Lectures 25

Section 17.5 from

Fundamental methods of Mathematical Economics, McGraw Hill 2005, 4th Edition.
A market model with inventory
Read details of general case from book including table 17.2.
A market model with inventory some numerical examples
Note: In a market model with inventory, we will always get a difference equation of
form
𝑃𝑡+1 + 𝑎𝑃𝑡 = 𝑐
𝑐
with (𝑎 ≠ −1) and its solution is 𝑃𝑡 = 𝐴(−𝑎)𝑡 +
1+𝑎

Example 1: If in market model with inventory has the following numerical form:

𝑄𝑑𝑡 = 25 − 𝑃𝑡 (1)
𝑄𝑠𝑡 = −7 + 15𝑃𝑡 (2)
𝑃𝑡+1 = 𝑃𝑡 − 0.1 𝑄𝑠𝑡 − 𝑄𝑑𝑡 (3)
Find the time path 𝑃𝑡 and determine whether it is convergent.
Solution:
Using (1) and (2) in (3) , we have

𝑃𝑡+1 = 𝑃𝑡 − 0.1 −7 + 15𝑃𝑡 − 25 + 𝑃𝑡

Simplifying

𝑃𝑡+1 + 0.6𝑃𝑡 = 3.2

This is first-order linear difference equation with 𝑎 = 0.6, c=3.2, its solution is
𝑐
𝑃𝑡 = 𝐴(−𝑎)𝑡 + 1+𝑎 (or you can derive this solution by finding complementary and
particular integrals).
𝑃𝑡 = 𝐴(−0.6)𝑡 + 2 (4)
𝐴𝑡 𝑡 = 0
𝑃0 = 𝐴 + 2 ⇒ 𝐴 = 𝑃0 − 2 (5)
Using (5) in (4), we have
𝑃𝑡 = 𝑃0 − 2 (−0.6)𝑡 + 2 (6)
Since 𝑏 = −0.6 < 0, the time path is oscillatory. But since 𝑏 = −0.6 = 0.6 < 1, then time
path is convergent and oscillations are damped.
(This was an example of region V)

Example 2: If in market model with inventory has the following numerical form:

𝑄𝑑𝑡 = 6 − 5𝑃𝑡 (7)

1
Instructor Dr Rehana Naz Mathematical Economics II
 𝑄𝑠𝑡 = −14 + 5𝑃𝑡 (8)
𝑃𝑡+1 = 𝑃𝑡 − 0.2 𝑄𝑠𝑡 − 𝑄𝑑𝑡 (9)
Find the time path 𝑃𝑡 and determine whether it is convergent.
Solution:
Using (7) and (8) in (9) , we have

𝑃𝑡+1 = 𝑃𝑡 − 0.2 −14 + 5𝑃𝑡 − 6 + 5𝑃𝑡

Simplifying

𝑃𝑡+1 + 𝑃𝑡 = 4 (10)
This is first-order linear difference equation with 𝑎 = 1, c=4, its solution is
𝑐
𝑃𝑡 = 𝐴(−𝑎)𝑡 + 1+𝑎 (or you can derive this solution by finding complementary and
particular integrals).
𝑃𝑡 = 𝐴(−1)𝑡 + 2 (11)
𝐴𝑡 𝑡 = 0
𝑃0 = 𝐴 + 2 ⇒ 𝐴 = 𝑃0 − 2 (12)
Using (12) in (11), we have
𝑃𝑡 = 𝑃0 − 2 (−1)𝑡 + 2 (13)

Since 𝑏 = −1 < 0, the time path is oscillatory. But since 𝑏 = −1 = 1, then time path
is divergent and oscillations are uniform.
(This was an example of region VI)

Example 3: If in market model with inventory has the following numerical form:

𝑄𝑑𝑡 = 21 − 2𝑃𝑡 (14)

𝑄𝑠𝑡 = −3 + 6𝑃𝑡 (15)
𝑃𝑡+1 = 𝑃𝑡 − 0.3 𝑄𝑠𝑡 − 𝑄𝑑𝑡 (16)
Find the time path 𝑃𝑡 and determine whether it is convergent.
Solution:
Using (14) and (15) in (16) , we have

𝑃𝑡+1 = 𝑃𝑡 − 0.3 −3 + 6𝑃𝑡 − 21 + 2𝑃𝑡

Simplifying

𝑃𝑡+1 + 1.4𝑃𝑡 = 7.2 (17)

This is first-order linear difference equation with 𝑎 = 1.4, c=7.2, its solution is
𝑐
𝑃𝑡 = 𝐴(−𝑎)𝑡 + 1+𝑎 (or you can derive this solution by finding complementary and
particular integrals).

