Slides TKT Dynamic

Mathematical Economics
PART II: Dynamic Analysis
Hà Văn Hiếu
University of Economics and Law
23rd October 2023
Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 1 / 42

Dynamic Analysis
Dynamic Analysis is concerned with the movement of economic variables over time. There
are two ways of treating time in economics: discrete-time analysis and continuous-time
analysis. In this chapter, we will study two main mathematical tools of economic
dynamics: differential equations and difference equation.
Differential equations belong to continuous-time analysis.
Difference equations belong to discrete-time analysis
Example
Differential equations: Difference equations:
y′ − y = t yt+1 − yt = t

First Example
Suppose that population size H is known to change over time at the rate
dH
= t−1/2
dt
We then try to find what time path of population H = H(t) can yield the above rate of
change.
By integration, we have
H(t) = 2t1/2 + c (c = an arbitrary constant)
If we have knowledge of the initial condition or boundary condition H(0) - that is,
the value of H at t = 0, let us say H(0) = 100 - then
H(t) = 2t1/2 + 100

Linear Differential Equations
A first-order linear differential equation:

dy
+ u(t)y = w(t) or y ′ + u(t)y = w(t)
dt
Example
Which of the followings are first-order linear differential equations?
1 y′ + y = 0 4 y ′′ − y ′ + y = 1
2 y ′ + y = t2
3 y ′ − ty = t2 + 1 5 y′ − y2 = 0

Examples
1 Determine all function y = y(t) such that
y ′ − t2 = 3. (1)
2 Determine all function y = y(t) such that:
dy
− y = 3. (2)
dt
Hint: Change variable: y = et · z.

Constant coefficients
dy
+ ay = b (3)
dt
where a, b are some constants.
Example
All functions y = y(t) which satisfy y ′ − y = 3 is
y = −3 + Cet .
This function is called the general solution of the equation. y = −3 and y = −3 + et are
particular solutions of the equation. y = −3 is called the particular integral of the
equation. y = Cet is called the complementary function of the equation.
Remark: the complementary function of the equation Eq. (3) is the general solution of
the homogeneous equation: y ′ + ay = 0.
Definite solution
dy
+ ay = b
dt
with a ̸= 0 and with an initial condition (or boundary condition) y(0) = M .
The complementary function: The particular integral:
yc = Ce−at b
yp = (a ̸= 0)
a
The general solution (a ̸= 0): The definite solution (a ̸= 0):

b
y(t) = Ce−at + y(t) = M −
b −at b
e +
a a a
Exercise: Write the solution for the case where a = 0. More exercises: p479.
General case
y ′ + u(t)y = w(t)
Example-Exercise: Determine the general solution of the following equation:
y ′ + ty = t.
2
Hint: Use the following change: y = e−t z.

Fomula
General solution is Z
R R
− udt udt
y(t) = e C + we dt
Example
Find the general and definite solutions of the following equations:
dy dy
a) + 5y = 15 d) + t2 y = 5t2 , y(0) = 6
dt dt
dy dy
b) + 2ty = 0 e) 2 + 12y + 2et = 0, y(0) = 7
dt dt
dy dy
c) + 2ty = t, y(0) = 3 f) +y =t
dt dt

Exact Differential Equations
Definition-Example
A differential equation Example: Determine whether the following
equations are exact.
M (y, t)dy + N (y, t)dt = 0
1 ydy + tdt = 5
is exact if and only if
2 y′ + t = 6
∂M ∂N
= 3 y 2 dy + 2ytdt = 0
∂t ∂y
The general solution of the above exact differential equation is
F (y, t) = c
where F (y, t) satisfies

∂F ∂F
M= and N =
∂y ∂t
Solution of Exact Differential Equations
 Z
F (y, t) = M dy + ψ(t)
( ′ 
Fy = M

⇐⇒ Z ′
Ft′ = N 

 M dy + ψ(t) = N
t
Example
Verify that the following differential equations is exact, and solve those:
a) 2yt3 dy + 3y 2 t2 dt = 0 dy 2y 4 t + 3t3
d) + =0
b) 3y 2 tdy + (y 3 + 2t)dt = 0 dt 4y 3 t2
c) t(1 + 2y)dy + y(1 + y)dt = 0
More exercises: p491

Nonlinear Differential Equations
dy
f (y, t)dy + g(y, t)dt = 0 or = h(y, t)
dt
Exact differential equation
df dg
f (y, t)dy + g(y, t)dt = 0 with =
dt dy
Solution: Z
f dy + ψ(t) = c
Separable Variables
f (y)dy + g(t)dt = 0
Solution: Z Z
f (y)dy + g(t)dt = c

