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Contains detailed analysis of dynamic stability in economics by the HOD of economics at Presidency University.

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**The difference between static stability analysis and dynamic stability analysis is that the latter
**

explicitly incorporates time, while the former does not. In fact, in economics there are two

types of models, static and dynamic. The former does not explicitly consider time, but the

latter does. Thus, the model of price determination we are doing here is a static model. In the

dynamic stability analysis also, we have to first specify the adjustment rules that state how

the endogenous variables behave in all possible situations. Regarding D and S we assume, as

before, that they are given by (4 and (! in all possible situations. "ore precisely, if at any

point of time t the value of

#

p

is

t

p

#

, values of D and S at that t are

( ) ( ) $... and $..

# # t t

p S p D

respectively. %or the purpose of dynamic stability analysis only,

we shall represent

( ) ( ) $... and $..

# # t t

p S p D

by

( ) ( )

t t

p S p D

# #

and

respectively. Regarding

#

p

, for reasons we have already discussed, we assume that

( ) ( ) ( ) ( ) & , & &

# #

#

> ′ = − = F F p S p D F

dt

dp

t t

t

('

(et us explain ('.

dt

dp

t #

gives the amount of change in

t

p

#

per unit increase in t (which

denotes time when t increases by an infinitesimally small amount. In other words

dt

dp

t #

gives the rate of change of

t

p

#

over time. (' states that if at any t,

t

p

#

is such that

( ) ( ) &

# #

= −

t t

p S p D

so that there is e)uilibrium in the mar*et for

#

x

, &

#

=

dt

dp

t

, i.e.,

t

p

#

ceases to change over time$ it comes to a position of rest. +gain, if at any time t,

t

p

#

is such

that

( ) ( ) &

# #

> −

t t

p S p D

, then &

#

>

dt

dp

t

too, i.e.,

t

p

#

begins to rise over time. ,ot only that,

the larger the amount of excess demand,

( ) ( ) [ ]

t t

p S p D

# #

−

, the greater is the speed of

increase in

t

p

#

over time, i.e., the larger is the value of

dt

dp

t #

. The reason may be explained

as follows. The larger the amount of excess demand for

#

x

, the greater is the desperation on

the part of the dissatisfied buyers to get more of the good and hence the larger is li*ely to be

the increase in the price offered by them or the greater is li*ely to be the hi*e in the price

affected by the suppliers. -imilarly, the situations of excess supply can be explained. .e can

solve (' for

t

p

#

. It gives us the time path of

#

p

. .e shall first solve (' by ta*ing simple

linear forms of

( ) ( ) ( )

t t

p S p D F

# #

and , •

. -uppose ( ) ( ) ( ) & .

# #

#

> − = α α

t t

t

p S p D

dt

dp

( ) & and &

# # # #

> > − = a a p a a p D

t t

. +gain,

( ) & and &

# # # #

> > + = b b p b b p S

t t

.

/sing these, we rewrite (' as follows0

[ ] [ ] ( ) & .

# # # #

#

> + − − = α α

t t

t

p b b p a a

dt

dp

(1

.e rewrite (1 as

[ ] [ ] ( ) & .

# # #

#

> + − − = α α

t

t

p b a b a

dt

dp

(#&

2ifferential e)uation (#& may be solved as follows0 Its solution has two components, a

particular solution and a complementary function. (et us first derive the particular solution.

-ince the constant term in (#& is independent of t, let us try

p p

t

=

#

, where

p

is a

constant, as a solution of (#&. If it is a solution of (#&, it must satisfy (#&. If

p p

t

=

#

,

&

#

=

dt

dp

t

. If

p p

t

=

#

is a solution of (#&, then, if we substitute & for

t

t

p p

dt

dp

for and

#

in (#&, the (3- and R3- of (#& must be e)ual. Thus, we must

have

( ) ( ) p b a b a

# #

& + − − = α α

-olving the above e)uation, we get

# #

b a

b a

p

+

−

=

If

p p

t

=

# is a solution of (#&, then

p

must assume the above value. Thus

# #

#

b a

b a

p

t

+

−

=

(##

is a solution of (## and it is called the particular solution.

