UNIT SIX

DYNAMIC EQUILIBRIUM ANALYSI

Introduction
Dear colleague! So far we have discussed about comparative static analysis which is
emphasized on comparison of different equilibrium situations. For instance, in the theory of
supply and demand analysis, an increase in demand for a product increases equilibrium price
and quantity, other things being equal. However, nothing is said about the process by which
price and quantity are being adjusted to the new equilibrium values. The study of the process
of adjustment over time is the concern of dynamic analysis. In this unit you will deal about
discrete time and continuous time dynamic analysis and their economic application. In the
former case there will be a change in variable only once with in a period of time where as in
the later case there may be a change in variables at each point of time.

Unit Objective
After completing this unit, you should be able to
- discuss the difference between dynamic equilibrium analysis and comparative static
analysis
- describe dynamic analysis over continuous time period
- explain dynamic analysis over discrete time period
- describe differential equations and difference equations
- explain the cobweb model and the Keynesian macro economic model, and Harrods
Domar growth models and others

Section 6.1 Continuous Time Dynamic Analysis

Up on the completion of this section, you are expected to

- describe differential equations

- explain general solution and definite
solution of a differential equation
- apply differential equations on
economic functions to determine
dynamic stability of equilibrium

Dear Colleague! What is differential equation? You studied concerning this concept in
Quantitative Method for economists I. Thus, try to remember it and answer this question.
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Have you answered this question? Ok, good, try to relate your answer with the following
analysis.
Differential equation is an equation that shows an implicit or explicit relationship between
the function and one or more of its derivatives. For instance,
= 6t + 10, where t represents time

= 15 y, -2 + 19 = 0

The highest power attained by the derivative in the equation is known as degree of the
differential equation where as the order of a differential equation is the order of the highest
derivative in the equation.
Example

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 a) = 3x + 7 (first degree, first order)

b) +( + 2x2 = 0 (third order, first degree)

6.1.1. First - Order Linear Differential Equations

In this case, if the derivative, and have to be is first degree and if no product of

exist, then the equation is referred to as first order linear differential equation. This
equation will generally take a form
+Vy=Z or + V (t) y = Z (t) ---------------- (1)
Where V and Z are constants or functions of time, t, like y
When V and Z are constants and Z is zero, then equation (1) will be
=0 ------------------------------------- (2)
Where is constant which represents V. Such type of differential equation is referred to as
homogenous as each term in the equation is in first degree in terms of y and .
Rearranging equation (2), we get
---------------------------------------- (3)
Now we can obtain the solution of equation (3) by integrating both sides of the equation with
respect to t.
By substitution rule and log rule, the left side of the equation gives us
,
The right side gives us
, (as - is constant)
By equating the above two integrals and combining the two constants, we get
+C
Using the method of antilogarithm
=
=

, where ----------------------- (4)

There is an arbitrary constant A in equation (4). Therefore, it is a general solution.
If we substitute a particular value for A, then it will be a definite solution. We have seen two
situations in the solution of differential equation. These are.
 The solution is given in function form, not in number.
 The solution is free of any derivative. As result, we can determine the value of y if a
specific value is assigned for t.
When we put a nonzero constant in equation (2) in place of Z, we get the equation,
+ = , where is constant ---------------------------- (5)
Such type of equation is known as non homogenous linear differential equation. Here, the
problem is how can we determine the solution? The solution of this equation will contain two
different terms. One is complementary function represented by and the other is particular
integral represented by as we will see it later.

