Giancarlo Gandolfo Economic Dynamics Study Edition Fourth Edition a SpringerChapter 2 Difference Equations: General Principles 2.1 Definitions Given a function y = f(t), its first difference is defined as the difference between the value of the function when the argument assumes the value t+h, (h > 0), and the value of the function corresponding to the value ¢ of the argument. In symbols, Ay = f(t+h) — f(t). It should be noted that it is unimportant whether the values run forwards or backwards, namely we could as well define the first difference of the function as Ay = f(t) — f(t — h) Without loss of generality we can assume unit increments of the depen- dent variable, ic. Ay = f(t+ 1) — f(t), or Ay = f(t) — f(t— 1). From now on we shall conventionally use forward-running values of If we consider successive equally-spaced values of the independent variable (f+ 1,t+2,t+ 3, etc.), we can obtain successir Ayn =ft+1)-f(O) Ayr = f(t+2)—f(t+1) Ayia = f(t+3)— f(t+2) = yess — vere, and so on. We can then compute the second differences, i.e. the sequence of differences between two successive first differences: Dy, = Ayers — Aye = era — Yer) — Yeon — Ye) = Yerr — 2yeer + Yer Ayer = yess — Ayer = yes — 2ye-2 + Yer, Aya = Ayers — Auess = Yea — 2ye43 + Yer, and so on. Note that the superscript 2 means that the operation of computing the difference has been repeated twice, i.e. that the difference operator A has been applied twice. G, Gandolfo, Economie Dynamics, 9 © Springer-Verlag Berlin Heidelberg 201010 Chapter 2. Difference Equations: General Principles Proceeding similarly we can compute the differences between two succes- sive second differences and obtain the third differences of the function: AS yy, Ayer — Ay = (Auei2 — Ayers) — (Auer — Aue) = Aye ~ 2Aysr + Ay: (ees — esa) — 2Qu42 — Yer) + (Meer — Ye) is — Byere + 3yera — Ye AS8ygy = A?yese — A2yer = Ysa — 343 + 38Y42 — Merde and so on, Higher-order differences can be computed by the reader as an exercise, We can now define an ordinary difference equation as a functional equa- tion involving one or more of the differences Ay, A*y, ete., of an unknown function of time. Since the argument f varies in a discontinuous way, taking on equally-spaced values, it follows that our unknown function will be defined only corresponding to these values of f (ie. the graph of the funetion will be a succession of separate points, as we shall see in detail in Chap. 3) We have called this equation ordinary because the unknown function is a function of only one argument. When the partial differences of a function having more than one argument are involved, the equation becomes a partial difference equation, a type of difference equation that will not be treated in this book. The order of a difference equation is that of the highest difference appear: ing in the equation. If, for example, the highest difference contained is the third difference, the equation is of the third order: note that the equation is of the third order independently of the fact that the lower-order differences are or are not contained in the equation, Since the differences of any order can be expressed, as we have seen. above, in terms of values of the function at different points of time, a difference equation may also be defined as a functional equation involving two or more of the values y. yet. ete., of an unknown function of time. For example: the difference equation aAy + by, = 0 transforms, if we substitute Ay: isa — Yes into ayes + (b—a)ys = 0. In this form, the order of the equation is given by the highest difference between time subscripts: if the equation, for example, contains yrg. Yre1 and y,. it is of the third order. We shall consider the difference equation expressed in this second form as it is the form they commonly take in economic models. Let us note again that it makes no difference whether the equally spaced values of { are computed forwards or backwards, so long as the structure of the time lags remains unaltered. The equation ays1 + (b — @)ye = 0, for example, is identical with the equation ay, +(b-a)yh1 = 0. The reason is that to solve the difference equation means, as we know from the Introduction, to find a function (or functions) which satisfies (satisfy) the equation for any admissible value of t. This allows us to shift all the time subscript as we2.2. Linear difference equations with constant coelficients ll like, provided that they are all shifted by the same amount (neglecting this proviso would alter the structure of the equation) Consider