Cobweb Theory

1
Cobweb Theory
2
Intro

• Cobweb Theory is used to explain fluctuations and
  instability in price and quantity within certain
  markets - e.g. agricultural markets
• Demand for agricultural produce is affected by
• PED which is inelastic
• YED which is normal but inelastic
• Population which is roughly constant
• Supply is determined by
• Harvest yields which are uncertain due to weather
  etc.
• PES which is
• very inelastic in the SR due to time lags
• More elastic in the LR
• Expectation of future prices - we assume
  E(Pt1)Pt

3
Stable Cobweb

• From a position of equilibrium we experience a
  supply side shock such as a late frost.
• This results in a reduction in Q from Q to Q1
  and a shortage from Q1 to Q2
• There is no more supply available (due to lag
  time) and so price rises to meet demand. (b)

S

b
D
a
Q
Q
Q1
Q2
4
Stable Cobweb

• Farmers expect prices to remain constant and so
  plant and harvest accordingly (c)
• This leads to excess supply and as such the price
  falls until all stocks are sold (d)
• This process continues.
• As this is a stable cobweb, prices eventually
  meet equilibrium

S

c
b
d
D
a
Q
Q
Q1
Q2
5
Stable Cobweb

• Why?
• Demand is much more elastic than supply
• This may be due to the presence of substitutes,
  meaning that when the price rises people switch
  to buying something else.
• Supply is inelastic due to the lag time
• An e.g. might be bacon, where people can simply
  buy another meat but farmers elasticity is
  limited by the 3 month gestation period of pigs

• So?
• After the initial shock to demand or supply price
  will be volatile but slowly settle back to
  equilibrium

• Farmers expect prices to remain constant and so
  plant and harvest accordingly (c)
• This leads to excess supply and as such the price
  falls until all stocks are sold (d)
• This process continues.
• As this is a stable cobweb, prices eventually
  meet equilibrium

S

c
b
d
D
a
Q
Q
Q1
Q2
6
Unstable Cobweb

• As before, from a position of equilibrium we
  experience a supply side shock such as a late
  frost.
• This results in the same reduction in Q from Q
  to Q1 and a shortage from Q1 to Q2
• There is still no more supply available and so
  price rises to meet demand. (b)

S
b
a
D
Q
Q
Q1
Q2
7
Unstable Cobweb

• As before, farmers expect prices to remain
  constant and so plant and harvest accordingly (c)
• This still leads to excess supply and as such the
  price falls until all stocks are sold (d)
• This process continues, however the unstable
  nature of this cobweb means that prices will
  continue to vary more and more and a stable
  equilibrium will not be reached without
  intervention.

S
b
c
a
d
D
Q
Q1
8
Unstable Cobweb

• Why?
• Supply is much more elastic than demand
• This may be due to the presence of stockpiles
  etc, meaning that when the price rises more are
  released onto the market.
• Demand is inelastic, perhaps due to lack of
  substitutes
• An e.g. might be Wheat, it is easy to store and a
  staple part of many peoples diet.

• So?
• After the initial shock to demand or supply price
  will be volatile and only increase in volatility.

• As before, farmers expect prices to remain
  constant and so plant and harvest accordingly (c)
• This still leads to excess supply and as such the
  price falls until all stocks are sold (d)
• This process continues, however the unstable
  nature of this cobweb means that prices will
  continue to vary more and more and a stable
  equilibrium will not be reached without
  intervention.

S
b
c
a
d
D
Q
Q1