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Let us observe the solution of the homogenous equation even if we are dealing about the way
to solve non homogenous equation. For convenient let us consider the homogenous equation
as reduced equation and the non homogenous one as complete equation. Thus, the solution of
the reduced equation represents and represents particular solution of the complete
equation. This means,
, from equation (4)
We have said that denotes a particular solution of the complete function. Thus, let us first

try to obtain the simplest type of solution taking y as some constant . Then, when y is
constant. As a result equation (5)

Then the general solution of the complete function is

When t = 0,

Thus, , ( definite solution, 0 ) ------------ ( 7)

Example
1. Find the definite solution of the equation + 4y = 12, y (0) = 0. In this case,
, thus

2. Determine the general solution of the equation 3 + 6y = 5

Dividing both sides by 3, we get the equation
+ 2y =

6.1.2Economic Applications
Dear colleague! Differential equations are beneficial to determine the dynamic stability
condition of the market equilibrium. When the rate of growth of a function is given,
differential equation enables us to get the function whose growth is explained.

Example
1. Assume that the demand and supply functions of a particular product are given as

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As we remember from comparative static analysis, equilibrium Price, is
= ------------------------------------------------------------- (9)

Assuming that the rate of change of price in the market, is a positive linear function of

excess demand, ,

, is constant, > 0 ------------- (10)

Given sufficient time for adjustment process, under what condition converges to
the equilibrium price as t
----------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------?
We know that = 0 if and only if

Substituting the given parameters for and Qs in equation (10)

We have seen that equation (11) is expressed in the form of differential equation. As the
coefficient is different form zero, it is possible to apply the solution formula and present
the solution as

As P (0) and are constants whether P (t) as t or not depends on the exponential
expression . If k (b+ d) > 0, the exponential expression approaches to zero as t
approaches to infinity. As a result, the time path will really direct the price towards
equilibrium position on the assumption of our model. In this case, the equilibrium is refereed
to as dynamically stable.

2. If are deviations of consumption, investment and income from their

respective equilibrium values , and , determine the dynamic stability conditions for the
two sector income determination model.
, and
In come changes at a rate proportional to excess demand and ,

, ,

Using substitution,

When we integrate this function, we get

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Using the method of antilogarithm
ŷ=

As t = 0, ŷ = y (0) - ŷ = k
As a result, . However,
Thus,
This solution shows that as , if and only if .

3. It is clear that a change in the rate of investment will affect both aggregate demand and
productive capacity of the economy. The Domar model wants to determine the time path
along which an economy can grow while maintaining full utilization of its productive
capacity. Given the marginal propensity to save and the marginal capital- output ratio as
constant, determine the desired investment function for the growth to be needed.

Dear colleague! As we know change in aggregate demand is equal to change in investment

multiplied by the multiplier .

= --------------------------------------------- (16)
Change in productive capacity is equal to the change in capital stock multiplied by the
reciprocal of marginal capital- output ratio,
= = I, as = I ---------------------- (17)
Equating equation (16) and (17), gives us
= I

--------------------------------------------------- (18)
Rearranging this equation, we get
-------------------------------------------------- (19)
Applying the method of integration on equation (19), it becomes

Using antilogarithm

Equation (20) is the desired investment function for the growth to be needed which indicates
that investment has to grow at a constant rate determined by (saving rate divided by capital
output ratio).

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6.1.3 Second - Order Linear Differential Equations
Functions of the form +a + a y = b where a , a , and b are constants is referred

to as second - order linear differential equations. ------------------------------ (21)

If the tem b is zero, the given function is homogenous. However, if b is different from zero,
the equation is known as non homogenous equation.

The solution of the given equation has two components. These are complementary function (
) and particular integral ( ).

Similar to the previous analysis represents the deviation of y (t) from equilibrium for
every point of time path where as denotes the equilibrium value of the variable in
intertemporal sense.

Particular integral ( )
Dear colleague! Let us try the simplest possible way, i.e., setting y = a, constant, to find the
particular integral .
 If y = a which is constant, then the above second order linear differential equation

becomes As a result, the equation +a + a y = b , will be

reduced to a y = b which gives us .

Thus, the particular integral is ,

 If we have to find some non constant form of a solution. Setting y = k t

which is the simplest possibility, the second order differential equation (21) is
reduced to
.This gives us the value of which is the particular integral .Then the particular
integral is
, ---------------------------------- (23)

 If , the solution with a form fails since it is undefined. consequently, we

have to find other solution of the form when , then equation ( 21)

is reduced to = b ------------------------------- ( 24)

y = kt implies that, . Then the differential equation (24) can be

presented as 2k = b which implies that and then the particular integral is

Example
Find the particular integral of the equation

- 2 + 5y = 2

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Solution:

If , (using equation (23)).But, if .

