Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Mathematics for Economic Dynamics II

Muhammad Ryan Sanjaya

Department of Economics, Universitas Gadjah Mada

20 April 2020

Corresponding e-mail: m.ryan.sanjaya@ugm.ac.id

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada
Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Nonlinear, First-order Difference Equations

Phase Diagram
Cycles and Chaos

Linear, First-Order Differential Equations

Autonomous equations
Steady State and Convergence
The Case when a = 0

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Nonlinear, First-order Difference Equations

Phase Diagram
Cycles and Chaos

Linear, First-Order Differential Equations

Autonomous equations
Steady State and Convergence
The Case when a = 0

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Phase Diagram

Introduction

I We will only focus on autonomous, nonlinear, first-order

difference equations

yt+1 = f (yt ), t = 0, 1, 2, ...

I Steady state equilibrium (ȳ ≡ yt+1 = yt ) is written as

ȳ = f (ȳ )

I In most cases, we’re only interested in finding whether or not

yt converges to a steady-state equilibrium using a phase
diagram that plots yt+1 with yt

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Phase Diagram

Example

1/2
I The steady-state equilibrium for yt+1 = yt is

ȳ = ȳ 1/2

(ȳ = ȳ 1/2 )2
ȳ 2 − ȳ = 0
ȳ (ȳ − 1) = 0
ȳ = 0 and ȳ = 1
I The phase diagram is (see next slide)

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Phase Diagram

Phase Diagram

The equilibrium point ȳ = 1 is

locally stable, while ȳ = 0 is
unstable

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Phase Diagram

Phase Diagram

I The equilibrium point

ȳ = 0 is locally stable,
while ȳ = 1 is unstable
I What if y0 > ȳ ?

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Phase Diagram

Stability of the Equilibrium

Definition
A steady-state equilibrium of any autonomous, nonlinear, first-order
difference equations is locally stable if |f 0 (ȳ )| < 1 and unstable if
|f 0 (ȳ )| > 1 at that point.
In other words, a system is converging towards (diverging from) an
equilibrium if it is stable (unstable).

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Phase Diagram

Approach Paths

Theorem
For all yt > 0, an autonomous, nonlinear, first-order difference
equation will lead to oscillations in yt if f 0 < 0, but will move
monotonically if f 0 > 0.

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Phase Diagram

A Model of Economic Growth

An economy evolves overtime at yt and is determined by aggregate

capital kt in the following fashion

yt = ktα , 0 < α < 1; t = 0, 1, 2, ...

Capital is accumulated by saving current output and depreciates at

rate δ
kt+1 = kt − δkt + syt , 0 < s, δ < 1
Substitute yt into the capital equation gives

kt+1 = kt (1 − δ) + sktα

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Phase Diagram

A Model of Economic Growth

Let α = 0.5, s = 0.2 and δ = 0.1, then the capital equation is

1/2
kt+1 = 0.9kt + 0.2kt

At the steady-state
k̄ = 0.9k̄ + 0.2k̄ 1/2
k̄ = 0 and k̄ = 4
The first derivative of f (k̄) is f 0 (k̄) = 0.9 + 0.1k̄ −1/2
I |f 0 (0)| = ∞ → unstable
I |f 0 (4)| = 0.95 < 1 → locally stable and yt moves
monotonically

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Cycles and Chaos

Cycles and Chaos

I Finally some catchy names!

I A hill-shaped phase diagram may have a cycle or chaos
I The term ’cycle’ suggests regularity, while ’chaos’ suggests the
lack of regularity
I The discussion will be short

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Cycles and Chaos

Example

Consider this equation

yt+1 = ryt (1 − yt ), t = 0, 1, 2, ...

where its steady-state values are

r −1
ȳ = 0 and ȳ =
r
The latter is stable iff
1<r <3

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Cycles and Chaos

Hill-shaped Phase Diagram

I The system is stable

when 1 < r < 3
I This diagram corresponds
to a stable system
I Initial value at y0 : starts
monotonically but then
oscillating around the
peak of the hill before
converging at ȳ

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Cycles and Chaos

Cycle

I This diagram corresponds

to r = 3.2
I The system bifurcates
at r = 3, when yt
converges to a path that
cycles back and forth in
successive periods
between two values
(where the steady-state
point lies in between).
I What are the two
values?
I What if y0 is close to
the origin?

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Cycles and Chaos

Chaos

Chaos theory. Butterfly effect (yes, the same as that Ashton

Kutcher’s movie). Yeah. It’s hard. Not going to discuss this.

