PHYSALIS: A new method for particle flow simulation. III: Convergence analysis of two-dimensional flows. We study the convergence property of PHYSALIS when it is applied to incompressible particle flows in two-dimensional space. PHYSALIS is a recently proposed iterative method which computes the solution without imposing the boundary conditions on the particle surfaces directly. Instead, a consistency equation based on the local (near particle) representation of the solution is used as the boundary conditions. One of the important issues needs to be addressed is the convergence properties of the iterative procedure. In this paper, we present the convergence analysis using Laplace and biharmonic equations as two model problems. It is shown that convergence of the method can be achieved but the rate of convergence depends on the relative locations of the cages. The results are directly related to potential and Stokes flows. However, they are also relevant to Navier-Stokes flows, heat conduction in composite media, and other problems.