Chapter 5

Comparative Static Analysis

Comparative statics is concerned with the comparison of different equilibrium states that are
associated with different sets of values of parameters or exogenous variables. We have two
classes of variables.
1. Choice variables- are also called endogenous variables are variables that are determined within
the model. They are under the control of decision makers or firms.
2. Exogenous Variables or Parameters-are variables outside the model. They are out of the
control of the firms (decision makers). They are determined by factors outside the model.

In comparative statics, there is a need for point of reference or starting point so as to make the
comparison clear and visible. For example, initial equilibrium states are most commonly used as
starting points.
Example: In the theory of demand and supply price is exogenous: Qd =f ( p ) ∧Qs=f ( p)
In both cases p is exogenous in the sense that it is not influenced by the actions of decision
makers. It is rather determined by factors outside the control of both consumers and suppliers in
the market.
The initial (pre-change) equilibrium may be represented by equilibrium, P, and the corresponding
quantity,Q . If P changes, quantity demanded and quantity supplied can change and hence the
initial equilibrium will be upset (disturbed). If the new equilibrium state relevant to the new price
can be defined and attained, the question to be posed in comparative statics is ‘how would one
compare the new equilibrium with the old one?’
In comparative statics, we disregard the process of adjustment of the variables i.e. we simply
compare the pre-change and the post-change equilibrium states and the way through which the
change has come is out of the concern of the field. Hence, comparative statics is essentially
concerned with finding the rate of change of the equilibrium value of the choice or endogenous
variables with respect to the change in a particular parameter or exogenous variable.
From example; what happens to the quantity demanded of a good when the price of the good, the
price of relative commodities or income changes is a representative question in comparative
statics.

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 A comparative static analysis can be either qualitative or quantitative in nature. If the interest is
to known the direction of change of the endogenous variables as a result of the change in the
parameters, the analysis is qualitative type. However, if the concern is both on direction and
magnitude of the change, the analysis will be quantitative.
In economics, theories are commonly tested on the basis of changes in the variables which may
or may not result in relation of assumptions.

5.1. Differentiation and its application to comparative static Analysis

In comparative statics we make use of derivatives in assessing the rate of change of one
endogenous variable as a result of the change in one or more parameters or exogenous variables.
We can consider different models to illustrate this point.
1. Let R(x) =total revenue as a function of out put, x.
C(x) =total cost as a function of out put, x.
tx=total tax paid and t is a per unit tax as a parameter beyond the control of the firm.
Here, while x is an endogeneous variable, t is exogeneous.
Let’s define the profit function,

π=R ( x )−C ( x ) −tx

' ' '
Foc: π =R ( x ) −C ( x ) −t=0
If the firm is in perfect competitative market, P=MR ; but from the above,
MR=MC +t ⇒ P=MC +t . This implies that the firm chooses the level of output such that
MR=MC +t .
SOC: π ' ' =R '' (x )−C '' ( x )< 0⇒ R' ' (x )<C' ' (x) i.e., the slope of the marginal revenue should be
less than that of marginal cost.
Any way X is a function of t. A change in t change the optimal level of the out put produced
¿
⇒ X=X (t )∨ X=f (t) . If this is the case, we can insert this definition in the FOC.
' ' ¿ ' ¿
∂ π ( x ) d (R ( X )) d x ¿ d (C ( X )) d x¿ dt
= ¿ , − ¿ . − =0
∂t dx dt dx dt dt
¿ ¿
'' ¿ dx '' ¿ dx
R (x ) −C ( x ) =1
dt dt
¿
d x '' ¿
dt
[ R ( X )−C ( X ) ]=1
'' ¿

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 ¿
dx 1
= '' ¿ , but look at the SOC and for π to be maximized R' ' ( X ¿ )−C ' ' ( X ¿ ) <0
dt R ( X )−C ' ' ( X ¿ )
¿
dx 1
⇒ = '' ¿ <0
dt R ( X ) −C' ' ( X ¿ )
¿
dx
<0 , implies optimal level of output and tax rate are negatively related.i.e. Out put of the
dt
firm decreases as the tax rate of the firm faces incerases and viceversa.
Conclusion: A prediction about the size and direction of the change of the choice variable (out
put in the above case) can be made by looking at the change in the parameter facing the decision
maker-a goal in compartive statics.
2. Maxmize π ( x ) =R ( x ) −C ( x )=Px−C ( x)
Here the assumption is that P is an exogeneous variable.i.e. P is taken as a parameter beyond the
control of decision maker.
FOC: π ' ( x )=P−C' ( x )=0 … ..(1)
SOC: π ' ' ( x )=−C' ' ( x ) ≤ 0 … ..(2) ,C '' ( X ) >0 the MC must be upward slopping.

