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Topology of Second Order Linear Difference Equations with Constant Coefficients
Author(s): William J. Baumol

Source: Econometrica, Vol. 26, No. 2 (Apr., 1958), pp. 258-285
Published by: The Econometric Society
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TOPOLOGY OF SECOND ORDER LINEAR DIFFERENCE
EQUATIONS WITH CONSTANT COEFFICIENTS1
By WILLIAM J. BAUMOL
This article describes the geometric tools which can be employed

for the qualitative analysis of second order difference equations.
By showing how linear equations can be investigated by geometric
methods it suggests how some nonlinear equations can also
be handled with the aid of these tools. This is illustrated by a
geometric restatement of the Hicksian (nonlinear second order
difference equation) trade cycle model.
1. INTRODUCTION
FOR MANY PROBLEMS of economic dynamics linearity assumptions have proved

unsatisfactory. This is because linearity sometimes seriously misrepresents
the facts under analysis and because, in misrepresenting these facts it leads
to conclusions characterized by undesirable properties.2 But unfortunately
most of our analytic apparatus fails us once nonlinearities make their appear-
ance. Usually we have only two alternatives: algebraic methods of approxima-
tion to obtain quantitative conclusions, and geometric methods for
qualitative analysis.
This paper deals with linear equations as a means for investigating the
relevant geometry. It expounds results for difference equations which are
already well known for differential equations.3
I My very sincere gratitude for their help is due to Mrs. L. Atiyah, Mr. R. G. Davis,
Professor Robert Dorfman, Dr. Lawrence Markus, and other members of Professor
Lefschetz' 0. N. R. Project on nonlinear differential equations, and Professor Richard
Quandt. I accept no responsibility for the term "topology" in the title and employ
it in response to intimidation by the mathematicians.
2 For example, a cycle produced by a linear model is virtually certain to explode
or fade away. Roots must be of modulus precisely unity if these alternatives are to be
avoided, and a root of modulus 0.99997 or 1.00001 will not do the trick though for prac-
tical purposes we may be content to observe that for a considerable time the system
will act very much as if the cycle were stable. But our statistics are never fine enough
to permit us to distinguish between a unit root and one which takes values so close to
it. I have seen systems which yield unit roots but these roots have always been built
into the model often unobserved by the author. In such a case it is usually possible
to show that a slight amendment in one of the simplifying assumptions will eliminate
the unit roots and so have profound qualitative effects on the system. As Solow has
pointed out, since our premises are always necessarily more or less false, good theorizing
consists to a large extent in avoiding assumptions like these, where a small change
in what is posited will seriously affect the conclusions.
3 See, e.g., Andronow, A. A. and Chaikin, C. E., Theory of Oscillations, Princeton
University Press, Princeton, 1949, Chapter I; or Minorsky, N., Introduction to Non-
Linear Mechanics, J. W. Edwards, Ann Arbor, 1947.
258
SECOND ORDER DIFFERENCE EQUATIONS 259
The phase plane4 for a second order difference equation may be defined
as a two dimensional graph which shows the relationship between the values
of the relevant variable in two consecutive periods. From this we can trace
thiough the time path of the variable from one period to the next, and as
will be seen presently the graphics work out very much as they do in the
familiar cobweb or the reaction curve diagrams.
Existence of the Second Order Phase Plane Relationship
The relationship which we have undertaken to plot on the phase diagram iS5
(1) Yt + 1 = t(Yt)
In the first order case this is given by the difference equation itself and
clearly the general linear first order equation with constant coefficients6
(2) Yt+ 1 =aY, + b

is just such a relation. In the case of the second order equation the matter
is less obvious and it may not be intuitively clear that any such expression
can be deduced from the general equation
(3) Y+ 1 =aY, + bYt11 + c.

This is because there is no obvious way of eliminating the bY,_1 term. How-
ever this elimination can ordinarily be performied because (3) has a solution
(4) Y -uX + vXt + Z,

where u and v are constants whose values are determined by the initial con-
ditions, X1 and X2 are the roots of the characteristic equation and Z is a
particular solution. From (4) we also obtain
(4a) YX + 1 - uXl+ 1 + vX + 1 + Z,
which together with (4) gives us two equations in Y, + 1, Yt, and t. If between
4 Strictly speaking, the relevant concept for an Nth order equation is an N dimensional
phase space. The phase space for a first order equation is then one dimensional, i.e.,
just one straight line axis with numbers indicating where to go next period. For example
-4 -2 0 2 4 6 8 10 12
the difference equation Yt + l-2 Yt can be represented by 2 1 0 1 2 3 4 5 6
Here if YO = 1 we read from above the axis that Y1 2, and move to where there is
a 2 below the axis. Again reading above the axis there we see that Y2 will be 4, etc.
However, for most purposes it is more illuminating to diagram first order equations
on a two dimensional plane with the numbers previously shown above the line moved to
the vertical axis.
5 As we shall see, it is sometimes convenient to express Yt + 1 as a function of both
Yt and t, i.e., as Yt + 1 = /(Yt, t).
6 Note that the graph of (2) is always a straight line.
260 WILLIAM J. BAUMOL
them t can be eliminated (although as we shall see it is not always desirable

that this be done), we obtain, at least implicitly, the phase relationship (1)
between Y, + 1 and Y1. This is essentially the procedure which we shall follow.
The Number of Degrees of Freedom
There is one more point to be noted. The graph of the general first order
equation will be uniquely determined by (2). We have no degrees of freedom
in drawing the curve. On the other hand the second order equation, (3),
will, given any Y1, yield different values for Y, + 1 which depend on the mag-
nitude of Y1 -. This means that we have one degree of freedom in drawing
our phase plane graph. Rather than a single curve Y + 1 f(Y,) there will
be a family of such lines. Given any historical value of Y which can be taken
as an initial condition Y., (3) yields a unique relationship between the values
of the variable for the next two periods. In other words, in the second
order case one initial condition will determine which of a family of curves
representing the equation will be followed by the movement of the vari-
able Y,.
2. THE COMPLEX ROOTS CASE
Where the roots of the characteristic equation are complex, the solution
(4) can be written7
(5) Yt rt [p cos Qt + q sin Qt].

