# INTERMEDIATE METHODS

:
DIFFERENCE EQUATIONS
DIFFERENCE EQUATIONS
Not a whole lot of theory, really.
Difference Equations are concerned with DISCRETE
changes in a variable over time.
Differential equations were a continuous change, difference
equations look at data which is reported only once a time
period.
For example, lags if you had a lagged variable in a model,
then it·s rate of change over time would be modelled by a
difference equation.
A typical difference equation looks like:
Y
t
= a + bY
t-1
We call such a difference equation a first order
difference equation because it only goes back one
period.
DIFFERENCE EQUATIONS
Primarily Concerned with two types of Difference
Equation, homogenous and non-homogenous.
Pretty much the same definition as homogenous
+ non-homogenous Dif. Equations.
Homogenous:
y Y
t
= bY
t-1
y A.k.a, ¶a = 0·
Non ² Homogenous:
y Y
t
= a + bY
t-1
DIFFERENCE EQUATIONS
Solution of the homogenous case:
Y
t
= Y(0).b
t
Solution of the non-homogenous case (when re-
arranged):
However, note that ¶b· CANNOT equal 1, otherwise
the solution is undefined. Thus, the equation to use
when ¶b· = 1, is:
Y
t
= at + Y(0)
´ )
t
t
b
b
a
Y
b
a
Y
¦
¦
¦

+

=
1
0
1
Particul
ar
Solution
Complementa
ry Function
DIFFERENCE EQUATIONS
Stability Conditions:
We can thus model the typical general solution for a difference equation thusly:
Y
t
= c + mb
t
¶c· and ¶m· are constants, so the stability of the model depends on ¶bt· more
specifically, it depends on the value of ¶b·.
IF:
y b > 1 NON-CONVERGENCE, DIVERGES FROM LONG-RUN SOLUTION (¶c·)
y b = 1 NON-CONVERGENCE, CONSTANT DEVIATION FROM ¶c·.
y 1 > b > 0 CONVERGES TOWARDS EQUILIBRIUM.
y b = 0 Y is a CONSTANT.
y -1 < b < 0 CONVERGES TOWARDS EQUILIRBRIUM, OSCILLATES!
y b = -1 NON-CONVERGENCE, OSCILLATING AROUND ¶c·
y b < -1 NON-CONVERGENCE, OSCILLATES IN A DIVERGENT FASHION.
DIFFERENCE EQUATIONS
Thus, if ¶b· is less than 1, the effect largely
mirrors what will happen if b > 1, except the path
now oscillates about the long-run equilibrium.
Another thing; the time path for a difference
equations is different to that for a continuous
differential equation.
P
t
150
500
_
_
_
_
_
_
_
_
_
_
_
_
_
_
0
DIFFERENCE EQUATIONS
Questions on Difference Equations:
Generally just mash equations together to get an
equation in the form of an exact/non-exact difference
and solve.
Only one you need to really know any theory for is the
HARROD-DOMAR model:
y In equilibrium k(Y
t
² Y
t-1
) = sY
t
y Where ¶k· is K/Y and ¶s· is MPS
y Re-arrange to get into the form of a homogenous difference
equation.
y The WARRANTED GROWTH RATE is (Y1 ² Y0)/Y0
y Find ¶Y1· from the general solution you get from computing
the equilibrium problem, then re-arrange.
y Eventually, should reach the equation:
s k
s
G
w

=