Equations Reducible to the Linear Form
Bernoulli equation
dy
+ f (t)y = g(t)y m with m ̸= 1
dt
Let z = y 1−m then
dz + [(1 − m)f (t)z − (1 − m)g(t)]dt = 0
The general solution:

R
Z R

− (1−m)f (t)dt (1−m)f (t)dt
z=e C + (1 − m)g(t)e dt

Practices
Solve the following equations:
dy y 2t
a) + ty = 3ty 2 d) dt + dt = 0
dt y+t y+t
b) 2tdy + 2ydt = 0
dy t dy
c) =− e) = 3y 2 t
dt y dt
More exercises: p491, p495

Higher-order Differential Equations
An example of a model involving the second-order differential equation is a describing

of the the rate of change of the rate of change:
d2 Y
= kY
dt2
A simple variety of linear differential equations of order n:
dn y dn−1 dy
n
+ a 1 dt + · · · + an−1 + an y = b
dt y dt

Second-order Differential Equations
Linear case (with constant coefficients):
y ′′ (t) + a1 y ′ (t) + a2 y = b
Example (Teamwork)
Solve the following differential equations:
1 y ′′ (t) + y ′ (t) = 5 5 y ′′ (t) − 4y ′ (t) + 4y(t) = 0

2 y ′′ (t) − y(t) = 5 6 y ′′ (t) − y ′ (t) = 5
3 y ′′ (t) − 2y ′ (t) + y(t) = 0 7 y ′′ (t) = 12
4 y ′′ (t) − 3y ′ (t) + 2y(t) = 0 8 y ′′ (t) + 8y ′ (t) + 16 = 0
Hint: let z = y ′ + my with suitable m ∈ R

The Particular Function of y ′′ (t) + a1 y ′ (t) + a2 y = b
y ′′ (t) + a1 y ′ (t) + a2 y = b (4)
If b = 0, the equation is said to be homogeneous. Otherwise, the equation is said to be

nonhomogeneous.
If yc is the complementary function, i.e. the general solution of
y ′′ (t) + a1 y ′ (t) + a2 y = 0 (5)
and if yp is the particular integral, i.e. any particular solution of the equation (4),
then the general solution of Eq. (4) is
y(t) = yc + yp
b b
If a2 ̸= 0 then yp = . If a2 = 0 and a1 ̸= 0 then yp = t. Otherwise, if a1 = a2 = 0
a2 a1
b
then yp = t2 .
2
The Complementary Function of y ′′ (t) + a1 y ′ (t) + a2 y = b
The complementary function of Eq. (4) is the general solution of
y ′′ (t) + a1 y ′ (t) + a2 y = 0 (6)
The characteristic equation of Eq. (6) is
r2 + a1 r + a2 = 0. (7)
If a21 − 4a2 > 0 then Eq. (7) has two distinct real roots:
p
−a1 ± a21 − 4a2
r1 , r2 =
2
2
If a1 − 4a2 = 0 then Eq. (7) has unique real root (repeated real roots):
−a1
r(= r1 = r2 ) =
2
2
If a1 − 4a2 < 0 then Eq. (7) has two complex roots:
r1 , r2 = α ± βi
The Complementary Function of y ′′ (t) + a1 y ′ (t) + a2 y = b
Let r1 , r2 be the roots of the characteristic equation
r2 + a1 r + a2 = 0
If r1 ̸= r2 and r1 , r2 ∈ R then
yc = C1 er1 t + C2 er2 t
If r = r1 = r2 ∈ R then
yc = C1 ert + C2 tert
If r1 , r2 = α ± βi ∈
/ R then
yc = eαt (C1 cos βt + C1 sin βt)

Examples - Practices
Find the yp , the yc , the general solution and the definite solution (if any) of the following:
1 y ′′ (t) − 2y ′ (t) + 5y = 2 5 y ′′ (t) + 4y ′ (t) + 8y = 2, y(0) =

2 y ′′ (t) + y ′ (t) = 7 2, y ′ (0) = 4
3 y ′′ (t) + 3y(t) = 9
4 y ′′ (t) − 4y ′ (t) + 8y = 0, y(0) = 6 2y ′′ (t) − 12y ′ (t) + 20y = 39, y(0) =
3, y ′ (0) = 7 4, y ′ (0) = 5
More exercises: p511, p527, p540