This expression can in turn be rewritten
(6) Yt -rtK cos (Qt + w)

where K and w are constants.
The Phase Plane Relationship (Comlplex Roots)
Expression (6) almost directly produces the relationshlip between Y, + 1 and

Y, required for the phase plane representation. For we have
Yt+1 = Krt+' [cos (Qt + Q + w)]
- Kr+t'[cos Q cos (Qt + w) - sin Q sin (Qt + w)],
and since for any angle A, sin A i ? VI - cos2 A
Yt+1 -Krt+ [cos Q cos (Qt + w) ? (sin Q) Vi - COS2 (Qt + w)]

= r cos Q [Krt cos (Qt + w)] ? r (sin Q) V/(Kr1)2 [Krtcos (Qt + w)]2.
I Until a later section I will take the difference equation (3) to be homogeneous,
i.e., I assume c = 0.
By (6) the items in the square brackets are equal to Yt so that the ex-
pression reduces to
(7) Yt+ r (cos Q) Y, ? r (sin Q) V/(Krt)2-_ yt2

which is the desired relationship (1) between Y,+1 and Yt.
The Phase Plane Diagram (Complex Roots)
The shape of the geometric representation of (7) may not be immediately

obvious. Although a more direct approach is possible, it is convenient to
divide this problem into two parts by examining in turn the two terms on
the righthand side of (7). First we note that, letting Y* 1 denote the first term,
Y* 1 r (cos Q) Yt
is a straight line through the origin of the phase plane diagram with slope
r cos Q. The shape of Yt+l will be given by the vertical sum of this line with
that representing the second term: that is, by Yt+l Y 1- + Yt* where
(8) Y*1zr ? i r sin Q V/ (Krt)2 _ yt2

The shape of (8) then remains to be analyzed. Squaring both sides and
rearranging terms gives
(Y**)2 + (r sin Q. Yt) 2 (r sin Q Krt)2.
If we set Yt = r sin Q . Y1 this becomes
(9) (Y**)2 + (Yt)2 = (r sin Q Krt)2 - (Art) 2.

Where r -1 this will be recognized as the standard formula for the circle,
with its center at the origin, X2 + Y 2 B2.
Yt+, yt;, Y;+,
FIGURE1
Suppose on the other hand r > 1. The formula (9) then says that the
distance +(Y )2 + (y1) 2 of the point (Yt,Y**) from the center (the
radius of the "circle") keeps growing larger and larger as t increases.8 This
means that the figure will spiral outward. Similarly with r < 1 it will spiral
inward. We then have the relationship shown9 in Figure 1.
As already noted, for different values of A there will be different curves so
that in each case an entire family rather than a single curve will be involved.
This is shown in the case of the circles but to avoid complication in the draw-
ing of the spiral diagrams every member but two of the family of curves is
omitted.
Transformation to the Yt+l, Y, Diagram

This then is the relationship between Y ** and Y,. But these are both
only artificial variables invented to make the drawing easier. What we really
want is the Yt+ 1, Y, graph. First, to get back to a graph which has Yt instead
of Yt on its horizontal axis we note that the transformation Yt - r sin Q .Y
used to obtain (9) merely shrinks or stretches the horizontal axis depending
on whether r sin Q is less than or greater than unity. For example, if it is less
than 1, every value of Y, is simply decreased proportionally to yield a Y,
smaller than itself. Thus to get from the graph which has a Y, axis to one
employing a Yt axis we must merely unshrink or unstretch the diagram
horizontally. This will turn the circle into an ellipse and deform the spirals
analagously as shown in Figure 2.
Yt; Yt.y Yt
r,l ~~~r=i r<
FIGURE 2
Figure 2 (rsin Q<1)
Points A, B and C are referred to, respectively, as an unstable focus, a center,

and a stable focus.
Finally, to get to a Y + 1 (MY*+1 + Y7*+l) axis from the Y"4 l vertical
axis employed in Figure 2 we must add the straight line Y*1 -r cos Q Y,
to the Y*+* values shown in Figure 2. In Figure 3 this line is superimposed
8 Indeed, in polar coordinates (9) is given by e = Art.

