Government College University Lahore

Submitted to : Sir Bilal

Submitted by : Mubeen Qaiser
Roll no : 1229-R-BH-ECO-14
Semester : 6th
Subject : Advanced Mathematical Economics
Topic : The cobweb Model
The cobweb Model (with Equations) Market Equilibrium

‘’Cobweb model is an economic model that explains why prices might be subject
to periodic fluctuations in certain types of markets.’’

Example 1:
Consider the following cobweb model (the notations having their usual meanings):

Qdt = Qst ; Qdt =α-βPt(α,β>0);

Qst= ϒ + ẟPt -1(ϒ<0,ẟ>0)

Find the time-path of Q and analyse the conditions for its convergence.

Solution:
The equations for the given model are:

Qdt =Qst (Equation 1)

Qdt = α-βPt(α,β>0) (Equation 2)

Qst= ϒ + ẟPt -1(ϒ<0,ẟ>0) (Equation3)

We need to find the time path for Q and analyse the conditions for its convergence:

By putting equations 2 and 3 in equation 1, we have:

α-βPt = ϒ + ẟPt -1 (Equation 4)

In equilibrium:

Pt = Pt -1= 𝑃̅ (Equation 5)

So from equation 4, in equilibrium;

 α-β𝑃̅ = ϒ+ẟ𝑃̅ (Equation 6)

Subtracting equation 4 from equation 6:

-β(𝑃̅-Pt) = ẟ(𝑃̅-Pt-1)
-β𝑃̂t= ẟ𝑃̂t-1 (Equation 7)

Where 𝑃̂t =deviation of Pt from 𝑃̅ =𝑃̅-Pt

and 𝑃̂t-1= deviation of Pt-1 from 𝑃̅=𝑃̅-Pt-1

From equation 7:

𝑃̂t/𝑃̂t-1= -ẟ/β=A (=constant), say (Equation 8)

Where A =negative, since β, ẟ > 0.

Since the market is cleared in each period, we have:

Qt=α-βPt = ϒ+ẟPt-1 (Equation 9)

Qt-1=α-βPt-1 = ϒ+ẟPt-2 (Equation 10)

At the equilibrium point, we have

𝑄̅ =α-β𝑃̅= ϒ+ẟ𝑃̅ (Equation 11)

Subtracting equation 9 from equation 11

𝑄̅ -Qt= -β(𝑃̅-Pt)= ẟ(𝑃̅-Pt-1)

𝑄̂ t=-β𝑃̂t= ẟ 𝑃̂t-1 (Equation 12)

Also, subtracting equation 10 from equation 11;

𝑄̅ -Qt-1= -β(𝑃̅-Pt-1)= ẟ(𝑃̅-Pt-2)

𝑄̂ t-1=-β𝑃̂t-1= ẟ 𝑃̂t-2 (Equation 13)

Where , 𝑄̂ t= 𝑄̅ -Qt, etc.

From equation 12 and equation 13:

𝑄̂ t/𝑄̂ t-1 = 𝑃̂t/𝑃̂t-1=𝑃̂t-1/𝑃̂t-2 (Equation 14)

From equation 14 and equation 8:

 𝑄̂ t/𝑄̂ t-1 = 𝑃̂t/𝑃̂t-1 = A

𝑄̂ t= A 𝑄̂ t-1 (Equation 15)

Where A = - ẟ /β = negative.

Equation 15 is a first order difference equation. From this equation, we have

𝑄̂ 1= A𝑄̂ 0

𝑄̂ 2 = A𝑄̂ 1=A2𝑄̂ 0

𝑄̂ 1 =A1𝑄̂ 0

Equation 16 gives us the solution of the difference equation 15 and this solution, i.e., 16 is the
time path of Q.

Since A=negative, the deviation of output from equilibrium output, i.e., 𝑄̅ -Q=𝑄̂ would alternate
in sign in the successive periods. If 𝑄̂ 0<0, then 𝑄̂ 1 would be positive, 𝑄̂ 2 would be negative, and
so on.

The time-path would convergence if IAI < 1, for then, as t increases. 𝑄̂ t diminishes. So the
condition for convergence for the time-path is: IAI<1 ; ẟ /β<1; S<β, i.e., the numerical slope of
the supply function equation 3 should be less than the numerical slope of the demand function
equation 2 , i.e., the supply function should be flatter than the demand function.

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