The complementary function ( )

The complementary function of equation (21) denotes the general solution of the equation

+ a1 + a2 y = 0 ---------------------------------------- (26)

As we have discussed in equation (4), .. Adopting this solution, and

Substituting these terms in equation (26) , we get

Equation (27) shows that A = 0 or

We know that the value of A is determined by the use of the initial condition of the problem.
Consequently, we cannot set A = 0. Thus, it is necessary to observe the value of r which
satisfies the equation . This equation is referred to as characteristic equation
of the homogenous function expressed in equation (26). This characteristic equation has a
form of quadratic equation which will result in two solutions (roots). These roots are known
as characteristic roots. Using quadratic formula,

and are the only values we can put for r in the solution y = A . Since there are two
roots, and , then we will have two solutions. These are,
and , where and are constants and and are
characteristic roots. The general solution is the summation of the above two solutions. This
means,

Dear Colleague! The characteristic equation may have three different types of roots, namely
distinct real roots, reaped real roots and complex roots.
Case 1 When , the square root in equation (28) will be a real number and the two
roots and will be distinct real numbers. In this case +
,( ) ------------------------------- (30)
Case 2 When , the term in the square root of equation (28) becomes zero. As a
result the two roots will be equal. The complementary function will be

Case 3 When the term in the square root of equation (28) becomes negative
number which is referred to as imaginary number. For the time being let us ignored this case.
For the first two cases it is possible to determine the dynamic stability of equilibrium
condition based on the sign of the characteristic roots. The condition (i.e., as t ) is
fulfilled iff both and have negative sign.

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Example
Find , the general solution and the definite solution of the equation

Since the value of is different from zero,

To determine the complementary function , we should first find the value of and

, = , = , =

We know that + ------------------------------ (33)

Subsisting the value of r1 and r2 in equation (33) gives us

Therefore, the general solution of the equation is

When y (0) = and (0) = 6, then the definite solution becomes,

When t = 0,

Taking equation (35) and (36) simultaneously, multiplying (35) by 2 deduct it from equation
(36) gives A2 = - 2.
Substituting the value of in equation (35), we get
A1 - 2 = 2
A1 = 4
Therefore, is the definite solution when y (0) = and
=6

6.1.4 Economic Applications

Dear colleague! It is clear that future price expectation affects supply and demand decisions.
The price tread existing at the moment in continuous time context can be found in and

.Therefore, we ought to incorporate these two derivatives in the demand and supply

functions as additional components to consider the price trend in our analysis.

Example
1.Suppose the demand and supply functions of a product are given as

With initial condition and . Assuming market clearance at every point of

time, find the time path

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Dear colleague! As we know market equilibrium is achieved when . Thus, at the point
of equilibrium

Rearranging this equation, we get

-4 - 12P = - 48 which is second order differential equation in form. Thus,

where represents the particular integral and P c denotes the complementary

function. Thus, to determine the general solution we should find and .In this

equation, , since then .

To determine, we should find and . Using the formula presented in equation (28 ),

, = =

, = , i.e., = 6 and =-2

This means
Therefore, the general solution is

Considering the initial conditions p (0) = 6 and (0) = 4,

Taking equation (40) and (41) simultaneously, multiplying equation (40) by 2 and adding it
on (41), we get and . Therefore, the definite solution is

Since , cannot converge to the intertemporal equilibrium. It is dynamically

unstable.

Dear colleague! By now you have completed the first section of this unit. Therefore, try to do
the following self - test questions to examine how you understand this section.