9 Movements along the spiral are always clockwise because above a 450 line through
the origin Y; > Yt so that movement is to the right, and below the 45? line movement
is to the left. (See section on phase line and time path below.)
-~~~~~t IIy
FIGURE 3
on the ellipse of Figure 2 (dotted lines). Their vertical sum is the new tilted
ellipse shown in the solid line. This is obtained by picking points like A on
the Yt axis and noting that here Y* 1 -AB and Y*+ AC (= BD)
so that Y, + 1 AD D A B + AC . That then is the representation of the second
order linear difference equation with complex roots on the phase plane. It
consists of tilted ellipses,10 and tilted elliptical spirals.
The Time Path (Complex Roots)
We can now see at once what will be the time path of Y. I will onlv draw
it (Figure 4) for the elliptical case where the roots are of unit modulus (r 1).
The extension to other values of r is obvious and will only be considered
explicitly in the illustrative application to the Hicks trade cycle model in
the last section of this paper.
In the phase plane diagram, suppose the given initial value of Y, is Y.
as shown in Figure 4. Then the next value of Y, that is, Y1, will be represented
by a point directly above or below Y., that point representing Y1 f(YO).
This second point is determined by the two initial conditions in our second
order difference equation system, since the two initial conditions give the
values of YO and Y1 which are the coordinates of this point. It is in this
way that we discover which of the family of ellipses in the phase diagram
will determine the time path. Suppose then that point A in Figure 4 is this
point with coordinates (YO, Y1) and that it lies on the ellipse shown in the
diagram. Now superimpose a 450 line, RR' on this graph. By moving horizon-
tally from point A, whose vertical coordinate is Y1, to point J on the 450
line, and then directly down to the horizontal axis we can locate Y1 on that
axis. Y2 is now shown as I(Yl) by point B on the ellipse directly above Y1,
and above the 450 line. Continuing in this way we see that the time path
of Y is given by A B C D E ... in Figure 4.
10 This could have been shown directly in terms of the discriminant of the quad-
ratic (7).
FIGURE 4
We can see as follows why from point A the time path moves to B rather
than to D and why from B it moves to C rather than c, etc.
To do this I shall prove the following theorem: from any point on the time
path which lies above the 450 line the next point on the time path will lie
on the upper arc"l of the ellipse. From any point which lies below the 450
line the next move will be to a point on the lower arc of the ellipse.
The time path is given by equation (6) from which our phase diagram is
also derived. By symmetry we need only deal with initial points which lie
above the 450 line and are therefore points of increasing Y (i.e., Yt+?1 > ?t
everywhere above the 450 line). Only the following two cases are possible
and I shall show that the theorem holds in each case.
Case (i). The second point also lies above the 45? line. The coordinates of
the two points are (Y1, Y:+?l) and (Yt+1, Y1?2) where Yt?2 > Yt+?1> Y:
Thus the second point lies above and to the right of the first. The slope of
NT whAich is the only segment of the lower arc of the phase line which lies above
the 45? line is everywhere negative (as can be shown via the expression for
11 By "upper arc" of the ellipse I mean the upper arc connecting the two vertical
points on the ellipse.
dYt +1!dY in footnote 12). N is (by the assumed negative slope of Y* 1 (Figure
3)) the lowest point on the upper arc of the ellipse, so that every point on
NT must lie below every point on the upper arc of the ellipse. Hence every
move from a point above the 450 line to another point above the 450 line,
since it involves a move which is uphill and to the right, must end at a point
on the upper arc of the ellipse.
Case (ii). The second point lies below the 45? line and hence must involve
declining Y. (The move from B to C or c.) Let t' be that (not necessarily
integral) t for which Y= K cos (Qt + w) attains its maximum, K. Our two
points can be labelled (Y,*-1, Y,*) and (Y*,, Y1*+1) with Y,*,+ < Yt* >
Y,*-, so that by (6) t* must be the largest integer < t', i.e., the last date
before Y begins to decline. We then have t* < t' < t* + 1. Since in Y, =
K cos (Qt + w) K cos (-Qt - w) we may by appropriate choice of ze take
Q to lie between zero and 7i. By out choice of t' Y, is monotonically decreas-
ing for Qt + w in the interval between Qt' + w and Qt' + w + a. And if t
t* + 1 or t t' + 1, where t* + 1 < t' + 1, Qt + w lies in this interval
since0 < Q < a. Thus Yt*+1 > Y, + where these are the respective ordinates
of points C (or c) and M. Hence the former cannot be the ordinate of c which is
on the lower arc of the ellipse and therefore is lower than M. Q.E.D. I conjec-
ture that similar arguments can be developed for other multiple valued phase
functions (see, e.g., Figures 11, 14, and 15 below).
Phase Line and Time Path
There are several basic relationships between the shape and location of
the phase line and the nature of the time path of Y which are required for
the analysis:
1. When a phase line is above the 450 line, Yt+1 is by definition greater
than Y,, so that Y must always be increasing, i.e., motion must be upward
and to the right. The reverse holds below the 450 line.
2. If the phase line always has a slope greater than unity, the time path
will be explosive upward or explosive downward and go ever further from
the 450 line and certainly never cross it. On the other hand, if the phase
line's slope is positive but less than unity the motion will approach the 450
line asymptotically but never cross it (damped movement toward equi-
librium).
3. V/here the phase line has a negative slope, Y, will oscillate in the
familiar cobweb pattern, as the reader may easily verify by drawing such
a diagram.
4. If motion is to be periodic, it must involve rises in Y (the phase line
above the 450 line) interspersed with falls in Y (phase line below the 450
line). Thus in periodic motion the time path must cross the 45? line. But we
have just seen that this can never occur where the phase line has a positive
slope. Thus where motion is periodic the phase line must ordinarily have a
negative slope where it crosses the 450 line.
5. Where the phase line is defined only for a limited range of Y, e.g.,
for the range Y1Y2 in Figure 5 there is often a simple interpretation of the
consequences of an initial Y outside that range. To see this we turn back
to the general expression (7) for the phase line in the complex roots case
where we take r 1.
FIGURE 5
First suppose 1ft2 < K2. Then the expression under the radical in the last
term will be positive, its square root will be real, and there will be two values
of Yt+1 corresponding respectively to the square root term + VK2 -:
and to - K2 yt2. This will be a point inside the range Y1Y2 in Figure
5; e.g., at point Y3 there will be two values of Yt+1, R and S. Second, if
Yt? K the last term in (7) will be zero and there will be only one corre-
sponding value of Y<+ This occurs at points Y1 (= K) and Y2 (= K) in
the figure. Finally, outside this range where Yt2 < K2 the last term in (7)
will be imaginary. That is why there is no representation of a phase line in
the diagram which has only axes showing real magnitudes. We see, then,
that a Yt ik Y4 will produce a complex Y+1 For some phase lines such
a point might even be reached from an initial position inside the real range
Y1Y2. For example with initial point Y. the time path is traced out by broken
line A B C . . . where C is to the right of Y2 so that we know that in the next
period Y will be complex. This could have been avoided if the phase line
extended further to the right underneath the 450 line as does the dotted
figure, for then we would have had the real time path construction line
A B C D E .... Correspondingly, to the left of the axis to prevent complex
values the phase line must extend far enough to the left above the 450 line.
Since in economics our variables ordinarily take on only real values we want
assurance that the ellipse of periodic motion will have a shape which prevents
the appearance of complex values in this way.
The Complex Roots Phase Line and Periodicity
We want to show that the phase relationship (7) produces real periodic
motion. To do this we must show that the slope of its graph will be negative
where it crosses the 450 line (point 4 of the preceding section) and that its
shape will not lead to the occurrence of complex values. Both are easily
demonstrated. Transposing the first term on the right-hand side of (7) and
squaring both sides gives
(Y,+,) 2 2 r cos Q * YtYt+ + (r cos Q. Y) 2 (r sin Q Krt) 2 -(r sin Q Yt) 2.