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Nonlinear, First-order Difference Equations

Phase Diagram
Cycles and Chaos

Linear, First-Order Differential Equations

Autonomous equations
Steady State and Convergence
The Case when a = 0

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Autonomous equations

Introduction

Definition
The general form of an autonomous, linear, first-order differential
equations is
ẏ + ay = b
where a and b are known constants.
The general solution y = yh + yp where
I The general solution to the homogeneous form (i.e., when
b = 0) yh
I The particular solution to the complete equation yp

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Autonomous equations

Homogeneous Solution
The homogeneous form is ẏ + ay = 0 and a 6= 0. Rearrange to get
ẏ
=−a
y
Z Z
dy /dt
dt = −adt
y
1
Z
dy =c1 − at
y
ln y + c2 =c1 − at
y =e c1 −c2 −at
y =Ce −at

Where C = e c1 −c2 is an arbitrary constant

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada
Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Autonomous equations

Homogeneous Solution

Theorem
The general solution of the homogeneous form of a linear,
autonomous, first-order differential equations is

y = Ce −at

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Autonomous equations

Steady State

Definition
A steady-state value (ȳ ) of a differential equation is defined by the
condition ẏ = 0.

ẏ + ay =b
0 + aȳ =b
b
ȳ =
a

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Autonomous equations

Particular and General Solution

In fact
b
yp = ȳ =
a

Theorem
The general solution to the complete linear, autonomous, first-order
differential equations is
b
y (t) = Ce −at +
a

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Autonomous equations

Example

Let the evolution of capital over time follows the following equation

K̇ = I¯ − δK , δ>0

The steady-state value is

I¯
K̄ =
δ
The general solution is

I¯
K (t) = Ce −δt +
δ
Easy!

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Autonomous equations

Example

If we know the initial value K (0) = K0

I¯
K0 = C +
δ
I¯
C = K0 −
δ
Substitute C to the general solution and we’ll obtain

I¯ −δt I¯
 
K (t) = K0 − e +
δ δ

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Steady State and Convergence

Convergence

Theorem
The solution to the linear, autonomous, first-order differential
equations converges to ȳ iff a > 0.

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

Steady State and Convergence

Example

I In our previous example a = δ > 0 so K (t) converges to K̄

I How about this equation

ẏ = 5y − 10

Does it converges? What is the solution if y (0) = 100?

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

The Case when a = 0

The case of a = 0

I We’ve discussed this a bit in our introduction to mathematical

dynamics (week 8)
I When a = 0, the differential equation becomes

ẏ = b

I The solution can be simply obtained by integration

y (t) = bt + C

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

The Case when a = 0

Example: National Debt Accumulation (1/4)

I Let D(t) the level of debt and Y (t) the nation’s income, both
at time t and in real dollar value
I An increase in debt implies (budget) deficit, which is assumed
to be a constant proportion of Y
Ḋ = bY , b>0 (1)

I Q: what do you think is the value of b in Indonesia?

I Assume that the economy grows at constant rate g > 0
Ẏ =gY
Ẏ
=g
Y
Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada
Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

The Case when a = 0

Example: National Debt Accumulation (2/4)

I Integrate both sides to obtain the differential equation that

shows how Y , now a function of t, evolves over time
Z Z
Ẏ
dt = gdt
Y
ln Y (t) + c2 =gt + c1
Y (t) =e gt+c1 −c2
Y (t) =C1 e gt

I C1 = e c1 −c2 is an arbitrary constant

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

The Case when a = 0

Example: National Debt Accumulation (3/4)

I At t = 0, Y (0) = Y0 = C1 , thus

Y (t) = Y0 e gt (2)
I Substitute (2) to the deficit equation (1) and integrate both
sides
Ḋ = bY0 e gt
Z Z
Ḋdt = bY0 e gt dt

e gt
Z
dD
dt = bY0
dt g
e gt
D(t) = bY0 + C2 (3)
g
Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada
Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

The Case when a = 0

Example: National Debt Accumulation (4/4)

I At t = 0, D(0) = D0 = bY0 /g + C2 , or

b
C2 = D 0 − Y0
g
I Put this back to equation (3) to obtain the solution

b gt
D(t) = D0 + (e − 1)Y0 (4)
g
I This exercise can be extended to include interest payment for
the debt and to find the condition for the debt to be
sustainable (see pp. 865-866 in Hoy’s textbook)

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada

Outline Nonlinear, First-order Difference Equations Linear, First-Order Differential Equations

The Case when a = 0

Problem Set 9

1. Sketch the phase diagram and identify the local stability

properties of the following difference equations
3
I yt+1 = 16 + yt2
I yt+1 = 2 − 3yt2
2. Find the solution for the following differential equations when
y (0) = 10 and determine whether they converge to their
steady-state values
I ẏ = −0.5y + 1
I ẏ = 0.5y − 1

Mathematics for Economic Dynamics II Department of Economics, Universitas Gadjah Mada