Self - Test 6.1

Do the following questions based on the information given above.
1. Describe dynamic equilibrium
analysis-------------------------------------------------------------------------------------------------------
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2. What is differential equation explain it briefly.
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3. Describe the difference between homogenous and non homogenous differential equation.
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4. Explain the difference between general solution and definite solution of an equation
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5. Given demand and supply functions of a product as

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Determine whether the equilibrium price , is dynamically stable over time or not as there is
sufficient time for adjustment using the formula presented in equation ( 12)
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----------------------

6. Suppose the demand and supply functions of a product are given as:

With P (0) = 4 and , determine the price path, assuming market clearance at every
point of time. Is the time path convergent?
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Dear colleague! Have you answered these questions? If your answer is no, please reread this
section and answer them. If your answer is yes, go to the next section.

Section 6.2 Discrete Time Dynamic Analysis

Up on the completion of this section, you should be able to

- describe what a difference equation is

- explain the difference between first- order linear difference equation
and second-order difference equation
-explain the dynamic adjustment process in a cobweb model and in ----
Keynesian macroeconomic model
-explain the Harrod model of growth in the economy

Dear colleague! In the previous section we have discussed the continuous time dynamic
analysis. In that case, the magnitude of change in time is very small. As result, the change in
y which is emanated from this change in time is expressed in the form of derivative.
However, this section is emphasized on discrete time dynamic analysis. In this case, time is
considered as discrete variable and the dynamic adjustment process between equilibriums is
observed as a step-by-step process rather than that of continual adjustment. Thus the change
in y has to be explained by "differences" rather than derivatives or differentials. Accordingly,
we can calculate the different values of the variables which are adjusting to new equilibrium
levels using
 The mathematical concept of difference equation and

165
  Spreadsheet

Dear colleague! What is difference equation?

Have you answered this question? Good. Try to relate it with the following analysis.

Difference equation is an equation which expresses the relation ship between the dependent
variable and a lagged independent variable that changes at discrete intervals of time. The
largest number of periods lagged represents the order of difference equation.

6.2.1 First Order Linear Difference Equations

First order difference equation represents a time lag of one period. The change in y which is
resulted from change in time t from is referred to as the first difference of y
which is represented by

This equation is first-order linear difference equation. Given the first-order linear difference
equation

Let us find the solution of this equation by using iterative method first and then the general
method.

A. Iterative Method

Given equation (2), it is not difficult to find the value of provided that the initial value of
is given. We can also find the value of once we have determined the value of

EXAMPLE
1. Find the solution of the difference equation provided that using
iteration method.

For any period t, the solution of equation (2) with is

2. Find the solution of the difference equation . In this case, the initial value is
unspecified simply represented by using the method of iteration,

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The solution of at any period t is

B) General method

Given the first order linear difference equation

Where a and b are constants, the general solution s a combination of the particular integral
and the complementary function . denotes the intertemporal equilibrium level of y
where as represents the deviation of the time path from this equilibrium. Incorporating the
initial condition we can determine the definite solution.

Dear colleague! Let us first determine the complementary function which is the solution of
the reduced equation . Based on equation (4) above,

Putting the constant A in place of we get

Thus, the complementary function is

Now let us find the particular integral

Taking the simplest form where k is constant, we have to have If we
substitute these n to equation (5), we will get k+ b k=

Then the particular integral becomes,

Therefore, the general solution of the equation is

If b=-1 the general solution will be

Setting the initial condition that when t =0,

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Are a result, the definite solution is

Example

Solve the first order difference equation

when

Using the formula in equation (10) , =-8 , b 3,

The given equation s referred to as dynamically stable or convergent provided that the
complementary function approaches to zero as t approaches to infinity. The convergence of
the term depend the absolute value of b. If , the time path will move away from
equilibrium. If , the time path will move towards to equilibrium, i.e., convergent.
In our example above, b=-3, Therefore, the equilibrium is dynamically
unstable. In other words, the time path is divergent.

