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**Inst r uct or Dr Rehana Naz M at hemat i cal Economi cs I
**

Lecture 24

Section 17.4 from

Fundamental methods of Mathematical Economics, McGraw Hill 2005, 4

th

Edition.

By A. C. Chiang & Kevin Wainwright is covered.

The Cobweb model

Read details from book.

Question: The cobweb model is essentially based on the static market model in which

µ

d

= µ

s

. What economic assumption is the dynamizing agent in the present case?

Explain.

Answer:

In the cobweb model, the supply and demand functions are of the form

µ

dt

= ∝ −[P

t

( o, [ > 0) (1)

µ

st

= −y + oP

t-1

( y, o > 0) (2)

To get first-order difference equation representing the cobweb model, we assume that in

each time period the market price is always set at a level which clears the market i.e

µ

dt

= µ

st

(3)

Now µ

dt

= µ

st

, assumption is same as we do in static analysis. The dynamizing agent is

the lag in the supply function. This introduces P

t-1

term into the model, which together

with P

t

, forms a pattern of change.

Interpret the solution of cobweb model given as follows:

P

t

= ( P

0

− P

) _−

o

[

]

t

+ P

Note that b = −

6

[

< 0 implies that the time path is oscillatory. Since

| b| = _−

o

[

_ =

o

[

There can be three types of oscillations, explosive, uniform and damped depending on

| b| ⋛ 1.

(i) If | b| =

6

[

> 1 ⇒ o > [, then time path is divergent and oscillations are

explosive.

(ii) If | b| =

6

[

= 1 ⇒ o = [, then time path is divergent and oscillations are uniform.

(iii) If | b| =

6

[

< 1 ⇒ o < [, then time path is convergent and oscillations are

damped.

Example 1: Given demand and supply for the cobweb model as follows,

2

Inst r uct or Dr Rehana Naz M at hemat i cal Economi cs I

µ

dt

= 18 − 3P

t

(4)

µ

st

= −3 + 4P

t-1

(5)

(a) Assuming that in each time period the market price is always set at a level which clears

the market find the time path P

t

. At t=0 P

0

.

(b) Find the intertemporal equilibrium price.

(c) Determine whether the equilibrium is stable.

(d) Find the time path of Q and analyze the condition for its convergence.

Solution:

(a) Assuming that in each time period the market price is always set at a level which clears

the market yields

µ

dt

= µ

st

(6)

Usi ng ( 4) and ( 5) i n equat i on ( 6) , we have

18 − 3P

t

= −3 + 4P

t-1

3P

t

+ 4P

t-1

= 21 ( 7)

Letting t → t + 1 in (7), we have

3P

t+1

+ 4P

t

= 21

Or

P

t+1

+

4

3

P

t

= 7 ( 8)

This is first-order linear difference equation with o =

4

3

, c=7, its solution is

P

t

= A( −o)

t

+

c

1 + o

[You can use above formula directly. If you want to do all steps in finding

complementary and particular solutions you can solve by general solution method]

P

t

= A( −

4

3

)

t

+ 3 ( 9)

At t=0 P

0

, (9) yields

P

0

= A + 3 ⇒ A = P

0

−3 ( 10)

Using (10) in (9), we have

P

t

= ( P

0

− 3) ( −

4

3

)

t

+ 3 ( 11)

(b) To find intertemporal equilibrium price set P

t

= P

t-1

= P

**in the demand and supply
**

functions and equate them i.e

3

Inst r uct or Dr Rehana Naz M at hemat i cal Economi cs I

18 − 3P

= −3 + 4P

⇒ P

= 3

P

**= 3 is the intertemporal equilibrium price.
**

(c) We need to check whether the equilibrium is stable.

From (11) b = −

4

3

<0, the time path is oscillatory. But since

| b| = _−

4

3

_ =

4

3

> 1

The time path is divergent and oscillations are explosive.