2
Instructor Dr Rehana Naz Mathematical Economics II
 𝑃𝑡 = 𝐴(−1.4)𝑡 + 3 (18)
𝐴𝑡 𝑡 = 0
𝑃0 = 𝐴 + 3 ⇒ 𝐴 = 𝑃0 − 3 (19)
Using (19) in (18), we have
𝑃𝑡 = 𝑃0 − 3 (−1.4)𝑡 + 3 (20)

Since 𝑏 = −1.4 < 0, the time path is oscillatory. But since 𝑏 = −1.4 = 1.4 > 1, then
time path is divergent and oscillations are explosive.
(This was an example of region VII)

Example 4: If in market model with inventory has the following numerical form:

𝑄𝑑𝑡 = 30 − 2𝑃𝑡 (21)

𝑄𝑠𝑡 = −5 + 3𝑃𝑡 (22)
𝑃𝑡+1 = 𝑃𝑡 − 0.1 𝑄𝑠𝑡 − 𝑄𝑑𝑡 (23)
Find the time path 𝑃𝑡 and determine whether it is convergent.
Solution:
Using (21) and (22) in (23) , we have

𝑃𝑡+1 = 𝑃𝑡 − 0.1 −5 + 3𝑃𝑡 − 30 + 2𝑃𝑡

Simplifying

𝑃𝑡+1 − 0.5𝑃𝑡 = 3.5 (24)

This is first-order linear difference equation with 𝑎 = −0.5, c=3.5, its solution is
𝑐
𝑃𝑡 = 𝐴(−𝑎)𝑡 + 1+𝑎 (or you can derive this solution by finding complementary and
particular integrals).
𝑃𝑡 = 𝐴(0.5)𝑡 + 7 (25)
𝐴𝑡 𝑡 = 0
𝑃0 = 𝐴 + 7 ⇒ 𝐴 = 𝑃0 − 7 (26)
Using (26) in (25), we have
𝑃𝑡 = 𝑃0 − 7 (0.5)𝑡 + 7 (27)

Since 𝑏 = 0.5 > 0, the time path is nonoscillatory. But since 𝑏 = 0.5 = 0.5 < 1,
then time path is Convergent.
(This was an example of region III)

Example 5: If in market model with inventory has the following numerical form:

𝑄𝑑𝑡 = 30 − 2𝑃𝑡 (28)

𝑄𝑠𝑡 = −5 + 3𝑃𝑡 (29)
𝑃𝑡+1 = 𝑃𝑡 − 0.2 𝑄𝑠𝑡 − 𝑄𝑑𝑡 (30)

3
Instructor Dr Rehana Naz Mathematical Economics II
 Find the time path 𝑃𝑡 and determine whether it is convergent.
Solution:
Using (28) and (29) in (30) , we have

𝑃𝑡+1 = 𝑃𝑡 − 0.2 −5 + 3𝑃𝑡 − 30 + 2𝑃𝑡

Simplifying

𝑃𝑡+1 = 7 (31)
Then
𝑃𝑡 = 7
Since 𝑏 = 0 the time path is remaining in equilibrium.
(This was an example of region IV)

Remark:
We have given numerical examples from region III to region VII. We know region I and
II are not including in market model with inventory due to parameter specifications.

Note that in Examples 1, 2, and 3 the time path was oscillatory (b<0) and we had
described whether the oscillations are damped, uniform or explosive.

In Example 4 and 5 (b>0), the time path is nonoscillatory and market model with
inventory is convergent here.

