<p>The first order condition is $U_1(C(Y),Y)=0$, where $U_i$ means the partial derivative with respect to the $i$th argument.</p>

<p>Now, totally differentiate with respect to $Y$:
$$U_{12}(C(Y),Y)+U_{11}(C(Y),Y)C'(Y)=0.$$
This can be rearranged to give
$$C'(Y)=-\frac{U_{12}(C(Y),Y)}{U_{11}(C(Y),Y)}.$$</p>

<p>Usually, we expect the objective function is concave (i.e. $U_{11}&lt;0$), so the sign of $C'(Y)$ is the same as the sign of $U_{12}(C(Y),Y)$.</p>

<hr>

<p>Usually, when applying this kind of comparative static trick, the theory tells us what the sign of $U_{12}$ should be. As an example, if a entrepreneur's output as a function of effort and skill is $y(e,s)$, you might think that $y_{12}&gt;0$ (i.e. an increase in effort yields a bigger increase in output for more skilled people). The analagous exercise to the one you are conducting above would then yield $y_{12}&gt;0\implies e'(s)&gt;0$ so more skilled entrepreneurs try harder.</p>

<p>It's hard to know what the appropriate assumption on $U_{12}$ in your example might be because it's not clear why income is in the utility function in the first place and why $U$ isn't just increasing in $c$. Perhaps you have some application in mind that can pin this down.</p>

<hr>

<p>The envelope theorem would have a different use here. Suppose we found the optimal $C(Y)$ and are interested in the question "evaluated at $C(Y)$, how does an increase in income affect utility"?</p>

<p>The answer is</p>

<p>$$\frac{d U(C(Y),Y)}{dY}=\underbrace{U_1(C(Y),Y)}_{=0}C'(Y)+U_2(C(Y),Y)$$</p>

<p>The envelope theorem tells us that we can ignore the first term (i.e. the indirect effect of $Y$ on $C$) because the first order condition for optimal choice of $C$ (i.e. $U_1=0$) guarantees this effect is zero.</p>

CC BY-SA 3.0
2015-08-28T19:11:33.740Z
2015-08-28T19:20:38.670Z
2015-08-28T19:20:38.670Z
Ubiquitous
<p>Say I'm solving for consumption given income, and we assume that an interior solution exists:</p>

<p>$$ \max_c U(c, Y)\\
C(Y) = \arg\max_c U(c, Y)\\
$$</p>

<p>However, there is no closed-form solution for $C(Y)$. But I know it is cont. differentiable. Now I am not interested in $C(Y)$, but I want to know the sign of $C'(Y)$. Here was my approach:</p>

<p>Define the first-order condition as $G(c,Y) = 0$. Differentiate:</p>

<p>$$ 
\frac{d}{d Y} G(c,Y) = \frac{\partial G(c,Y)}{\partial Y} + \frac{\partial G(c,Y)}{\partial c}\frac{d c}{d Y} = 0
$$</p>

<p>Now I am somewhat stuck: How can I actually compute $\frac{d c}{d Y}$? That's what I'm, after all. I seem to remember that the envelope theorem says that $\partial c/\partial Y$ should be zero. How do I proceed?</p>

<mathematical-economics>
Envelope Theorem
FooBar
# Envelope Theorem

(Asked by: username_0 on 2015-08-28)

Say I'm solving for consumption given income, and we assume that an interior solution exists:

$$ \max\_c U(c, Y)\\
C(Y) = \arg\max\_c U(c, Y)\\
$$

However, there is no closed-form solution for $C(Y)$. But I know it is cont. differentiable. Now I am not interested in $C(Y)$, but I want to know the sign of $C'(Y)$. Here was my approach:

Define the first-order condition as $G(c,Y) = 0$. Differentiate:

$$
\frac{d}{d Y} G(c,Y) = \frac{\partial G(c,Y)}{\partial Y} + \frac{\partial G(c,Y)}{\partial c}\frac{d c}{d Y} = 0
$$

Now I am somewhat stuck: How can I actually compute $\frac{d c}{d Y}$? That's what I'm, after all. I seem to remember that the envelope theorem says that $\partial c/\partial Y$ should be zero. How do I proceed?

**Tags:** mathematical-economics


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## 1 answers

### Answer by username_1 on 2015-08-28. Score: 5

The first order condition is $U\_1(C(Y),Y)=0$, where $U\_i$ means the partial derivative with respect to the $i$th argument.

Now, totally differentiate with respect to $Y$:
$$U\_{12}(C(Y),Y)+U\_{11}(C(Y),Y)C'(Y)=0.$$
This can be rearranged to give
$$C'(Y)=-\frac{U\_{12}(C(Y),Y)}{U\_{11}(C(Y),Y)}.$$

Usually, we expect the objective function is concave (i.e. $U\_{11}<0$), so the sign of $C'(Y)$ is the same as the sign of $U\_{12}(C(Y),Y)$.

---

Usually, when applying this kind of comparative static trick, the theory tells us what the sign of $U\_{12}$ should be. As an example, if a entrepreneur's output as a function of effort and skill is $y(e,s)$, you might think that $y\_{12}>0$ (i.e. an increase in effort yields a bigger increase in output for more skilled people). The analagous exercise to the one you are conducting above would then yield $y\_{12}>0\implies e'(s)>0$ so more skilled entrepreneurs try harder.

It's hard to know what the appropriate assumption on $U\_{12}$ in your example might be because it's not clear why income is in the utility function in the first place and why $U$ isn't just increasing in $c$. Perhaps you have some application in mind that can pin this down.

---

The envelope theorem would have a different use here. Suppose we found the optimal $C(Y)$ and are interested in the question "evaluated at $C(Y)$, how does an increase in income affect utility"?

The answer is

$$\frac{d U(C(Y),Y)}{dY}=\underbrace{U\_1(C(Y),Y)}\_{=0}C'(Y)+U\_2(C(Y),Y)$$

The envelope theorem tells us that we can ignore the first term (i.e. the indirect effect of $Y$ on $C$) because the first order condition for optimal choice of $C$ (i.e. $U\_1=0$) guarantees this effect is zero.


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