(d) Substitution of the time path (11) into the demand equation (4) leads to the time path of

µ

dt

, which we can simply write as µ

t

(since µ

dt

= µ

st

by the equilibrium condition):

µ

t

= 18 −3 _( P

0

− 3) ( −

4

3

)

t

+ 3 _

µ

t

= 18 − 3( P

0

− 3) ( −

4

3

)

t

−3( 3)

or

µ

t

= 9 −3( P

0

−3) ( −

4

3

)

t

( 12)

Convergence of µ

t

depends on the ( −

4

3

)

t

term, which determines the convergence of

P

t

os wcll. Thus P

t

and µ

t

must be either both convergent or both divergent.

As for this case the time path P

t

is divergent so µ

t

is also divergent and oscillations are

explosive.

Example 2: Given demand and supply for the cobweb model as follows,

µ

dt

= 22 − 3P

t

( 13)

µ

st

= −2 + P

t-1

( 14)

(a) Assuming that in each time period the market price is always set at a level which clears

the market find the time path P

t

.

(b) Find the intertemporal equilibrium price.

(c) Determine whether the equilibrium is stable.

(d) Find the time path of Q and analyze the condition for its convergence.

Solution:

(a) Assuming that in each time period the market price is always set at a level which

clears the market yields

µ

dt

= µ

st

(15)

Usi ng ( 13) and ( 14) i n equat i on ( 15) , we have

22 − 3P

t

= −2 + P

t-1

4

Inst r uct or Dr Rehana Naz M at hemat i cal Economi cs I

3P

t

+ P

t-1

= 24 ( 16)

Letting t → t + 1 in (16), we have

3P

t+1

+ P

t

= 24

Or

P

t+1

+

1

3

P

t

= 8 ( 17)

This is first-order linear difference equation with o =

1

3

, c=8, its solution is

P

t

= A( −o)

t

+

c

1 + o

P

t

= A( −

1

3

)

t

+ 6 ( 18)

At t=0 P

0

, (18) yields

P

0

= A + 6 ⇒ A = P

0

−6 ( 19)

Using (19) in (18), we have

P

t

= ( P

0

− 6) ( −

1

3

)

t

+ 6 ( 20)

(b) To find intertemporal equilibrium price set P

t

= P

t-1

= P

**in the demand and
**

supply functions and equate them i.e

22 −3P

= −2 + P

⇒ P

= 6

P

**= 6 is the intertemporal equilibrium price.
**

(c) We need to check whether the equilibrium is stable.

From (20) b = −

1

3

<0, the time path is oscillatory. But since

| b| = _−

1

3

_ =

1

3

< 1

The time path is convergent and oscillations are damped.

(d) Substitution of the time path (20) into the demand equation (13) leads to the time path

of µ

dt

, which we can simply write as µ

t

(since µ

dt

= µ

st

by the equilibrium

condition):

µ

t

= 22 −3 _( P

0

− 6) ( −

1

3

)

t

+ 6 _

µ

t

= 4 −3( P

0

−6) ( −

1

3

)

t

( 21)

Convergence of µ

t

depends on the ( −

1

3

)

t

term, which determines the convergence of

P

t

os wcll. Thus P

t

and µ

t

must be either both convergent or both divergent.

5

Inst r uct or Dr Rehana Naz M at hemat i cal Economi cs I

As for this case the time path P

t

is convergent so µ

t

is also convergent and oscillations are

damped.

Example 3: Given demand and supply for the cobweb model as follows,

µ

dt

= 19 −6P

t

( 22)

µ

st

= 6P

t-1

−5 ( 23)

(a) Assuming that in each time period the market price is always set at a level which clears

the market find the time path P

t

.

(b) Find the intertemporal equilibrium price.

(c) Determine whether the equilibrium is stable.

(d) Find the time path of Q and analyze the condition for its convergence.