Subtracting the last term from both sides we have
(Y+1)2 2 r cos Q -Y, Y+,+ +r2 Y' (cos2 Q +sin2 Q) =(r sin Q * Krt) 2
or, since cos2 Q + sin2 Q 1,
(10) (Yt,)2- 2 r cos Q * Y, Y,+, + r2Yt2 ~ (r sin Q * Kr)2.

When r - 1, relationship (10) is said to be symmetrical in Y, and Y,+1,
for its form is such that interchange of Y, and Y,+, does not affect the ex-
pression. This means the diagram is the same no matter which of these vari-
ables we put on the vertical axis and which we put on the horizontal axis.
But that can only occur if the graph is symmetrical about the point where
it crosses the 450 line, i.e., the graph between the 450 line and the vertical
axis must mirror that between the 450 line and the horizontal axis. If this
is so the phase line will be perpendicular to the 450 line,12 i.e., it will have a
negative slope, more specifically, a slope of -1. The symmetry of the phase
12 A more formal proof is obtained by settingr = 1 in (10) and differentiating totally

to obtain
2[Yt + 1- cos Q * Yt] dYt + 1 + 2[Yt cos Q * Yt + 1] dYt = 0
or
dYt+ 1 Yt -cOsQ- Y+1
dYt Yt+i-cosQ Yt
and on the 45? line where Yt = Ye + 1, this is equal to -1.
curve about the 450 line also suffices to preclude a time path which leads
into complex values of the variable. This can be seen by referring back to
Figure 5. The symmetry property means that corresponding to any point
like B in the positive quadrant which lies above the 450 line and, incidentally,
lies on a negatively sloping segment of the phase line, there must be another
point D on the phase line which is similarly placed on the other side of the
450 line. It follows that any movement from a point like B to the 450 line
at C must be followed by move CD. In other words there exists no point
B on the phase curve from which the next move will be to a point on the
450 line to the right of the phase curve. No point can then be the stepping
stone to a complex value of our variable, Y.
3. REAL ROOTS
The Equation of the Phase Lines
Having examined the phase plane representation of the second order equa-
tion whose roots are complex we turn to the real roots case, continuing on
the assumption that the equation is homogeneous and positing, in addition,
that the two roots are distinct. The solution is given by expression (4) above
with Z = 0. Together with (4a) this yields by a simple calculation
Yt+- 1 t -vXt2+l- vX1 XA2= v(X2 - X1) X2
and similarly Yt+-X2 Yt t(X1 - X2) XAt.

Clearly the ratio of Y+1 X-1 Yt to Yt+1 - X2 Y, is a non-constant function
of t. But is there any function of the left-hand sides of the two preceding
equations which does not depend on t? Such a function would, of course,
be the phase graph relationship which we are seeking. To answer the ques-
tion, square both sides of the first equation and raise both sides of the second
to the 2a power, where a is a constant whose value is still to be decided on.
Dividing one of the resulting equations by the other we find
(Yt?+1 X, Yt) 2 AT22t k(A2\t

(11) (Y -X ~AT2Y~)2a kx2at = AT2a!
where k - [(-1) (X1 - X2)(1a) _l2 >0.

,,a
This is independent of t if and only if the parenthesis on the right-hand side
equals unity, i.e., if x2 -X12a

Thus any number, a, which satisfies this equation will do. Clearly such a
number is given by
(12) a z log (X2)/log (X2).
For this value of a the right-hand side of (11) is equal to k. This is the basic
equation of the phase lines in the real roots case.
The Phase Diagram: JlXi > 1 and IX21 > 1

First consider the case where both roots are greater than unity in absolute
value so that their logs are both positive. It involves no loss of generality
to take log (X2) > log (X1) so that, by (12), a > 1. Setting
(13) Y+1-X1,Y1 =R and Yt+ 1-X2Y =S

equation (11) becomes
(14) R KSa
where K -v
The graph of this function with axes R and S is the family of curves of
parabolic type shown in Figure 6. If, for example, a is an even integer, then
for different values of K, AOB and COD will be typical curves given by
A B
FIGURE 6
(14), while if a is an odd integer, COB and AOD will be among the graphic
representations of the equation. Note that the curves all go through the
origin, aretangenttotheS axis (dRIdS - ? aKSa- I- 0 forS =0), and asymp-
totically approach lines parallel to the R axis, i.e., their slope approaches
infinity.
We must now transform this diagram with axes S and R into the phase
diagram with axes Y1 and Y, + l This transformation is given by equations
(13). These equations state that in the phase diagram the previous S axis
(R -- 0) is given by the straight line through the origin with slope X1
(15) R -Yt+l-X1 Yt -0 [S axis]

and similarly the R axis becomes
(16) S - Y+ I---X2Yt -0? [R axis]

Thus the transformation simply involves a rotation of the S and R axes
with a corresponding distortion of the parabolic curves. For example, if both
roots Xl and X2 are negative, lines (15) and (16) will both have negative
slopes. The position of the old S and R axes in the phase plane is shown in
Figure 7. It will be noted that since LX21 is greater than JlXj the line given
V=O 1l-O y
\1>0\
u~o
<o\
Yt
LL>0
v'C0
V\c\ FORMER
FORMER S AXIS
R AXIS
FIGURE 7
by (16), i.e., the old R axis, will have the greater slope in absolute value. Also,
since the absolute value of both roots is greater than unity both lines will
be steeper than a 450 line.
The distorted parabolas which result from this rotation of axes are shown
in Figure 8. It will be noted that they are still tangent to the former S axis
Yt+ I
FORMERt
FORMER\ \SAXIS
R AXIS
FIGURE 8
at the origin and still curl up about the former R axis, forming U shapes
lying on their sides with the transformed R axis between the two branches
of the U. It will be remembered that we are dealing with negative roots. If
the roots X1 and X. are positive the slope of the transformed R and S axes
is positive and the parabolas would have the shape shown in Figure 9. The
origin in both these diagrams is called a node. To see what these apparently
odd shapes mean for the time path of Y a preliminary matter must first be
settled.
The "Initial" Conditions and the Arbitrary Constants
Any two successive values of Y can be used to determine the values of

