Combining basic Dierential Equations and

Economics
Afiq Hatta
August 2015

Introduction

In this document, Ill be playing around with first and second order ordinary
dierential equations and some of their applications to supply and demand
functions in economics.

Figure 1: Irrational Behaviour

Linear supply and demand

Lets look at simple supply and demand functions which may have popped up
in a standard Pre-University microeconomics syllabus. What is usually taught

is that the intersection of these functions define the particular price (P) and
quantity (Q) of a specific good sold onto a market.
Qdemanded = A

BP

(1)

A and B are positive constants which depend on the particular elasticity or

overall demand of that good. Likewise,
Qsupplied = C + DP

(2)

is a function which denotes the quantity supplied a supplier is willing to

supply at a particular price.
The actual price and quantity supplied on the market occurs where the
expectations of price and quantity meet.
Qsupplied = Qdemanded

(3)

A C
=P
B+D

(4)

We can see that

Qsupplied = Qdemanded = C + D

A C
.
B+D

(5)

Non-linear Quantity functions

Suppose we have a product whos demand curve follows that of:

Qd =

lnP

(6)

We may ask: how does the rate of increase of quantity change as price
increases? That can be solved easily with elementary calculus.
1
d(Qd )
=
(7)
dP
P
As Price increases by an increment, the corresponding decreasing increment
of Quantity demanded decreases.

Price functions of time

We learn that if demand exceeds supply at a given price and supply, then the
price and quantity of a given good will increase. We can express this as the
dierential equation
dP
= k(Qd
dt

Qs )

(8)

Which is quantitatively saying that the larger the dierence between supply
and demand, the more the price will increase at a given time increment. So
whats the price function for this given dierential?
dP
= k(A
dt

BP

dP
= k(A
dt

(A
Z
ln(A
A

(A
C

DP )

(9)

(B + D)P )

(10)

dP
= k dt
C (B + D)P )
Z
dP
= k dt
C (B + D)P )
(B + D)P ) =

(B + D)kt +
(B+D)kt+

(11)
(12)
(13)

(B + D)P = e

(14)

e (B+D)kt+
=P
(B + D)

(15)

C
e (B+D)kt
=P
(B + D)

(16)

Quantity functions in First Order Dierential

Equations

What if we had a function which varied supply according to time? A good such
as a crop whos harvest varied with the seasons should obey this rule. As such,
perhaps the sinusoidal function:
Q = ksin(t) + P

(17)

where k is a constant may be a good fit?

Suppose we had a perfectly elastic demand function which varied with time:
Qd = A

cosec(t)

(18)

Suppose also, we had a supply function with a seasonal price elasticity of

supply (the coefficient of P changes according to time).
Qs = B + P cot(t)
For simplicitys sake, let B = 0.
We can see that a possible dierential could be
3

(19)

dP
= (Qd
dt

Qs )

(20)

dP
= A cosec(t) P cot(t)
(21)
dt
Notice that this can be arranged to a first order dierential equation:
dP
+ P cot(t) = A cosec(t)
(22)
dt
We can use a technique, integrating factors to convert the expression to a
particular integral which would make it easier to solve:
R
R
R
dP
e cot(t)dt
+ e cot(t)dt P cot(t) = e cot(t)dt (A cosec(t))
(23)
dt
eln|sin(t)|

dP
+ eln|sin(t)| P cot(t) = eln|sin(t)| (A
dt

sin(t)

dP
+ sin(t)P cot(t) = sin(t)(A
dt

sin(t)

dP
+ P cos(t) = sin(t)(A
dt

d
(P sint) = sin(t)(A
dt

d(P sint) =
P sint =

P =

Acot(t) + (C

cosec(t))

1dt

(Asin(t)

Acos(t)

cosec(t))

cosec(t))

d(P sint) = Asin(t)

cosec(t))

1)dt

(24)
(25)
(26)
(27)
(28)
(29)

t+C

(30)

t)cosec(t)

(31)

Price functions in second order dierential equations

One could say an important point to consider in economics is not merely just
prices but also a humans perception and expectation of where prices are going
to go in the future. Lets look at a suppliers point of view. We have a simple
supply function
Qs = aP
4

