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Implicit Function Theorem

The implicit function theorem states that if a function U(h,w) equals 0 and the partial derivative of U with respect to h is not 0, then there exists an implicit solution h(w) with a derivative that can be expressed as the negative ratio of the partial derivatives of U with respect to w and h. This theorem allows the expression of one variable as an implicit function of others if the conditions are met. The key step is partially differentiating the function U with respect to w and h to obtain an expression for the derivative of the implicit function h(w). Comparative statics analysis can then use this theorem to determine how optimal choices change with respect to an exogenous parameter like a price.

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Eloise Taylor
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21 views

Implicit Function Theorem

The implicit function theorem states that if a function U(h,w) equals 0 and the partial derivative of U with respect to h is not 0, then there exists an implicit solution h(w) with a derivative that can be expressed as the negative ratio of the partial derivatives of U with respect to w and h. This theorem allows the expression of one variable as an implicit function of others if the conditions are met. The key step is partially differentiating the function U with respect to w and h to obtain an expression for the derivative of the implicit function h(w). Comparative statics analysis can then use this theorem to determine how optimal choices change with respect to an exogenous parameter like a price.

Uploaded by

Eloise Taylor
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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IMPLICIT FUNCTION THEOREM:

Suppose we have an equation

U ( h , w )=0
hen an implicit solution is a function

h( w) so that,

U ( h ( w ) , w )=0
We say that the variables

are the exogenous variables and the variables

are the endogenous variables.

Theorem: Suppose

U ( h0 , w0 ) =0 and

continuous implicit solution

U ( h 0 , w 0 )
0 . Then there exists a
h

h ( w ) , with derivative:

h ( w ) U w ( h ( w ) , w )
=
w
U h( h( w) , w)
for

close to

w0 .

Proof:
If we differentiate

U ( h ( w ) , w ) w.r.t. w

U ( h ( w ) , w ) h ( w ) U ( h ( w ) , w )
+
=0
h
w
w
Rearranging the equation yields

h ( w ) U ( h ( w ) , w ) / w
=
w
U ( h ( w ) , w ) / h

we get

which exists for all

computed

only if

U ( h ( w ) , w ) / x 0 for all w . Since we have

h ( w )
h(w) is continuous, since all differentiable
w , it follows that

functions are continuous.

The key step in proving the implicit function theorem is equation:

U ( h ( w ) , w ) h ( w ) U ( h ( w ) , w )
+
=0
h
w
w
The first term is the equilibrium effect or indirect effect: The system itself adjusts
the endogenous variables to restore equilibrium in the equation

U ( h ( w ) , w )=0

(for us, this will occur because a change in c causes agents to re-optimize,
cancelling out part of the change). The second term is the direct effect: By
changing the parameters, the nature of the system has changed slightly, so that
equilibrium will be achieved in a slightly different manner.

Maximum and Comparative Statics


Suppose we have an optimisation problem

max U ( h , w )
h

where

is some parameter the decision-maker takes as given (like a price

that cant be influenced by gaming the market). Let

h ( w ) be a maximiser of

U ( h , w ) . Then the First Order Necessary Conditions (FONCs) imply

U ( h ( w ) , w )

=U h ( h ( w ) , w )=0
h
and

2 U ( h ( w ) , w )
=U hh ( h ( w ) , w ) 0
2
h
(nb: we know that
assuming that

U h ( h ( w ) , w )=0 and U hh ( h ( w ) , w ) 0

h ( w ) is the maximiser).

since we are

If we differentiate the FOCN w.r.t.

w , we get (using the product rule)

U hh ( h ( w ) , w )

h ( w)

+ U hw (h ( w ) , w)
w

and solving for

h ( w )
w

yields

h ( w ) U hw ( h ( w ) , w)
=
w
U hh ( h ( w ) , w )
This is the comparative static of

w.r.t.

w : we are measuring how h ( w )

the agents behaviour (i.e. hours worked) responds to a change in


exogenous parameter outside their control (i.e. wage).
The SOSC implies that

U hh ( h ( w ) , w ) <0

, so we know that

h ( w)

sign
=sign ( U hw ( h ( w ) , w ) )
w

so that

h ( w ) is increasing in w

if

U hw ( h ( w ) , w ) 0 .

some

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