the arbitrary coilstants u and v in the solution (4) of the difference equation.
17 Yt
FORMER/ /
S AXIS
FORMER
/ / R AXIS
FIGURE 9
Now any point on the phase plane represents just such two consecutive values
of Y since the abscissa represents a value of Y during the period t and the
ordinate of the point represents its value in period t + 1. Still assuming
Z 0 O, this can be used to determine the X and v in (4) and (4a) by solving
simultaneously
Yt- uX,' + VX2
and
Yt I 1 = Xl+1 + vX2+l
for u and v in terms of Y, and Y, + We obtain
(17) Xt(Xy -X1) V Yt + lX-Xl Y
Suppose X2 > X1 and t even. Then the denominators will be positive and
u will be positive, zero or negative as- (Y1 + 1-X2 Yt) <, i.e., as Y, +
X2 Y1. Then a time path which lies below the transformed R axis will involve
a positive u in the solution (4). If the time path is on transformed R, u will
be zero, and if it is above R, u will be negative (Figure 7). Similarly v will
be positive, zero, or negative as the time path lies above, on, or below the
transformed S axis. It will be noted that "in between" the transformed R and
S axes u and v are of like sign while in the rest of the diagram u is positive and
v negative or vice versa. This italicised result is easily seen to be unaffected
by removal of the assumptions X2 > X1 and t even. Since any time path
is associated with unique values of u and v this theorem has an important
corollary: any time path going through a point between the transformed R
and S axes will never go through a point outside these lines, and any time
path outside these lines will never go through a point which lies between them.
The Time Path in the Phase Plane (Real Explosive Roots)
We can now divide our examination of the time path into two parts. First
we consider just the phase lines "between" R and S. Here u and v are of
like sign and behavior is very similar to that which follows from a first order
difference equation. This is shown in Figure 10 by construction lines A B C . . .
Here only one member of the family of phase lines is shown (heavy line).
The positive roots case is explosive upward or downward while the negative
PHASE PHASE
LINE LINE
Yt. Iy
\ tfD
.~~~~~~~~A~'
fORME S AXI fORMEPR

R AXIS R AXIS
FIGURE 10
roots case involves explosive cobweb type cycles. This qualitatively unchang-
ing behavior is to be expected because, as we have seen, we are dealing with
the region where u and v, the constants in solution (4), are of the same sign
so that both terms in the solution behave similarly and so their effects on
the time path reinforce one another.
Next we can explore the portion of the phase lines outside the R and S
lines. We show only a negative roots case. Consider as an illustration the
time path given by the solution
Yt = --4(-l.l)t + (-2)t
whereu 4, v - 1.
This yields the following table of values:
t 0 1 2 3 4
Yt -3.0 2.4 0.8 -2.7 10.1

Yt + l 2.4 0.8 -2.7 10.1 -25.6
Yt+1
\X//~~~
-8
-6
-4YO 4 6 8 Y
-2-
-6~
PHASE
LINE
FIGURE 11
0S
FIGURE 12
What has happened can be described as follows. Because u and v are of

opposite sign the two terms in the solution (4) involve oscillations which are
out of phase. The two terms then influence the time path in opposite direc-
tions. During periods 0 to 2, because of the relatively high absolute value
of u, the first term dominates the expression and so the time path of (4)
approximates the oscillatory movement of that term. By periods 3 and 4
the second term, because of its larger root, overtakes the first. In the pro-
cess of transition the out of phase oscillatory influences of the two terms
cancel out. There is therefore no oscillation of Y between periods two and
three. But thereafter the time path of Y will be characterized by the cycle
of the second term. The data in the table are plotted in the phase diagram
of Figure 11.
The Phase Plane With Convergent Time Path
As is well known, where both roots of the characteristic equation are less
than unity in absolute value the motion will be stable and converge toward
equilibrium. Since Xl and X2 are both less than unity, both their logarithms
will be negative and hence the exponent in (12) will again be positive. The
Y;+j
y /t
S AXIS
/FORMER
R AXIS
FIGURE 13
same analysis applies as in the case where, both roots are greater than unity
in absolute value. Only the slope of the transformed R and S lines in the
phase plane will now be less than unity in absolute value with the S now
steeper than the R. 13
One Root Explosive, One Root Convergen-t
Where the roots are real but one is greater and one less than unity in
absolute value the solution (12) still applies. It must be reinterpreted, however,
because the exponent is now negative. If, for example, we take X12 < I and
X22 > I then log X1 < 0 and log X2 > 0. The substitution (13) yields
inistead of (14), for appropriate choice of X1 and X2,
13 This is because in (14) we require a > 1, where, by (12), a == log (X2 2) /log (Xl 2).
With Xi12 < 1land X2 2 < I both logs are negative and a > 1 implies I log (X2 2) | >
I log (XI12) | which for such small X' s involves X2 < XI, where these are the respective
slopes of the R and S lines by (13).
R -?KS a, a> 1
i.e., RSa ? K.
This will be recognized at once as a family of quasi-rectangular hyperbolas
as shown in Figure 12 where the curves in the northwest and southeast quad-
rants correspond to negative values of K. Again the transformation from
the R S plane into the Y, + 1, Y, plane involves a rotation of the R and the
S axes in accord with (13), with the R axis transformed into the line through
the origin with slope X2, etc. The result in the positive roots case is shown
in Figure 13. Here the point of intersection of the R S lines is called a "saddle
point" and it is easy to see that the phase lines can be interpreted as contour
lines of a three dimensional saddle point. One of the transformed axes (here
taken to be the S axis) will have a slope less than unity and the other a slope
greater than unity.
The interpretation of the phase lines in terms of the time path is again
conveniently divisible into two parts, that between the transformed axes'4
and that outside these axes. Dealing with the latter first, we take two typical
phase lines outside the R and S lines and get the time paths depicted in
Yt +
YO YO Yt
FIGURE 14
14 We denote the area "between" the transformed axes as that which contains the
450 line.
FORMER/
R AXIS/
// B
FigureY14.OThe phase line above the 450 line involves a time pAh wI
d w e s Is O Yo YE
FIGURE 1 5
Figure 14. The phase line above the 45? line involves a time path which is
uninterruptedly explosive upward, while the lower phase line dictates a
downward explosion.- It is easy to show from (17) by the methods previously
employed that these phase lines involve arbitrary constants u and v of op-
posite sign in the solution (4). The time paths are of a variety which can be
expected intuitively because if, e.g., |lXi < 1 and lX21 > 1, then Xlt will
be decreasing and X2' will be increasing in absolute value. If, however, these
terms are given coefficients of opposite sign in solution (4) they will then be
working in the same direction, in the one case upward, in the other downward
and there is therefore no way in which the direction or nature of the move-
ment can be reversed at any point.
Let us now consider the phase lines between the transformed axes and the
corresponding time paths. These are shown in Figure 15. It is to be noted
that the time paths A B C D . . . reverse themselves. They converge at first
but then move outward again. Here the arbitrary constants of the solution
are of like sign and the convergent movement represents the time during
which the root of smaller absolute value dominates the time path. As we
know the larger root will eventually swamp the rest of the solution and
that is when the explosive movement occurs. We see then, as was expected,
that in the saddle point case all movement ultimately becomes explosive. 15
4. NON-HOMOGENEOUS EQUATIONS AND THE EQUILIBRIUM POINT
If the difference equation (3) has an equilibrium (stationary) solution, that