The Dynamic Stability of Equilibrium
Economic interpretation for yc and yp : yc represents the deviation from equilibrium

while yp represents the intertemporal equilibrium level
If yp is a constant, we have a stationary equilibrium in the intertemporal sense.
Otherwise, we may interpret it as a moving equilibrium.
If limt→∞ y(t) = yp or limt→∞ yc = 0 then we say that the model or the equilibrium is
dynamically stable.
Example

dy b −at b
The solution of the equation + ay = b is y(t) = y(0) − e + . Hence,
dt a a

a>0 converges to
⇐⇒ y(t) equilibrium
a<0 diverges to

Example
The one-commodity market model: The equilibrium price:
Qd = α − βP (α, β > 0) α+γ

P∗ =
Qs = −γ + δP (γ, δ > 0) β+δ
Our dynamic question: given sufficient time for the adjustment process to work itself out,
does it tend to bring price (from the initial price) to the equilibrium price P ∗ ? That is,
lim P (t) = P ∗ ?
t→∞

Example - 2
Assumption:
The rate of price change w.r.t. time at any moment is always directly proportional to
the excess demand (Qd − Qs ):
dP
= A(Qd − Qs ) (A > 0)
dt
where A represents a (constant) adjustment coeffcient.
Hence,
dP
+ A(β + δ)P = A(α + γ)
dt
This yields the solution:
P (t) = [P (0) − P ∗ ] e−A(β+δ)t + P ∗
Since A > 0, lim P (t) = P ∗ . In this case, the equilibrium is said to be dynamically stable.
t→∞
The Dynamic Stability of Equilibrium - Case 1 and 2
The complete equation: The homogeneous equation:
y ′′ (t) + a1 y ′ (t) + a2 y = b y ′′ (t) + a1 y ′ (t) + a2 y = 0
yc = C1 er1 t + C2 er2 t b b
yp = or yp = t
a2 a1
The dynamic stability attains if and only if yc → 0 as t → ∞. Equivalently, r1 , r2 are

both negative.
Similarly, if r = r1 = r2 then (the dynamic stability attains if and only if
r = r1 = r2 < 0)
The Dynamic Stability of Equilibrium - Case 3
The complete equation: The homogeneous equation:
y ′′ (t) + a1 y ′ (t) + a2 y = b y ′′ (t) + a1 y ′ (t) + a2 y = 0
If r1 , r2 = α ± βi ∈ C then
yc = eαt (C1 cos βt + C1 sin βt) b

yp =
a2
The dynamic stability attains if and only if yc → 0 as t → ∞, or the real parts of

r1 , r2 are negative, i.e. α < 0.
For all cases, we can say that the condition for dynamic stability of equilibrium is
“the real part of every characteristic root is negative".
A Market model with Price expectations
In the continuous-time context, the price-trend information is to be found primarily
in the two derivatives dP/dt (whether price is rising) and d2 P/dt2 (whether
increasing at an increasing rate).
Qd = Qd P (t), P ′ (t), P ′′ (t)

Qs = Qs P (t), P ′ (t), P ′′ (t)

In the case of linearity:
Qd = α − βP + mP ′ + nP ′′ (α, β > 0)
′ ′′
Qs = −γ + δP + uP + wP (γ, δ > 0)
If u = w = 0 and the market is cleared at every point of time, i.e. Qs (t) = Qd (t) for
every t, then
m β+δ α+γ
P ′′ + P ′ − P =−
n n n
Teamwork
Solve the equation

m ′ β+δ α+γ
P ′′ + P − P =− .
n n n
Find the conditions for the parameters m, n so that the equilibrium is dynamically
stable.
Exercise 16.4 (p532)

Difference Equations
When we are dealing with discrete time, the value of variable y will change only when
the variable t changes from one integer value to the next, such as from t = 1 to t = 2.
In this light, it becomes more convenient to interpret the values of t as referring to
periods, rather than points, of time.
The discrete-time version of economic dynamics is oftern referred to as period
analysis.
Remark that even in the same model, each successive period should not necessarily be
constructed as meaning equal calendar time. In the analytical sense, a period is
merely a length of time that elapses before the variable y undergoes a change.

