5.difference & Differential Equations

CHAPTER THREE
DIFFERENTIAL AND DIFFERENCE
malebo2004@gmail.com: AMU
Malebo Mancha Massa:
EQUATIONS AND THEIR APPLICATIONS
IN ECONOMIC DYNAMICS
1
Introduction …
• Both differential and difference equations are used
to solve problems of economic dynamics.
➢ They are used to find a time path from some given
pattern of changes of a variable over time.
➢ Differential equations are applicable where the
time value of variables takes only continuous
values. The pattern of changes is represented by the
𝒅𝒚
differential in the case of differential equations.
𝒅𝒕
➢ Difference equations are applicable where the time
value of variables takes only discrete values. The
pattern of changes is represented by the difference
𝜟𝒚 2
quotient in the case of difference equations.
𝜟𝒕
Differential Equations and Their
Applications in Economic Dynamics
3
Differential Equations …
• Differential equations contain the derivative of one
or more dependent variables with respect to one or
more independent variables. For example,
dy
= 2xy
dx
dy
x =y−1
dx
d2 y dy
2
+ +y=0
dx dx
d2 u d2 u
2
+ 2 =0
dx dt
𝜕2u 𝜕2u 𝜕u
2
+ 2 =2 4
𝜕x 𝜕t 𝜕t
Ordinary versus partial differential equations
• Ordinary differential equations (ODE)
➢involves only one independent variable and
➢contains only total differentials.
𝑑𝑦(𝑥)
+ x 2 y x = 4x
d𝑥
• A partial differential equation (PDE)
➢involves more than one independent variable and
➢contains partial differentials.
𝜕𝑧(𝑥, 𝑦) 𝜕𝑧(𝑥, 𝑦)
+ 5xy + 𝑧(𝑥, 𝑦) = 0
𝜕𝑥 𝜕𝑦 5
Linear versus nonlinear differential equations
• A linear differential equation contains only terms that

are linear in the dependent variable or its derivatives.
𝑑𝑦(𝑥)
+ x 2 y x = 4x
d𝑥
• A nonlinear differential equation contains nonlinear
function of the dependent variable.
d2 𝑦(𝑥) 2
𝒅𝒚(𝒙) 6
2
+x 𝐲 𝐱 =0
dx 𝐝𝒙
Homogenous versus non-homogenous
• Here is example of homogenous differential equation:
𝒅𝒚
+ 𝐚𝐲 = 𝟎
𝒅𝒕
• Here is example of homogenous differential equation:
𝒅𝒚
+ 𝐚𝐲 = 𝒃 (𝒃 ⧧ 𝟎)
𝒅𝒕
7
Order of differential equations
• Differential equations can be of different orders.
• The order of a differential equation is determined
by the highest derivative in the equation.
• A simple linear differential equation of order n,
with variable coefficient, takes the form
𝐝𝐧 𝐲 𝐝𝐧−𝟏 𝐲 𝐝𝐧−𝟐 𝐲
𝐧
+ 𝐚𝟏 𝐭 𝐧−𝟏
+ 𝐚𝟐 𝐭
𝐝𝐭 𝐝𝐭 𝐝𝐭 𝐧−𝟐
𝐝𝐲
+ ⋯ + 𝐚𝐧−𝟏 𝐭 + 𝐚𝐧 𝐭 𝐲 = 𝐰 𝐭 (𝟒)
𝐝𝐭
8
Order of differential equations …
• And the most general nth order linear differential

equation with constant coefficient takes the form
𝐝𝐧 𝐲 𝐝𝐧−𝟏 𝐲 𝐝𝐧−𝟐 𝐲
𝐧
+ 𝐚𝟏 𝐧−𝟏 + 𝐚𝟐 𝐧−𝟐
𝐝𝐭 𝐝𝐭 𝐝𝐭
𝐝𝐲
+ ⋯ + 𝐚𝐧−𝟏 + 𝐚𝐧 𝐲 = 𝐛 (𝟓)
𝐝𝐭
9
Order of differential equations …
• The first-order differential equation contains only

𝑑𝑦
the first derivative, ;
𝑑𝑡
• The second-order differential equation takes the
𝑑𝑦 2
form ( ) ;
𝑑𝑡
• The third-order differential equation takes the

𝑑𝑦 3 10
form ( ) , and so on.
𝑑𝑡
• For example, the general linear second-order differential
equation (n = 2) with variable coefficient takes the form
𝐝𝟐 𝐲 𝐝𝐲
𝟐
+ 𝐚𝟏 𝐭 + 𝐚𝟐 𝐭 𝐲 = 𝐰 𝐭 (𝟔)
𝐝𝐭 𝐝𝐭
• In the case where constants are used, the second-order
linear differential equation becomes
𝐝𝟐 𝐲 𝐝𝐲
𝟐
+ 𝐚𝟏 + 𝐚𝟐 𝐲 = 𝐛 (𝟕)
𝐝𝐭 𝐝𝐭 11
• The most general form of first-order linear
differential equation will take the form
𝑑𝑦
+u t y=w t (1)
𝑑𝑡
𝒅𝒚
➢The first derivative is the only derivative that
𝒅𝒕
can appear in a first-order differential equation.
➢In the first-order linear differential equation,
𝒅𝒚
no product of the form 𝒚 occurs.
𝒅𝒕
12
• When the functions u(t) (the coefficient of the
dependent variable y) and w(t) are constant, equation
(1) reduces to first-order linear differential equation
with constant coefficient and constant term:
𝒅𝒚
+ 𝐚𝐲 = 𝐛 (𝟐)
𝒅𝒕
• Every term in equation (2) is uniformly in the first
𝑑𝑦
degree in terms of y and .
𝑑𝑡 13
• When w(t) = 0 we call it homogenous. Here is linear
first-order homogenous differential equation:
𝒅𝒚
+ 𝐚𝐲 = 𝟎 (𝟑)
𝒅𝒕
• When w(t) ≠ 0 we call it non-homogenous. Here is
linear first-order non-homogenous differential
equation:
𝒅𝒚
+ 𝐚𝐲 = 𝒃 (𝒃 ⧧ 𝟎)
𝒅𝒕
14
Solving First-Order Linear
Differential Equations with
Constant Coefficient and Constant
Constant Term
15
• Solving a differential equation means finding an
expression for y in terms t without the derivative
A) The Homogenous Case: b = 0
• We have seen that the first-order homogenous