Solution:

(e) Assuming that in each time period the market price is always set at a level which clears

the market yields

µ

dt

= µ

st

(24)

Usi ng ( 22) and ( 23) i n equat i on ( 24) , we have

19 −6P

t

= −5 + 6P

t-1

P

t

+ P

t-1

= 4 ( 25)

Letting t → t + 1 in (25), we have

P

t+1

+ P

t

= 4 ( 26)

This is first-order linear difference equation with o = 1, c=4, its solution is

P

t

= A( −o)

t

+

c

1 + o

P

t

= A( −1)

t

+ 2 ( 27)

At t=0 P

0

, (27) yields

P

0

= A + 2 ⇒ A = P

0

− 2 ( 28)

Using (28) in (27), we have

P

t

= ( P

0

−2) ( −1)

t

+ 2 ( 29)

(b) To find intertemporal equilibrium price set P

t

= P

t-1

= P

**in the demand and supply
**

functions and equate them i.e

19 − 6P

= −5 + 6P

⇒ P

= 2

P

**= 2 is the intertemporal equilibrium price.
**

6

Inst r uct or Dr Rehana Naz M at hemat i cal Economi cs I

(c) We need to check whether the equilibrium is stable.

From (29) b = −1<0, the time path is oscillatory. But since

| b| = | −1| = 1

The time path is divergent and oscillations are uniform.

(d) Substitution of the time path (29) into the demand equation (22) leads to the time path of

µ

dt

, which we can simply write as µ

t

(since µ

dt

= µ

st

by the equilibrium condition):

µ

t

= 19 −6[ ( P

0

−2) ( −1)

t

+ 2 ]

µ

t

= 7 − 6( P

0

−2) ( −1)

t

( 30)

As for this case the time path P

t

is divergent so µ

t

is also divergent.

Example 4: If

µ

dt

= ∝ −[P

t

( o, [ > 0) (31)

µ

st

= −y + oP

t

∗

( y, o > 0) (32)

w her e

P

t

∗

= P

t-1

∗

+ p( P

t-1

− P

t-1

∗

) , 0 < p ≤ 1 (33)

µ

dt

= µ

st

(34)

What happens if p takes its maximum value? Can we consider the cobweb model as a

special case of the present model?

Solution: Maximum value of p i s 1. Taking p = 1 in (33), we have

P

t

∗

= P

t-1

∗

+ 1( P

t-1

− P

t-1

∗

) ⇒ P

t

∗

= P

t-1

and t he model r educes t o t he cobw eb model . Thus the present model includes the

cobweb model as a special case.

its solution is 1+ [You can use above formula directly. c=7. we have 18 − 3 = −3 + 4 3 Letting → + 1 in (7). If you want to do all steps in finding complementary and particular solutions you can solve by general solution method] 4 = (− ) + 3 (9) 3 At t=0 . we have =( 4 − 3)(− ) + 3 3 = (11) = in the demand and supply +3 ⇒ = −3 (10) = (− ) + 3 +4 = 21 (7) (b) To find intertemporal equilibrium price set functions and equate them i. At t=0 . (d) Find the time path of Q and analyze the condition for its convergence. (c) Determine whether the equilibrium is stable.= 18 − 3 = −3 + 4 (4) (5) (a) Assuming that in each time period the market price is always set at a level which clears the market find the time path . (9) yields = Using (10) in (9). Solution: (a) Assuming that in each time period the market price is always set at a level which clears the market yields = (6) Using (4)and (5)in equation (6).e 2 Instructor Dr Rehana Naz Mathematical Economics I . (b) Find the intertemporal equilibrium price. we have + 4 = 21 Or 4 + = 7 (8) 3 This is first-order linear difference equation with = .

Thus 4 − 3)(− ) (12) 3 depends on the (− ) term. Example 2: Given demand and supply for the cobweb model as follows. which determines the convergence of = 9 − 3( and must be either both convergent or both divergent.18 − 3 = −3 + 4 ⇒ = 3 is the intertemporal equilibrium price. = 22 − 3 (13) = −2 + (14) Assuming that in each time period the market price is always set at a level which clears the market find the time path . =3 = − <0. Determine whether the equilibrium is stable. (c) We need to check whether the equilibrium is stable. Find the time path of Q and analyze the condition for its convergence. is divergent so is also divergent and oscillations are As for this case the time path explosive. Find the intertemporal equilibrium price. which we can simply write as (since = by the equilibrium condition): From (11) = 18 − 3 ( = 18 − 3( 4 − 3)(− ) + 3 3 4 − 3)(− ) − 3(3) 3 Convergence of . we have 22 − 3 = −2 + (a) (b) (c) (d) 3 Instructor Dr Rehana Naz Mathematical Economics I . the time path is oscillatory. But since 4 4 | |= − = >1 3 3 The time path is divergent and oscillations are explosive. Solution: (a) Assuming that in each time period the market price is always set at a level which clears the market yields = (15) Using (13)and (14)in equation (15). (d) Substitution of the time path (11) into the demand equation (4) leads to the time path of .

