Chapter 4.

Differential Equation

1
4.1 DEFINITION AND TYPE OF DIFFERENTIAL EQUATION

 Introduction
 In the previous chapters much of the economic analysis
used has been comparative statics.
 This entails the comparison of different (static) equilibrium
situations, with no regard on how variables adjust to their
new equilibrium values.
 The study of the mechanism by which variables adjust
between equilibrium values is called ‘dynamics’. Or
 The branch of economics that looks at how variables adjust
between equilibrium value is known as dynamics.
 Many of the topics studied by economists can be
characterized as decisions taken in one period that have
consequences in some other periods.
2
CONT’D
 In the continuous time, context, the pattern of change of
a variable y is embodied in the derivatives y’(t), y’’(t),etc.
 The time change involved in these is infinitesimal in magnitude.
 When the time is instead taken to be a discrete variable,
so that the concept of the derivative is no longer
appropriate.
 Example:
 Current savings finance future consumption
 Investment this year increases the potential for production next
year.
 Asset purchased today reward investors with payoff tomorrow.

 Each of this activities can only be properly addressed in

the context of a dynamic analysis that includes an
explicitly role for events occurring at different moments in
time. 3
CONT’D
 Dynamic equations may be viewed in two
ways.
 Based on the dynamic behaviour of
variables, time may be considered as a
continuous or discrete quantity.
 In language of mathematics, the former is
called differential equation and the latter is
difference equation.
 Notation:
 For differential equation we use y(t) & dy/dt
or y’(t).
 For difference equation we use yt & ∆y/ ∆t 4
 DEFINITION OF DIFFERENTIAL EQUATION

 Differential equation is a continuous time analysis of

the path of a variable.
 A differential equation is an equation which expresses
an explicit or implicit relationship between a function
y=f(t) and one or more of its derivatives or differential.
 Example of differential equation

 Solving a differential equation entails finding the

function y in terms of t.
 This is to find the value of y for any given value of t.

5
 TYPES OF DIFFERENTIAL EQUATION
 Differential equation can be:
 Linear Differential Equation (LDE) or
 Non Linear Differential Equation (NLDE).
 Differential Equation can also be classified as:
 Homogeneous differential Equation. or
 Non-homogeneous differential Equation.
 In this part we will study LDE
 which linearly relates the values of variables at a given point in time and the
changes in these values over time.
 LDE are classified according to the highest degree of derivative
involved.
 The order of a differential equation is determined by the order of the
highest derivative in the equation.
 The highest power to which the highest order derivative is raised is
called the degree of the differential equation.
 First-Order LDE: F(t, y(t), y'(t))=0 for all t.
 Second-Order LDE: F(t, y(t),y'(t), y’’(t ))=0 for all t.
 Nth-Order LDE: F(t, y(t), y'(t), ..., yn(t)) = 0 for all t.
 Examples 1: First-order LDE : y'(t) + ay(t) = b
Second-order LDE: y’’(t) + a y’(t) + by(t) = c 6
Nth-order LDE: yn(t) +….+ a y’(t) + by(t) = c
CONT’D
 Example 2. The order and degree of DE

Second order, first degree

 Homogeneous vs non-homogeneous
 Homogeneous DE has a zero constant

 Non-homogeneous DE has non zero constant

7
 4.2 SOLUTION TO A DIFFERENTIAL EQUATION
 Here we are interested in finding a solution that
express the value of a dependent variable at some
moment in time as function of independent variables,
of time itself , and of given values of the dependent
variable at one or more moments in time.
 A Study of differential equations focuses on the
nature of the solution, including issues of stability and
the value of the steady state.

8
 CONT’D
 An equation F(x,y) which assumes a functional
relationship between dependent and independent
variable x and y which includes x, y and the derivatives
of y with respect x is called an ordinary differential
equation.
 It is an implicit relationship between functions and
their derivatives.
 NB: the order of a differential equation determined by
the order of the highest derivatives in the equation.