differential equation will become
𝑑𝑦
+ ay = 0 (3)
𝑑𝑡
• Equation (3) can be re-written alternatively as
16
1 𝑑𝑦
= −a (3′)
𝑦 𝑑𝑡
A) The Homogenous Case …
• Since differential equations involve continuous time
rather than discrete time, the solution to a differential
equation is the integral of that equation.
• Integrating both sides of equation (𝟑′ ) with respect
to t, we have the solution
1 𝑑𝑦
න dt = න −𝑎dt
𝑦 𝑑𝑡
• By substitution rule and the log rule, we have
1
න 𝑑𝑦 = න −𝑎dt ⟹ 𝑙𝑛 𝑦 + 𝑐1 = −𝑎𝑡 + 𝑐2
𝑦
17
• Combining the two constants, we have
𝑙𝑛 𝑦 = −𝑎𝑡 + 𝑐
• Taking the anti-log of 𝐥𝐧 𝐲 [which utilizes the fact
that elnx = x], we obtain
𝐞𝐥𝐧 𝐲 = 𝐞−𝐚𝐭+𝐜 ⟹ 𝐲 = 𝐞−𝐚𝐭 𝐞𝐜 = 𝐀𝐞−𝐚𝐭
where A ≡ ec
• If we take y to be positive (as most economic
variables take positive values), then y = y ≥ 0, so that
the general solution of the first-order linear
homogenous differential equation becomes
𝐲 𝐭 = 𝐀𝐞−𝐚𝐭 (𝟖)
Where A is an arbitrary constant
18
• Setting t = 0, we definitize an arbitrary constant A and
get initial value y(0) as follows
𝑡 = 0 ⟹ 𝐲 𝟎 = 𝐀𝐞−𝐚 𝟎 = 𝑨 ⟹ 𝐲 𝟎 = 𝑨
• Then the definite solution becomes
𝐲 𝐭 = 𝐲 𝟎 𝐞−𝐚𝐭 (𝟗)
• Two points are worth mentioning about the definite
solution or the time path y(t) of a differential equation:
i. It is not a numerical value, but a function of time,
ii. It is free of any derivative or differential expression,
so that as soon a specific value of t is substituted a
corresponding value of y can be calculated directly.
19
B) The Non-Homogenous Case
• The non-homogenous linear differential equation
𝑑𝑦
+ 𝑎𝑦 = 𝑏 (𝑏 ≠ 0) (10)
𝑑𝑡
• The general solution of the non-homogenous differential
equation 𝒚 𝒕 will consist of the sum of two terms:
1) The particular integral, 𝑦𝑝 , which is any particular
solution of the complete (non-homogenous) equation.
2) The complementary function, 𝑦𝑐 , which is the
general solution of the reduced equation (homogenous
version of the complete equation).
𝑦 𝑡 = 𝑦𝑐 + 𝑦𝑝 (11)
20
B) The Non-Homogenous Case …
The complementary function 𝒚𝒄
• From our discussion of the homogenous case, the
general solution of the reduced equation of the first-
order differential equation is 𝐲 𝐭 = 𝐀𝐞−𝐚𝐭 .
• Thus, the complementary function 𝒚𝒄 is
𝑦𝑐 = 𝐀𝐞−𝐚𝐭 (𝟖′)
• This also implies the complementary function is the
general solution of the reduced (homogenous)
equation of the differential equations.
21
The particular integral 𝒚𝑷
• Since the particular integral is any particular solution
of the complete equation, we can first try the simplest
possible type of solution, namely, taking y = k where k
𝑑𝑦
is constant. If y is constant, then it follows that = 0,
𝑑𝑡
and equation (10) will become ay = b, with the
𝑏
solution 𝑦 = . So, the constant solution will work as
𝑎
long as a ≠ 0. In that case, the particular integral is
𝒃
𝒚𝒑 = , (𝒂 ≠ 𝟎)
𝒂
22
The general solution of the complete equation
• The general solution of the complete equation is
−𝐚𝐭
𝒃
𝑦 𝑡 = 𝑦𝑐 + 𝑦𝑝 = 𝐀𝐞 + (𝒂 ≠ 𝟎) (12)
𝒂
• The presence of the arbitrary constant A makes
equation (12) a general solution. We may definitize this
constant by means of an initial condition (setting t = 0).
−𝐚(𝟎)
𝒃
𝑦 0 = 𝐀𝐞 +
𝒂
𝒃 𝒃
⟹ 𝑦 0 =𝐀+ ⟹𝑨=𝑦 0 −
𝒂 𝒂
23
• Thus, the definite solution of the first-order
differential equation, case of a ≠ 0 can be rewritten as
𝒃 −𝐚𝐭 𝒃
𝑦 𝑡 = 𝑦 0 − 𝐞 + (𝒂 ≠ 𝟎) (12′)
𝒂 𝒂
• If a = 0, the definite solution in equation (12′) is
undefined. In that case, the differential equation (10) is
of the extremely simple form and becomes
𝑑𝑦
=𝑏 (13)
𝑑𝑡
24
• By integration of equation (13), its general solution can
be readily found to be y t = bt + c
dy
න = න bdt ⟹ y t = bt + c (14)
dt
Where c is an arbitrary constant
• The two component terms in (14) can again be
identified as yc (= bt) and yp (= c) of the given
differential equation, respectively.
25
• Since a = 0, the complementary function can be
expressed simply as
yc = 𝐀𝐞−𝐚𝐭 = 𝐀𝐞−𝟎(𝐭) = 𝐀 (𝟏𝟓)
Where, as usual, A is arbitrary constant
• As to the particular integral, the constant solution y = k
fails to work in the present case of a = 0, however.
• Thus, we should try instead a non-constant solution. If
dy
we let y = kt, then = k, and the complete equation
dt
(10) will reduce to k = b, so that we may write
𝐲𝐩 = 𝐛𝐭, 𝐟𝐨𝐫 𝐚 = 𝟎 (𝟏𝟔)
26
• The general solution of equation (13) is therefore
y t = yc + yp = 𝐀 + 𝐛𝐭 (𝐚 = 𝟎) (17)
• By setting t = 0, we definitize the arbitrary constant A,
and then find the definite solution.
t = 0 ⟹ y 0 = 𝐀 + 𝐛(𝟎) ⟹ y 0 =𝐀
differential equation when a = 0 is given by
y t = y 0 + 𝐛𝐭 (𝐚 = 𝟎) (17′)
27
Numerical Example
dy
• Solve + 2y = 6, with the initial condition y(0) = 10
dt
Solution
Step 1: The complementary function 𝒚𝒄
• The 𝒚𝒄 is the general solution of the reduced

(homogenous) equation of the differential equations.
𝑦𝑐 = 𝐀𝐞−𝐚𝐭 (𝟖′) 28
Numerical Example …
Step 2: The particular integral 𝒚𝑷
• Since a = 2 ≠ 0, the simplest possible type of solution
(the constant solution, namely y = k) will work.
𝑑𝑦
• If y is constant, then it follows that = 0, and
𝑑𝑡
dy
• The complete equation + 2y = 6 will become
dt
ay = b
𝑏
with the solution 𝑦 = .
𝑎
• In that case, the particular integral is
𝒃 29
𝒚𝒑 = , (𝒂 ≠ 𝟎)
𝒂
Step 3: The general solution
• The general solution of the complete equation is
−𝐚𝐭
𝒃
𝑦 𝑡 = 𝑦𝑐 + 𝑦𝑝 = 𝐀𝐞 + (𝒂 ≠ 𝟎)
𝒂
Step 4: definitizing the arbitrary constant A
• We may definitize the general solution by means of an
initial condition (setting t = 0).
−𝐚(𝟎)
𝒃
𝑦 0 = 𝐀𝐞 +
𝒂
𝒃 𝒃
⟹ 𝑦 0 =𝐀+ ⟹𝑨=𝑦 0 −
𝒂 𝒂
30
• Since a = 2, b = 6, and y(0) = 10,
𝟔
𝑨 = 10 − = 𝟕
𝟐
dy
differential equation + 2y = 6 becomes
dt
𝟔 −𝐚𝐭 𝟔
y t = 10 − 𝐞 +
𝟐 𝟐
𝟔 −𝟐𝐭 𝟔
= 10 − 𝐞 +
𝟐 𝟐
= 𝟕𝐞−𝟐𝐭 + 𝟑
When t = 10, for example, y(t) = = 𝟕𝐞−𝟐𝟎 + 𝟑 31
Solving First-Order Linear
Differential Equations with Variable
Coefficient and Variable Term
32
• We know that the general case of a first-order linear
differential equation with variable coefficients and
variable constant term takes the form
𝐝𝐲
+𝐮 𝐭 𝐲=𝐰 𝐭
𝐝𝐭
A) The Homogenous Case: w(t) = 0
• The homogenous differential equation takes the form
𝐝𝐲
+𝐮 𝐭 𝐲=𝟎
𝐝𝐭
𝟏 𝐝𝐲
⟹ = −𝐮 𝐭 (𝟏𝟖)
𝐲 𝐝𝐭
33
A) The Homogenous Case: w(t) = 0 …
• Integrating both sides of equation (18) with respect to t,
we have
𝟏 𝐝𝐲 𝟏
න dt = න −𝐮 𝐭 𝐝𝐭 ⟹ න 𝐝𝐲 = න −𝐮 𝐭 𝐝𝐭
𝐲 𝐝𝐭 𝐲
⟹ lny + 𝐜 = − න 𝐮 𝐭 𝐝𝐭
⟹ lny = −𝐜 − න 𝐮 𝐭 𝐝𝐭
34
• Taking the anti-log 𝑙𝑛𝑦, we obtain the desired time

path of y as follows:
𝐲 𝐭 = 𝐞𝐥𝐧𝐲 = 𝐞−𝐜 𝐞− ‫𝐮 ׬‬ 𝐭 𝐝𝐭
(𝟏𝟗)
• The general solution becomes
𝐲 𝐭 = 𝐀𝐞− ‫𝐮 ׬‬ 𝐭 𝐝𝐭
, 𝐰𝐡𝐞𝐫𝐞 𝐀 ≡ 𝐞−𝐜 (𝟐𝟎)
• Now it can easily be definitized by the help of an

appropriate initial condition y(0), setting t = 0.
35
Numerical Example
𝑑𝑦
• Solve the general solution of + 3𝑡 2 𝑦 = 0
𝑑𝑡
• Since 𝑢 = 3𝑡 2 , w = 0,‫ ׬ = 𝑡𝑑 𝑢׬‬3𝑡 2 𝑑𝑡 = 𝑡 3 + 𝑐
• Thus, by equation (20), the general solution is
− 𝑡 3 +𝑐 −𝑡 3 −𝑐
𝐲 𝐭 = 𝐀𝐞 ⟹ 𝐲 𝐭 = 𝐀𝐞 𝐞
3
⟹ 𝐲 𝐭 = 𝐁𝐞 , 𝒘𝒉𝒆𝒓𝒆 𝑩 ≡ 𝐀𝐞−𝑐
−𝑡
• Setting t = 0, the general solution will be definitized

