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Chiang Ch. 10 Exponential and Logarithmic Functions 10.1 The Nature of Exponential Functions 10.2 Natural Exponential Functions and the Problem of Growth 10.3 Logarithms 10.4 Logarithmic Functions 10.5 Derivatives of Exponential and Logarithmic Functions 10.6 Optimal Timing 10.7 Further Applications of Exponential and Logarithmic Derivatives 1 10.1(a) Types of functions (Chiang, p.26) functionname specific form Polynominals (algebraicfunctions) economicuse Constant y a0 fixed costs,interestrates Linear y a0 a1 x equilibria Quadratic y a0 a1 x a2 x 2 optimaand/or equilibria Cubic y a0 a1 x a2 x 2 a3 x 3 optima Rational (algebraic) y a / x optima T ranscendental (non- algebraic,independent var.associatedw/ exponent) Exponentia l y bx Logarithmic x logb y (inverse) compounding & discounting growth,productionfunctions 2 Rules of exponents 1) x m n x m x n m x 2) x m n n x 1 n 3) x n x 4) x 0 1 5) x 1 n x0 n x 7) xy x y 6) x mn x m m n m m Chiang & Wainwright, pp.23 - 24 3 7.3.2 Inverse-function rule • This property of one to one mapping is unique to the class of functions known as monotonic functions: • Definition of a function (p. 17) – Function – Monotonic function – One x for each y, aka one y for each x and one x for each y inverse function A monotonicallyincreasingfunction,if 1) x1 x 2 then f x1 f x2 e.g., supplyfunction(whereb1 0) 2) Q s b 0 b1P and an inversesupplyfunction 3) P - b 0 /b1 (1/b1 )Q s 4) 5) y ex x ln y range0, , domain - , range- , , domain 0, 4 7.3 Rules of Differentiation Involving Functions of Different Variables Inverse- functionrule Let y be a strictlymonotonicfunctionof x 1) y f ( x) 2) dy dx f x Then 3) 4) x f 1 ( y ) dx dy f 1 y 1 dy dx 1 f x 5 10.1 The Nature of Exponential Functions 10.1(a) Simple exponential function 10.1(b) Graphical form 10.1(c) Generalized exponential function 10.1(d) A preferred base 7 10.1(a) Simple exponential function y = f(x) = bx where base b > 1, x is exponent, f(x) The term exponent (x) refers to the power to which a base number (b) is raised. Base exclusions: • b 1 and b 0, because f(x) = 1x = 1; f(x) = 0x = 0, i.e., constants • 0 < b < 1 excluded since they can be expressed as negative exponents • b<0 excluded because many values of f(x) from the domain would be imaginary, e.g., (-b)½ • popular bases: e and 10 8 10.1(c) Generalized exponential function • Where y = dependent variable b = base t = independent variable a = vertical scale factor (directly related) c = horizontal scale factor (inversely related) y ab ct 9 10.1(b) Graphical Exponential Functions y=bt where b=3,e,2 10 10.1(d) A preferred base (e) Given 1) y bt b t t b t b t b t b t b t 1 t 2) dy dt f (t ) lim lim b lim t 0 t 0 t 0 t t t A logarithmis the power towhicha baseis raised to attaina particularnumber.Let / b t 1 ln b t 1 t ln b ln1 3) lim ln b lim lim t 0 t t 0 t 0 t t Such that 4) f / (t ) b t ln b Is there a base e such that 5) If 6) ln e 1? e lim 1 1 m m 2.71828... m Then 7) 8) e t 1 ln e lim 1 t 0 t dy dt f / (t ) e t ln e e t y 11 y1=e and y2=(1+1/m)m as m 12 10.5 Derivative of the inverse of y=et, i.e. y=ln t (p. 277) Given theinverseof y e t in which we reverse y and t 1) 2) y e t ln y t alternatively y ln t dy d f (t ) f ( N ) ln t ln N ln t lim lim tN tN dt dt tN tN lnt N 1 lim lim lnt N tN tN t N tN Let m N t N m N 1 t N t N N 1 m t N N N 1 m t N 11 m dy m 1 1 1 