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Dynamic Stability

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.