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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

=

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