1 1 m 8) lim ln1 1 m lim ln1 1 m or t dt N t N N tN N t y e 3) 4) 5) 6) 7) 13 10.5 Derivative of y=et using the Inverse function rule 1) y et function 2) ln y t ln e 3) t ln y inverse derivativeof the inverse d 4) ln y 1 y dy derivativeof the function d t 1 5) e y et dt 1y 14 10.5(d) The case of base b derivativeof a transendentalfunctionin thebase b exponentia l function logarithmic function d logb t dbt 1 t b ln b dt dt t ln b derivativeof a transendentalfunctionin thebase e exponentia l function logarithmic function de t t e dt d loge t d ln t 1 dt dt t 15 10.1(d) A preferred base (e) (e) = 2.71828…, irrational number w/ beautifully simple characteristics Derivativeof 1) y bx 2) ln y x ln b 3) f ( x) / x x ln b x ln b lim x x ln b lim x 0 x ln b x 0 What ln (baseb) willhavea slope f / ( 0 ) 1 as x 0 4) if b e, 5) then ln b ln e 1 16 10.1(d) A preferred base (e) (e) = 2.71828, irrational number w/ beautifully simple characteristics) x b 1 / 0 f (0) b lim ln b x 0 x What base b will havea slope f / ( 0 ) 1 as x 0 base b x 2 2.718282 3 10 0.1 0.7177 1.0517 1.1612 2.5893 0.01 0.6956 1.0050 1.1047 2.3293 0.001 0.6934 1.0005 1.0992 2.3052 0.0001 0.6932 1.0001 1.0987 2.3029 0.00001 0.6931 1.0000 1.0986 2.3026 17 10.1(b) Graphic for f(x)=ex f(x) e x where b e domain of x : (-, ) range of y : (0 , ) y - int ercept: 1 x - int ercept s: none horizont alasympt ot e: x - axis as x - At (0,1) t heslope of t he t angent f / ( 0 ) 1 18 10.1(d) A preferred base (e) (e) = 2.71828, irrational number w/ beautifully simple characteristics) At x 0, what base b will havea slope f / ( 0 ) 1 as x 0 e Δx 1 lim 1 Δx0 Δx Δx e 1 f / (x) e x lim e x( 1 ) e x Δx0 Δx f ( x) e is theone whose tangentline at (0,1)has a slope f / ( 0 ) thatis exactly1 (45o ). (Stewart,Calculus, 3rd , p. 355) 19 10.1(d) A preferred base (e) (e) = 2.71828, an irrational number w/ beautifully simple characteristics) Derivativeof y et wrt t, thenaturalexponentia l function dy d t d et d t e et 1 et y dt dt d t dt d2y d d t d t t e e e dt 2 dt dt dt Derivativeof V Aert wrt t, thegeneralnaturalexponentia l function dV dAert d Aert d rt r Aert rV dt dt d rt dt 20 10.2 Natural Exponential Functions and the Problem of Growth • 10.2(a) The number e • 10.2(b) An economic interpretation of e • 10.2(c) Interest compounding and the function Aert • 10.2(d) Instantaneous rate of growth • 10.2(e) Continuous vs. discrete growth • 10.2(f) Discounting and negative growth 21 10.2(a) The number e m 1 1) base e lim 1 m m A Maclaurinseries approx.of e x when x0 0 2) f(x) f(x0 ) f '(x0 )(x x0 ) f "(x0 )/ 2! (x x0 )2 f (n)(x0 )/n! (x x0 )n R Given e x f(x) f /(x) f //(x) , then e x0 2 e x0 n 3) f(x) e e (x) (x) (x) R 2! n! Because x 0 0 e x0 e 0 1 x0 x0 1 1 e x 1 x (x)2 (x)3 R 2 6 At x 1 theMaclaurinapprox.convergeson e 1 1 1 5) e 11 2.71828 2 6 24 4) 22 10.2(b&c) Interest compounding and the function Aert • y = Aert is the value of an $A investment at nominal interest rate r / compounding period compounded t times over the investment period (# days, months, or years) (growth in an investment) • As m , e $2.71828 … • $1 = initial investment • $1 = 100% return (if m = 1 at the end of the year, then e = 2 if m > 1, then r = 100% is a nominal rate and e > 2) • $.71828 = interest on the interest received during the year as m , r = 171.8% (effective rate) 23 10.2(e) Continuous vs. discrete growth Find the value for continuouscompounding