¿
But, we know the optimal level of x is a function of P i.e. x=x (P) and from(1)
'
C ( x )=MC=P
¿
x=x (P) Shows the supply function of the firm starting from the point where MC=P.
¿
x=x (P) tells us how much the firm offers to the market for every market determined level of
price. Inserting x=x ¿(P) in FOC P−C ' ¿ (P)) =0 and applying the SOC:

' ¿
dp d C ( x ) d x ¿
. =0
dp d x ¿ dp
¿ ¿
dx
¿ dx 1
=0⇒
''
1−C ( X ) . = ' ' ¿ and C '' ( x¿ ) >0 from S.O.C
dp dp C (X )
¿
dx
⇒ >0
dp

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 This shows there is a positive relationship between the parameter P and the endogenous variable
output. In other words the supply function of a competitive firm is up ward slopping.i.e,
¿
x=x ( p) has a graph of the slope.

3. Market model: let us consider a market model for a single commodity.

Qd =a−bP ( a , b> 0 )
Qs =−c +dP ( c , d> 0 )
We have two endogenous variables (P & Q) and four parameters (a, b, c & d). At equilibrium,
a+c
Qd ¿ Q s ⇒−c +dP=a−bP ⇒ P=
b+ d
Assume P and Q are initial equilibrium levels of the P and Q, comparative statics helps us to
compute the change in the initial equilibrium values.
∂P 1
= >0
∂ a b+ d
∂ P −(a+ c)
= <0
∂ b (b+ d)2
∂P 1
= >0
∂ c b+ d
∂ P −(a+ c)
= <0
∂ d (b+ d)2
NB: There is an inverse relationship between the price of the commodity and the slopes of
demand and supply.
i) An increase in ‘a’ indicates an upward shift of the demand curve, that is, as a ↑ ⇒ P ↑.
Q
S

Q2
Q1

'
D
D

P
P1 P2

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ii. Similarly, an increase in ‘c’ shifts the supply curve to the right. That is, as c ↑⇒ P ↑.

Q
S
'
S
Q1
Q2

P
P1 P 2
iii. An increase in ‘b’ increases the slope of the demand curve. That is, as b ↑ ⇒ P ↓.

Q
S

Q1
Q2
D

'
D
P
P2 P 1

iv) An increase in‘d’ increases the slope of the demand curve. That is, d ↑⇒ P ↓.

Q '
S

S
Q2
5
Q1
0
D

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 Notional Income model
1. National Income Model: The discussion of comparative static analysis can also be made on
national income model. We have
Y =C + I 0 +G0
C=α + β ( Y −T ) ; ( α >0 ; 0< β <1 )
T =γ +δY ;(γ >0 ; 0< δ<1)
Where ,
α −shows the autonomous consumption level .
β−measures the marginal proponesity ¿ consumption ( MPC ) .
γ −indicates the non−income tax rate .
δ−income tax rate .

¿ , Y −T is usually referred to as disposable income (that is, income after tax). Y and C stand for
the endogenous variables national income and consumption expenditure respectively. I 0∧G0
are exogeneously determined investment and government expenditures. The first equation is
an equilibrium condition (National Income = Total Expenditure), while the second and third are
behavioral equations, that is, consumption and tax functions. Moreover, the equations show
that the model is of closed type because the trade terms are not incorporated.
NB : The equations are neither functionally dependent nor inconsistent with each other.
Thus , we can determine the equilibrium levels of the endogeneous variables, Y, C and T in
terms of the exogenous variables. I 0∧G0 and the parameters α , β , γ ∧δ .

Substitution of the third equation in the second and then the second in the first, we have
C=α + β ( Y −( γ +δY ) )=α + β (Y −γ −δY )=α −γβ + ( 1−δ ) Y
Y =α + βY −γβ −βδY + I 0 +G0
Y + βδY −βY =α −γβ + I 0 +G0
Y ( 1+ βδ −β )=α −γβ + I 0 +G0

Y= [ α−γβ + I 0 +G0
1+ βδ −β ]
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 α −γβ + I 0 +G 0
T =γ +δ ⌈ ⌉
1+ βδ −β
The interest in comparative static is to see the effect of the change in one of the exogenous
variable on the endogenous variables. To do so we make first order derivatives.
For example:
∂Y 1
= > 0indicate the government expenditure multiplier.
∂ G 1+ βδ −β
∂Y −2
=−( 1+ βδ− β ) ( α−βγ + I 0+G 0 ) β
∂δ
− β ( α −βγ + I 0 +G0 )
¿
( 1+ βδ−β ) ( 1+ βδ −β )
−β Y
¿ <0
( 1+ βδ−β )
This result indicates income tax multiplier.

