Cobweb model

Cobweb theory is an economic model that explains why prices might be subject to periodic

fluctuations in certain types of markets. Nicholas Kaldor analyzed the model in 1934, coining the
term "cobweb theorem. Producers' expectations about prices are assumed to be based on
observations of previous prices." The cobweb model is generally based on a time lag between
supply and demand decisions. Agricultural markets are a context where the cobweb model might
apply, since there is a lag between planting and harvesting.

It is a dynamic stability model which shows the time path of adjustment process between
demand and supply from a disequilibrium state towards the equilibrium price and
quantity levels. Let us explain the dynamics of cob web model with an example of market
where the supply of farm produce wheat is a lagged function of price. The peculiarity of this
market is that the farmer decide this year’s planting and supply on the basis of previous year’s
price. It means there is a one year lag in response of quantity supplied of wheat to a given market
price of it.

St =f (P)

It asserts that supply adjusts itself to changing conditions of demand which are seen through
price changes not suddenly but after certain period. This time, taken by the supply to adjust itself
to changes in demand is known as lag. The quantity ofwh eat supplied in a year ‘t’ depends on
the price prevailing in the previous year (Pt-1).

This theorem is based on three assumptions:

(i)There is Perfect competition the market.

(ii) Price is completely a function of the preceding period’s supply

(iii) The commodity concerned is perishable. The theory is particularly applicable to agricultural
product.

Convergent Fluctuation:

When supply is less elastic than demand, which is shown in Fig

Starting with a large supply and low price in the first period, P1 there
would be a very short supply and high price, Q2, and P2, in the second
period.

Production would expand again in the third period to Q3 but to a smaller production than that in
the first period. This would set a moderately low price, P3, in the third period, with a moderate
reduction to Q4 in the fourth period; and a moderately high price P4.
Continuing through Q9, P6 and Q6, and P6, production and price approach more and more closely
to the equilibrium condition where further changes would occur. Of the three case considered
thus so far, only this one behaves in the manner assumed by equilibrium theory ; and even it
converges rapidly. If the supply curve is markedly less elastic than the demand curve. The case
has been designated “the case of convergent fluctuation.

 
This cyclical movement (oscillation) over time goes on until it reaches the point at which long
run demand and supply intersect at point E the point of equilibrium. This is the long run
equilibrium price. Once it is attained neither the price nor the quantity will change until either the
demand curve or the supply curve is disturbed.
The Cobweb theory of trade cycle represents an important forward step in the development of
the dynamic explanations of the cyclical fluctuations. The earlier approaches to the study of the
cycle problem were static in character. They treated the economy as of a point in time ignoring
completely the movements of the economy through time.

The Cobweb Theorem furnishes us with an illustration of the dynamic process of adjustment
movements through time.