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max ( ) (2.16)
( ) 0, = 1
where represent the Lagrange multipliers for the problem. Let () denote the solution to
the problem as a function of . That is, for any choice of , () represents the choices of that
maximize ( ) subject to the constraints. Due to the fact that = (0 ) is optimal when
= 0 , you might imagine that is almost optimal for s near 0 , and that there would be little
improvement from choosing () instead of when is close to 0 . This is, in fact, true, and it
is what drives the envelope theorem, which essentially says that we can ignore the dependence of
() on when computing the impact on the objective function of changing .
Theorem 10 The Envelope Theorem: Consider a constrained optimization problem like (2.16)
with Lagrangian (2.17).
( ) ( ) X ( )
= | = | .
=1
That is, the total derivative of the optimized value of the objective function with respect to an
exogenous variable is equal to the partial derivative of the Lagrangian evaluated at the optimal
solution to the optimization problem.
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Avery and Miller Applied Microeconomic Theory: Chapter 2 ver: March 2014
Proof. The proof of the envelope theorem mimics the derivation from the previous section.
We provide a proof for the case where there is a single constraint and that constraint binds. It
makes use of two facts: the optimality of () and the fact that the constraint holds as an identity.
()
The first-order condition for the optimization problem implies that = ()
. Note these
are partial derivatives with respect to , not . If the constraint holds as an identity, we have
P (()) ()
( () ) 0. Dierentiating this with respect to yields: = . Begin
( () ) X ( () ) ( () )
= +
X
( ) ( () )
= +
X ( ) ( () )
= +
( () ) ( )
=
This completes the proof. Note how the steps of using the first order condition and then the
dierentiated form of the constraint mirror the steps above. This proof technique arises in a
number of circumstances.
To get a sense of the intuition underlying the Envelope Theorem, consider Figure 2.15, which
is a stylized representation of the impact on a firms cost of increasing the cost of labor. At wage
rate 0 , the firms cost as a function of labor is ( 0 ), and the firm minimizes cost by choosing
labor quantity 0 . When the cost of labor increases to 00 , we expect there to be two eects. First,
the cost of the labor the firm is already using increases. This is represented by the upward shift
in the curve from ( 0 ) to ( 00 ). Second, we expect the firm to use less labor, since it has
become more expensive relative to other inputs. This is represented by the movement in the point
that minimizes cost leftward from 0 to 00 .
What can we say about the relative size of these two eects? If the firm continued to use the
same amount of labor after the wage increase, its cost would shift upward by (00 0 ) 0 , i.e., in
proportion to the size of the wage change. On the other hand, if the firm reduces its labor use
from 0 to 00 , its savings is roughly proportional to the slope of the cost curve times the change in
, (0 00 ) (00 0 ). The envelope theorem says that, since the firm chose labor in order to set
the derivative of the cost function equal to zero initially, (0 00 ) is likely to be very small, and
so the additional savings from changing is going to be negligible relative to the direct impact of
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Avery and Miller Applied Microeconomic Theory: Chapter 2 ver: March 2014
the wage increase on the cost of labor. The derivation of the envelope theorem just restates this
point using derivative.29
Using the envelope theorem,
( ( )) = can be proved easily. The Lagrangian for the
UMP is:
= () ( ) ,
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