Thus . the time path is oscillatory. we have + = 24 (16) 3 + + = 24 Or 1 = 8 (17) 3 This is first-order linear difference equation with = . its solution is = (− ) + 1 = (− ) + 6 3 At t=0 . But since 1 1 | |= − = <1 3 3 The time path is convergent and oscillations are damped. (d) Substitution of the time path (20) into the demand equation (13) leads to the time path of . (18) yields = Using (19) in (18). we have =( 1 − 6)(− ) + 6 3 = ⇒ (20) = =6 in the demand and +6 ⇒ = −6 (19) 1+ (18) (b) To find intertemporal equilibrium price set supply functions and equate them i. (c) We need to check whether the equilibrium is stable. which determines the convergence of = 22 − 3 ( and must be either both convergent or both divergent. 4 Instructor Dr Rehana Naz Mathematical Economics I Convergence of . which we can simply write as (since = by the equilibrium condition): From (20) 1 − 6)(− ) + 6 3 1 = 4 − 3( − 6)(− ) (21) 3 depends on the (− ) term. c=8.3 Letting → + 1 in (16).e 22 − 3 = −2 + = 6 is the intertemporal equilibrium price. = − <0.

(a) (b) (c) (d) Solution: (e) Assuming that in each time period the market price is always set at a level which clears the market yields = (24) (22)and (23)in equation (24). (27) yields = Using (28) in (27). its solution is 1+ = (−1) + 2 (27) At t=0 . 5 Instructor Dr Rehana Naz Mathematical Economics I . we have + = 4 (26) This is first-order linear difference equation with = 1.As for this case the time path damped. c=4. Find the intertemporal equilibrium price. we have =( − 2)(−1) + 2 (29) +2⇒ = −2 (28) = (− ) + = 4 (25) (b) To find intertemporal equilibrium price set = = in the demand and supply functions and equate them i. Determine whether the equilibrium is stable. we have Using 19 − 6 = −5 + 6 + Letting → + 1 in (25).e 19 − 6 = −5 + 6 ⇒ = 2 = 2 is the intertemporal equilibrium price. Find the time path of Q and analyze the condition for its convergence. is convergent so is also convergent and oscillations are Example 3: Given demand and supply for the cobweb model as follows. = 19 − 6 (22) =6 − 5 (23) Assuming that in each time period the market price is always set at a level which clears the market find the time path .

we have ∗ ∗ = ∗ + 1( − ∗ )⇒ = and the model reduces to the cobweb model. Taking = 1 in (33). > 0) (32) 6 Instructor Dr Rehana Naz Mathematical Economics I . the time path is oscillatory. = + ( ∗ ∗ ∗ is divergent so is also divergent. (d) Substitution of the time path (29) into the demand equation (22) leads to the time path of . > 0) (31) ( . ( . Thus the present model includes the cobweb model as a special case. 0 < ≤ 1 (33) = (34) What happens if takes its maximum value? Can we consider the cobweb model as a special case of the present model? Solution: Maximum value of is 1.(c) We need to check whether the equilibrium is stable. But since | | = |−1| = 1 The time path is divergent and oscillations are uniform. which we can simply write as (since = by the equilibrium condition): = 19 − 6[( − 2)(−1) + 2 ] = 7 − 6( − 2)(−1) (30) As for this case the time path Example 4: If =∝ − =− + where − ∗ ). From (29) = −1<0.

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