Example 6: If in market model with inventory has the following demand and supply functions:

𝑄𝑑𝑡 = 𝛼 − 𝛽𝑃𝑡 (𝛼, 𝛽 > 0) (32)

𝑄𝑠𝑡 = 𝑘 (𝑓𝑖𝑥𝑒𝑑 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦) (33)
𝑃𝑡+1 = 𝑃𝑡 − 𝜎 𝑄𝑠𝑡 − 𝑄𝑑𝑡 𝜎 > 0 (34)
Find the time path 𝑃𝑡 and determine whether it is convergent.
Solution:
Using (32) and (33) in (34) , we have

𝑃𝑡+1 = 𝑃𝑡 − 𝜎 𝑘 − 𝛼 + 𝛽𝑃𝑡

Simplifying

𝑃𝑡+1 − (1 − 𝜎𝛽)𝑃𝑡 = 𝜎 𝛼 − 𝑘 (35)

This is first-order linear difference equation with 𝑎 = − 1 − 𝜎𝛽 ≠ −1, c= 𝜎 𝛼 − 𝑘 ,
its solution is

4
Instructor Dr Rehana Naz Mathematical Economics II
 𝑐
𝑃𝑡 = 𝐴(−𝑎)𝑡 + 1+𝑎 (or you can derive this solution by finding complementary and
particular integrals).
𝛼−𝑘
𝑃𝑡 = 𝐴(1 − 𝜎𝛽)𝑡 + (36)
𝛽
𝐴𝑡 𝑡 = 0
𝛼−𝑘 𝛼−𝑘
𝑃0 = 𝐴 + ⇒ 𝐴 = 𝑃0 − (37)
𝛽 𝛽
Using (37) in (36), we have
𝛼−𝑘 𝛼−𝑘
𝑃𝑡 = 𝑃0 − (1 − 𝜎𝛽)𝑡 + (38)
𝛽 𝛽

The nature of path depends on 𝑏 = 1 − 𝜎𝛽. Due to parameter specifications b>1 and b=1
is not possible. So we will discuss nature in following five regions;
(Region III) : 0<b<1 in this region time path is nonoscillatory as b>0 and convergent
since 𝑏 < 1. Now
0<b<1 ⇒ 0 < 1 − 𝜎𝛽 < 1
1
−1 < −𝜎𝛽 < 0 ⇒ > 𝜎 > 0
𝛽
𝑜𝑟
1
0<𝜎<
𝛽
(Region IV) : Remaining in equilibrium.
1
b=0 ⇒ 1 − 𝜎𝛽 = 0 ⇒ 𝜎 = 𝛽
(Region V) : -1<b<0 in this region time path is oscillatory as b<0 and convergent
since 𝑏 < 1 and oscillations are damped.
Now
-1<b<0⇒ −1 < 1 − 𝜎𝛽 < 0
2 1
−2 < −𝜎𝛽 < −1 ⇒ > 𝜎 >
𝛽 𝛽
𝑜𝑟
1 2
<𝜎<
𝛽 𝛽
(Region VI) : b=-1 in this region time path is oscillatory as b<0 and divergentt since
𝑏 = 1 and oscillations are unifrom.
Now
b=-1⇒ 1 − 𝜎𝛽 = −1
2
𝜎=
𝛽
(Region VII) : b<-1 in this region time path is oscillatory as b<0 and divergent since
𝑏 > 1 and oscillations are explosive.

5
Instructor Dr Rehana Naz Mathematical Economics II
 Now
b<-1⇒ 1 − 𝜎𝛽 < −1
2
−𝜎𝛽 < −2 ⇒ 𝜎 >
𝛽
This all discussion can be summarized in following table:

Table:
Region b 𝝈 Nature of time path
1
III 0<b<1 0<𝜎<𝛽 Nonoscillatory and convergent
1
IV b=0 𝜎=𝛽 Remaining in equilibrium.
1 2
V -1<b<0 <𝜎<𝛽 With damped oscillation
𝛽
2
VI b=-1 𝜎=𝛽 With uniform oscillation
2
VII b<-1 𝜎>𝛽 With explosive oscillation

6
Instructor Dr Rehana Naz Mathematical Economics II