9
METHODS OF SOLVING DIFFERENTIAL EQUATIONS

 There are several methods of solving differential

equations.
 These are
i. Direct integration: - for a differential equation of the
dy
form dx  f x solution can be found using our knowledge of
integral calculus i.e.
dy
 f x
dx
dy  f  x dx
taking the integral of both sides
 dy   f  x dx

y  F x   c
10
CONT’D
ii. Separable Differential Equations
 A separable differential equation is any differential
equation that we can write in the following form.
dy
N  y  M x 
dx
 Note that in order for a differential equation to be
separable all the y's in the differential equation must
be multiplied by the derivative and all the x's in the
differential equation must be on the other side of the
equal sign.
 The solution for the above type of equation is found
first by rewriting it as: N( y)dy = M( x)dx
 Then integrating both sides we get
 N ( y )dy   M ( x)dx
11
4.3 . FIRST ORDER LINEAR DIFFERENTIAL EQUATIONS

 First order means that only first order derivatives

are included.
 Linear means that a differential equation does not
contain a product such as y(dy/dt).
 Thus, the first order linear differential equation
(FOLDE) may contain:
 A constant (although this may be zero)
 The unknown function y
 The first order derivative dy/dt

12
CONT’D

 F.O. Linear Differential Equation is an equation of

the form:
dy ( t )
 ay ( t )  b ( t )        (1 )
dt
Where y(t) is the dependent variable
b(t) is an independent variable

dy(t)/dt is time derivative we also written as y t

13
CONT’D
 A differential equation that includes time as a
separate arguments is known as non-autonomous, as
with non-homogeneous part.

y (t )  a y (t )  b (t )  c t     e q u ( 2 )

 The above equation (equation 1) is non homogenous

and consists of the homogeneous part ay(t) and the
non-homogeneous part b(t).
 Solutions to such problems will be found in two steps

 Case1: When b=0; Solution to Homogeneous Equation

14
CONT’D
 From equation (1) we have homogeneous part
dy ( t )
 ay ( t )  b
dt
dy ( t )
 ay ( t ) when b  0 - - - (3)
dt
 The time path of y(t) away from the steady state is
given by:

y ( t )  Ce at
   is general solution

dy ( t ) d ( Ce at )
  aCe at  ay ( t )
dt dt 15
CONT’D
 At t=0, the endogenous variable equals the given
value y(0).
 Since the constant C equals the initial value of the
variable y(0).
 Therefore, the definite solution to equation (3) is

y(0)  Ce a.0
C
 Suppose that y(0) does not equal the steady state
value of zero.
i) if a<0,

y (t )  y ( 0 ) e      ( 4 )
at
16
CONT’D
lim y (t )  y (0) lim e at  0; and the solution is stable.
t  t 

ii) if a>0 and y(0) is positive

lim y (t )  y (0) lim e at  ; the solution is unstable if a  0
t  t 

iii) If a>0 and y(0) is negative,

lim y(t )  y(0)lim eat  ; the solution is unstable if a  0

t  t 

17
CONT’D
 Case 2: When b is constant term
dy ( t )
 ay ( t )  b
dt

i) The steady state value (SSV)

 One component of the solution to eq(2) is the
steady state value.
 The steady state value of y(t) is also called the
equilibrium value, the long run value, or the
stationary value is its value after all dynamic
adjustment has taken place.
18
CONT’D
 ay ( t )  b
y (t )  0  
a a
b
y (t ) 
a
b b
SSV  y   lim y ( t )   lim ( ) 
t  t a a

 The solution to the homogeneous part is given as:

y ( t )  ke at
 Where the parameter k is a constant to be
determined.
19
CONT’D

 General Solution
 It is a sum of SSV+ Homogeneous part

b b
y ( t )  ke at   ke at  y ( t )  , see consistence of the result as:
a a
d b
( ke  )  ake at
at

dt a
b
 a ( y (t )  )
a
 ay ( t )  b
 Give the value of y(0), it is possible to find definite
solution using the value in the solution
b b
y ( 0 )  ke a 0
  k  20
a a
b
k  y (0 ) 
a
CONT’D
 Therefore, the definite solution
b at b
y (t )  ( y ( 0 )  ) e 
a a
 1
 Example 1: u ( t )  u (t )  2; u (0 )  1
2