(et us now derive the complementary function. %or that we have to consider e)uation (#&

without the constant term. It is given by

[ ]

t

t

p b a

dt

dp

# # #

#

+ − = α (#4

The solution of (#4 is the complementary function. (et us try

mt

t

Ae p =

#

as the solution.

Then, ( ) ( )

# # # #

b a m Ae b a m Ae

mt mt

+ − = ⇒ + − = α α

Therefore,

( ) t b a

t

Ae p

# #

#

+

=

α

(#5

The solution to (#& is the sum of (## and (#5. Thus,

( ) t b a

t

Ae

b a

b a

p

# #

# #

#

+ −

+

+

−

=

α

(#4

(#4 contains just one un*nown A. +t

& = t

(#4 becomes

# #

#&

# #

#&

b a

b a

p A A

b a

b a

p

+

−

− = ⇒ +

+

−

=

(#!

-ubstituting (#! into (#4, we get

( ) t b a

t

e

b a

b a

p

b a

b a

p

# #

# #

#&

# #

#

+ −

+

−

− +

+

−

=

α

(#6

.e can write (#6 as

( ) t b a

t

e

b a

b a

p

b a

b a

p

# #

# #

#&

# #

#

+

+

−

−

+

+

−

=

α

(#7

%rom (#7 it follows that, if ( ) & .

# #

> + b a α , the second term on the R3- of (#7 tends to 8ero

as t tends to infinity. %rom the above it follows that

# #

#

&

b a

b a

p Lim

t

t

+

−

=

→

if and only if ( ) & .

# #

> + b a α . Thus, ( ) & .

# #

> + b a α is both necessary and

sufficient for the stability of

t

p

#

. (9rove this point yourself. we can plot (#6 or (#7 in a

diagram as follows0

t

p

#

( )

# #

b a

b a

+

−

#&

p

t

t

p

#

#&

p

( )

# #

b a

b a

+

−

t

The above diagram may be explained as follows. %rom (#6 or (#7 it follows that at & = t ,

#& #

p p

t

=

and the deviation of

t

p

#

from its e)uilibrium value approaches 8ero as t increases,

but it does so at a decreasing rate. (9rove this last statement yourself.

Exercise:

Draw the time path of

t

p

#

, when the equilibrium is unstable, i.e., when ( ) &

# #

< + b a .

The stability condition can be explained using the following diagram as well where the line

pp represents (#&. The diagram has been drawn under two alternative assumptions, namely,

( ) ( ) ii (%igure & and i (%igure &

# # # #

< + > + b a b a

.

dt

dp

t #

r

β =

#&

p

#

p

λ =

#&

p

t

p

#

pp

Figure i

dt

dp

t #

r

β =

#&

p

#

p

λ =

#&

p

t

p

#

pp

Figure ii

%igures i and ii are called phase diagrams of the differential e)uation (#&. %ocus on %igure i.

%irst consider the case where the

# #&

p p < = β

, where

#

p

is the e)uilibrium value of

#

p

. +t

β =

#&

p

, the value of &

#

> = r

dt

dp

t

. This means that, with an increase in t, i.e., with the

passage of time

t

p

#

will increase and it will increase at the rate r. This means that if t

increases from 8ero by an infinitesimally small amount,

t

p

#

will rise by r per unit increase

in t. Thus,

t

p

#

will not stay put at

β

. It will start rising. -ince at very value of

# #

p p

t

<

, the

value of

dt

dp

t #

is positive, it will go on rising over time from

β

as indicated by the arrows

until it becomes e)ual to

#

p

. (,ote that as

t

p

#

approaches

#

p

, its rate of increase over time

steadily falls. +s soon as

t

p

#

reaches

#

p

, the value of

dt

dp

t #

becomes 8ero and

t

p

#

ceases

to change with time. It comes to a position of rest. -imilarly, if

# #&

p p > = λ

, the value of

dt

dp

t #

corresponding to such a value of

t

p

#

is negative and so it will fall over time until it

reaches

#

p

.

Exercise: 1. Explain Figure ii yourself.

2. Suppose

# . & and 5 $ #&&

# #

= = − = α p S p D

. arry out the !ynamic stability analysis

of equilibrium. Draw the phase !iagram an! explain it.

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