Problem: Modeling Price Adjustment

In a competitive market, the price P (t) of a good changes over time based on the excess demand
Qd − Qs , where Qd is the quantity demanded and Qs is the quantity supplied. The price adjustment
​ ​ ​ ​

mechanism is described by the differential equation:

dP
= α(Qd − Qs )
dt
​ ​ ​

where:
dP
dt
: Rate of change of price with respect to time,
​

α: Speed of adjustment constant (α > 0),

Qd = a − bP : Demand function, where a and b are constants (a > 0, b > 0),
​

Qs = c + dP : Supply function, where c and d are constants (c ≥ 0, d > 0).

​

If the initial price is P (0) = P0 , solve for the price P (t) over time.
​

Solution

Step 1: Substitute the demand and supply functions into the differential equation

Substituting Qd ​ = a − bP and Qs = c + dP into the differential equation gives:

​

dP
α[(a − bP ) − (c + dP )]
dt
​

Simplify the expression:

dP
= α[(a − c) − (b + d)P ]
dt
​

Let k = α(a − c) and m = α(b + d), then:

dP
= k − mP
dt
​

Step 2: Solve the differential equation

This is a first-order linear differential equation. Rearrange it as:
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 dP
+ mP = k
dt
​

Using the integrating factor method, the integrating factor is:

emt

Multiply through by emt :

dP
emt + memt P = kemt
dt
​

The left-hand side is the derivative of P emt :

d
(P emt ) = kemt
dt
​

Integrate both sides:

P emt = ∫ kemt dt

The integral of kemt is:

k mt
P emt = e +C
m
​

Divide through by emt :

k
P = + Ce−mt
m
​

Step 3: Apply the initial condition

The initial condition is P (0) = P0 . Substituting t = 0 into the solution:

​

k
P0 = + Ce−m⋅0
m
​ ​

k
P0 = +C
m
​ ​

k
C = P0 −
m
​ ​

Substitute C back into the solution:

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 k k
P (t) = + (P0 − ) e−mt
m m
​ ​ ​

Final Answer
The price as a function of time is:

α(a − c) α(a − c) −α(b+d)t

P (t) = + ( P0 − )e
α(b + d) α(b + d)
​ ​ ​

Where:
α(a−c)
α(b+d) is the equilibrium price,
​

The exponential term e−α(b+d)t describes how the price converges to equilibrium over time.

Interpretation
a−c
1. The equilibrium price is b+d , the point where supply equals demand.
​

2. If the initial price P0 is not at equilibrium, the price adjusts dynamically over time, moving closer
​

to the equilibrium price as t → ∞.

3. The speed of adjustment depends on α(b + d). Higher values of α or b + d result in faster
convergence to equilibrium.

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