ECON 222: MATHEMATICS FOR BUSINESS

Tutorial # 03 (Week 4)
ANSWERS

Topic # 4: Part I Limits

It is not expected that students will become experts in the computations of limits. The
expectation is very modest: “Students will develop some intuition about the concept of
limit of a function.”

Question 1

Let y=f ( x )=−x 2+ 10× x−16 ¿

Then, lim f (x ) is
x →5

a. –
b. 8.9999
c. 9.0
d. 9.0001
e. +

Answer

The correct answer is c.

Comment
The primitive method to evaluate the limit:

lim f (x )
x →a

is to calculate the value of the function at x=a and see how it goes. Often, but not always,
this will give you the right answer. But you can encounter cases where

f (a)

is not defined, and the method breaks down. The drawback of the “primitive method” is
illustrated, for example, in Questions 2 and 3.

In the present case,

2
f ( 5 )=−5 +10 ×5−16=−25+50−16=9

so that

lim f ( x )=9
x →5

1
Question 2
Let

1
f ( x )= 2 (x > 0)
x

Then, x→ lim ¿ is
0+¿ f (x)¿

a. –
b. 8.9999
c. 9.0
d. 9.0001
e. +

Answer

The correct answer is e.

Question 3

(a) “If a function y=f ( x )is not defined at a particular value x of the independent variable x ,
°

then lim f (x )does not exist.”

°
x→ x

True or False? Explain briefly.

(b) Let
1
x
f ( x )=9×(1+ x )

Then, lim f (x ) is
x →0

a. –e
b. 8.999  e
c. 9e
d. 9.0001  e
e. +e

Answer

(a) False. The definition of limit does not require that the function f ( x ) has to be defined at
°
x=x for
lim f (x )to exist.
°
x→ x

2
For example, the esoteric function
1
x
f ( x )=(1+ x)

Is not defined at x=0 , but lim f (x )exists and

x →0

1
lim (1+ x ) x =e ← Euler number
x →0

See Figure 1.

Figure 1

(b) There are several rules for limits. The one useful to answer this question is Rule # 1,
namely:

“The limit of a constant C times a function is the constant C times the limit of the function. In
symbols,

lim { C × f ( x ) }=C × lim f (x )”

x →a x→a

The correct answer is c because

3
 1
x
lim (1+ x ) =e
x →0

Question 4  Difficult (for a Philomath only)

Let

x 2−16
f ( x )=
4 × √ x−8
2

Using Rule # 2 for limits, namely:

f ( x )=g ( x ) for x ≠ a implies lim f (x )=lim g (x)

x→ a x→ a

show that

lim f ( x )=6
x→ 4

Answer

We can use a trick to factorize the fraction as follows:

(x +4)(x −4) ( x+ 4 ) ( √ x+2)( √ x−2) 1

2 2
x2 −16
= ( x +4) ×( √ x+2)
2
= =
4 × √ x−8
2
4 ( √ x −2)
2
4 ( √ x−2)
2
4

We identify the relevant functions as follows:

x 2−16 1
g ( x )= (x + 4)×( √ x +2)
2
f ( x )= and
4 × √ x−8 4
2

Therefore,
2
x −16
lim f (x )=lim =¿
x→ 4 4 × √ x−8
2
x→ 4

1
(x + 4)×( √ x +2)=6 ¿
2
lim g ( x )=¿ lim
x →a x→4 4

Question 5  Difficult (for a Philomath only)

Consider
x
e −1
lim f (x )=lim
x →0 x →0 x

Does this limit exist? If so, what is its value?

Answer

4
 x
e −1
The function f ( x )= exhibits an indeterminate form “0/0” at x=0 :
x
0
e −1 1−1 0
= =
0 0 0

This is not a problem because the definition of limit does not require f ( x ) to be defined at x=0 .

The behaviour of this function close to 0 is illustrated in Table 1.

 If we start with x=−1 and approach zero from the left, we can see that f (x)→1 .
 Similarly, if we start with x=+1 and approach zero from the right, we can see that
f (x)→1 .
−¿¿ +¿ ¿
x→0 f (x) x→0 f (x)
−¿1 0.63212 1 1.71827
−¿0.1 0.95163 0.1 1.05171
−¿0.01 0.99502 0.01 1.0050
−¿0.001 0.99950 0.01 1.00050
… …
Table 1

The message conveyed by Table 1 is as follows. When x gets closer and closer to zero (through
both negative and positive values) f (x) approaches 1. This means that

x
e −1
lim f (x )=lim =1
x →0 x →0 x

Topic # 4: Part II Continuity

Question 1

There are three conditions for the continuity of a function f(x) at a point x =a :

Condition 1
The limit of f ( x ) as x tends to a exists.