solution obviously will have the property Y, + 1 -Y Y,-1 = k (a constant)
Substituting this in (3) yields
(18) k ak + bk + c,
i.e., k =c/(l a b). Thus, provided -a -b #0, the equation will be con-
sistent with a stationary state. It is a standard theorem that this equilibrium
value k of Y is the same as the constant term, Z (the particular solution),
in (4). Where equation (3) is homogeneous so that c 0, the equilibrium
value k is zero, so that the equilibrium point in the phase plane will involve
Y +1 Yt 0, i.e., the origin will be the only equilibrium point.'6 This has
been true of all the equations examined so far since we have dealt only with
homogeneous cases. Where the equation is non-homogeneous,the equilibrium
point is moved up from the origin to the point Y, + 1 Y k which lies
on the 450 line. I shall show now that the entire phase diagram is at the same
time shifted k units upward and to the right.'7 Thus the previous analysis
applies unchanged to the non-homogeneous case except that the point which
is a center, a focus, a node, or a saddle point will lie at (k,k) rather than
at the origin and the rest of the graph will be moved correspondingly.
To prove this, apply the transformation
(19) Yt Y'Y* + k,
so that Y + Y* + k, etc., to equation (3). This yields
Y.e+,+k a(Y* +k)-b(YY1+k) c,

i.e., Y* aY* - bY* 1 + k ak bk c,
or, by (18)
(20) Y* aY* + bY*
(20) then is essentially the same as equation (3) with the non-homogeneous
term equal to zero, that is, it is the homogeneous equation whose phase plane
15 There is a trivial exception. The transformed S axis in Figure 15 is itself a phase

line and movement along it clearly converges on the origin. Examination of (15) and
(17) indicates that this is the case where there is a zero coefficient before the root of
largest absolute value in the solution (4). For by (15) the slope of the transformed S
axis (R = 0) is Xl, and therefore from the drawing in Figure 15 X1 is the smaller root
in absolute value. But the numerator of the expression for v in (17) is R (= 0).
16 At any other point on the 45? line two consecutive values of Y will be the same
but the next Y thereafter will be different.
17 If k is negative this will, of course, mean moving downward and to the left.
representation has been described throughout this paper. To find the phase
plane representation of the non-homogeneous equation we must then consider
the effect of the transformation from Y* to Y. This transformation (19)
clearly involves the move k units to the right and k units upward which has
already been discussed.
This representation can easily be extended to the more general case where
the non-homogeneous part of the difference equation is a function of time
c(t) rather than a constant c. The particular solution, Z, in (4) is now a func-
tion of time, k(t). Instead of a stationary equilibrium solution, the system
now will usually permit only the moving equilibrium solution Y(t) =k(t),
which by substitution in (3) yields, instead of (18),
k(t + 1) = ak(t) + bk(t- 1) + c(t).
The rest of the argument of this section now follows. The center, node, or
focus shifts from period to period, and not generally along the 450 line. At
any date t that point will be given by Y, + 1= k(t + 1), Yt = k(t). The entire
phase diagram shifts along with this point.
The time path followed by our variable can be traced out by employing
for each date the appropriate phase diagram position, as shown in Figure 16.
Y 0* ,
FIGURE 16
Here I depict the shift of only two of the ellipses in a family from period
0 (solid curves) to period 1 (dotted curves). The focus moves from P0 to
P1 and the phase curves shift correspondingly. Suppose our initial point
is A. Then the time path of Y will move to point B in the next period. Note
that while A was a point on the inner curve in the previous period B does
not lie on the transposed inner curve. Rather it lies on that transposed ellipse
which also goes through the preceding point A (whose coordinates are the
initial conditions generating B). In the case shown in the diagram this hap-
pens to be the outer curve. That is because it is the only curve which meets
all three of the following conditions: (i) it satisfies the difference equation,
(ii) its center lies at Y, + 1 k(t + 1), Yt k(t), and (iii) its equation is satis-
fied by the initial conditions given by the coordinates of A.
It is obvious how the value of Y in succeeding periods in the variable
non-homogeneous term case can be found in the same way. The diagrams
are messy but the principle nevertheless remains simple.
5. ILLUSTRATIVE APPLICATION TO A NONLINEAR MODEL:
HICKS' TRADE CYCLE
As Goodwin first pointed out, the Hicks' trade cycle model18 is a second
order nonlinear system. But it is of a simple variety since it consists of
several connected linear segments, as I shall show in the simplified illustrative
version of the model which follows.
In the Hicks model national income is, as usual, divided into consumption
and investment (goods used by consumers and goods used in the production
process). Also, as usual, Hicks takes the consumption, Ct, to be a fixed pro-
portion of income in the previous period, Y,-1, plus a constant:
(21) Ct= aY -1 + b, a, bconstants.