−(0)3
t = 0 ⟹ y 0 = 𝐁𝐞 ⟹ y 0 =𝐁
• Thus, the definite solution is
−t 3
y t = y 0 𝐞 (𝐰(𝐭) = 𝟎) 36
B) The non-homogenous case: w(t) ≠ 0
• In this case, we shall use the concept of exact
differential equations. Given a function of two
variables F(y, t), its total differential is
𝜕F 𝜕F
dF y, t = dy + dt
𝜕y 𝜕t
• When this differential is set to zero, we have what is
known as an exact differential equation.
𝜕F 𝜕F
dy + dt = 0
𝜕y 𝜕t
37
B) The non-homogenous case: w(t) ≠ 0 …
• For further understanding you have to go through (i.e.,
read) exact differential equations.
• Generally, given the first-order linear differential
equations with variable coefficient and variable term
𝑑𝑦
+ 𝑢 𝑡 𝑦 = 𝑤 𝑡 the general solution is
𝑑𝑡
𝐲 𝐭 = 𝐞− ‫𝐮 ׬‬ 𝐭 𝐝𝐭
(𝐀 + න 𝐰 𝐭 𝐞‫𝐮 ׬‬ 𝐭 𝐝𝐭
𝐝𝐭 (𝟐𝟏)
• Where A is an arbitrary constant that can be definitized

if we have an appropriate initial condition y(0).
38
B) The non-homogenous case: w(t) ≠ 0 …
Numerical Example
𝑑𝑦
• Solve the general solution of + 2𝑡𝑦 = 𝑡
𝑑𝑡
• Since in this example, u(t) = 2t, w(t) = t
න 𝐮 𝐭 𝐝𝐭 = න 𝟐𝐭 𝐝𝐭 = 𝒕𝟐 + 𝒌 (𝒌 𝒊𝒔 𝒄𝒐𝒏𝒔𝒕𝒂𝒏𝒕)
• Thus, by equation (21), we have
− 𝒕𝟐 +𝒌 𝒕𝟐 +𝒌
𝐲 𝐭 =𝐞 𝐀 + න𝐭𝐞 𝐝𝐭
39
B) The non-homogenous case: w(t) ≠ 0 ….
−𝒕𝟐 −𝐤 𝒌 𝒕𝟐
= 𝐞 𝐞 𝐀+ 𝐞 න𝐭𝐞 𝐝𝐭
−𝐤 −𝒕𝟐
𝟏 𝒕𝟐
−𝒕𝟐
= 𝑨𝐞 𝐞 + 𝐞 𝐞 +𝒄 , [𝐞−𝒌 𝐞𝒌 = 𝟏]
𝟐
−𝐤 −𝒕𝟐
𝟏 −𝒕𝟐 𝒕𝟐
= 𝑨𝐞 + 𝐜 𝐞 + , [𝐞 𝐞 = 𝟏]
𝟐
−𝒕𝟐
𝟏
= 𝑩𝐞 + , 𝒘𝒉𝒆𝒓𝒆 𝑩 ≡ 𝑨𝐞−𝐤 + 𝐜
𝟐
40
Equations
Solving Second-Order Differential

