎𝑎
• 𝑓𝑓’’(𝑎𝑎) = 0, then the point cannot be classified.

Step 3: Maximizing or minimizing

If 𝑓𝑓 ′′ (𝑎𝑎) < 0, then the point is a maximum

〖 If f〗^''(𝑎𝑎) > 0, then the point is a minimum

EXAMPLE 1

A firm’s short-run production function is given by

𝑄𝑄 = 6𝐿𝐿2 − 0.2𝐿𝐿3

where L denotes the number of workers.

a) Find the size of the workforce that maximizes output and hence sketch a graph of this
production function.
b) Find the size of the workforce that maximizes the average product of labour. Calculate
MPL and APL, at this value of L. What do you observe?

4.7 Marginal Approach to Profit Maximization

An alternative approach to finding the profit maximization point involves marginal analysis.
Popular among economists, marginal analysis examines incremental effects on profitability.
Given that a firm is producing a certain number of units each year, marginal analysis would be
concerned with the effect on profit if one additional unit is produced and sold. To utilize the
marginal approach to profit maximization, the following conditions must hold.

Requirements for Using the Marginal Approach

I It must be possible to identify the total revenue function and the total cost function,
separately.
II The revenue and cost functions must be stated in terms of the level of output or number
of units produced and sold.

54
Marginal Revenue
One of the two important concepts in marginal analysis is marginal revenue. Marginal revenue is
the additional revenue derived from selling one more unit of a product or service. For a total
revenue function R(q), the derivative R’(q) represents the instantaneous rate of change in total
revenue given a change in the number of units sold. R’ also represents a general expression for
the slope of the graph of the total revenue function.
For purposes of marginal analysis, the derivative is used to represent the marginal revenue, or

𝑀𝑀𝑀𝑀 = 𝑅𝑅’ (𝑞𝑞)

Marginal Cost
The other important concept in marginal analysis is marginal cost.
Marginal cost is the additional cost incurred as a result of producing and selling one more unit of
a product or service. For a total cost function C(q), the derivative C’(q) represents the
instantaneous rate of change in total cost given a change in the number of units produced. C’(q)
also represents a general expression for the slope of the graph of the total cost function.
For purposes of marginal analysis, the derivative is used to represent the marginal cost, or

𝑀𝑀𝑀𝑀 = 𝐶𝐶’(𝑞𝑞)
Marginal Profit
As indicated earlier, marginal profit analysis is concerned with the effect of profit if one additional
unit of a product is processes and sold. As long as additional revenue brought in by the next unit
exceeds the cost of producing and selling that unit, there is a net profit from producing and selling
that unit and total profit increases. If however the additional revenue from selling the next unit is
exceeded by the cost of producing and selling the additional unit, there is a net loss from that next
unit and total profit decreases.

1. If 𝑀𝑀𝑀𝑀 > 𝑀𝑀𝑀𝑀, produce the next unit

2. If 𝑀𝑀𝑀𝑀 < 𝑀𝑀𝑀𝑀, do not produce the next unit.

EXAMPLE 2

The demand equation of a good is

𝑃𝑃 + 𝑄𝑄 = 30

and the total cost function is

1 2
𝑇𝑇𝑇𝑇 = 𝑄𝑄 + 6𝑄𝑄 + 7.
2

a) Find the level of output that maximizes total revenue.

b) Find the level of output that maximizes profit and show that 𝑀𝑀𝑀𝑀 = 𝑀𝑀𝑀𝑀 at this value of Q.

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