now the equation Ay = a, i.e. Yui — ye = a. In words, the problem is: find a function such that its first difference equals the given constant a for any value of ¢. It can be checked that the linear function y =at + satisfies the equation, since {a(t +1) +5} —(at+b) = Yeu — Ue Note that in the solution function an arbitrary constant (b) appears. This is not surprising, since the constancy of first differences is not affected by a parallel shift of the straight line. More generally, in the operation of differ- encing, the presence of an arbitrary constant, that is eliminated in the course of the operation, does not alter the result. Therefore, an arbitrary constant always appears in the solution of a first-order difference equation, and no more than one can appear. Proceeding further, consider the equation A?y, = 0 (find a function such that its second difference equals zero for any value t). The solution is al- ways the linear function y = at + b, but now both a and b are arbitrary constants; in fact, any straight line has a zero second difference. In general, the computation of second difference eliminates in succession two (and only two) arbitrary constants. We shall see later on how the arbitrary constant(s) can be determined through additional conditions; what interests us here is to note that we can induce, from the reasoning above, the following important theorem: Theorem 2.1 The general solution of a difference equation of order n is a function of t involving exactly n arbitrary constants. 2.2 Linear difference equations with constant coefficients We can now summarize the scope of our treatment. In Part I we shall be concerned with linear, constant-coefficient difference equations. The general n-th order form of such equations is Cotten + Cn-iYten—1 bo + cress + Come = g(t), (2.1) where the c's are given constant and g(t) is a known function. Some c's may be zero, but of course both c, and cy must be different from zero if the T Actually, this function is also the only one that satisfies the equation. This is shown by the ‘existence and uniqueness’ theorem, which we shall not treat. All types of equations considered in this book are ‘well-behaved’, i.e. their solution exists and is unique.2.2. Linear difference equations with constant coefficients 13 is identically satisfied for all admissible values of ¢. Otherwise the functions are linearly independent. Theorem 2.3 If y;(t),yo(t) are two distinct (i.e., linearly independent) solutions of the homogeneous equation (n>1), then Aiy:(t) + Aaye (t) is also a solution for any two constants Ay, As. The proof is similar to that of Theorem 2.2 and is left as an exercise. Theorem 2.3—called the superposition theorem—can easily be extended to any number & < n of distinct solutions of Eq. (2.3), and gives us the procedure to obtain the general solution of Eq. (2.3). This procedure con- sists in finding n distinct solutions y(¢), yp(t),--- Y(t) and combining them linearly, as stated in Theorem 2.4: Theorem 2.4 The general solution of Eq. (2.3) is given by J (8) At Aa, +) An) = Artn(t) + Arya(t) +--+ Anya (i) (2.5) where 1(t), ¥o(4), +1 Y(t) are n linearly independent solutions of Ea. (2.3), and Ay, Ag. An are arbitrary constants. ‘The proof is straightforward: by Theorem 2.3, the function (2.5) is a so- lution of the difference equation (2.3). Since this function contains exactly n arbitrary constants, we can conchide—from Theorem 2.1—that it is the general solution of Eq. (2.3). The practical problem of how to find the n functions y:(t), y(t), -, Yn(t) will be tackled in the following chapters; for the moment we observe that, given a homogeneous equation of order n, a set, of n linearly independent solutions is called a fundamental set. The condition for a set of n solutions to form a fundamental set is contained in Theorem 2.5 Theorem 2.5 Let yi(t), Yo(t),-- Ya(t) be n solutions of Eq. (2.3). They are linearly independent (i.e. form a fundamental set) if, and only if, the following determinant (called the Casorati determinant) | n(2) w(t) o unlt) Di) = w(t +1) yo(t +1) - Yn(t +1) (2.6) n(t+n—-1) y(t+n—1) .. ga(ttn- | To prove this theorem, consider Eq. (2.4): since the functions we are considering are solutions to Eq. (2.3), they hold for any ¢ by definition of solution, and hence also for t + 1,...,¢-+n— 1. Hence we can write the following linear system12 Chapter 2. Difference Equations: General Principles equation is of order n. Eq. (2.1) is called the forward form; the equivalent backward form is Cale + CnaYea +--+ 1Ye-ntt + Coven = 9(t)- (2.2) In order to avoid cumbersome sentences, from now on we shall use the expression ‘difference equations’ (or even, where there is no danger of misun- derstanding, simply ‘equations’) in the sense of ‘ordinary difference equations, linear and with constant coefficients’. We must now distinguish between homogeneous and non-homogeneous equations. Eq. (2.1) is non-homogeneous; the corresponding n-th order homogeneous equation is CaYeen + Cn-iYern—1 + + erytst + Cou (2.3) ‘The reason for dealing with these two forms separately is that the solution of Eq. (2.1) can be obtained in a relatively simple manner when the solution of Eq, (2.3) is known. 