6.2.1 Second order Linear Difference Equations

Given the second order difference equation

, the
general solution is composed of that of particular integral and complementary function. We
know that the particular integral is any solution of the complete equation. Thus, setting the
simplest solution
equation (11) becomes

Therefore, ,

If equation (13) will be undefined. Thus, we have to set another value for
.Let then equation (11) becomes,

Rearranging this equation,

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This equation becomes

Thus, ,

When then equation (15) will be undefined. Therefore, we should

set another value for . Let then equation (11) becomes,

This equation becomes,

Therefore, ,

Dear colleague! As complementary function is the solution of the reduced equation, we

should emphasize on the equation
to determine the complementary
function of the given equation we know that Thus the
above reduced equation becomes

Ignoring the nonzero common factory gives us,

This equation is referred to as characteristic equation of equation (18)

The solution of this equation using the quadratic formula

We face three possible phenomenon based on the term in the square root of equation (21)

case1, When the characteristic equation will have two distinct roots,
In this case, the complementary solution will be

Case 2 when the characteristic equation will have only one root, this means,

The complementary function becomes

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Case 3.when the term in the square root will be negative which an imaginary
number is. There is no characteristic root for the equation provided that we restrict our
domain to the real number system. Thus, we are forced to include numbers outside the real
number system. Ideally, we can define which a square root of negative one is. It is
not real number rather it is known as imaginary number. Therefore, we can write

Given the diagrams

Imaginary
axis

R
v

h Real axis

Then the conjugate complex number

According to De movers theorem

If in equation (21), ten the roots will tae the form

R=

The complementary function becomes

In al of the above three cases, the equilibrium will be dynamically stable provided that the
absolute value of every root is less than one whatever the initial condition may be

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Table 6 1. Values of sin

Example
Given the equation
a. Determine the general and definite solution of the equation
b. Is the time path convergent or not?

Solution

.Thus, as it is shown in table 1, when we substitute this value

in equation (25), the complementary function will be

Then the general solution becomes

When

When t=1,

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Therefore, the definite solution be comes

6.2.3 Economic Applications

Dear colleague! In this sub topic you will learn about the application of first order and second
order linear difference equations on economic models.

A. Application of First Order Linear Difference Equation

Cobweb Model
Dear Colleague! In certain markets particularly agricultural markets, if demand for a product
increase, supply cannot immediately increase to satisfy the prevailing demand. Crops must be
planted and growth and livestock takes time to raise. Some manufactured products may also
take certain time when customers order that products suddenly. The Cobweb model considers
this lagged in supply side of the market by supposing that the present quantity supplied is
based on the ruling price in the previous time period. That is,

But the consumers demand for the same product depends on the prevailing price that is

This is a logical situation of several agricultural markets. The quantity supplied this year is
based on the price of that product in last year. The Cobweb model assume that
 The market is perfectly competitive.
 The demand and supply functions are linear.
Given these assumptions, the Cobweb model can still give a fair idea of how price and
quantity adjust in many markets with a lagged supply. Based on the above assumptions, the
demand and supply functions of a product can be expressed in the form

Dear Colleague! As you know, the market achieves its equilibrium when quantity demanded
is equal to quantity supplied.
In other words,

This equation is the Cobweb difference equation.

Thus, solving the Cobweb difference equation means setting it in the format As a
result; we can calculate the value of at any time period.

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The solution of the Cobweb difference equation includes two parts. There are:
a) Long run equilibrium price
b) a complementary function which indicates how much price diverges from this
equilibrium level at different points in time.
Dear colleague! Now let us first find the long run equilibrium price . In the log run,
. Therefore

Become

To determine the complementary function, we can rewrite equation (28) as

Using the method of determining the complementary function described in equation (7)
above,

If we substitute, A, a Constance in place of we get

In this case the value of A can be determined if a certain value of is known for specific
value of t.
The complete solution of the Cobweb difference equation, therefore, becomes

From this equation

1. If approaches to zero when t approach to infinity. In this case the
market is stable. Price converges to the long run equilibrium price .
2. If In this case the market is unstable. Price
diverges from the equilibrium level.
3. If In this case, price neither return to its equilibrium
nor 'explode'.