41
Solving Second-Order Differential Equations …
• The general constant coefficient, linear, second-
order differential equation takes the form
𝐲′′(𝐭) + 𝐚𝟏 𝐲′(𝐭) + 𝐚𝟐 𝐲(𝐭) = 𝐛 (𝟕′)
Where a1 , a2 and b are all constants.
➢As usual, if the term b is zero constant, we call it a
homogenous equation; and if b is nonzero constant,
we call it a non-homogenous equation.
➢As usual, again the general solution of the complete
equation 𝟕′ consists of two components
𝑦 𝑡 = 𝑦𝑐 + 𝑦𝑝
42
The particular integral, 𝒚𝒑
• Since 𝑦𝑝 can take any solution of the complete
equation 𝐲′′(𝐭) + 𝐚𝟏 𝐲′(𝐭) + 𝐚𝟐 𝐲(𝐭) = 𝐛, we should
always try the simplest possible type first: say y = k.
• If y = k, then
𝑦 ′′ 𝑡 = 𝑦 ′ 𝑡 = 0
• In effect, the complete equation will become
𝐛
𝐚𝟐 𝐲 = 𝐛 ⟹ 𝐲 =
𝐚𝟐
• Thus, the particular integral is
𝐛
𝒚𝒑 = , 𝐚𝟐 ≠ 𝟎 (𝟐𝟎)
𝐚𝟐
43
The particular integral, 𝐲𝐩 …
𝐛
• If a2 = 0, the expression 𝒚𝒑 = is not defined and the
𝐚𝟐
constant solution for 𝐲𝐩 fails to work. So, we must try
some non-constant form of solution, let we try y = kt.
• Note that if a2 = 0 , the differential equation becomes
𝒚′′ 𝐭 + 𝐚𝟏 𝒚′ 𝐭 = 𝐛
• And if y = kt, 𝑦′ t = k and𝒚′′ 𝐭 = 0.
• As a result, the complete equation 𝒚′′ 𝐭 + a1 𝑦′ t = b
reduces to a1 k = b and the k value becomes
𝐛
𝐤=
𝐚𝟏
44
• The particular integral now is
𝑏
𝒚𝒑 = 𝑡, 𝐚𝟐 = 𝟎; a1 ≠ 0 (𝟐𝟑)
a1
• As this 𝒚𝒑 is a noncontact function of time, we shall
refer it a moving equilibrium.
• Again, if a1 = 0, the solution form of y = kt will break
down. So must try a solution of the form 𝑦 = 𝑘𝑡 2 .
• If 𝐚𝟐 = a1 = 0 the differential equation 𝑦 ′′ 𝑡 +
a1 𝑦 ′ 𝑡 + +𝐚𝟐 𝐲 𝐭 = 𝐛 reduces to
𝑦 ′′ 𝑡 = 𝒃
45
• And if 𝑦 = 𝑘𝑡 2 , 𝑦 ′ 𝑡 = 2𝑘𝑡 and 𝑦 ′′ 𝑡 = 2𝑘.
• As a result, the differential equation 𝑦 ′′ 𝑡 = 𝒃
𝑏
becomes 2k = b. Thus, we find 𝑘 = .
2
• Therefore, the particular integral is
𝑏 2
𝒚𝒑 = 𝑡 , 𝐚𝟏 = a2 = 0 (𝟐𝟒)
2
• The equilibrium represented by this particular integral
is again a moving equilibrium.
46
The complementary function, 𝐲𝐂
• Note that the yC is the general solution of reduced
(homogenous) equation,
𝐲 ′′ 𝐭 + 𝐚𝟏 𝐲 ′ 𝐭 + 𝐚𝟐 𝐲 𝐭 = 𝟎 (𝟐𝟓)
• Recall that exponential expressions of the form 𝐴𝑒 𝑟𝑡
figure very prominently in the yC of first-order
differential equations with constant coefficients.
• So, we may also try a solution of the form 𝑦 = 𝐴𝑒 𝑟𝑡 in
the second-order equation. Thus,
𝐲 = 𝐀𝐞𝐫𝐭 ⟹ 𝐲 ′ 𝐭 = 𝐫𝐀𝐞𝐫𝐭 𝐚𝐧𝐝 𝐲 ′′ 𝐭 = 𝐫 𝟐 𝐀𝐞𝐫𝐭
• The differential equation (25) can be transformed into
𝐫 𝟐 𝐀𝐞𝐫𝐭 + 𝐚𝟏 𝐫𝐀𝐞𝐫𝐭 + 𝐚𝟐 𝐀𝐞𝐫𝐭 = 𝟎
⟹ 𝐀𝐞𝐫𝐭 (𝐫 𝟐 + 𝐚𝟏 𝐫 + 𝐚𝟐 ) = 𝟎 (𝟐𝟔) 47
The complementary function, 𝐲𝐂 …
• Equation (26) can be satisfied either if A = 0 or the
equation r 2 + a1 r + a2 = 0.
• Since the value of the arbitrary constant A is to be
definitized by use of the initial conditions of the
problem, we cannot simply set A = 0 at all.
• Thus, it is essential to look for values of r that satisfy
r 2 + a1 r + a 2 = 0 (27)
• Equation (27) is known as the characteristic (or
auxiliary) equation of the complete equation
𝐲′′(𝐭) + 𝐚𝟏 𝐲′(𝐭) + 𝐚𝟐 𝐲(𝐭) = 𝐛.
48
• Since (27) is a quadratic equation in r, it yields two
characteristic roots, as follows
−𝑎1 ± 𝑎1 2 − 4𝑎2
𝑟1 , 𝑟2 = (28)
2
• As far as the values of 𝑟1 and 𝑟2 are concerned, three
possible cases can arise:
Case 1: distinct real roots: when 𝑎1 2 > 4𝑎2 .
• In this case the complementary function becomes
𝑦𝑐 = 𝑦1 + 𝑦2
= 𝐴1 e𝑟1 t + 𝐴2 e𝑟2 t 𝑟1 ≠ 𝑟2 (29)
49
• Case 2: repeated real roots: when a1 2 = 4a2 ,
➢In this case, the two characteristic roots, 𝑟1 and 𝑟2 ,
take an identical value r, as follows.
𝒂𝟏
𝒓 = 𝒓𝟏 = 𝒓𝟐 = −
𝟐
➢The complementary function becomes
𝒚𝒄 = 𝒚𝟏 + 𝒚𝟐 = 𝑨𝟏 𝐞𝒓𝐭 + 𝑨𝟐 𝐞𝒓𝐭 = 𝑨𝟏 + 𝑨𝟐 𝐞𝒓𝐭
= 𝑨𝟑 𝐞𝒓𝐭 𝒓𝟏 = 𝒓𝟐 (𝟑𝟎)
➢Expression (30) is not sufficient to solve. The only
way out is to find another eligible component term
which satisfies the homogenous differential equation
and is linearly independent of the term𝐴3 e𝑟t .
50
➢ An expression that will satisfy these requirements
and qualify as a solution is 𝐴4 𝑡e𝑟t . This expression
will also enable us to introduce another constant, 𝐴4 .
➢ Hence, the complementary function of the repeated
root can be written as
𝑦𝑐 = 𝐴3 e𝑟t + 𝐴4 𝑡e𝑟t (31)
Case 3: complex roots: when a1 2 < 4a2 ,
• When a1 2 < 4a2 , the square root in (28) will be a
negative number, which cannot be handled easily.
51
Numerical Example:
• Solve the differential equation
𝐲 ′′ 𝐭 + 𝐲 ′ 𝐭 − 𝟐𝐲 𝐭 = −𝟏𝟎
• Given: a1 = 1; a2 = −2; b = -10
Step 1: the complementary function, yc
• The yc is the general solution of reduced equation
y ′′ t + y ′ t − 2y t = 0
• Using the trial solution y = Aert ,
y ′ t = rAert and y ′′ t = r 2 Aert
• Substituting these into the homogenous equation,
r 2 Aert + rAert − 2Aert = 0
⟹ Aert (r 2 + r − 2) = 0
52
• Cancelling the nonzero term Aert , we have
r2 + r − 2 = 0
❖The characteristic roots are
−1 ± (1)2 −4(−2)
r1 , r2 = = 1, −2
2
❖The complementary function is
yc = A1 er1t + A2 er2t = A1 et + A2 e−2t
Step 2: the particular integral, 𝐲𝐩
❖Taking y = k, it follows that y ′ t = 0; and y′′(t) = 0.
• Substituting these into the complete equation, 𝐲 ′′ 𝐭 +
𝐲 ′ 𝐭 − 𝟐𝐲 𝐭 = −𝟏𝟎, we get
𝟎 + 𝟎 − 𝟐𝐤 = −𝟏𝟎 ⟹ 𝐤 = 𝟓
• In effect, the particular integral is
𝐲𝐩 = 𝟓
53
• Step 3: the general solution, 𝒚𝒕
𝒚𝒕 = 𝒚𝒄 + 𝒚𝒑 = 𝐴1 et + 𝐴2 e−2t + 5
• Step 4: the definite solution, 𝒚𝒕
• In order to definitize the constants 𝐴1 and 𝐴2 , we need
two initial conditions.
• Let these conditions be 𝑦0 = 12 and 𝑦 ′ 0 = −2.
• When t = 0, y(t) and 𝑦′ 𝑡 are, respectively, 12 and -2.
• Setting t = 0 in the general solution, we find that
𝒚𝟎 = 𝐴1 e0 + 𝐴2 e−2(0) + 5
⟹ 𝒚𝟎 = 𝐴1 + 𝐴2 + 5
54
• Differentiating the general solution with respect to t
and then setting t = 0 in the derivative, we find that
𝒚′ 𝒕 = 𝐴1 et − 2𝐴2 e−2t
𝒚′ 𝟎 = 𝐴1 e0 − 2𝐴2 e−2 0 = 𝐴1 − 2𝐴2
• Considering the two initial conditions, we come up
with the following pair of simultaneous equations
𝐴1 + 𝐴2 = 7
𝐴1 − 2𝐴2 = −2
• Solving simultaneously, we have
A1 = 4
A2 = 3
𝒚𝒕 = 4et + 3e−2t + 5 55
Economic Application of
Differential Equations
56
Solow Growth Model
• Robert Solow (1956) contributed an influential article
on “a contribution to the theory of economic growth”.
• The Solow growth model (Solow, 1956) is purported to
show, among other things, that the razor's-edge growth
path of the Damar model is primarily a result of the
particular production-function
• In the Domar model, output is explicitly stated as a
function of capital alone
𝑄𝑡 = 𝑓(𝐾𝑡 )
• The absence of a labor input in the production
function carries the implication that labor is always
combined with capital in a fixed proportion 57
Solow Growth Model …
• The Solow production function appears in the form
Q = f(K, L) (K, L > 0)
➢It is assumed that 𝐟𝐋 and 𝐟𝐊 are positive (positive
marginal products), and fKK and fLL are negative
(diminishing returns to each input).
➢Furthermore, the production function is taken to
be linearly homogeneous (constant returns to
scale). Consequently, it is possible to write
𝐾
𝑄 = 𝐿𝑓 , 1 = 𝐿ѱ 𝑘 (𝑎)
𝐿
𝐾
𝑤ℎ𝑒𝑟𝑒 𝑘 =
𝐿 58
• In view of the assumed signs fL , fK > 0 and fKK , fLL <

0, the newly introduced ѱ . function (which has only
a single argument, k) must be characterized
ѱ′ 𝑘 > 0
ѱ′′ 𝑘 < 0
• Given that Q = f(K, L), it is necessary now to stipulate

how the latter two variables themselves are determined.
59
• Solow's assumptions are:
1) Constant proportion of Q is invested
𝑑𝐾
𝐾ሶ ≡ = sQ (b)
𝑑𝑡
2) Labor force grows exponentially
𝐿ሶ 𝑑𝐿/𝑑𝑡
≡ =n n>0 (c)
𝐿 𝐿
• Where s represents a (constant) marginal propensity to
save, and n, a (constant) rate of growth of labor.
60
• Equations (a), (b), and (c) constitute a complete model.
• To solve this model, we shall first condense it into a
single equation in one variable.
• To begin with, substitute (a) into (b) to get
Kሶ = sLѱ k (d)
• Since k = K/ L, and K = kL, we can obtain another
expression for k by differentiating the latter identity:
Kሶ = 𝐿kሶ + kLሶ (product rule)
Kሶ = 𝐿kሶ + k𝑛𝐿 by equation c (e)
61
• When (e) is equated to (d) and the common factor L