 Example 2: x (t )  4 x (t )  2; x ( 0 )  1

21
 FIRST ORDER DE: STEADY STATE
 A first-order DE:
y'(t) = F(t, y(t)) for all t.

 Notation  dy
y t  y ' (t ) 
dt
 The steady state represents an equilibrium value where
the system does not change anymore.
 When y(t) does not change anymore, i.e., y'(t) = 0, we
call its value the steady state value denoted by y∞.
 Example: y'(t) + ay(t) = b, with a≠0.
When y'(t) = 0, y∞=b/a (steady state solution)
 Thus, solution for DE follows two steps:
 Complementary solution ..…. yc = Ae-at,
 Particular solution …….......... y∞=b/a 22
FIRST-ORDER LINEAR DIFFERENTIAL EQUATIONS
Example-1: y'(t) + 0.5y(t) = 2.
 General solution
 complementary function (yc=Ae-0.5t) plus
 particular solution(y∞=b/a=4)
y(t) = Ae-0.5t + 4. (Solution is stable b/c a= 0.5>0).
 Steady state: y∞ = b/a = 2/0.5 = 4
 If y(0) = 20 => A = 20-4=16, => Specific solution or
definite solution is : y(t) = 16 e-0.5t + 4.
Example-2: y'(t) - 2 y(t) = -4.
 General solution:
y(t) = Ae2t +2 (Solution is unstable b/c a= -2<0)
 Steady state: y∞ = b/a = -4/-2 = 2
 If y(0) = 9 => A =9-2= 7,
=> Definite solution: y(t) = 7e2t + 2. 23
4.4 EXACT DIFFERENTIAL EQUATION
 Given a function of two variables F(y, t), its total
differential is:
F F
dF ( y, t )  dy  dt
y t
 When the left hand side of the equation is set equal to
0, the equation becomes:
F F
dy  dt  0
y t

 This is called exact differential equation.

 Generally, an equation of the form Mdy  Ndt  0 is said to
be exact if and only if there exists a function F(y, t),
such that,
t, F F
M and N  24
y t
CONT’D
 Using Young’s theorem, this may also be written as:
M N

t y
 Why? By Young’s theorem we have
2F 2F   F    F  M N
       
yt ty t  y  y  t  t y

 Solution to exact differential equation

dF ( y , t )  o  F  y , t   c
 But the main task is to find the primitive function
F(y, t).
 To find the primitive function, we should resort to
integration. 25
CONT’D
F
 Since M , F(y, t) must contain the partial integral
y
of M with respect to y. This leads us to:
F  y, t    Mdy   t 

 Where  t  represents those additive terms containing

only t and lost during partial differentiation with
respect to y.
 The first term on the right side may be easy to find.

 But the difficulty is to find  t  .

 We use the second partial differential dt to find  t  .

dN

26
 4.5 SECOND ORDER LINEAR DIFFERENTIAL EQUATIONS

 A second-order linear differential equation is a differential

equation of the form:
 G(t, y(t), y'(t), y"(t)) = 0 for all t involving only t, y(t), and the
first and second derivatives of y(t).
 We can write such an equation in the form:
 y"(t) = F (t, y(t), y'(t)).

 y"(t) + ay'(t) + by(t) = c is the standardized S.O.L.D.E.

 Based on the solutions for first-order differential equations, we
guess that the homogeneous equation(c = 0) has a
complementary solution of the form y(t) = Aert. 27
 SECOND-ORDER LINEAR DIFFERENTIAL EQUATION:
FINDING A SOLUTION
 Check: the complementary function y(t) = Aert , from this
y'(t) = rAert ,
y"(t) = r2Aert.
=> y"(t) + ay'(t) + by(t) = r2Aert + a(rAert )+ b(Aert )= 0
=> Aert(r2 + ar + b) = 0.For y(t) to be a solution of the
equation we need r2 + ar + b = 0.
 This equation is called characteristic /quadratic equation
of the S.O.D.E.
r1 , r2 = (-a ± [a2 -4b]1/2)/2
 Here we have 3 cases:
 If a - 4b >0 => two distinct real roots
2