Example
1. Given the demand and supply for the Cobweb model as

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Determine the long run (intertemporal) equilibrium price the complementary function
and the complete solution.
Determine whether the equilibrium is stable or not.

Solution

=400, b =-20, c =-50, d=10

(inter temporal equilibrium).

The complementary function is

Therefore, the complete solution is

Since the equilibrium is dynamically stable.

Dear colleague! What happens to the market if quantity supplied suddenly changes
to 160? ______________________________________________________________
___________________________________________________________________
The initial stock output level is so that price will adjust until all output is sold.
Then can be calculated from the demand function by substituting
Therefore, .

By now we can determine the value of A.

Thus, the definite solution is

Using thin equation we can calculate the price of the product at any time period and there by
we can check whether the price converges to the equilibrium level or not.
2. In a market where the assumptions of the cobweb model hold,

The long run equilibrium is disturbed when quantity suddenly changes to 90.
What happens to price in the following time period?
Solution
In the long run equilibrium , Thus,

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The complementary function is

Thus, the general solution is

When

Thus, the definite solution is

The Keynesian Macroeconomic Model

In the Keynesian model of national income determination, if foreign trade and government
expenditure and tax are not included, the model becomes,
And

Where is national income, is consumption, I is investments is autonomous

consumption and is marginal propensity to consume. Then equilibrium level of national
income is

This equation shows that this national equilibrium income can be evaluated fro a given
values of and .
When there is a disturbance from this equilibrium, there will not be an immediate adjustment
to the new equilibrium. As the consumer expenditure may not adjust immediately to the new
level of income, a lagged effect may be introduced in the consumption function, as follows,

This means, consumer's expenditure at present depends on the income of the previous year.
But national income is still determined by the sum all current expenditure

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Substituting (43) in to (44) gives us

Equation (45) is a first order linear difference equation,

The general solution of this equation includes two parts, namely intertemporal equilibrium
and complementary function , At the point of equilibrium,

The complementary function as referred to equation ()7

Thus, the general solution becomes

This equation shows that the equilibrium will be dynamically stable provided that
Example

Given the Keynesian model

Then it suddenly increases to 420

Dear colleague! What will be the actual level of six time periods after this change?

Solution

The initial equilibrium level of income is

Thus, consumption is

Thus, the value of immediately after the shock is

The new equilibrium level is

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Substituting this value in general solution above, we will get

Dear colleague! How much time period will it take y to reach 2,130?
-----------------------------------------------------------------------------------------------------------------
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----------------------------------

Putting this equation in it's logarithm form

The equilibrium national income will reach 2,130units after 3.585 time period.
SAMUEL SON'S MULTIPLIER-ACCELERATION INTERACTION MODEL

Dear colleague! To observe the application of second order difference equations in

economies, let us consider Samuel son's classics interaction model. This model examines the
dynamic process of income determination if the acceleration principle works with the
Keynesian multiplier. The model describes the situation that the interaction of, the multiplier
and the accelerator results in cyclical fluctuation endogenously.

Assume that national income is a combination of consumption investment and

government expenditure . It is also assumed that current consumption is a function of last
years income Investment is function of difference in consumption
suppose is s fixed proportion of is assumed to be
exogenous. Thus, the model becomes

,Where is marginal propensity to consume and is accelerator coefficient. Now we can

express in terms of income as

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If we substitute (50) and in equation (49), we get

This means

This equation is a second order linear difference equation. As a result, we can solve it using
the method discussed in equation (11).

Solution
The general solution will include the particular integral and the complementary function

The particular integral is

Complementary function

As far as the complementary function is concerned, we are faced with three possible
phenomena

Case .1 If ,
Equation (51) with characteristic equation
will have two roots,

As we know whether the equilibrium is dynamically stable or not depends on and which
in turn are based on the value of a and b, we can express the dynamic stability in terms of

Case. 2 If =4ab, we will have only one root,

Case. 3. If then we should use the method explained in equation (25)

Then the complementary function becomes

Then the general solution in case 3 becomes,

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Dear colleague! Now try to determine the general solution of the equation in case 1 and case
2.
In all of the three cases, the equilibrium will be dynamically stable iff a b < 1, that is, the
product of the accelerator and marginal propensity to consume muse be less than one.