lim V m m given initialinvestmentA overt years at r interestpaid m periods / year t m r r r mr V m A1 A1 A1 m m m mt (1) rt w m 1 Let w and given e lim 1 w r w T hecontinuouscompounding equation (2) 1 lim V m A lim 1 m w w w rt rt Ae 24 10.2(e) Continuous vs. discrete growth Given initialinvestmentA overt years at i interestpaid m periods / year i T hediscretecompounding equationin base b 1 and base e where b m e r m mt mt m m i i rt (1) V m A1 Aert ; 1 e ; m m Discretecompounding equation over one year (t 1) i m t ln1 rt m i i i r (2) V m A1 Aer ; m ln1 r 1 e ; m m m Discreteannualcompounding equation over one year (t 1, m 1) (3) V m A1 i Aer ; 1 i er ; ln1 i r Solving for i and r for effective(i ) and nominal(r ) rateequivalence (4) i e r 1; r ln(1 i ) 25 Relation between effective (i) and nominal (r) rates of interest i : effectiverateof interestper year compounded discretely r : nominalrateof interestper year compounded continuously m : number of compounding periodsper year m i (1) e r 1 m let m 1, compoundedyearly (2) er 1 i Given i, solve(2) for r (3) r ln ( 1 i) Given r, solve(2) for i (4) i e r -1 let m , compounding continuously m (5) i lim 1 e r m m ir 26 10.2(d) Instantaneous rate of growth of a stock at two points in time (Chiang, pp. 278-289) V is thefuture value of an initialinvestment(A) over time(t) at interestrate(r) w/ compounding V Ae rt dV rAert rV dt dV / dt r V dV / dt V r Future value (V) Flow of returnsdV dt T herateof growth (r) Relationof stock toflow 27 10.2(d) Instantaneous rate of growth of a stock at two points in time (Chiang, pp. 278-289) V is t hefut ure value of an init ialinvest ment(A) over t ime(t ) at int erestrat e(r) w/ compounding V Ae Fut ure value (V) A Ve -rt P resent value (A) rt dA dt rVe rt rA dA / dt -r A dA / dt A r Flow of ret urnsdA dt T herat eof growt h (r) Relat ionof st ock t oflow 28 T hestock (V) - flow (v) problem: Given interestrate(r) provethat v v v v ... (1 r ) (1 r ) 2 (1 r ) n r v v v V ... ... (1 r ) (1 r ) 2 (1 r ) n V 1 1 1 v ... ... 2 n ( 1 r ) ( 1 r ) ( 1 r ) 1 Let x and applyingthegeometricseries 1 r 1 V v x x2 xn v 1 1 x 1 v 1 1 1 1 r 1 r v 1 r 1 v 1 1 r 1 1 r 1 r r 1 v v r r 1 v 1 1 V v ... ... 2 n ( 1 r ) ( 1 r ) ( 1 r ) r WalterNicholson,Microeconomic T heory,1972,p. 381, 29 10.2(f) Discounting as negative growth or rate of decay future V= present A= f(compounding the present A) f(discounting the future V) V Ae rt A Ve rt 30 10.3 Logarithms • • • • 10.3(a) The meaning of logarithm 10.3(b) Common log and natural log 10.3(c) Rules of logarithms 10.3(d) An application 31 10.3(a) The meaning of logarithm • Exponents • (solve for y given t) t 3 2 1 0 -1 -2 -3 y=10t 1000 100 10 1 0.1 0.01 0.001 Common logs (solve for t given y) Log10 1000 3 Log10 10 1 Log10 1 0 Log10 0.1 1 Log10 0.01 2 Log10 0.001 3 32 10.3(b) Common log and natural log • Exponent Y e Natural log t • Exponent Y b t loge Y ln Y Common log t t logb Y 33 10.3(c) Rules of logarithms in the land of exponents • • • • Product Quotient Power Base inversion • Base conversion lnuv ln u ln v lnu / v lnu lnv lnu alnu a 1 1 logb e loge b ln b ln(u ) logb u logb e loge u ln(b) 34 10.4 Logarithmic Functions • 10.4(a) Log functions and exponential functions • 10.4(b) The graphical form • 10.4(c) Base conversion 35 10.4(a) Log functions and exponential functions • Exponential function Log function – Dependent variable on left – Monotonically increasing functions • If ln y1 = ln y2, then y1 = y2 Y e t t loge Y ln Y 36 10.4(b) The graphical form y=et (blue), y=2t (red-top), y=ln(t) (red), 45o (green) 37 10.4(c) Base conversion • Let er = bc • Then ln er = ln bc r = ln bc = c ln b • Therefore er = e c ln b • And y = Abct = Ae(c ln b)t =Aert 38 10.4- 6 (b) Find the cont inuous- compounding nominalinterest rateper annum (r) thatis equivalent to a discret e - compounding rate(i) of 5% per annum, compounded semiannually. y abct aert i where a 1, i .05, c 2, t 1, b 1 1.025 c let e r b c r ln e c ln b r c ln b 2 ln 1.025 4.94% y e c lnb t e 2 ln1.025 1 1.050625 39 Derivationof continuousfromdiscrete, (Chiang& Wainwright, pp.263& 265) compounding equation: V A(1 i) t V Aert mt r V (m) A1 m Let i r m , and b 1 i V (m) A1 i mt discretecompounding equation V (m) Abmt Let b m e r , such that ln b m ln e r m lnb r V m Aert continuouscompounding equation 40 10.5 Derivatives of Exponential and Logarithmic Functions • • • • • 10.5(a) Log-function rule 10.5(b) Exponential-function rule 10.5(c) The rules generalized 10.5(d) The case of base b 10.5(e) Higher derivatives 41 Given 1) 2) Let 3) 4) 5) 6) 7) 8) 10.5 Derivative of y=ln t y ln t d f (t ) f ( N ) ln t ln N ln t lim lim tN tN dt tN tN lnt N 1 lim lim lnt N tN tN t N tN m N t N m N 1 t N t N N 1 m t N N N 1 m t N 11 m d m 1 1 1 m ln t lim ln1 1 m lim ln1 1 m dt N tN N tN N t 42 10.5(a) Log-function rule • Derivative of a log function with base e Simple d ln t 1 dt t General d ln f t f t dt f t 43 10.5(b) Exponential-function rule • Derivative of an exponential function with base e Simple General t dy de t e dt dt f t dy d e dt dt f t e f t 44 10.3(d) An application The common use of the logarithmic transformation in economic research is when estimating production functions and other multiplication nonlinear theoretical specifications Transforming a multiplicative production function into a logarithmic one suitable for estimation by linear regression. Let Q = output and L & K are labor and capital inputs respectively Q AL K lnQ ln A ln L ln K 45 Total differential of Q using logs Q AK L lnQ ln A lnK lnL d ln Q d ln A d ln K d ln L dQ 1 dA dK dL Q A K L 1 dQ Q dA dK dL K L A 46 Exponent example 11.6(c)Input decisionsof a firm (Example5, pp.337- 38) 1) π R-C PQ-wL-rK 2) Q Lα K α α .5 3) π P L K -wL-rK α α α L K P-r 0 α 1 4) π L α L K P-w 0 5) π K α * α α 1 Solve for L and K * 47 11.6(c)Input decisionsof a firm (Example5, p. 337) Solving (4) for K and substituting theresultsinto(7) 1α 6) 7) w 1α K L Pα α α 1 Pαα K r 0 w 1α 8) Pαα L Pα Solve for L* 1α α 9) r 0 1 1 1 2 L Pw * α 1 r 48 10.5(d) The case of base b derivativeof a transendentalfunctionin thebase b exponentia l function logarithmic function d logb t dbt 1 t b ln b dt dt t ln b derivativeof a transendentalfunctionin thebase e exponentia l function logarithmic function de t t e dt d loge t d ln t 1 dt dt t 49 10.5(e) Higher derivatives derivatives of transendentalfunctionsin thebase e exponentia l logarithmic de t et dt d 2e t t e dt 2 d 3e t t e dt 3 d 4e t t e dt 4 d loge t d ln t 1 dt dt t d 2 loge t d t 1 1 2 2 dt dt t d 3 loge t d t 2 2 3 3 dt dt t d 4 loge t d 2t 3 6 4 4 dt dt t 50 10.6 Optimal Timing • 10.6(a) A problem of wine storage • 10.6(b) Maximization conditions • 10.6(c) A problem of timber cutting 51 10.6(a) A problem of wine storage A(t ) Ve rt P resent value V ke