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Non-Linear, First-Order Difference Equations

**In this chapter, we learn the method to
**

find out qualitative properties of non-linear

first-order autonomous difference equations.

Basically, we are interested in finding steady-

state solutions and their stability properties.

In order to so, we make use of phase dia-

gram, which basically involves plotting yt+1

against yt . In the case of non-linear difference

equation there can be more than one steady

state (multiplicity of equilibria).

The general form of non-linear first-order

autonomous difference equation is

yt+1 = f (yt ); f 0 (yt ), f 00 (yt ) 6= 0. (19.1)

The steady state solutions are given by

y = f (y). (19.2)

1

The existence and convergence properties of

steady-states depend on the f 0 (yt ) & f 00 (yt ).

In phase diagram, steady state values are gi-

ven by points at which f (yt ) intersects 450

line (curve depicting yt+1 = yt ).

**Theorem 19.1: A steady-state equilib-
**

rium is locally stable if the |f 0 (y)| < 1.

It is unstable otherwise.

**Theorem 19.2: A first-order difference
**

equation leads to oscillation in yt if the

derivative f 0 (yt ) < 0, ∀yt > 0, but m-

oves monotonically if the derivative

f 0 (yt ) > 0, ∀yt > 0.

2

Solow Model Revisited

**Suppose that aggregate output, yt , is gi-
**

ven by

yt = ktα , 0 < α < 1

where kt is the capital stock at time t. The

capital stock evolves over time as follows:

kt+1 = (1 − δ)kt + It , 0 < δ < 1

**where δ is the depreciation rate and It is the
**

investment at time t. The economy saves a

constant proportion, s, of output every pe-

riod. Thus savings, St , is given by

St = syt .

Imposing the equilibrium condition St =

It , we derive a non-linear difference equation

in capital stock, which tells us about the im-

plications of Solow growth model:

3

kt+1 = (1 − δ)kt + sktα .

The difference equation has two steady states

³ s ´ 1−α

1

k = 0, .

δ

¡ s ¢ 1−α

1

k = 0 is unstable and k = δ is stable.

4

Stable Limit Cycles

**So far we have considered the case in
**

which f 0 (y) does not change sign and thus

f (y) is either increasing or decreasing. Now

suppose that f 0 (y) can change its sign and

f 00 (y) < 0. Such nonlinear function produces

hill-shaped curve.

Now further suppose that f 0 (y) < −1,

then the steady state is not stable. However,

the value of yt will not diverge either to 0

or ∞. Rather it will oscillate around steady

state within finite bounds. In certain cases,

yt converges to a path that cycles back and

fourth in successive periods between two val-

ues. In this case, yt converges to stable limit

cycle of two period.

5

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