These conditions determine the optimal choice functions (XI(a), xs(a)),

which in turn determine the maximum value function

M(a)

g(xl(a),xz(a), a). (5.2)

The envelope theorem gives us a formula for the derivative of the value
function with respect to a parameter in the maximization problem. Specifically,
the formula is
As before, the interpretation of the partial derivatives needs special care:
they are the derivatives of g and h with respect to a holdzng xl and x2
fied at thew optzmal values. The proof of the envelope theorem is given
in Chapter 27, page 501. Here we simply apply it to the cost minimization
problem.
In this problem the parameter a can be chosen to be one of the factor
prices, w,. The optimal value function M(a) is the cost function c(w, y).
The envelope theorem asserts that
which is simply Shephard's lemma.
76COST FUNCTION (Ch. 5)

EXAMPLE: Marginal cost revisited

As another application of the envelope theorem, consider the derivative of
the cost function with respect to y. According to the envelope theorem,
this is given by the derivative of the Lagrangian with respect to y. The
Lagrangian for the cost minimization problem is