eliminated, the result emerges that
𝐿kሶ + k𝑛𝐿 = sLѱ k
kሶ = sѱ k − k𝑛 (𝑓)
• This equation-a differential equation in the variable
k, with two parameters s and n, is the fundamental
equation of the Solow growth model.
62
Solow Growth Model: A Quantitative Illustration
• Let us write the production function as
α
𝐾
𝑄 = 𝑓 𝐿, 𝐾 = 𝐿α 𝐾 1−α =𝐿 = 𝐿𝑘 α
𝐿
• So that
ѱ k = 𝑘α
• Then equation (f) becomes

kሶ = s𝑘 α − k𝑛
63
DIFFERENCE EQUATIONS AND
APPLICATIONS IN ECONOMIC DYNAMICS
64
• In solving a difference equation, we still find a time
path y(t) from a given pattern of change of a
dependent variable y over time.
• But the pattern of change should now be denoted by the
Δ𝑦
difference quotient , which is the discrete-time
Δ𝑡
𝑑𝑦
counterpart of the derivative .
𝑑𝑡
• Analogous to differential equations, difference
equations can be either
• linear or nonlinear,
• homogenous or non-homogenous,
• of the first-order or second (or higher) order. 65
• The first-order difference equation contains only the
Δy
first difference quotient ;
Δt
Δy 2
• The second-order difference equation becomes ( ) ;
Δt
and
Δy 3
• The third-order differential equation becomes ( ) ,
Δt
and so on.
66
• In first-order difference equations, we only consider
two consecutive time periods, so that Δ𝑡 = 1.
Δ𝑦
• For this reason, the difference quotient for the first
Δ𝑡
difference of y can be simplified to expression Δ𝑦.
• The expression Δ𝑦 can take various values, depending
on which two consecutive time periods are involved in
the differencing. More specifically, the first difference
of y involves a one-period time lag only.
Δyt ≡ yt+1 − yt (33)
• For example, we may describe the pattern of change of
y by a difference equation such as
67
Δyt = 2 (34)
Δyt = −0.1yt (35)
Solving First-Order Difference Equations …
• Alternatively, we can express equations (34) and (35)
in a more convenient way without Δ expression.
• For example, by virtue of equation (33), we can rewrite
equation (34) as
yt+1 − yt = 2 (34′)
yt+1 = yt + 2 (34′′)
• Equation (34′) can also be rewritten as
yt − yt−1 = 2
yt−2 − yt+1 = 2
• Similarly, equation (35) can be rewritten as
yt+1 − yt = −0.1yt (35′)
68
yt+1 = 0.9yt (35′′)
• First-order difference equations can be either
➢Linear or nonlinear,
➢Homogenous or non-homogenous, and
➢Constant coefficients and a constant term or
variable coefficients and a variable term.
69
• Equation (34′), for instance, can be classified as:
a) linear, for no y term (of any period) is raised to the
second (or higher) power or is multiplied by a y term
of another period;
b) non-homogenous, since the right hand side is non-
zero; and
c) a constant coefficients and a constant term.
Equation (35′) is also linear; but unlike equation (34′),
it is homogenous.
70
• Analogous to differential equation, our objective in

solving difference equation is to find a time path y(t).
• However, in solving differential equations we use

integration, but in solving a difference equations, we
can use either an iterative method or a general method.
71
Iterative Method
• Examples 1: find the solution of the first-order
difference Δ𝑦𝑡 = 2, assuming 𝑦0 = 15
• The time path of y can be solved iteratively as follows:
Δ𝑦𝑡 = 2 ⟹ yt+1 − yt = 2 ⟹
y1 − y0 = 2 ⟹ y1 = y0 + 2
y2 = y1 + 2 ⟹ y2 = (y0 + 2) + 2 ⟹ y2 = y0 + 2(2)
y3 = y2 + 2 ⟹ y3 = y0 + 2 2 + 2 ⟹ y2 = y0 + 3(2)
⋮
yt = y0 + 𝑡(2) = 15 + 2𝑡
• The final equation, yt = y0 + 𝑡(2) = 15 + 2𝑡, is the
72
time path for any time period t, with y0 = 15.
• Example 2: Solve the difference equation of Δyt =
− 0.1yt , taking y0 as unspecified.
• Solution:
Δyt = −0.1yt ⟹ yt+1 − yt = −0.1yt ⟹ yt+1 = 0.9yt
⟹ y1 = 0.9y0
y2 = 0.9y1 ⟹ y2 = 0.9(0.9y0 ) ⟹ y2 = (0.9)2 y0
y3 = 0.9y2 ⟹ y3 = 0.9(0.9)2 y0 ⟹ y3 = (0.9)3 y0
⋮
yt = (0.9)t y0
73
• Example 3: Solve the homogenous difference equation
myt+1 − nyt = 0
• Solution:
n
myt+1 = nyt ⟹ yt+1 = yt ⟹
m
n
y1 = y0
m
n n n n 2
y2 = y1 ⟹ y2 = y0 ⟹ y2 = y0
m m m m
n n n 2 n 3
y3 = y2 ⟹ y3 = y0 ⟹ y3 = y0
m m m m
⋮ 74
n t
yt = y0
m
𝑛
• This solution shows us that it is through term that
𝑚
various values of t will lead to their corresponding
values of y. If we write it more generally as 𝑏 𝑡 (b for
base) and attach the more general multiplicative
constant A (instead of 𝑦0 ), the solution of the general
homogenous difference equation will be in the form
𝑦𝑡 = 𝐴𝑏 𝑡 (36)
➢The expression 𝑨𝒃𝒕 will play the same important
role in difference equations as the expression 𝑨𝒆𝒓𝒕
did in differential equations.
75
General Method
• Let the first-order difference equation yt+1 + ayt = 𝑐
where a and c are constants. Then, as usual, the
general solution will consist of two components:
1) A complementary function, yc , which is the
general solution of the reduced homogenous
equation yt+1 + ayt = 0.
2) A particular integral, yp , which is any solution of
the complete non-homogenous equation yt+1 +
ayt = 𝑐, and
yt = yp + yc
76
The complementary function, 𝐲𝐜
• The 𝐲𝐜 is the general solution of the reduced
homogenous equation 𝐲𝐭+𝟏 + 𝐚𝐲𝐭 = 𝟎
• From example 3 in iterative method section, our
experience suggests that the solution of the general
homogenous difference equation may take the form
yt = Abt (with Abt ≠ 0) (36)
• Equation (36) also suggests
yt+1 = Abt+1 (with Abt ≠ 0) (37)
• If the values of 𝑦𝑡 and 𝑦𝑡+1 hold, the homogenous
equation 𝐲𝐭+𝟏 + 𝐚𝐲𝐭 = 𝟎 will become
77
Abt+1 + aAbt = 0 ⟹ Abt b + a = 0 (38)
The complementary function, 𝐲𝐜 …
• Up on cancelling the nonzero common factor Abt ,
equation (38) will become
b + a = 0 ⟹ b = −a
• For the trial solution to work, we must set b = -a.
• Thus, the complementary function should be written as
𝑦𝑐 = Abt = A(−a)t (39)
78
The particular integral, 𝐲𝐏
• The 𝐲𝐏 is any solution of the complete equation
𝐲𝐭+𝟏 + 𝐚𝐲𝐭 = 𝒄. Thus, iterative method is of no help at
all, as it relates only to a homogenous equation.
• Since the 𝐲𝐏 is any solution of the complete
equation 𝐲𝐭+𝟏 +𝐚𝐲𝐭 = 𝒄, let us a trial solution of the
simplest form yt = 𝑘, where k is constant.
• If 𝒚𝒕 = 𝒌, then y will maintain the same constant value
over time. As a result,
yt+1 = 𝑘
79
The particular integral, 𝐲𝐏 …
• Substitution of these values into the complete
equation yt+1 +ayt = 𝑐 yields
c
k + ak = c ⟹ k = (40)
1+a
• The particular integral can be written as
c
𝑦𝑝 = k = , 𝑓𝑜𝑟 𝑎 ≠ −1 (41)
1+a
c
• If a = -1, the particular integral 𝑦𝑝 = is not defined.
1+a
• So, some other solution of the non-homogenous (or
complete) equation yt+1 + ayt = 𝑐 must be sought.
80
The particular integral, 𝐲𝐏 …
• Let try yt = 𝑘𝑡, which also implies yt+1 = 𝑘(𝑡 + 1).
• Substitution of these trial solutions into the complete
equation yt+1 +ayt = 𝑐, we have
k t + 1 + akt = c
c
⟹k= =c,
t + 1 + at
(because a ≠ −1) (42)
• Thus, the 𝑦𝑝 is a non-constant function of time t.
𝑦𝑝 = kt = ct, 𝑓𝑜𝑟 𝑎 = −1 (43)
• This 𝑦𝑝 represents a moving equilibrium.
81
The general solution, 𝐲𝐭
• Adding yc and yp together, we may now write the
general solution in one of the following two forms:
𝐭
𝐜
𝐲𝐭 = 𝐲𝐜 + 𝐲𝐩 = 𝐀(−𝐚) + ,
𝟏+𝐚
case of a ≠ −1 (44)
𝐲𝐭 = 𝐲𝐜 + 𝐲𝐩 = 𝐀(−𝐚)𝐭 +𝐜𝐭 = 𝐀 + 𝐜𝐭,
case of a = −1 (45)
82
The definite solution, 𝐲𝐭
• Setting t = 0 in equation (44), we have
0
c c
𝑦0 = A(−a) + =𝐴+
1+a 1+a
c
⟹ 𝐴 = 𝑦0 −
1+a
• Consequently, the definite solution of equation (44) is
𝒄 𝒕
𝒄
𝒚𝒕 = 𝒚𝟎 − −𝒂 +
𝟏+𝒂 𝟏+𝒂
𝑐𝑎𝑠𝑒 𝑜𝑓 𝑎 ≠ −1 (44′ )
• Similarly, letting t = 0 in equation (45), we find 𝑦0 = A,
so that the definite solution of (45) is
83
𝒚𝒕 = 𝒚𝟎 + 𝐜𝐭, 𝑐𝑎𝑠𝑒 𝑜𝑓 𝑎 = −1 (45′)
Stability of the Equilibrium
The Role of b:
• The solution of a difference equation gives an