First-order Difference Equations
Linear Difference Equations: Reduced homogeneous:
yt+1 + ayt = b yt+1 + ayt = 0
Particular solution: Complementary function:

b
yp = (a ̸= −1) yc = C · (−a)t
1+a
yp = bt (a = −1) yc → 0 as t → ∞ if and only if |a| < 1
General solution and definite solution:

t b b b
yt = C(−a) + = yo − (−a)t + (if a ̸= −1)
1+a 1+a 1+a
yt = C + bt = yo + bt (if a = −1)

Practices
Solve the following difference equations:

yt+1 = yt + 1 (yo = 10)
yt+1 = αyt (yo = β)
yt+1 + 3yt = 4 (yo = 4)
2yt+1 − yt = 6
yt+1 = 0.2yt + 4

Second-order Linear Difference Equations
General form:
yt+2 + a1 yt+1 + a2 yt = b
Particular solution:
b
yp = if a1 + a2 ̸= −1
1 + a1 + a2
b
yp = t if a1 ̸= 2, and a1 + a2 = −1
a1 + 2
b
yp = t2 if a1 = 2, and a1 + a2 = −1
2

Complementary function
General form: Homogeneous form:
yt+2 + a1 yt+1 + a2 yt = b yt+2 + a1 yt+1 + a2 yt = 0
Characteristic equation:
r2 + a1 r + a2 = 0
yc = C1 r1t + C2 r2t
If r = r1 = r2 ∈ R then
yc = C1 rt + C2 trt
If r1 , r2 = α ± βi = R(cos θ ± i sin θ) then
yc = Rt (C1 cos θt + C2 sin θt)

Practices
Solve the following difference equations:

1 1 1
1 yt+2 − yt+1 + yt = 2 3 yt+2 + yt − yt−1 = 5
2 2 2
2 yt+2 − 4yt+1 + 4yt = 7 4 yt+2 − 2yt+1 + 3yt = 4
7
5yt+2 + 3yt+1 − yt = 9 (y0 = 6, y1 = 3)
4
6 y
t+2 − 2yt+1 + 2yt = 1 (y0 = 3, y1 = 4)
1
7 y
t+2 − yt+1 + yt = 2 (y0 = 4, y1 = 7)
4

Dynamic Stability
Theorem
The model determined by yt+1 + ayt = b is dynamical stable if and only if |a| < 1.
The model determined by yt+2 + a1 yt+1 + a2 yt = b is dynamical stable if and only if
the norm of the roots of the characteristic equation r2 + a1 r + a2 = 0 is strictly less
than 1.
Norm
If r = α + βi then the norm of r is defined as
p
|r| = α2 + β 2 .

The cobweb model
Let’s assume that the output decision in a period t is based on the then-prevailing price
Pt . Since this output will not be available for the sale until the period t + 1, Pt will
determine not Qs,t , but Qs,t+1 :
Qs,t+t = S(Pt ) or Qs,t = S(Pt−1 ).
When such a supply function interacts with a demand function of the form:
Qd,t = D(Pt ).
In the case, the functions are modelled as linear functions, we have


Qd,t = Qs,t

Qd,t = α − βPt

Qs,t = −γ + δPt−1


The Stability
The equation The general solution with initial condition

 P (0) = P0 :
Qd,t = Qs,t

Qd,t = α − βPt t
α+γ δ α+γ
 Pt = P0 − − +
Qs,t = −γ + δPt−1 β+δ β β+δ

Q S = −0.13 + 0.9pt−1 Q S = −0.4 + pt−1

D1 S1 D1 S1
S2 S2
D = 5 − pt D = 5 − 0.8pt
p p
p1 p∗ p2 po p1 po p2
p∗
The market model with a price expectation
In this model, we assume that

1 the output decision in a period t is based on an expected price (EP )t , and
2 the expected price in the period t is adjusted according to the price and the expected
price in the previous period.
If so, we have the following model:


 Dt = a − bpt (a, b > 0)
St = −c + d(Ep)t (c, d > 0)

D = St
 t


(Ep)t = λpt−1 + (1 − λ)(Ep)t−1 ,
with 0 < λ ≤ 1.

Dynamical Stability
From the system, we get

λd λ(a + c)
pt+1 − 1 − λ − pt = .
b b
If an initial condition P (0) = Po is given, we have
λd t

a+c a+c
pt = + po − 1−λ− .
b+d b+d b

λd d
The model is dynamically stable if and only if 1 − λ − < 1, or λ 1 + < 2.
b b

The market model with inventory
Let’s assume that
1 Both the quantity demanded, Qd,t , and the quantity currently produced, Qs,t , are
linear functions of price Pt ,
2 The adjustment of price is effected not through market clearance in every period, but
through a process of price-setting by the sellers: if, as a result of the preceding-period
price, inventory accumulated, the current-period price is set at a lower level than
before, and vice versa.
3 The price adjustment made from period to period is inversely proportional to the
observed change in the inventory.