Growth in value t A(t) ke e t1 2 rt t 1 2 rt ke ln At lnk lne lnk t ln k t ½ ½ t ½ rt rt rt lne 10.6(a) A problem of wine storage ln At dA 1 dt A dA dt dA dt ln k t ½ rt 1 1 2 t r 2 1 1 2 A t r 0 2 1 1 2 t r 0 2 53 10.6(b) Maximization conditions 1 2 t r 1 2r t 1 t 2 4r 1 t 2r let (r ) 10% 1 t 25 years 2 4( 0.10 ) t ½ rt A(t) ke let ( k ) $1 / bot tle A(t) e 5(.1 )(( 25 ) A(t) e 2 .5 $12.18 / bot tle V Aert V $12.18e(.1 )( 25 ) V $148.38 / bot tle 54 10.6(a) A problem of wine storage plot of .5(t)-.5=r, r=.10, t=25 55 10.6(c)T he timbercut tingproblem(p.285) At Ve rt V 2 t present value 2 t1 2 fut ure value At 2 e rt t1 2 ln At ln(2) t1 2 ln(e) rt t 1 2 ln(2) rt 1 dA 1 1 2 t ln 2 r A dt 2 dA 1 1 2 A t ln 2 r 0 dt 2 1 1 2 r t ln 2 solvefor t* 2 56 10.6(c)T he timbercuttingproblem(p.285) At Ve rt V 2 1 1 2 r t ln 2, 2 t 1 2 t 2 2r ln 2 t1 2 ln 2 t 2r 2 2 ln 2 48 years t 2.05 Let r 5% V 2 48 $121.92 thou. (future value) At 121.92e .05 48 $11.06 thou. (present value) 57 10.6(c) Timber cutting problem plot of .5(t)-.5ln(2)=r, r=.05, t=48 58 10.7 Further Applications of Exponential and Logarithmic Derivatives • 10.7(a) Finding the rate of growth • 10.7(b) Rate of growth of a combination of functions • 10.7(c) Finding the point elasticity 59 10.7(a) Finding the rate of growth dy ry dt f ' (t ) marginalfunction y f (t ) totalfunction d ln f t f t dt f t V Aert ln(V ) ln(A) rt ln(e) d d d ln(V ) A rt dt dt dt 1 dV dV dt r V dt V 60 10.7(b) Rate of growth of a combination of functions; Example 3 consumption & pop. C A1e t ln(C ) ln(A1 ) t ln(e) d d d ln(C ) ln(A1 ) t dt dt dt H A2 e t rC ln(H ) ln(A2 ) t ln(e) d d d rH ln(H ) ln(A2 ) t dt dt dt d C d d rC H ln ln(C ) ln(H ) dt H dt dt 61 10.7(b) Rate of growth of a combination of functions; Example 3 consumption & pop. z uv u f (t ) ln(z ) ln(u v) v g (t ) d d ln(z ) (u v) dt dt 1 d rz (u v) u v dt 1 d rz ( f (t ) g (t )) u v dt 1 rz ( f ' (t ) g ' (t )) uv f ' (t ) if (ru ) , then f ' (t ) uru , and g ' (t ) vrv f (t ) u v ru v ru rv su ru sv rv uv uv rz d ln f t f t dt f t 62 10.7(c) Finding the point elasticity M d f y (t ), i (t ) dM d dy di f y ' fi ' dt dt dt dM d dt f y ' dy f i ' di rM d Md f dt f dt rM d rM d rM d f y ' y dy f i ' i di f y dt f i dt f y ' y dy f i ' i di f ydt f idt M d y ry md i ri 63 10.7- 11Given theproductionfunctionbelow, find a generalexpressionfor therate of growth of Q in termsof thegrowth in K and L. (T herateof growth is definedin eq 10.23,p. 302) Given Q Q( K , L), where K K (t ) L L(t ) show that rQ QK rK QL rL Method1 takedifferentials, thensubstitute, divide, and substitute Q QK , L , where K K (t ) Q Q dK dQ dK dL dK dt K L dt Q dK Q dL dQ dt dt K dt L dt dQ Q dK Q dL dt K dt L dt 1 dQ 1 Q K dK 1 Q L dL Q dt Q K K dt Q L L dt L L(t ) dL dL dt dt 1 dQ K Q 1 dK L Q 1 dL Q dt Q K K dt Q L L dt rQ QK rK QL rL 64 10.7- 11Given theproductionfunctionbelow, find a generalexpressionfor therate of growth of Q in termsof thegrowth in K and L. (T herateof growth is defined in eq 10.23,p. 302) Given Q Q( K , L), K K (t ) where L L(t ) show that rQ QK rK QL rL Method2 makelogarithmic transformation,then takedifferentials and substitute ln Q ln Qln K , ln L , where ln Q ln Q d ln Q d ln K d ln L ln K ln L ln K ln K (t ) d ln K 1 dK dt K dt ln L ln L(t ) d ln L 1 dL dt L dt K Q 1 dK L Q 1 dL 1 dQ dt dt Q Q K K dt Q L L dt 1 dQ K Q 1 dK L Q 1 dL Q dt Q K K dt Q L L dt rQ QK rK QL rL 65