expression for a time path of the relevant variable, y(t).
• The behavior of this time path depends on the 𝑨𝒃𝒕
term in the complementary function.
• More importantly, it depends on the value of b.
• We examine the dynamic stability of the equilibrium

84
in terms of whether or not the complementary
function will tend to zero as t ⟶ ∞.
• Examination of the time path of 𝒚𝒕 = 𝑨(𝒃)𝒕 + 𝒚𝒑 (b ≠

0) can be generalized as follows:
1) 𝑏 < 1: 𝑨(𝒃)𝒕 converges to zero and then 𝒚𝒕

converges to 𝒚𝒑 (= y*). The solution is stable.
• There are two subcases:
➢0 < b < 1: Monotonic convergence
➢-1 < b < 0: Damped oscillations

85
2) 𝑏 > 1: 𝑨(𝒃)𝒕 diverges away from zero.
• As a result, the 𝒚𝒕 diverges away from 𝒚𝒑 (= y*).

The solution is not stable.
• There are two subcases as well:
➢b > 1: Explosion
➢b < -1: Explosive oscillations
86
In summary,
• If 𝑏 > 1, time path explodes (diverges)
• If 𝑏 < 1, time path converges
• If b > 0, time path non-oscillating
• If b < 0, time path oscillating.
87
Stability of the Equilibrium …
The Role of A:
• The role of A is to produce a scale effect without