2.2.1 The homogeneous equation ‘The following theorems are fundamental in the theory of homogeneous dif- ference equations: Theorem 2.2 If yi(t) is a solution of the homogeneous equation, then ‘Ay; (t), where A is an arbitrary constant, is also a solution. ‘The proof is simple. Assume that yi(t) satisfies Eq. (2.3). Substitute Ay;(t) in the same equation, obtaining cnAgn(t + 2) + CrrAyi(t + n—1l)+..+cAm(t+1) + oAn(t) therefore Aleayi(t +n) + coayi(t += 1) +b eun(t +1) + com(d)] = 0 If Ayi(t) has to be a solution the last relation must be satisfied. Since in(t) is a solution of Eq. (2.3), the expression in square brackets vanishes, and so the relationship Aleatn (t+) + cram(t-+n—1) +. + elt +) + coy (t)] = 0 is satisfied. This proves the theorem. Before going on to the next theorem, it is as well to, recall the notion of linearly independent functions. Given n functions y1(t), yo(),--- Y(t), they are said to be linearly depen- dent if n constants Ay, Az,..., An exist, which do not all vanish, and such that the equation Ayyi(t) + Aage(t) +--+ Amtm(t) = 0 (2.4)2.3. Determination of the arbitrary constants 15 equation, and the expression ‘reduced equation’ is used to indicate the homo- geneous part of a non-homogeneous equation, i.e. the corresponding homo- gencous equation obtained putting g(t) = 0 in the course of the procedure to solve a non-homogeneous equation, To avoid confusion, we shall not adopt these uses. ‘Theorem 2.6 contains the method to follow for solving the non-homogene- ous equation: (a) find a particular solution 9(¢) of the non-homogeneous equation; (b) put g(¢) = 0 and solve the resulting homogencous-equation (often called the ‘reduced’ equation); (c) add the two results. Steps (a) and (b) can be taken in any order; step (c) gives the general solution of the non-homogeneous equation. ‘The particular solution of the non-homogeneous equation will depend, ceteris paribus, on the form of the known function g(t). This suggest the fol- lowing general approach: to find a particular solution of the non-homogeneous equation, try a function having the same form of g(t) but with undetermined constant(s) (e.g. if g(t) is a constant, try an undetermined constant; if it is an exponential function, try the same exponential function with an un- determined multiplicative constant, and so on). Substitute this function in the non-homogencous equation and determine the coefficient(s) so that the equation is satisfied. ‘This method—called method of undetermined coefficients—will be ex- pounded in more detail in the following chapter, where we shall also examine the cases in which it cannot be applied. It is interesting to note, from the economic point of view, that in the general solution of the non-homogeneous equation the particular solution g(t) may usually be interpreted as the equilibrium state of the variable y (a stationary equilibrium or a moving equilibrium according to whether 9(¢) is a constant or a function of t ). The component f(t; Ai, Az,-.., An) in Eq. (2.8) may then be interpreted as giving the deviations from the equilibrium. Of course, from the mathematical point of view it is always true that y(t)—a(t) = f(t; At, Ag,-,An), independently of the possibility of giving an economic interpretation to the particular solution 9(¢). 2.3. Determination of the arbitrary constants The problem remains of how to determine the arbitrary constants A;. To do this we need an adequate number of additional conditions. This need derives from the fact that the solution—namely Eq. (2.5) or Eq. (2.8) as the case may be—of the difference equation under consideration gives only the form of the function y(t) but not its position in the Cartesian plane (t,y). However, as soon as the function is constrained to pass through n given points, its14 Chapter 2. Difference Equations: General Principles Ari (t) + Aaya(t) tect Antn(t) 0, Aryi(t +1) +Aoyo(t + 1) tet AnYn(t +1) =0, (2.7) Ayi(ttn—-1) +Aoy(t+n—1) +..