Condition 2
The function f ( x ) is defined at x=a

Condition 3
lim f ( x )must be exactly equal to f (a)
x→ a

Is the function f ( x )=x 2 continuous at x=3 ?

Answer

Yes, because

5
 2
lim x =9=L (Condition 1  satisfied)
x →3

2
f ( 3 )=3 =9 (Condition 2  satisfied)

2
lim x =9=f ( 3 )(Condition 3  satisfied)
x →3

Question 2  Difficult (for a Philomath only)

The function
x
e −1
f ( x )=
x

has a point of discontinuity at x=0 . Which condition is not satisfied?

Answer

Condition 1 is satisfied because the limit exists (and it is equal to one):

x
e −1
lim f (x )=lim =1
x →0 x →0 x

However, if we attempt to evaluate

x
e −1
f ( x )=
x

at x = 0, we are faced with an indeterminate form “0/0”:

0
e −1 0
=
0 0

That is, Condition 2 is not satisfied because

x
e −1
f ( x )= is undefined at x=0 .
x

Topic # 4: Part I (Appendix I) Indeterminate Forms

No questions

Topic # 4: Part I (Appendix I) Incremental Ratio

Question 1

Given the function y=f ( x )the increment of the independent variable x is denoted by

6
 ∆ x=h

Write the formula for the evaluation of the incremental ratio and explain why h ≠ 0.

Answer

The formula to evaluate the incremental ratio is

∆y f ( x+ h )−f (x )
Incremental ratio ¿ ∆ x = h
(h ≠ 0)

0
When h=0 , the incremental ratio becomes and is undefined.
0

Question 2

Even though the incremental ratio is not defined when h=0, the limit

∆y
lim
∆ x→ 0 ∆x

may exist. Consider the function y=f ( x )=x 2.

(a) Show that the incremental ratio is equal to

∆ y f ( x+ h )−f (x )
= =2 x +h
∆x h

(b) Does

∆y
lim
∆ x→ 0 ∆x

exist?

(c) If so, what is the value of this limit?

Answer

(a)

∆ y f ( x+ h )−f ( x ) 2 xh+h ( 2 x +h ) h
2
= = =
∆x h h h

Because we can cancel h whenever h ≠ 0, it is mathematically admissible to write

f ( x+ h )−f ( x )
=2 x +h,
h

which is the desired result.

7
 ∆y
(b) By inspection of =2 x+ h, we can see that the limit exists because
∆x

∆y
=2 x+ h
∆x

is sufficiently close to 2 x , if ∆ x=h is sufficiently close to zero.

(c) Finally,

∆y
lim =2 x
∆ x→ 0 ∆x

Topic # 5: Part I Continuous Compounding

Question 1

Is it true that ¿ can be rewritten as

[(1+ x) ] r
1 (r ×t )
x with x= ?
k

Answer

Yes.

Proof

{
r
x=
k

[ ]
r 1 (r × t)
k= ∴ ¿ ¿ (1+ x ) x
x
r 1
k ×t= ×t= (r ×t )
x x

Question 2

Find
lim ¿ ¿
k→∞

Answer

8
{
r
x=
k
r
 k →∞  x→0
¿ k=
x

lim ¿ ¿ ¿ Using Question 1=¿

k→∞

[ ] [ ]
1 rt 1 rt
¿ lim (1+ x ) x
=¿ lim (1+ x) x
=er ×t ¿
k→∞ x→ 0

Therefore,

lim ¿ ¿
k→∞

Question 3

Find the value of $100 at 5 percent for six years when compounded continuously.

Answer

The correct formula to use is

r×t
St =P ×e

From the information provided it follows that

p 5
P = 100, p = 6, r = = =0.05, t = 6
100 100

Therefore,

S5=100 × e
0.05× 6
= 100 ×e 0.3 ≈ 100 ×1.3499 ≈ $ 134.99

Question 4

A principal, $10, is invested at 12% for one year. Determine the compound amount if the interest
is compounded continuously.

Answer

The correct formula for the computation is

r×t
St =P ×e

9
In this case,

p 12
P = 10, p=12 , r = = =0.12, t = 1
100 100

Therefore,

St =P ×e
r×t
= 10 ×e 0.12 ×1=10 × e 0.12 ≈ 10 ×1.1275=$ 11.27
Question 5

We all know that the Euler number is irrational. This number to 20 decimal places is

e=2.718 281 828 459 045 235 36  But it is non-terminating and non-repeating

What is the economic meaning of the Euler number?