 If a -4b =0 => one repeated real root

2
28
 If a - 4b <0 => two distinct complex roots.
2
 CONT’D
 If a2 - 4b > 0 , then the two distinct real roots are r1 = a and
r2=b.
=> y1(t) = Aer1t and y2(t) = Ber2t, for any values of A and B,
are complementary solutions.
=> This gives us a solution of a form: y(t) = Aer1t + Ber2t is
a complementary solution.
 It can be shown that every solution of the equation takes this
form.
 If a2 - 4b =0 , then the single repeated real root is r1 =r2 = r
=> (A + Bt)ert is a complementary solution (r = (-a/2) is
the root).
 If a - 4b < 0,then the two complex roots are r1= α+ β &
2
r2 = α- β
Where α= −a/2, β=√(b−a2/4)
=> y1(t) = e(α+β)t and y2(t) = e(α- β)t => y(t) = e(α + β )t + e(α- β)t
29
 CONT’D
 Example:y"(t) + y'(t) − 2y(t) = 14. a2 - 4b >0 b/c 1-
4*(-2)= 9>0. Characteristic equation: r2 + r − 2 = 0 => r1
=a=1 and r2=b=−2.
Complementary function : y(t) = Aet + Be−2t.
 Example:y"(t) + 6y'(t) + 9y(t) = 20. a2-4b =0 b/c 62 - 4*9=0
Characteristic equation : r2 + 6r + 9 = 0 => r=(-
6)/2=−3.
Complementary function: y(t) = (A + Bt)e−3t.
 Example:y"(t) + 2y'(t) + 17y(t) = 17. a2- 4b<0 b/c 22 -4*(17)=
-64<0 Characteristic equation: r2 + 2r + 17 = 0 =>roots are
complex with α = −a/2 = -1 and β = √(b − a2/4) = 4.
Complementary function : y1(t) = e(α+β)t = e(-1+4)t = e3t and
y2(t) = e(α-β)t = e(-1-4)t =e-5t . Adding the two solution : y(t) = e3t
+ e−5t
 The particular solution for all cases equals to y(t)=c/b where b ≠ 0 30
4.6. ECONOMIC APPLICATIONS OF DIFFERENTIAL EQUATIONS
 Example 1. F. O. LDE: Price Dynamics(cob web
model)
 Let p be price of a good
 Total demand: D(p)= a-bp
 Total supply: S(p) = -c +dp,
 a, b, c and d are constants
 Price dynamics: p’(t) = [D(p)-S(p)], with  > 0
 replacing supply and demand:
p’(t) +  (b + d)p(t)=  (a + c) ….. gives us a first order
linear differential equation.
 General solution

p(t) = Ae- (b +d)t + (a+c)/(b+d)

p = (a+c)/(b+d) is equilibrium price 31

 Given (b +d) > 0, this equilibrium is stable.

CONT’D...


32
 2.ADJUSTMENT IN A KEYNESIAN MACROECONOMIC MODEL
 In a basic Keynesian macroeconomic model, with no
foreign trade and no government sector, total expenditure
(E) will be the sum of consumer expenditure (C) and
exogenous investment (I ).
 This model can therefore be specified as:

E(t) = C(t) + I where C(t) = a + bY(t)

 At equilibrium E(t) = Y(t) and so Y(t) = C(t) + I
 However, this macroeconomic system may not always be
at equilibrium.
 Let us assume that the speed with which Y adjusts is
directly proportional to the difference between total
expenditure E and current income Y at ratio .
33
 CONT’D...
 This relationship can be written as:
dY/dt = (E(t) − Y(t)) = (C(t) + I – Y(t))
= (a + bY(t) + I – Y(t))
= (b -1)Y(t) + (a + I)
 It is first order differential equation

 The standard method of solution for first-order linear

differential equations can therefore be employed to
solve this equation.

34
CONT’D...


35
 NUMERICAL EXAMPLES
1. In a basic Keynesian macroeconomic model
C = 360 + 0.8Y
I = 120
When the system is out of equilibrium the rate of adjustment of
Y is:
dY/dt= 0.25(E(t) – Y(t)) = 0.25(C(t) + I –Y(t))
If national income is initially 2,000 birr, derive a general and
specific solutions and comment on the stability of this system.
2. In a macroeconomic model
C(t) = 200 + 0.75Y(t)
E(t) = C (t)+ I and I = 80
dY/dt= 0.8(E(t) − Y(t))= 0.8(C(t) + I –Y(t))
If Y0 = 1,200 birr, derive a general and specific solutions and
comment on the stability of this model. 36
 CONT’D
 Solution for Equation 1
dY/dt = 0.25(360 + 0.8Y(t) + 120 − Y(t))
= 0.25(480 − 0.2Y(t))
= 120 − 0.05Y(t)
 Complementary solution

Y(t) = Ae−0.05t
 Particular solution

 Assuming Y equals a constant value K in equilibrium to

determine the particular solution:
dY/dt= 120 − 0.05K = 0
Yp = 2,400
 General solution Y(t) = Ae−0.05t + 2,400

 Definite solution Y(t) = −400e

−0.05t + 2,400
37
 The market is stable b/c a>0.
38