5.2. Comparative Statics of General function model

In the comparative static problems considered before, equilibrium values of endogenous
variables of the model could be explicitly expressed in terms of the exogenous variables;
accordingly, the technique of simple partial differentiation was all we need to obtain the desired
comparative static information.
However, when a model contains functions expressed in general form, explicit solutions are not
available. In such cases, a new technique must be employed that makes use of such concepts as
implicit function rule to find the comparative static derivatives directly from the given general
function model.
Example :- Consider a market model:
∂D ∂D
Qd=D ( p1 , y 0 ) , <0 , >0
∂p ∂ y0
∂s
Qs=s ( p ) , >0
∂p
In all the above models the equilibrium values of the endogenous variables could be explicitly
expressed in terms of the exogenous variables. Accordingly the technique of simple partial
differentiation was all we needed to obtain the desired comparative static information.

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 However, when a model contains functions expressed in general form, explicit solutions are not
available, i.e., the equilibrium values of the endogenous variables cannot be expressed
explicitly in terms of parameters and/or exogenous variables. In such cases a new technique
must be adopted that makes use of concepts such as total differentials, implicit function rule
e.t.c.
Let’s try to illustrate the point with a market model. Consider a market model where Qd is a
function of both price and an exogenously determined income Y 0 , and Qs is a function of price
alone.
∂ D 0∧∂ D
Q d =D ( P ,Y 0) where < > 0.
∂P ∂Y 0

dS
Qs =S ( P ) where >0.
dP
And, the equilibrium position of the market is defined by Qd =Qs . This implies
D ( P ,Y 0 )=S ( P )
D ( P ,Y 0 )−S ( P )=0.
Even though the above equation cannot be solved explicitly for the equilibrium price, P, we
assume that there does exist a static equilibrium before and after the change in the exogeneous
variable Y 0.
Say we have obtained P, if income of consumers changes, the whole equilibrium will be upset.
This indicates that the optimal value of P which sets the market at equilibrium is a function of
the exogenous variableY 0. That is, P=P (Y ¿¿ 0)¿ .
The change in income upsets the equilibrium by causing a shift in the demand function implying
that every value of Y 0 yields a unique value of P.
Since D ( P ,Y 0 )−S ( P )=0 is an implicit function, we can taket it as an identity: F ( P , Y 0 ) =0.
The comparative static analysis of such a model is concerned with how a change in Y will affect
the equilibrium position of the model. Thus, we can raise two equations:

( ddYP )?
(1) What is the effect of the change of Y 0 on P
0

(2) What is the effect of the change of Y on Q (

dY )
dQ
0 ?
0

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 From D ( P ,Y 0 )−S ( P )=0 , we can answer question number one.
Applying the implicit function rule:
−∂ F −∂ D
dP ∂Y 0 ∂Y0 negative ( Positive )
= = = >0.
dY 0 ∂F ∂ D dS Negative−Negative
−
∂P ∂P dP
dP
Hence , >0.This indicates that an increase in income results in an increase in equilibrium
dY0
price and vice versa.
dQ
To answer the second question, that is :
dY 0
At equilibrium, Qd =Qs =Q. We know that Qd =Qs =S ( P ) but P=P(Y ¿¿ 0)¿. Thus, substituting
we get:
Q=S ¿
Applying the chain rule, we have
d Q dS d P dS 0∧d P
= . where > >0
dY 0 d P dY0 d P dY0
dQ
Therefore, >0 implying that an increase in income increases the equilibrium level of output.
dY 0
Generally, the comparative static results convey the proposition that an upward shift of the
demand curve (due to a rise in Y), results in a higher equilibrium price and equilibrium quantity.
5.3 Limitations of Comparative Static Analysis
Comparative static is helpful in finding out how a dis-equilibriating change in a parameter, will
affect the equilibrium state of a model. However, by its very nature, it has the following
limitations.
1) It ignores the process of adjustment from the old equilibrium to the new one.
2) It neglects the time element involved in adjustment process from one equilibrium to another.
3) It assumes always a change in a parameter and/or exogenous variable results in a new
equilibrium. It disregards the possibility that new equilibrium may be attained even because of
the inherent instability of the model

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