Answer

e is the value at the end of one year of $1.00 invested at an annual interest rate of 100% with
continuous compounding. In fact, if P=$1.00, r=1, and t =1
r×t 1 ×1
St =P ×e reduces to S1=1 × e =e

Critical thinking

Question 6

What is wrong with the following reasoning?

“If a banker lends you one dollar at an exorbitant interest rate of 100 percent per annum and
subjects the loan to instantaneous compounding (infinite frequency of compounding), you would
need an infinite amount of dollars to repay the loan at the end of the first year. In fact, in the
limiting case where interest is compounded continuously during the year the compound interest
you will have to pay is virtually infinite.”

Answer

The compound interest is not a big amount of money.

According to the formula

r×t
St =P ×e

the value of the principal P = $1.00 at the interest rate r = 1.00 will be

10
 r×t
s1=P × e =¿ 1 ×e 1 ×1=e

or $e, that is, approximately, $2.718. Therefore, the compound interest you will have to pay is

s1−P=$ 2.718−$ 1.00=$ 1.718

Question 7

What is the defect in the following reasoning?

“It does not make much difference to invest one trillion dollars with continuous
compounding or daily compounding at a nominal annual rate of 12 percent for 5 years
simply because the difference between continuous and daily interest compounding of $1
under the same conditions is negligible (= $0.00018).”

Answer

It is true that the difference between continuous and daily compounding (in both cases with

P = 1.00, p = 12, and t = 5) is negligible because

0.12 ×5
s5=1 × e ≈ 1.82212 Continuous compounding

and

( )
5 ×365
0.12
S5=1 × 1+ ≈ 1.82194 Daily compounding
365

And therefore,

Compound interest = $1.82212 – $1.00 ¿ $0.82212  Continuous compounding

Compound interest = $1.82194 – $1.00 ¿ $0.82194  Daily compounding

But it is also true that a principal of $1012 (one trillion dollars) will generate a difference equal to
$ 180,000,000.

In fact,
12
0.82212 – 0.8194=0.00018 , but 0.00018 10 =180,000,000

Topic # 5: Part II Effective Interest Rate

Notation

The interest rate r is usually quoted as an annual rate and it is called nominal rate.
r =nominalrate

If the nominal rate is compoundedk times a year, the number of interest periods per year is k :

11
 k =number of interest periods within a year

The rate per interest period is obtained by dividing r by the number of periods per year. In
symbols,
r
=interest rate per period
k
Finally,

re  Effective rate of interest (rate of interest actually earned)

Relationship between Nominal and Effective Rates (Discrete Compounding)

The relationship between r e and r is

( ) −1
k
r
r e = 1+  Discrete compounding
k

Question 1

If a nominal rate of interest 18% is compounded monthly, what is the effective rate?

Answer

r 0.18
= =0.0 15
k 12

r e =¿

Therefore, 19.56 % is the approximate rate of interest compounded annually that is actually
earned.

Question 2

Find the effective interest rate (rounded to three decimal places) that is equivalent to a nominal
rate of 10% compounded semi-annually.

Answer

r 0.10
= =0.05
2 2

12
 ( ) −1
k
r
r e = 1+ =¿
k

Therefore, the effective rate of interest is 10.25%

Question 3

Determine the annual equivalent rate of interest of a savings account that has a nominal rate of
6.6% compounded monthly.

Answer

r 0.066
= =0.005
k 12

( ) −1=¿
k
r
r e = 1+
k

Therefore, the annual equivalent rate is 6.8%

Relationship between Nominal and Effective Rates (Continuous Compounding)

r
r e =e −1  Continuous compounding

Where r e is the effective rate of interest (rate of interest compounded annually, actually earned).

Question 4

Find the effective interest rate that is equivalent to a nominal rate of 5% compounded
continuously.

Answer

The relevant formula is

r
r e =e −1

Therefore,
0.05
e =1.05127109638

r e =e −1= 0.051271
r

13
Therefore,

r e ≈ 0.05127 ←(5.127 %)

Question 5

Select the best choice to invest your money.

 First choice: 5% compounded continuously

 Second choice: 5.15% compounded daily

Answer

To select the best choice we have to find the effective interest rate corresponding to each choice.