(32)

which states that, provided a is positive, the larger the price of a good on
the market, the more supply a firm is willing to sell (such that its profit is
maximised). However, the suppliers decision to supply may be aected by
how prices could be falling. In this case, the supplier may choose to supply
less. Hence, it seems a reasonable assumption to say that the rate of change of
price with respect to time has an eect on a suppliers supply decision. This is
equivalent to saying that a more reasonable supply function could be:
dP
.
(33)
dt
The coefficient b represents just how much weight a suppliers expectation
aects the quantity supplied.
Hence, another factor could also be expectation of whether prices will increase in the longer term, in other words, will the current price fall turn into a
price rise? So we can refine the model further:
Qs = aP + b

dP
d2 P
+c 2
(34)
dt
dt
As an exercise, supposing the quantity supplied was some constant value,
and we had the following equation:
Qs = aP + b

dP
d2 P
+ 2
(35)
dt
dt
Could we deduce a price function of time? Note that we have a nonhomogeneous second order dierential equation. Lets start with attempting
to find the complementary function
k = 6P + 5

0 = 6P + 5

dP
d2 P
+ 2
dt
dt

(36)

And let
P = emt

(37)

0 = 6emt + 5memt + 1m2 emt

(38)

0 = emt (6 + 5m + m2 )

(39)

0 = emt (m + 2)(m + 3)

(40)

We can see that

We can see that the complementary function is then

P = Ae

2t

+ Be

3t

(41)

Where A and B are arbitrary constants. To deduce the particular integral lets
set
5

y=

(42)

k = 6

(43)

k
=
6

(44)

The solution is then

k
(45)
6
Lets look at the flip side and explore a model from the buyers point of view.
We can see that the plausible dierential equation would be:
2t

P = Ae

+ Be

3t

dP
d2 P
(46)
c1 2
dt
dt
Where a1, b1 and c1 are all positive constants. To put it in a more realistic
context, we also have to consider the buyers and sellers interaction. So lets
make an assumption, the price of a good occurs where supply and demand meet.
So:
dP
d2 P
dP
d2 P
aP + b
+ c 2 = a 1 P b1
c1 2
(47)
dt
dt
dt
dt
Which simplifies to
Qd =

a1 P

b1

dP
d2 P
+ (c + c1 ) 2 = 0
dt
dt
From statistical data we may have ascertained that
(a + a1 )P + (b + b1 )

(48)

a + a1 = 5

(49)

b + b1 = 2

(50)

c + c1 = 1

(51)

Hence our equation is

dP
d2 P
+ (1) 2 = 0
dt
dt

(52)

P = emt

(53)

emt (m2 + 2m + 5) = 0

(54)

(5)P + (2)
If we let

Then:

m = 1 + 2i

(55)

m=1

(56)

Or
2i

Hence our general solution for our price function would be

P = e(sin(2t) + cos(2t))

(57)

Chaos theory and economic behaviour

Suppose we had a system of slightly more complex behaviour. Lets have a

demand function be defined as
P5

Qd =

dP
dt

d2 P
dt

(58)

Notice the P function to the power 5. And lets also suppose we have a
perfectly elastic supply which varies throughout time:
Qs =

6sin(t)

(59)

Equating:
P5

d2 P
=
dt

dP
dt

6sin(t)

(60)

d2 P
dP
= P5 a
+ 6sin(t)
(61)
dt
dt
This set of equations actually creates a variation of an Ueda attractor - a
chaotic dynamical system. To best explain, we can graph a phase space by
creating a set of vector equations. Let:
dP
=y
dt
This transforms equation (61) into the following:
d
y=
dt
So we can plot the vectors:

d P
=
dt y

P5

ay + 6sin(t)

P5

y
0.02y + 7.5sin(t)

We can use a computer program to map out this phase

space as time evolves.
7

(62)

(63)

This graph shows specifically the space where x = 1, y = 0 when t = 0.

Already we can see that the line is irregular and seemingly unpredictable. If we
were to alter the equation just a little, we can see an entirely dierent shape.
For example, for the same initial conditions but for:

d P
y
=
P 5 0.02y + 10sin(t)
dt y
We have the phase space:

Conclusion

I will definitely continue to look at these types of questions in economics, and

will post them up on my blog afiqhatta.wordpress.com. Keep posted!
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