However, the investment relationship will vary over the trade cycle. If
we assume that there is an optimal economico-technological ratio, k, between
capital stock, K1, and national income (production), then when there is a
down-turn in business activity there will be an excessive stock of capital.
Equipment and inventories will not be replaced as they are used up and
so net investment will be negative. This can be espressed by
(22) It = -w for K,_1 > kYt-

where w is a positive constant.
On the other hand when the capital stock is not in excess, as income rises
investment will have to take place to keep the stock of capital at the desired
proportion of income. This gives us the ordinary acceleration principle
relationship
18 J. R. Hicks, The Trade Cycle, Oxford University Press, New York, 1946.
(23) - k(Yt_ - for K,-1 < kYt1

Since, as already mentioned, income is divided into consumption and in-
vestment we have the usual identity
(24) Yt It + Ct.
Finally Hicks provides us with the restriction that real income must never
exceed the full employment level
(25) Y Y Ye
with equality holding whenever there is a computed value of Y greater than
or equal to Ye
When there is excess capital, we have, substituting (21) and (22) into (24),
(26) Yt+ 1 ZaY, + b- w for Kt-1 > kYt-1.

This is a first order linear difference equation which is represented by the
straight phase line RR' in Figure 17. Since its slope, a, the marginal propensity
to consume, is presumably less than unity this line cuts the 450 line from above.
On the other hand when capital stock is not excessive, income is no longer
given by (26). Instead, by (21), (23), and (24), we have
(27) Y+ (a + k)Yt - kYt1 + b,

which is a second order linear equation with constant coefficients. Hicks
assumes that it involves complex roots of modulus greater than unity, i.e.,
explosive cyclical movement.19 Equation (27) will then be represented by
oYeo e
FIGURE 1 7
"I Ibid., pp. 91-94.
a family of spirals which move outward in a clockwise direction. These

spirals are shown in Figure 17 only for the relevant range in which real
income does not exceed its full employment level, Y,
We can now examine graphically the time path of real income. Let us
begin with the upswing of the cycle when presumably capital stock is re-
quired to grow, so that (23) and hence (27) apply. We begin at some point
A above the 450 line and move to B along an arc of the spiral representing
(27). Finally at point C full employment income is attained. Now income
can move no higher and stays in this position at most for two periods.20 This
is because investment will no longer be undertaken when income ceases to
rise (equation (23)) so that the investment component in income (equation
(24)) will suddenly drop to zero. By (21) and (24) income in the next period
will be
(28) Yt+1 --aYe+ b

(point D) which (unless a or b is very large2l) will be less than the full employ-
ment income Ye. Now, with the fall in income redundant capital will appear
(Kt > kYt) and in accord with (26) income will begin to move downward
along RR'. Thus income will move down along the path EFG. .. toward
"equilibrium point" p.22 During this time, however, the capital stock K, is
reduced by an amount w per period. Thus income will keep falling until
the capital which had been attained at full employment is cut down to size.
This will occur s periods after the period e when full employment income
had been attained, where s is the smallest integer for which
Ke ws _ ky? + s.
20 When income first reaches its full employment level, Ye the one period lag in
investment postulated by (23) means that capital stock will not yet have reached
the level kYe which is appropriate for full employment output. Therefore investment
in the next period will still be positive and (23) will still hold. Since income will just
have risen by quantity JY8_1 = VC, investment demand in the next period will be
given by kJ Ye-1. If this quantity together with consumption demand, aY8 + b add up
to a quantity no smaller than full employment income, i.e., if Ye < aYe + b + kzYfe,1J
income will remain at its full employment level one more period. On the other hand
if induced investment demand, kJ Y, 1, is insufficient to support a full employment
output, income in the next period will fall to some intermediate level like that shown
by point D in Fig. 17. But now this income level will not be given by (28). Instead it
will be equal to aY, + b + kA Y e- 1. In practice, of course, our rigid assumptions must
be modified. Then a full employment income may well last more than two periods
because input shortages can delay the filling of investment orders so that it may take
a long time before capital stock reaches its desired full employment level, kYe, i.e.,
before (26) replaced (27) as the equation governing income.
21 An a and b sufficiently large to cause trouble would imply an upward time path
of national income even with zero investment!
22 P is Hicks' lower national income equilibrium represented by line LL' in his
Figure 12 (ibid., p. 97).
Since the level of income cannot drop below the "equilibrium" level yb this
means that this down-swing phase of the cycle will last at most until
Ke - ws ? kYb,
i.e., for approximately
Ke kYb
S =
w
periods. At the end of this time capital stocks will have been reduced to
their desired level. Investment will therefore rise suddenly from -w to 0.
Provided that this rise in investment is greater than HJ, the fall in income
which would otherwise have occurred in the next period (Figure 17), income
will take a sudden jump since the negative investment component will have
been eliminated. Income will rise perhaps (though not necessarily) to point
A once more, and because income is increasing once again the time path
will return to the spiral phase lines, to begin another cycle.
Before leaving this discussion several comments are appropriate.
1. There is some presumption that after the "second go round" every cycle
will, in the absence of exogenous disturbances, be a precise duplicate of the
cycle which preceded it, for income will always drop from the full employ-
ment level to the level of full employment consumption given by (28) (point
D) so that we can take every cycle to start out from this point. Of course,
if, as in the Hicks model and as has been the case historically, the full employ-
ment ceiling moves upward with the passage of time, this will no longer
be true.
2. The graph shows how, as Hicks observes, some upswings may never
reach the full employment ceiling. This will occur, for example, if the upswing
begins at poinit A'.
3. In practice disinvestment doubtless declines gradually as capital stock
approaches its desired level (so that w becomes a function w(t - e) of the
length of time elapsed since the last full employmenlt period and, by (26),
RR' will shift upward gradually).
4. The fall in disinvestment may never be large enough to produce an
upturn, because it may never exceed HJ, the fall in income which would
occur next period if disinvestment were to remain unchanged. In such a case
we must depend on the Hicksian autonomous investment to produce an up-
turn. Autonomous investment will add another term A (t) (where A'(t) > 0)
to the investment functions (22) and (23). With the passage of time this
investment will grow and shift RR' upward until some period T when the
point on RR' with coordinates (YT + 1YT) lies above the 450 line and the
upturn will then begin.
Princeton University
APPENDIX
Note 1. The significance of the 450 line
In the preceding discussion the 450 line has played a role analagous to that of the
horizontal axis in the phase plane representation of differential equations. This is en-
tirely a matter of convenience. Since we have been plotting Yt + 1 against Yt points
above the 450 represent motion in the positive direction (Yt + 1 - Yt > 0). But had we
instead drawn a Yt = Yt + 1 -- Yt on the vertical axis, thereby more closely following
the differential equation procedure, all points above the horizontal axis would have
represented increasing Y. In this way the 45? line would be divested of its special
significance. The representation I have chosen, in accord with usage in the economic
literature, is really more convenient in that it permits a simple construction to trace
out the time path from one period to the next. With a J Yt axis it would be necessary
to add this amount to Yt at each step in order to obtain the value of Y for the next
period. In effect, at each Yt it would be necessary to draw a different 450 line from the
horizontal axis in order to addi Yt to Yt as shown in Figure 18.
AYt
; ~~~~~~~~~~~~AY3
450 0 5
0 Y, y2 Y3 Yt
FIGURE 18
Note 2.
In differential equations it is possible to find the phase plane equation directly from
the original equation as follows: The equation y = ay + by can be written y = x, x
-ax + by, where x = dx/dt, y = dy/dt. Then dx/dy = x/y = (ax + by) Ix. This is a first
order homogeneous equation which can be integrated to yield the phase plane equation.
A similar procedure is not possible in the case of difference equations. We can rewrite
Yt + 2 = aYt + 1 + bYt as Yt + 1 = Xt, Xt + 1-aXt + bYt so that
A Xt (a-1) Xt + bYt
AYt Xt -Yt
But we cannot interpret this as an approximation to dXl/dYt throughout the phase plane
since, by definition, a Yt - 0 only near the 450 line.

