Differential Equations

Dynamic Optimization
Definition
A differential equation is an equation which contains one or
more terms and the derivatives of one variable (i.e., dependent
variable) with respect to the other variable (i.e., independent
variable)
• dy/dx = f(x)
Here “x” is an independent variable and “y” is a dependent
variable
Definition
For example, dy/dx = 5x
A differential equation contains derivatives which are either partial
derivatives or ordinary derivatives. The derivative represents a
rate of change,
The differential equation describes a relationship between the
quantity that is continuously varying with respect to the change in
another quantity.
Types of Differential Equations
• Ordinary Differential Equations
• Partial Differential Equations
• Linear Differential Equations
• Non-linear differential equations
• Homogeneous Differential Equations
• Non-homogenous Differential Equations
 Order of Differential Equations
First Order Differential Equation
You can see in the first example, it is a first-order differential
equation which has degree equal to 1. All the linear equations in the
form of derivatives are in the first order. It has only the first
derivative such as dy/dx, where x and y are the two variables and is
represented as:
dy/dx = f(x, y) = y’
Second-Order Differential Equation
The equation which includes second-order derivative is the
second-order differential equation. It is represented as;
d/dx(dy/dx) = d2y/dx2 = f”(x) = y”
Degree of Differential Equation
The degree of the differential equation is the power of the highest
order derivative, where the original equation is represented in the
form of a polynomial equation in derivatives such as y’,y”, y”’, and
so on.
Suppose (d2y/dx2)+ 2 (dy/dx)+y = 0 is a differential equation, so
the degree of this equation here is 1. See some more examples
here:
dy/dx + 1 = 0, degree is 1
(y”’)3 + 3y” + 6y’ – 12 = 0, degree is 3
 Applications
Some differential equation applications in real-time as follow.
1) Differential equations describe various exponential growths and
decays.
2) They are also used to describe the change in return on investment
over time.
3) They are used in the field of medical science for modelling cancer
growth or the spread of disease in the body.
4) Movement of electricity can also be described with the help of it.
5) They help economists in finding optimum investment strategies.
6) The motion of waves or a pendulum can also be described using
these equations.
Phase Diagram
Solow Growth Model
The following model generalizes the one in an earlier example.
Suppose that the production function is a strictly increasing and
strictly concave function F that is homogeneous of degree 1 (i.e.
has “constant returns to scale”), rather than taking the specific
form assumed in the earlier example.We now have
K'(t) = sF(K(t), L(t)).
As before, the labor force grows at the constant rate λ, so that
L'(t)/L(t) = λ.
We may study the behavior of the capital-labor ratio K(t)/L(t) as
follows. Let k = K/L and define the function f of a single variable by
f(k) = F(k, 1) for all k.
Solow Growth Model
Since F is increasing and concave we have f' > 0 and f" < 0, and since it
is homogeneous of degree 1 we have
F(K, L) = LF(K/L, 1) = Lf(k).
Thus
K'(t) = sL(t)f(k(t)).
Now,
k'(t) = [K'(t)L(t) − K(t)L'(t)]/(L(t))2
= [K'(t) − k(t)L'(t)]/L(t)
so
k'(t) = sf(k(t)) − λk(t).
Solow Growth Model
The phase diagram of this equation is shown in the
following figure
 Solow Growth Model
We see that the equation has two equilibria, k* = 0, which is
unstable, and the value of k* for which sf(k*) = λk*, which is
locally stable.
The stable equilibrium value of k depends on s: the equation
sf(k*) = λk*
implicitly defines k* as a function of s. Which value of s maximizes
the equilibrium value of per capita consumption? Per capita
consumption is equal to (1 − s)F(K, L)/L, or, given our previous
calculations, (1 − s)f(k). Thus in an equilibrium per capita
consumption is equal to (1 − s)f(k*(s)). A stationary point of this
function satisfies(1 − s)f'(k*(s))k*'(s) = f(k*(s)).
Solow Growth Model
(1 − s)f'(k*(s))k*'(s) = f(k*(s)).
Now, differentiating the equation defining k* we obtain
f(k*(s)) + sf'(k*(s))k*'(s) = λk*'(s) for all s.
Combining the last two equations we deduce that
if s maximizes per capita consumption then f'(k*(s)) = λ.
That is, the marginal product of capital is equal to the
rate of population growth.