+ AnYn(t +n —1) which is a system of homogeneous linear equations. According to a well- known theorem in elementary algebra, when D(t) # 0, system (2.7) admits only the null solution, i.e. holds true if, and only if, Ar = A2 =... = An = 0, which is the definition of linearly independent functions (see above). On the contrary, D(t) = 0 is the necessary and sufficient condition for system (2.7) to possess non-trivial solutions (i.e., solutions with at least one non-zero Aj, i = 1,2,...,n), which is the definition of linearly dependent functions. 2.2.2 The non-homogeneous equation We have so far dealt with the homogeneous difference equation. We now prove the basic theorem concerning the solution of the non-homogeneous dif- ference equation. Theorem 2.6 If g(t) is any particular solution of the non-homogeneous equation [i.e., 9(t) is any function that satisfies (2.1)], the general solution of the same equation is obtained adding g(t) to the general solution of the corresponding homogeneous equation, namely y(t) = GE) + F(t; Ar, Aa, ---» An) (2.8) is the general solution of the non-homogeneous equation. The proof of the theorem can be given substituting (2.8) into (2.1) and checking that the latter is satisfied. Since the function (2.8) contains exactly n arbitrary constants, it is the general solution of Eq. (2.1). The general solution of the homogeneous equation is thus only a part of the general solution of the non-homogeneous equation, and so it is not ‘general’ with respect to the latter. This means that the expression ‘gen- eral solution’ must always be qualified. As a matter of terminology, note the following: (1) some authors use the world ‘integral’ (particular or general) in- stead of ‘solution’ but with the same meaning; (2) the expression ‘particular solution’ is also used (a) in the sense of a solution obtained from the general solution by giving specific values to the arbitrary constants, and (b) in the sense of any single non-general solution of the homogeneous equation (i.e., to indicate any one of y(t), ya(t), ete.); (3) the expression ‘complementary function’ is used to indicate the general solution of the homogeneous equa- tion when considered as part of the general solution of the non-homogeneous24, References 17 Goldberg, $., 1958, Introduction to Difference Equations, Chaps. 1, 2, 3.— Kenkel, J-L., 1974, Dynamic Linear Economic Models, Chaps. 3, 5. Milne-Thomson, L.M., 1960, The Calculus of Finite Differences, Chap. XU.16 Chapter 2. Difference Equations: General Principles position—which depends on n arbitrary constants—is determined, and the arbitrariness of the constants disappears. More formally, to determine the n arbitrary constants, n additional con- ditions are needed, which usually take the form y(t) =y for t =0, yt) =y for t =1, yt) =Yn-1 for t -1, where Yo, Yi, .---Yn—1 are known values (whence the name of initial condi- tions). Substituting such values in the general solution, we obtain a system of n linear equations in the n unknowns Aj, Ay An. Consider for example the general solution of Eq. (2.1) y(t) = Aisa (t) + Aryal(t) +... + Anyn(t) + GO), where y:(t), yo(t), ya(t) are n distinct solutions of the corresponding homo- geneous equation. Substituting the given values yo etc. in the place of y(0) etc. we obtain, after rearranging terms, Aryi(0) + Azya(0) +... + Angn(0) =v — 90), Ari (1) + Aaye(1) +... + Andn(1) =n - 91); (29) + Antal? 2) = tea — (n= 1), Axyn(ne~ 1) + Aao(n — 1) + where of course 9(0),9(1), g(n—1) are absent if we consider the solution of the homogeneous equation (2.3). System (2.9) is a linear system whose determinant is yn(0) yn(1) | v(0) y2(0) po) =|" 0) yan 1) It is easy to see that D(0) coincides with the determinant D(t)—as defined in Eq. (2.6)—for t = 0. Since the functions y;(t), yo(t), ..., Yn(t) form a fun- damental set, D(t) is different from zero for any t, and so also for t= 0. It follows that D(0) # 0. Thus system (2.9) can always be solved. ‘We now have enough general principles to pass on to a detailed treatment of the difference equations of the various orders. m(r—1) w(n—1) 2.4 References Boole, G., 1960 (1872), A Treatise on the Calculus of Finite Differences, Chap. IX, pp. 157-1612.4. References abe Goldberg, $., 1958, Introduction to Difference Equations, Chaps. 1, 2, 3. Kenkel, J-L., 1974, Dynamic Linear Economic Models, Chaps. 3, 5. Milne-Thomson, L.M., 1960, The Calculus of Finite Differences, Chap. XII.