22
DIFFERENCE EQUATIONS
CONTENTS
Iterative Method 296
General Method 296
Dynamic Stability of Equilibrium 298
Cobweb Model 299
Lagged Income Determination Model 303
Harrod Model 304
Phase Diagrams 306
A difference equation is an equation that shows the relationship between
successive values of a sequence and the differences among them. It defines the
pattern of change of y between consecutive periods. Similar to differential
equations, difference equations can be either linear or nonlinear, and of the first
or second (or higher) orders.
Suppose we are given
𝑦𝑡+1 − 𝑦𝑡 = 3
It is a first-order linear difference equation: first-order because it contains only
a first difference involving a one-period time lag only; linear because neither y
nor its lags is raised to any power other than 1.
While differential equations is applied in the continuous-time context where the
pattern of change of a variable y is described by its derivative, difference
equations is applied in the discrete-time context where the variable t takes only
integer values. In difference equations, the pattern of change of the variable y
changes only when the variable t changes from one integer value to the next, such
as from 𝑡 = 1 to 𝑡 = 2. The pattern of change is represented by the difference
Δ𝑦 𝑑𝑦
quotient 𝑜𝑟 (Δ𝑦𝑡 ), which is the discrete-time equivalent of the derivative .
Δ𝑡 𝑑𝑡
The first difference is thus:
Δ𝑦𝑡 = 𝑦𝑡+1 − 𝑦𝑡
Where 𝑦𝑡 represents the value of y in the tth period, and 𝑦𝑡+1 its value in the
period immediately after.
An example of differential equations:
Δ𝑦𝑡 = 3
Which can be written as
𝑦𝑡+1 − 𝑦𝑡 = 3
Or 𝑦𝑡+1 = 𝑦𝑡 + 3
296 Olaniyi Evans | University Mathematics
I TE R A T IV E M E T HO D
Analogous to solving a differential equation, the objective is to find a time path.
Iteration of the pattern of change specified in the difference equation will permit
us to infer a time path.
EXAMPLE 22.1
Find the solution of the difference equation 𝑦𝑡+1 − 𝑦𝑡 = 5, assuming an initial
value of 𝑦0 = 2.
S O L U T I O N tips
Rearrange
𝑦𝑡+1 = 𝑦𝑡 + 5
By iteration:
𝑦1 = 𝑦0 + 5
𝑦2 = 𝑦1 + 5 = (𝑦0 + 5) + 5
= 𝑦0 + 2(5)
𝑦3 = 𝑦2 + 5 = [𝑦0 + 2(5)] + 5
= 𝑦0 + 3(5)
Generalize for any period t
𝑦𝑡 = 𝑦0 + 𝑡(5) = 2 + 5𝑡
EXAMPLE 22.2
Solve the difference equation 𝑦𝑡+1 = 0.7𝑦t , assuming an initial value of 𝑦0 = 3.
S O L U T I O N tips
By iteration
𝑦1 = 0.7𝑦0
𝑦2 = 0.7𝑦1 = 0.7(0.7𝑦0 ) = (0.7)2 𝑦0
𝑦3 = 0.7𝑦2 = 0.7(0.7)2 𝑦0 = (0.7)3 𝑦0
Generalize for any period t
𝑦𝑡 = (0.7)𝑡 𝑦0 = 3(0.7)𝑡
G E N E R A L M E T HO D
Given the first-order difference equation
𝑦𝑡+1 + 𝑎𝑦𝑡 = 𝑐
Where a and c are constants.
The general solution consists of two components: a particular integral and a
complementary function. The particular integral represents the intertemporal
equilibrium level of y, and the complementary function, the deviations of the
time path from that equilibrium.
Chapter 22 | Difference Equations 297
Case 𝑎 ≠ −1 Case 𝑎 = −1
General 𝒄
𝒚𝒕 = 𝑨(−𝒂)𝒕 + 𝒚𝒕 = 𝑨 + 𝒄𝒕
Solution 𝟏+𝒂
Definite 𝒄 𝒄
𝒚𝒕 = (𝒚𝟎 − ) (−𝒂)𝒕 + 𝒚𝒕 = 𝒚𝟎 + 𝒄𝒕
Solution 𝟏+𝒂 𝟏+𝒂
Purchase the full book at:
https://unimath.5profz.com/
We donate 0.5% of the book sales
every year to charity, forever. When
you buy University Mathematics (I &
II) you are helping orphans and the
less privileged.
“Math practice makes math perfection.”
Olaniyi Evans