First choice (interest compounded continuously)

r e ≈ 0.05127 ←(5.127 %)

Second choice (interest compounded daily)

r 0.0515
= =0.00014109589
k 365

The relevant formula is

( ) −1
k
r
r e = 1+
k

( )
k
r 365
1+ =( 1.00014109589 ) =1.05284536
k

( ) −1=0.052845
k
r
1+
k

Therefore,

r e ≈ 0.052845← (5.284 %)

Since the second choice gives the highest effective rate, it is the best choice (in spite of the fact
that continuous compounding may be psychologically more appealing).

Critical thinking

Question 1

What is wrong with the following proposition?

14
“Under continuous compounding the nominal rate of interest r is always equal to the natural
logarithm of effective rate of interest re. In fact, the relationship between the nominal rate of
interest and the effective rate of interest under the assumption of continuous compounding is

r =ln(r e +1)=lnr e + ln1 r =ln r e because ln1=0

Answer

Under continuous compounding, the effective rate of interest is

r
r e =e −1

This can be slightly rewritten as

r
e =r e +1

Taking natural logarithms on both sides, yields

r
ln e =ln(r ¿ ¿ e+1)¿ that is, r × ln e=ln(r ¿ ¿ e+1)¿

It is mathematically correct to say that ln 1=0, so that

r ¿ ln (r ¿¿ e+1)¿ ← everything correct up ¿ this result

However, it is a mathematical atrocity to write

ln (r e + 1)=ln r e + ln 1 ← this isincorrect

Always keep in mind:

ln (r e + 1)≠ ln r e + ln 1

The reason being that the logarithm of a sum is not the sum of the logarithms. See Topic # 5
(Appendix)

Question 2

Your task is to analyse the logic of the following reasoning. An economist who hates the
mathematics of finance claims that he can show the irrelevance of the formula

( ) −1
k
r
r e = 1+
k

arguing as follows: “I have reached conclusion that It does not make sense to waist our time
finding the formula for the mathematical relationship between the effective rate of interest r e and
the nominal rate of interestr because the annual equivalent rate r e is always equal to a nominal

15
rate r compounded annually. If they are always equal to each other, why should business students
be mathematically harassed with trivialities?”

Answer

We are in the presence of what logicians call a “Hasty Generalization.” A hasty generalization is a
general statement without sufficient evidence to support it. More precisely, a hasty generalization
is made out of a rush to have a conclusion, leading the arguer to an unwarranted conclusion or
exaggeration.

Arguing that a particular case of the formula in question happens when k =1:

( ) – 1
1
r r e =r
r e = 1+
1

would be logically correct. The problem with the argument is that the conclusion that the
economist should prove, namely: irrelevance of the formula, is validated within the claim with a
trivial example of the application of the formula.

Logical fallacies are common errors in reasoning that will undermine the logic of your argument.
Fallacies can be either illegitimate arguments or irrelevant points. Avoid these common fallacies in
your own arguments and watch for them in the arguments of others.

Question 3

“One surprising attribute of the Euler number e=2.71828 … is that it can be interpreted as the
year-end value to which a principal of $1 will grow if interest at the rate of 100 percent per annum
is compounded continuously. An immediate conclusion –some people would say obvious
conclusion– is that under continuous compounding $1 becomes $ e=$ 2.71828 … after one year,
and therefore, the interest rate actually earned after one year is 100%.”
Evaluate the accuracy of the argument and explain your answer.

Answer

There is a fundamental misunderstanding in the preceding argument. The interest rate of 100
percent is only a nominal interest rate. The effective interest rate (the interest rate actually earned
after one year) is 172 percent per annum . To get the correct interest rate we have to use the
r
formula r e =e −1 with r =1:

1
r e =e −1=2.71828−1

¿ 1.71828 ← approximately 172 % per annum

Question 4

16
What is wrong in the following reasoning?

“For a given nominal interest rate r , the effective interest rate r e increases with the
number of interest periods per year (k ). For example, the effective rate equivalent
to a nominal rate of 6 % compounded semi-annually (k =2) is 6.09 % , but when
the same nominal rate is compounded quarterly (k =4 ) the effective rate is
approximately 6.14 % . Therefore, the effective interest rate grows without bound
when the number of interest periods k goes to infinity.”

Answer

The effective interest rate r e has a limit value when k → ∞ . In fact,

( ) [( ) ]
k k
r r r
lim r e =lim [ 1+ −1¿]=lim 1+ −1=¿ e −1 ¿¿
k→∞ k→∞ k k→∞ k

Regardless of how large k is, the maximum effective rate that can be obtained is
r
e −1 ← Maximum effective rate

In the case of nominal rate of a nominal rate of 6 % compounded continuously, we find that the
corresponding effective rate is

r 0.06
r e =e −1=e −1 ≈ 0.0618 ← 6.18 %

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