Dear colleague! By now you have completed the second section of this limit. Thus, try to do
the following question to evaluate how you understand this section.

Self Test 6.2

Solve the following questions based on the information above.

1. What is difference equation? __________________________________________

_________________________________________________________________
2. What is the difference between discrete and continuous variable _____________
__________________________________________________________________

3. Solve the difference equation _____________ ______

________________________________________________________________
4. Given the second order linear difference equation
Find the general solution _________________________
_______________________________________________________________
5. assuming the usual Cobweb assumption, derive the difference equation which will
calculate price in the time periods following the unexpected decrease in equilibrium quantity
to 75 given

____________________________________________________________________
______________________________________________________________
__
6. A Keynesian macroeconomic model with a single time period lag on the consumption
function described below is initially in equilibrium with the level of

If it is increased to 650, find the value of y in the fourth time period after this
disturbance. _______________________________________________________
_________________________________________________________________
7. If the accelerator is 0.5 and the marginal propensity to consume is 0.6, what will happen to
the time path? Answer this question using equation (51)
___________________________________________________________________________
_________________________________________________________
Dear colleagues! Have you answered these questions? If your answer is no, re read
this section and try to do them. If your answer is yes, good. Go to the following
check list.

Check List

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Write '' inside the box in front of the question that is easy for you.
1. Describe differential equations.-------------------------------------------------------------
2. Explain dynamic analysis--------------------------------------------------------------------
3. Analyze the difference between comparative static and dynamic analysis------------
4. Can you explain about the cobweb model--------------------------------------------------
5. Mention the difference between general solution and definite solution----------------
6. Explain the Samuel sons multiplier accelerator interaction model----------------------
7. What is particular integral--------------------------------------------------------------------
8. Describe about difference equation---------------------------------------------------------
9. Explain the Domar growth model-----------------------------------------------------------
10. Mention the difference between homogenous and non homogenous equation
differential equations-------------------------------------------------------------------------
Dear colleague! Is there any box in which you didn’t tick? If your answer is yes, reread this
unit and try to answer these questions. If your answer is no, good.

Unit Summary

The type of economic analysis that looks at the way in which variables adjust between
equilibrium values is referred to as dynamic economic analysis. The ways by which
markets adjust over time vary tremendously. In certain markets prices are changed by
a minute in response to change in supply and demand. In this case, the adjustment to
the new equilibrium is immediate. In other markets, the adjustment process may be
slow trial and error process over several years.

Dynamic analysis considers the time element in the analysis. Time can be taken as
discrete or continuous. In the case of continuous time dynamic analysis, the
adjustment process is considered as a continual adjustment. Therefore, the
mathematical technique of differential is appropriate in this analysis.

In discrete time dynamic analysis, time is considered as discrete variable and the dynamic
adjustment process between equilibriums is observed as a step-by-step process. Thus, the
change in the dependent variable has to be explained by differences rather than differentials
and total derivatives. Accordingly, we can calculate the different values of the variables
which are adjusting to new equilibrium levels using
 The mathematical concept of difference equation and
 Spreadsheet
In almost all agricultural markets, if demand for a product increase, supply cannot
immediately increase to satisfy the prevailing demand. Crops must be planted and grown and
livestock takes time to raise. Some manufactured products may also take certain time when
customers order that products suddenly. The Cobweb model considers this lagged in supply
side of the market by supposing that the present quantity supplied is based on the ruling price
in the previous time period. That is,

But the consumers demand for the same product depends on the prevailing price that is

This is a logical situation of several agricultural markets. The quantity supplied this year is
based on the price of that product in last year.