 Qd,t = α − βPt

Qs,t = −γ + δPt

Pt+1 = Pt − σ(Qs,t − Qd,t )

where σ denoted the stock-induced-price-adjustment coefficient.

The dynamic stability
The equation with initial condition P (0) = P0 :


 Qd,t = α − βPt

 α+γ α+γ
Qs,t = −γ + δPt Pt = P0 − (1 − σ(β + δ))t +
 β+δ β+δ
Pt+1 = Pt − σ(Qs,t − Qd,t )

with α, β, γ, δ, σ > 0. The general solution
Theorem
The model is dynamically stable if and only if |1 − σ(β + δ)| < 1 or
2
0<σ<
β+δ

Teamwork - Presentations
Domar Growth model (p471).

Solow Growth model (p498).
The interaction of Inflation and Unemployment (p532).
The cobweb model (p555).
The market model with inventory (p559).
The market model with a price ceiling (p575)
Samuelson Multiplier - Acceleration interaction model (p576).
The interaction of Inflation and Unemployment in discrete time (p581).
Dynamic Input-output model (p603).
The inflation-Unemployment model - more general case (p609).

Any question?
Thank you!

Slides TKT Dynamic

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Slides TKT Dynamic

Uploaded by

Copyright:

Available Formats

Mathematical Economics

PART II: Dynamic Analysis

University of Economics and Law

23rd October 2023

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 1 / 42

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 2 / 42

H(t) = 2t1/2 + c (c = an arbitrary constant)

H(t) = 2t1/2 + 100

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 3 / 42

A first-order linear differential equation:

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 4 / 42

1 Determine all function y = y(t) such that

2 Determine all function y = y(t) such that:

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 5 / 42

The complementary function: The particular integral:

The general solution (a ̸= 0): The definite solution (a ̸= 0):

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 8 / 42

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 9 / 42

where F (y, t) satisfies

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 11 / 42

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 12 / 42

The general solution:

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 13 / 42

Solve the following equations:

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 14 / 42

An example of a model involving the second-order differential equation is a describing

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 15 / 42

Linear case (with constant coefficients):

1 y ′′ (t) + y ′ (t) = 5 5 y ′′ (t) − 4y ′ (t) + 4y(t) = 0

Hint: let z = y ′ + my with suitable m ∈ R

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 16 / 42

y ′′ (t) + a1 y ′ (t) + a2 y = b (4)

If b = 0, the equation is said to be homogeneous. Otherwise, the equation is said to be

Let r1 , r2 be the roots of the characteristic equation

yc = eαt (C1 cos βt + C1 sin βt)

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 19 / 42

1 y ′′ (t) − 2y ′ (t) + 5y = 2 5 y ′′ (t) + 4y ′ (t) + 8y = 2, y(0) =

More exercises: p511, p527, p540

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 20 / 42

Economic interpretation for yc and yp : yc represents the deviation from equilibrium

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 21 / 42

The one-commodity market model: The equilibrium price:

Qd = α − βP (α, β > 0) α+γ

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 22 / 42

P (t) = [P (0) − P ∗ ] e−A(β+δ)t + P ∗

The complete equation: The homogeneous equation:

y ′′ (t) + a1 y ′ (t) + a2 y = b y ′′ (t) + a1 y ′ (t) + a2 y = 0

The complementary function: The particular integral:

The dynamic stability attains if and only if yc → 0 as t → ∞. Equivalently, r1 , r2 are

The complete equation: The homogeneous equation:

y ′′ (t) + a1 y ′ (t) + a2 y = b y ′′ (t) + a1 y ′ (t) + a2 y = 0

The complementary function: The particular integral:

yc = eαt (C1 cos βt + C1 sin βt) b

The dynamic stability attains if and only if yc → 0 as t → ∞, or the real parts of

Qd = Qd P (t), P ′ (t), P ′′ (t)

Qs = Qs P (t), P ′ (t), P ′′ (t)

In the case of linearity:

Solve the equation

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 27 / 42

Hà Văn Hiếu (UEL) Mathematical Economics 23rd October 2023 28 / 42

Linear Difference Equations: Reduced homogeneous:

yt+1 + ayt = b yt+1 + ayt = 0

Particular solution: Complementary function: