2.5.

TYPES OF FUNCTION 11

which is the set of all values that the y variable will take. Thus the domain
pertains to the independent variable x, and the range has to do with the
dependent variable y.

2.5 Types of Function

A function whose range consists of only one element is called a constant
function.

Example 2.5.1 The function y = f (x) = 7 is a constant function.

The constant function is actually a “degenerated" case of what are known

as polynomial functions. A polynomial functions of a single variable has
the general form

y = a0 + a1 x + a2 x2 + · · · + an xn

in which each term contains a coefficient as well as a nonnegative-integer

power of the variable x.
Depending on the value of the integer n (which specifies the highest
power of x), we have several subclasses of polynomial function:

Case of n = 0 : y = a0 [constant function]

Case of n = 1 : y = a0 + a1 x [linear function]
Case of n = 2 : y = a0 + a1 x + a2 x2 [quadritic function]
Case of n = 3 : y = a0 + a1 x + a2 x2 + a3 x3 [ cubic function]

A function such as
x−1
y=
x2 + 2x + 4
in which y is expressed as a ratio of two polynomials in the variable x,
is known as a rational function (again, meaning ratio-nal). According to
12 CHAPTER 2. ECONOMIC MODELS

the definition, any polynomial function must itself be a rational function,

because it can always be expressed as a ratio to 1, which is a constant
function.
Any function expressed in terms of polynomials and or roots (such as
square root) of polynomials is an algebraic function. Accordingly, the
function discussed thus far are all algebraic. A function such as y =
√
x2 + 1 is not rational, yet it is algebraic.
However, exponential functions such as y = bx , in which the inde-
pendent variable appears in the exponent, are nonalgebraic. The closely
related logarithmic functions, such as y = logb x, are also nonalgebraic.

Rules of Exponents:

Rule 1: xm × xn = xm+n
xm
Rule 2: = xm−n (x ̸= 0)
xn
1
Rule 3: x−n = n
x
Rule 4: x0 = 1 (x ̸= 0)
1 √
n
Rule 5: x n = x

Rule 6: (xm )n = xmn

Rule 7: xm × y m = (xy)m

2.6 Functions of Two or More Independent Vari-

ables

Thus for far, we have considered only functions of a single independent

variable, y = f (x). But the concept of a function can be readily extended
2.7. LEVELS OF GENERALITY 13

to the case of two or more independent variables. Given a function

z = g(x, y)

a given pair of x and y values will uniquely determine a value of the de-
pendent variable z. Such a function is exemplified by

z = ax + by or z = a0 + a1 x + a2 x2 + b1 y + b2 y 2

Functions of more than one variables can be classified into various

types, too. For instance, a function of the form

y = a1 x1 + a2 x2 + · · · + an xn

is a linear function, whose characteristic is that every variable is raised to

the first power only. A quadratic function, on the other hand, involves first
and second powers of one or more independent variables, but the sum of
exponents of the variables appearing in any single term must not exceed
two.

Example 2.6.1 y = ax2 + bxy + cy 2 + dx + ey + f is a quadratic function.

2.7 Levels of Generality

In discussing the various types of function, we have without explicit no-

tice introducing examples of functions that pertain to varying levels of
generality. In certain instances, we have written functions in the form

y = 7, y = 6x + 4, y = x2 − 3x + 1 (etc.)
14 CHAPTER 2. ECONOMIC MODELS

Not only are these expressed in terms of numerical coefficients, but they al-
so indicate specifically whether each function is constant, linear, or quadrat-
ic. In terms of graphs, each such function will give rise to a well-defined
unique curve. In view of the numerical nature of these functions, the so-
lutions of the model based on them will emerge as numerical values also.
The drawback is that, if we wish to know how our analytical conclusion
will change when a different set of numerical coefficients comes into effec-
t, we must go through the reasoning process afresh each time. Thus, the
result obtained from specific functions have very little generality.
On a more general level of discussion and analysis, there are functions
in the form
y = a, y = bx + a, y = cx2 + bx + a (etc.)

Since parameters are used, each function represents not a single curve but
a whole family of curves. With parametric functions, the outcome of math-
ematical operations will also be in terms of parameters. These results are
more general.
In order to attain an even higher level of generality, we may resort to
the general function statement y = f (x), or z = g(x, y). When expressed
in this form, the functions is not restricted to being either linear, quadrat-
ic, exponential, or trigonometric – all of which are subsumed under the
notation. The analytical result based on such a general formulation will
therefore have the most general applicability.
Chapter 3

Equilibrium Analysis in
Economics

3.1 The Meaning of Equilibrium

Like any economic term, equilibrium can be defined in various ways. One
definition here is that an equilibrium for a specific model is a situation where
there is no tendency to change. More generally, it means that from an avail-
able set of choices (options), choose the "best” one according to a certain
criterion. It is for this reason that the analysis of equilibrium is referred
to as statics. The fact that an equilibrium implies no tendency to change
may tempt one to conclude that an equilibrium necessarily constitutes a
desirable or ideal state of affairs.
This chapter provides two typical examples of equilibrium. One that is
from microeconomics is the equilibrium attained by a market under given
demand and supply conditions. The other that is from macroeconomics
is the equilibrium of national income model under given conditions of
consumption and investment patterns. We will use these two models as
running examples throughout the course.

15
16 CHAPTER 3. EQUILIBRIUM ANALYSIS IN ECONOMICS

3.2 Partial Market Equilibrium - A Linear Model

In a static-equilibrium model, the standard problem is that of finding the
set of values of the endogenous variables which will satisfy the equilibri-
um conditions of the model.

Partial-Equilibrium Market Model

Partial-equilibrium market model is a model of price determination in an

isolated market for a commodity.
Three variables:

Qd = the quantity demanded of the commodity;

Qs = the quantity supplied of the commodity;

P = the price of the commodity.

The Equilibrium Condition: Qd = Qs .

The model is

Qd = Qs ,
Qd = a − bP (a, b > 0),
Qs = −c + dP (c, d > 0),

−b is the slope of Qd , a is the vertical intercept of Qd , d is the slope of Qd ,

and −c is the vertical intercept of Qs .
Note that, contrary to the usual practice, quantity rather than price has
been plotted vertically in the figure.
One way of finding the equilibrium is by successive elimination of vari-
ables and equations through substitution.
From Qs = Qd , we have

a − bP = −c + dP
3.2. PARTIAL MARKET EQUILIBRIUM - A LINEAR MODEL 17

Qd , Q s

a
Qd = a - b P Qs = - c + d P
(demand) (supply)

Q= Qd= Qs (P, Q )

O P
P1 P

-c

Figure 3.1: The linear model and its market equilibrium.

and thus
(b + d)P = a + c.

Since b + d ̸= 0, the equilibrium price is

a+c
P̄ = .
b+d

The equilibrium quantity can be obtained by substituting P̄ into either

Qs or Qd :
ad − bc
Q̄ = .
b+d

Since the denominator (b + d) is positive, the positivity of Q̄ requires

that the numerator (ad − bc) > 0. Thus, to be economically meaningful, the
model should contain the additional restriction that ad > bc.
18 CHAPTER 3. EQUILIBRIUM ANALYSIS IN ECONOMICS

3.3 Partial Market Equilibrium - A Nonlinear Mod-

el

The partial market model can be nonlinear. Suppose the model is given by

Qd = Qs ;
Qd = 4 − P 2 ;
Qs = 4P − 1.

As previously stated, this system of three equations can be reduced to

a single equation by substitution.

4 − P 2 = 4P − 1,

or
P 2 + 4P − 5 = 0,

which is a quadratic equation. In general, given a quadratic equation in

the form
ax2 + bx + c = 0 (a ̸= 0),

its two roots can be obtained from the quadratic formula:

√
−b ± b2 − 4ac
x̄1 , x̄2 =
2a

where the “+" part of the “±" sign yields x̄1 and “−" part yields x̄2 . Thus,
by applying the quadratic formulas to P 2 +4P −5 = 0, we have P̄1 = 1 and
P̄2 = −5, but only the first is economically admissible, as negative prices
are ruled out.
3.4. GENERAL MARKET EQUILIBRIUM 19

The Graphical Solution

Qd , Qs

4
Qs = 4P - 1

3 ( 1, 3 )

Qd = 4 - P!
1

P
-2 -1 0 1 2

-1

Figure 3.2: The nonlinear model and its market equilibrium.

3.4 General Market Equilibrium

In the above, we have discussed methods of an isolated market, where-
in the Qd and Qs of a commodity are functions of the price of that com-
modity alone. In practice, there would normally exist many substitutes
and complementary goods. Thus a more realistic model for the demand
and supply functions of a commodity should take into account the effects
not only of the price of the commodity itself but also of the prices of oth-
er commodities. As a result, the price and quantity variables of multiple
commodities must enter endogenously into the model. Thus, when sever-
al interdependent commodities are simultaneously considered, equilibri-
um would require the absence of excess demand, which is the difference
20 CHAPTER 3. EQUILIBRIUM ANALYSIS IN ECONOMICS

between demand and supply, for each and every commodity included in
the model. Consequently, the equilibrium condition of an n−commodity
market model will involve n equations, one for each commodity, in the
form
Ei = Qdi − Qsi = 0 (i = 1, 2, · · · , n),

where Qdi = Qdi (P1 , P2 , · · · , Pn ) and Qsi = Qsi (P1 , P2 , · · · , Pn ) are the de-
mand and supply functions of commodity i, and (P1 , P2 , · · · , Pn ) are prices
of commodities.
Thus, solving n equations for P = (P1 , P2 , · · · , Pn ):

Ei (P1 , P2 , · · · , Pn ) = 0,

we obtain the n equilibrium prices P̄i – if a solution does indeed exist. And
then the Q̄i may be derived from the demand or supply functions.