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Topology of Second Order Linear Difference Equations with Constant Coefficients

Author(s): William J. Baumol

This article describes the geometric tools which can be employed

FOR MANY PROBLEMS of economic dynamics linearity assumptions have proved

Existence of the Second Order Phase Plane Relationship

(2) Yt+ 1 =aY, + b

(3) Y+ 1 =aY, + bYt11 + c.

(4) Y -uX + vXt + Z,

them t can be eliminated (although as we shall see it is not always desirable

The Number of Degrees of Freedom

(5) Yt rt [p cos Qt + q sin Qt].

(6) Yt -rtK cos (Qt + w)

The Phase Plane Relationship (Comlplex Roots)

Expression (6) almost directly produces the relationshlip between Y, + 1 and

and since for any angle A, sin A i ? VI - cos2 A

Yt+1 -Krt+ [cos Q cos (Qt + w) ? (sin Q) Vi - COS2 (Qt + w)]

(7) Yt+ r (cos Q) Y, ? r (sin Q) V/(Krt)2-_ yt2

The Phase Plane Diagram (Complex Roots)

The shape of the geometric representation of (7) may not be immediately

(8) Y*1zr ? i r sin Q V/ (Krt)2 _ yt2

(Y**)2 + (r sin Q. Yt) 2 (r sin Q Krt)2.

If we set Yt = r sin Q . Y1 this becomes

(9) (Y**)2 + (Yt)2 = (r sin Q Krt)2 - (Art) 2.

Yt+, yt;, Y;+,

Transformation to the Yt+l, Y, Diagram

r,l ~~~r=i r<

Figure 2 (rsin Q<1)

Points A, B and C are referred to, respectively, as an unstable focus, a center,

8 Indeed, in polar coordinates (9) is given by e = Art.

The Time Path (Complex Roots)

Phase Line and Time Path

The Complex Roots Phase Line and Periodicity

(Y,+,) 2 2 r cos Q * YtYt+ + (r cos Q. Y) 2 (r sin Q Krt) 2 -(r sin Q Yt) 2.

(10) (Yt,)2- 2 r cos Q * Y, Y,+, + r2Yt2 ~ (r sin Q * Kr)2.

12 A more formal proof is obtained by settingr = 1 in (10) and differentiating totally

and on the 45? line where Yt = Ye + 1, this is equal to -1.

The Equation of the Phase Lines

Yt+- 1 t -vXt2+l- vX1 XA2= v(X2 - X1) X2

and similarly Yt+-X2 Yt t(X1 - X2) XAt.

(Yt?+1 X, Yt) 2 AT22t k(A2\t

where k - [(-1) (X1 - X2)(1a) _l2 >0.

This is independent of t if and only if the parenthesis on the right-hand side

equals unity, i.e., if x2 -X12a

(12) a z log (X2)/log (X2).

The Phase Diagram: JlXi > 1 and IX21 > 1

(13) Y+1-X1,Y1 =R and Yt+ 1-X2Y =S

(R -- 0) is given by the straight line through the origin with slope X1

(15) R -Yt+l-X1 Yt -0 [S axis]

(16) S - Y+ I---X2Yt -0? [R axis]

The "Initial" Conditions and the Arbitrary Constants

Any two successive values of Y can be used to determine the values of

for u and v in terms of Y, and Y, + We obtain

(17) Xt(Xy -X1) V Yt + lX-Xl Y

The Time Path in the Phase Plane (Real Explosive Roots)

fORME S AXI fORMEPR

This yields the following table of values:

Yt -3.0 2.4 0.8 -2.7 10.1

What has happened can be described as follows. Because u and v are of

One Root Explosive, One Root Convergen-t

4. NON-HOMOGENEOUS EQUATIONS AND THE EQUILIBRIUM POINT

If the difference equation (3) has an equilibrium (stationary) solution, that

Y.e+,+k a(Y* +k)-b(YY1+k) c,