According to the Keynesian macroeconomic model when there is a disturbance from the
national equilibrium income, there will not be an immediate adjustment to the new
equilibrium as the consumer expenditure may not adjust immediately to the new level of
income.

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Samuelson's classics interaction model examines the dynamic process of income
determination if the acceleration principle works with the Keynesian multiplier. The model
describes the situation that the interaction of, the multiplier and the accelerator results in
cyclical fluctuation endogenously.

Important Points

Dynamic analysis
Continuous time
Discrete time
Adjustment
Differential equation
Difference equations
Cobweb model
Keynesian macro economic model
General solution
Definite solution
Particular integral
Complementary function
Imaginary number
Characteristic roots
Accelerator
Time Lagged

Answers for Self Test Questions

Self Test 6.1

5) it is dynamically stable.
6) ,As P(t) cannot converge to as .

Self test 6.2

3)
4)
5)
6)
7) .Thus, the time path is convergent or dynamically stable.

References
Chiang, A.C,(9184), Fundamental Methods of Mathematical Economies, 3rd ,McGraw-
Hill, Inc.
D.T Edward,(1980), Introduction to Mathematical Economics,2nd ed. McGraw- Hill, Inc.
Henderson, J.M. and R.E, Quandet (1980) Microeconomic Theory: A Mathematical
Approach, 3rd ed. McGraw- Hill, Inc

181
Kapoor, V.K,(2002),Introductory Mathematics for Business and Economics, Sultan
Chand and Sons.
N.D, DWIVED, (1987), Microeconomic Theory,3rd ed. Vikas Publishing Pv. Ltd.
Nicholson, W.(1995)Microeconomic Theory, Basic Principles and Extensions,6th ed.
The Dryden Press.
Varian, H.T (1996), Intermediate Microeconomics: A modern Approach 4th ed. W.W.
Norton.
Yamane, T.(1978), Mathematics for Economists: An Elementary Survey,2nd ed

Assignment Questions
1. A form produces two types of products X and Y passing through to two machines M and
M . Each unit of X requires 2 hours of time in M and 8 hours of time in M where as each
unit of Y requires 12 hours of time in M and 4 hrs of time in M .The total time available in
M is 40 hours and M is 28 hours. Determine the amount of X and Y produced using gauss -
Jordan elimination method.
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2. Find the price elasticity of demand if the demand function is

182
Q = 40 - 5P + 3P

3. Find the point elasticity of demand if the demand function is given as

Q = where k is constant.
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4. Prove that 1+ x as x is close to zero

5. Find the Taylor's seines of the function f( x) = 4x 2 + 6x+ 3 around x0 = 2

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6. Given the Cobb - Douglas production function Q= A K L Where Q represents total

product, K is capital and L is labor. Find the marginal product of each input and determine
whether the law of diminishing marginal productivity holds for each input as far as 0&
<1.
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7. Given the production function Q = 32K 0.5 L 0.25 R 0.4, derive the nine second - order partial
derivatives and show that the two cross partial derivatives with respect to each possible pair
of independent variables will be equal to each other.
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8. Suppose the total cost faction of the monopolist is given by TC = 2Q 2 + 10 Q + 15 and the
demand function is given by P = 10 - 3Q. Find
i) The level of output which maximize profit
ii) Determine the elasticity of demand at the point of equilibrium.
9. Discuss the difference between comparative static analysis and dynamic analysis briefly.

10. Go to section 5.1.2 observe the effect of change in all the parameters on equilibrium
quantity and interpret the result.

11. Explain the limitation of comparative static analysis.

12. Considering the following national- income model with tax ignored

(Where k is positive constant; )

Analyze the comparative static effect of the model when money supplies changes and
government expenditure changes.

13. Suppose that the monopolistic firm has the following average revenue functions in three
separated markets

and the cost function is

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 Determine the price that should be charged in each market to maximize profit. Check the
second order sufficient conditions using the Hessian determinant.

14. Given the demand and supply functions be

with

Find the price path assuming market clearance at every point of

time.
Is the time path convergent or not?

184