Two-Commodity Market Model

To illustrate the problem, let us consider a two-commodity market model

with linear demand and supply functions. In parametric terms, such a
model can be written as
Qd1 − Qs1 = 0;

Qd1 = a0 + a1 P1 + a2 P2 ;

Qs1 = b0 + b1 P1 + b2 P2 ;

Qd2 − Qs2 = 0;

Qd2 = α0 + α1 P1 + α2 P2 ;

Qs2 = β0 + β1 P1 + β2 P2 .

By substituting the second and third equations into the first and the
3.4. GENERAL MARKET EQUILIBRIUM 21

fifth and sixth equations into the fourth, the model is reduced to two e-
quations in two variable:

(a0 − b0 ) + (a1 − b1 )P1 + (a2 − b2 )P2 = 0

(α0 − β0 ) + (α1 − β1 )P1 + (α2 − β2 )P2 = 0

If we let
ci = ai − bi (i = 0, 1, 2),

γi = αi − βi (i = 0, 1, 2),

the above two linear equations can be written as

c1 P1 + c2 P2 = −c0 ;

γ1 P1 + γ2 P2 = −γ0 ,

which can be solved by further elimination of variables.

The solutions are
c2 γ0 − c0 γ2
P̄1 = ;
c1 γ2 − c2 γ1
c0 γ1 − c1 γ0
P̄2 = .
c1 γ2 − c2 γ1
For these two values to make sense, certain restrictions should be im-
posed on the model. Firstly, we require the common denominator c1 γ2 −
c2 γ1 ̸= 0. Secondly, to assure positivity, the numerator must have the same
sign as the denominator.

Numerical Example

Suppose that the demand and supply functions are numerically as follows:

Qd1 = 10 − 2P1 + P2 ;
22 CHAPTER 3. EQUILIBRIUM ANALYSIS IN ECONOMICS

Qs1 = −2 + 3P1 ;

Qd2 = 15 + P1 − P2 ;

Qs2 = −1 + 2P2 .

By substitution, we have

5P1 − P2 = 12;

−P1 + 3P2 = 16,

which are two linear equations. The solutions for the equilibrium prices
and quantities are P̄1 = 52/14, P̄2 = 92/14, Q̄1 = 64/7, Q̄2 = 85/7.
Similarly, for the n−commodities market model, when demand and
supply functions are linear in prices, we can have n linear equations. In the
above, we assume that an equal number of equations and unknowns has
a unique solution. However, some very simple examples should convince
us that an equal number of equations and unknowns does not necessarily
guarantee the existence of a unique solution.
For the two linear equations,


 x + y = 8,
,

 x+y =9

we can easily see that there is no solution.

The second example shows a system has an infinite number of solu-
tions:


 2x + y = 12;
.

 4x + 2y = 24

These two equations are functionally dependent, which means that one
3.5. EQUILIBRIUM IN NATIONAL-INCOME ANALYSIS 23

can be derived from the other. Consequently, one equation is redundant

and may be dropped from the system. Any pair (x̄, ȳ) is the solution as
long as (x̄, ȳ) satisfies y = 12 − x.
Now consider the case of more equations than unknowns. In gener-
al, there is no solution. But, when the number of unknowns equals the
number of functionally independent equations, the solution exists and is
unique. The following example shows this fact.

2x + 3y = 58;

y = 18;

x + y = 20.

Thus for simultaneous-equation model, we need systematic methods

of testing the existence of a unique (or determinate) solution. There are
our tasks in the following chapters.

3.5 Equilibrium in National-Income Analysis

The equilibrium analysis can be also applied to other areas of economics.
As a simple example, we may cite the familiar Keynesian national-income
model,
Y = C + I0 + G0 (equilibrium condition);

C = a + bY (theconsumption function),

where Y and C stand for the endogenous variables national income and
consumption expenditure, respectively, and I0 and G0 represent the ex-
ogenously determined investment and government expenditures, respec-
tively.
Solving these two linear equations, we obtain the equilibrium national
24 CHAPTER 3. EQUILIBRIUM ANALYSIS IN ECONOMICS

income and consumption expenditure:

a + I0 + G0
Ȳ = ,
1−b

a + b(I0 + G0 )
C̄ = .
1−b