changing the basic configuration of the time path.
• The sign of A does also materially affect the shape of
the path because, if 𝑏 𝑡 is multiplied by A = -1, then
each time path will be replaced by its own mirror
effect. Thus, a negative A can produce a mirror effect
as well as a scale effect. 88
Numerical Example
7
• Solve the time path of 𝑦𝑡+1 −5𝑦𝑡 = 1, (𝑦0 = ) and
4
examine the dynamics of the equilibrium.
Solution:
Step 1: the complementary function, 𝑦𝑐 .
• Trying a solution 𝑦𝑡 = 𝐴𝑏 𝑡 ⟹ 𝑦𝑡+1 = 𝐴𝑏 𝑡+1 .
• The homogenous equation 𝑦𝑡+1 −5𝑦𝑡 = 0 will become
𝐴𝑏 𝑡+1 − 5𝐴𝑏 𝑡 = 0 ⟹ 𝐴𝑏 𝑡 𝑏 − 5 = 0
• Cancelling the nonzero common factor 𝐴𝑏 𝑡 , we have
𝑏−5=0⟹𝑏 =5
• Thus, the complementary function is
𝑦𝑐 = 𝐴(5)𝑡 89
Step 2: the particular integral, 𝑦𝑝 .
• Since a = -5 ≠ 0, we try a solution 𝑦𝑡 = 𝑘.
• This implies 𝑦𝑡+1 = 𝑘.
• Substituting these values into the complete
equation 𝑦𝑡+1 −5𝑦𝑡 = 1, we have
1
𝑘 − 5𝑘 = 1 ⟹ 𝑘 = −
4
• Hence, the particular integral, which defines the
stable equilibrium level value, is
1
𝑦𝑝 = − 90
4
Step 3: the general solution, 𝑦𝑡
1 𝑡
𝑦𝑡 = 𝑦𝑐 + 𝑦𝑝 = 𝐴(5) −
4
Step 4: the definite solution, 𝑦𝑡
7
• Setting t = 0, and utilizing 𝑦0 = we obtain
,
4
0
1 7 1
𝑦0 = 𝐴(5) − ⟹ = 𝐴 −
4 4 4
7 1
⟹𝐴= + =2
4 4
𝑡
1 91
𝑦𝑡 = 2(5) −
4
𝒕 𝟏
Examination of the time path 𝒚𝒕 = 𝟐(𝟓) −
𝟒
𝑡 1
• Since b = 5 > 0, the time path𝑦𝑡 = 2(5) − is non-
4
oscillatory; and since 𝑏 = 5 > 1, the time path will
𝟏
diverge from the equilibrium level of − .
𝟒
92
Solving Second-Order Difference Equations
• Second-order difference equations involve a two-
period time lag in the variables with an expression
Δ2 yt and entail three y terms: yt+2 , yt+1 , and yt .
yt = f(yt−1 , yt−2 )
Δ2 yt = Δ Δyt = Δ yt+1 − yt
= yt+2 − yt−1 − yt+1 − yt
= yt+2 − 2yt−1 + yt
• A simple second-order linear difference equation
takes the form,
yt+2 + a1 yt+1 + a2 yt = c (46)
93
Solving Second-Order Difference Equations …
• As usual, the general solution will be expected to have
two components: (a) a yP representing the
intertemporal equilibrium level of y, and (b) a yc
specifying the deviation from the equilibrium.
The particular integral 𝐲𝐩
• The yP is any solution of the complete equation. It can
be found simply by trying a solution of the form yt = k.
• Substituting this constant value of y into the complete
equation yt+2 + a1 yt+1 + a2 yt = c, we have
k + a1 k + a 2 k = c ⟹ k 1 + a1 + a 2 = c
𝐜
⟹𝐤=
𝟏 + 𝐚𝟏 + 𝐚𝟐 94
The particular integral 𝐲𝐩 …
𝐜
𝐲𝐩 (= 𝐤) = a1 + a2 ≠ −1 (47)
𝟏 + 𝐚𝟏 + 𝐚𝟐
• In case a1 + a2 = −1, the trial solution yt = k breaks
down, and, therefore, we must try yt = kt.
• If yt = kt, yt+1 = k(t + 1) and yt+2 = k t + 2 .
• Substituting these terms into the complete equation
yt+2 + a1 yt+1 + a2 yt = c, we have
k(t + 1) + a1 k(t + 1) + a2 kt = c
𝐜 𝐜
⟹𝐤= = ,
𝟏 + 𝐚𝟏 + 𝐚𝟐 𝐭 + 𝐚𝟏 + 𝟐 𝐚𝟏 + 𝟐 95
[since a1 + a2 = −1]
The particular integral 𝐲𝐩 …
• Thus, the particular integral can be written as
𝐜
𝐲𝐩 = 𝐤𝐭 = 𝐭
𝐚𝟏 + 𝟐
case of a1 + a2 = −1; a2 ≠ −2 (48)
The complementary function 𝐲𝐂
• To find the complementary function, we must
concentrate on the reduced equation
yt+2 + a1 yt+1 + a2 yt = 0
• As usual, the expression Abt plays a prominent role in
the general solution of such an equation. 96
The complementary function 𝐲𝐂 …
• Let us try a solution of the form yt = Abt , which
implies yt+1 = Abt+1 and so on. Up on substitution of
the trial solution in the reduced equation, we have
Abt+2 + a1 Abt+1 + a2 Abt = 0
⟹ Abt b2 + a1 b + a2 = 0
• Cancelling the nonzero common factor Abt , we have
𝐛𝟐 + 𝐚𝟏 𝐛 + 𝐚𝟐
• This quadratic equation possesses two characteristic
roots each of which is acceptable in the solution 𝐴𝑏 𝑡 .
−𝒂𝟏 ± 𝒂𝟏 𝟐 − 𝟒𝒂𝟐
𝒃𝟏 , 𝒃𝟐 = (𝟒𝟗)
𝟐 97
• As before, three possible situations may be encountered
in regard to the characteristic roots, depending on the
square-root expression in (49).
Case 1: distinct real roots: when 𝑎1 2 > 4𝑎2 .
• The square-root in (49) is a real number, and 𝑏1 𝑎𝑛𝑑 𝑏2
are distinct. In that case, 𝑏1 𝑡 and 𝑏2 𝑡 are linearly
independent, and the 𝐲𝐂 can simply be written as a
linear combination of these expressions.
𝒚𝒄 = 𝑨𝟏 𝒃𝟏 𝒕 + 𝑨𝟐 𝒃𝟐 𝒕 (𝟓𝟎)
98
Case 2: repeated real roots: when 𝑎1 2 = 4𝑎2 .
• The square-root in (49) vanishes, and the
characteristics roots 𝑏1 𝑎𝑛𝑑 𝑏2 are repeated:
𝑎1
𝑏 = 𝑏1 = 𝑏2 = −
2
• If we express the 𝐲𝐂 in the form of (50), the two
components will collapse into a single term as follows:
𝑡 𝑡
𝐴1 𝑏1 + 𝐴2 𝑏2 = (𝐴1 + 𝐴2 )𝑏 𝑡 ≡ 𝐴3 𝑏 𝑡
• We are now short of one constant. To supply the
missing component, which we recall, should be linearly
independent of the term 𝐴3 𝑏 𝑡 . The new component is 99
therefore to take the form 𝐴4 𝑡𝑏 𝑡 .
• The 𝐴4 𝑡𝑏 𝑡 term does indeed qualify as a solution of the
homogenous equation 𝑦𝑡+2 + 𝑎1 𝑦𝑡+1 + 𝑎2 𝑦𝑡 = 0, just
as 𝐴3 𝑏 𝑡 does.
𝑦𝑡 = 𝐴4 𝑡𝑏 𝑡 ⟹ 𝑦𝑡+𝑡 = 𝐴4 (𝑡 + 1)𝑏 𝑡+1
• Substituting this into the homogenous equation as
linearly independent of the term 𝐴3 𝑏 𝑡 .
• Then, the 𝐲𝐂 for the repeated-root case is
𝑦𝑐 = 𝐴3 𝑏 𝑡 + 𝐴4 𝑡𝑏 𝑡 (51)
100
Case 3: complex roots: when 𝑎1 2 < 4𝑎2 .
• The characteristics roots are conjugate complex. They
will be in the form 𝑏1 = 𝑏2 = ℎ ± 𝑣, where,
−𝑎2 𝑎1 2 − 4𝑎2
ℎ= 𝑎𝑛𝑑 𝑣 =
2 2
• The complementary function itself thus becomes
𝑦𝑐 = 𝐴1 𝑏1 𝑡 + 𝐴2 𝑏2 𝑡
= 𝐴1 (ℎ + 𝑣𝑖)𝑡 +𝐴2 (ℎ − 𝑣𝑖)𝑡 (52)
• This complementary function is not easily interpreted.
But thanks to De Moivre’s theorem that you can
101
transform this 𝐲𝐂 into trigonometric terms.
The general solution 𝐲𝐭
𝐲𝐭 = yp + yc
• The convergence/divergence of the time path
• As in the case of first-order difference equations, the
converge/divergence of the time path yt hinges solely
on whether yc ⟶ 0 as t ⟶ ∞.
Case 1: distinct real roots: b1 ≠ b2 .
• The yc consists of the terms A1 b1 t and A2 b2 t
• If b1 > 1 and b2 > 1, then both component terms in
the yc , A1 b1 t and A2 b2 t , will be explosive. Thus both
terms in the yc will converge towards zero as t ⟶ ∞.
102
• If b1 > 1 but b2 < 1, A2 b2 t tend to die down while
A1 b1 t tends to deviate farther from zero. In such cases,
the time path will be convergent if and only if the
dominant root is less than 1 in absolute value.
Case 2: repeated roots: b = b1 = b2 . The yc consists
of the termsA3 bt and A3 tbt
• If b > 1, the bt term will be explosive and the
multiplicative t will simply serve to intensify the
explosiveness as t increases. The time path converges.
• If b < 1, the bt term will tend to zero as t increases
and the multiplicative t will run counter to each other.
The value of t will offset rather that reinforce bt . As a 103
result, the time path converges.
Numerical Example:
• Solve the solution of the difference equation yt+2 +
yt+1 − 2yt = 12 and analyze the convergence or
divergence state of its time path.
Solution:
• Given: a1 = 1; a2 = −2; c = 12
Step 1: the complementary function, yc : solution to the
reduced equation yt+2 + yt+1 − 2yt = 0
• Substituting Abt , we have
Abt+2 + Abt+1 − 2Abt = 0
⟹ Abt b2 + b − 2 = 0
104
• Cancelling the nonzero common factor Abt
b2 + b − 2 = 0
• The characteristic roots:
−a1 ± a1 2 −4a2 −1± (1)2 −4(−2)

• b1 , b2 = = = 1, −2
2 2
• Thus, the complementary function is
yc = A1 (1)t +A2 (−2)t = A1 + A2 (−2)t
Step 2: the particular integral: solution to the complete

equation yt+2 + yt+1 − 2yt = 12
• Since a1 + a2 = 1 − 2 = −1, the yt = k solution 105
breaks down. So we must try yt = kt

• Substituting yt = kt into the complete equation yt+2 +
yt+1 − 2yt = 12, we have
k t + 2 + k t + 1 − 2kt = 12
⟹ k t + 2 + t + 1 − 2t = 12
⟹ k 2t + 3 − 2t = 12 ⟹ k = 4
yp = 4t
• This represents a moving equilibrium
• Step 3: the general solution: 𝑦𝑡 = 𝑦𝑐 + 𝑦𝑝
𝑦𝑡 = 𝑦𝑐 + 𝑦𝑝 = 𝐴1 + 𝐴2 (−2)𝑡 +4𝑡
106
Step 4: the definite solution:
• Since there are two arbitrary constants 𝐴1 𝑎𝑛𝑑𝐴2 , two
initial conditions are required.
• Supposing 𝑦0 = 4 𝑎𝑛𝑑 𝑦1 = 5 and setting t = 0 and t =
1successively in the general solution (step 3), we have
𝑦0 = 𝐴1 + 𝐴2 (−2)0 +4(0) ⟹ 𝑦0 = 𝐴1 + 𝐴2
𝑦1 = 𝐴1 + 𝐴2 (−2)1 +4 1 ⟹ 𝑦1 = 𝐴1 − 2𝐴2 + 4
• Solving these two equations simultaneously, we find
𝐴1 = 3
𝐴2 = 1
• Then the definite solution is
𝑦𝑡 = 3 + 1(−2)𝑡 +4𝑡 ⟹ 𝑦𝑡 = 3 + (−2)𝑡 +4𝑡 107
Step 5: convergence/divergence of the time path:
• Since the definite solution is 𝑦𝑡 = 3 + (−2)𝑡 +4𝑡, the

distinct roots are 1 and -2 with the dominant root being
-2, and the solution has a moving equilibrium of 4t, the
time path is divergent.
108
Economic Application of Difference Equations
The Cobweb Model
• The Cobweb model mainly represents markets
characterizing a lagged supply function interacts with
an ordinary demand function of the form 𝑄𝐷 𝑡 = 𝐷 𝑃𝑡
• Taking the linear versions of these lagged supply and
ordinary demand functions, and assuming that in each
time period the market price is always set at a level
which clears the market, we have a market model
with the following three equations
𝑄𝐷 𝑡 = 𝑄𝑆 𝑡
𝑄𝐷 𝑡 = 𝛼 − 𝛽𝑃𝑡 , (𝛼, 𝛽 > 0)
𝑄𝑆 𝑡 = −𝛾 + 𝛿𝑃𝑡−1 , (𝛾, 𝛿 > 0) 109
The Cobweb Model …
• The equilibrium condition of the model can be reduced
to a single first-order difference equation as follows:
α − βPt = −γ + δPt−1
βPt +δPt−1 = α + γ
δ α+γ
Pt + Pt−1 =
β β
δ α+γ
⟹ Pt+1 + Pt =
β β
δ α+γ
• Here, y ≡ P; a ≡ ; and c ≡
β β
110
• Inasmuch as δ and β are both positive, it follows that a
≠ -1. Consequently, the time path of price with its
initial value of P0 is
t
α + γ −δ α+γ
Pt = P0 − +
β+δ β β+δ
• Three points may be observed from this time path:
α+γ
1) The ( ), which constitutes the particular integral
β+δ
of the model can be taken as the intertemporal
α+γ
ത
equilibrium price of the model: P = ( )
β+δ
111
2) Since the expression (𝑃0 − 𝑃)ത corresponds to the
constant A in the 𝐴𝑏 𝑡 term, its sign will bear on the
question of whether the time path will commence
above or below the equilibrium (mirror effect),
whereas its magnitude will decide how far above or
how far below the equilibrium (scale effect).
−𝛿
3) Since the expression corresponds to the b
𝛽
component of 𝐴𝑏 𝑡 , it deduces the characteristic of the
time path. Since 𝛿 > 0, we can deduce an oscillatory
time path. There can, of course, arise three possible
varieties of oscillation patterns in the model: explosive 112
if 𝛿 > 𝛽; uniform if 𝛿 = 𝛽; and damped if 𝛿 < 𝛽.
A Market Model with Inventory
• A market model is a model in which sellers do keep an
inventory of the commodity. The model considers that
1) Both the quantity demanded, 𝑄𝑑𝑡 , and the quantity
currently produced, 𝑄𝑆𝑡 , are unlagged linear
functions of price 𝑷𝒕 ,
2) The adjustment of price is effected not through market
clearance, but through a process of price-setting by
the sellers, and the sellers set a price for that period
after taking into consideration of he inventory
situation.
3) The price adjustment made from period to period is
inversely proportional to the observed change in the 113
inventory (stock).
A Market Model with Inventory …
• With these assumptions, the price-adjustment process
in terms of inventory 𝑄𝑆 𝑡 − 𝑄𝐷 𝑡 rather than excess
demand 𝑄𝐷 𝑡 − 𝑄𝑆 𝑡 is modeled as follows:
𝑄𝐷 𝑡 = 𝛼 − 𝛽𝑃𝑡 , (𝛼, 𝛽 > 0)
𝑄𝑆 𝑡 = −𝛾 + 𝛿𝑃𝑡−1 , (𝛾, 𝛿 > 0)
𝑃𝑡−1 = 𝑃𝑡 − 𝜎 𝑄𝑆 𝑡 − 𝑄𝐷 𝑡 (𝜎 > 0)
• Where 𝜎 denotes the stock-induced-price-adjustment
coefficient. The model is described in a discrete-time
counterpart of the market model.
114
A Market Model with Inventory …
• By substituting the first two equations into the third,
the model can be condensed into a single first-order
difference equation:
Pt+1 − 1 − σ β + δ Pt = σ α + γ
• Then the time path Pt is derived and given by
α+γ t
α+γ
Pt = P0 − 1−σ β+δ +
β+δ β+δ
⟹ Pt = P0 − Pത 1 − σ β + δ t + Pത
• The dynamic stability of this model will hinge on the
expression 1 − σ β + δ . 115
Harrod-Domar One Sector Model
• Production function
Qt = 𝑏K t
Where constant productivity of capital
• Accumulation of capital between t and t+1 is given by
• Then the time path Pt is derived and given by
It = K t+1 − K t
• Saving
St = 𝑠Qt
• Market equilibrium is determined by St = It . So,
𝑠Qt = K t+1 − K t
116
Harrod-Domar One Sector Model …
• Since Qt = 𝑏K t , we have
𝑠𝑏K t = K t+1 − K t
⟹ K t+1 = (1 + 𝑠𝑏)K t
⟹ K t+1 − 1 + 𝑠𝑏 K t = 0
a homogeneous first order linear difference equation
• Therefore, solution to this equation is given by

K t = 1 + 𝑠𝑏 t K 0 117
Harrod-Domar One Sector Model …
• Since b is productivity of capital in the model, we

1
write = capital-output ratio, let it be v. Thus,
𝑏
1 1
𝑣= ⟹𝑏=
𝑏 𝑣
𝑠 t 𝑠 t
⟹ Kt = 1 + K 0 𝑎𝑛𝑑 Qt = 1 + Q0
𝑣 𝑣
118
Samuelson’s model of interaction between the

multiplier and the accelerator.
• Consider the following macroeconomic equation

Yt = Ct + It
Ct = C0 + βYt−1 (0 < β < 1)
It = I0 + 𝑚(Ct − Ct−1 ) (𝑚 > 0)
119
• Where Ct = C0 + βYt−1 is the consumption function

with a one-period income lag; the It = I0 +
𝑚(Ct − Ct−1 ) is the investment function of the
accelerator type; C0 and I0 are the levels of
autonomous consumption and investment; β is the
marginal propensity to consume and m is the
accelerator coefficient; and Yt = Ct + It is the
condition of macroeconomic balance.
120
• The three equations together generate the following

second-order difference equation in Y
Yt − β 1 + 𝑚 Yt−1 + β𝑚Yt−2 = C0 + I0
121

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CHAPTER THREE

DIFFERENTIAL AND DIFFERENCE

• A linear differential equation contains only terms that

• And the most general nth order linear differential

• The first-order differential equation contains only

• The third-order differential equation takes the

A) The Homogenous Case: b = 0

• We have seen that the first-order homogenous

• The 𝒚𝒄 is the general solution of the reduced

• Taking the anti-log 𝑙𝑛𝑦, we obtain the desired time

• Now it can easily be definitized by the help of an

• Setting t = 0, the general solution will be definitized

• Where A is an arbitrary constant that can be definitized

Malebo Mancha Massa:

• In view of the assumed signs fL , fK > 0 and fKK , fLL <

• Given that Q = f(K, L), it is necessary now to stipulate

• When (e) is equated to (d) and the common factor L

• Let us write the production function as

• Then equation (f) becomes

• First-order difference equations can be either

➢Homogenous or non-homogenous, and

➢Constant coefficients and a constant term or

• Analogous to differential equation, our objective in

• However, in solving differential equations we use

• The solution of a difference equation gives an

• The behavior of this time path depends on the 𝑨𝒃𝒕

• More importantly, it depends on the value of b.

• We examine the dynamic stability of the equilibrium

• Examination of the time path of 𝒚𝒕 = 𝑨(𝒃)𝒕 + 𝒚𝒑 (b ≠

1) 𝑏 < 1: 𝑨(𝒃)𝒕 converges to zero and then 𝒚𝒕

➢0 < b < 1: Monotonic convergence

➢-1 < b < 0: Damped oscillations

2) 𝑏 > 1: 𝑨(𝒃)𝒕 diverges away from zero.

• As a result, the 𝒚𝒕 diverges away from 𝒚𝒑 (= y*).

• There are two subcases as well:

➢b < -1: Explosive oscillations

• If 𝑏 > 1, time path explodes (diverges)

• If 𝑏 < 1, time path converges

• If b > 0, time path non-oscillating

• The role of A is to produce a scale effect without

• The sign of A does also materially affect the shape of

• The characteristic roots:

−a1 ± a1 2 −4a2 −1± (1)2 −4(−2)

• Thus, the complementary function is

Step 2: the particular integral: solution to the complete

• Since a1 + a2 = 1 − 2 = −1, the yt = k solution 105

breaks down. So we must try yt = kt

Step 5: convergence/divergence of the time path:

• Since the definite solution is 𝑦𝑡 = 3 + (−2)𝑡 +4𝑡, the

Harrod-Domar One Sector Model …

a homogeneous first order linear difference equation

• Therefore, solution to this equation is given by

Harrod-Domar One Sector Model …

• Since b is productivity of capital in the model, we

Samuelson’s model of interaction between the

• Consider the following macroeconomic equation

• Where Ct = C0 + βYt−1 is the consumption function

• The three equations together generate the following

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