Cobweb Model

Published Mar 22, 2024

Definition of the Cobweb Model

The cobweb model is an economic theory used to explain fluctuations in prices and quantities in markets with supply time lags. It suggests that producers base their supply decisions on prices prevailing in the market in the previous period (or periods), leading to a cyclical pattern of over- and under-production relative to demand. This cyclical pattern resembles the appearance of a spider’s web when prices and quantities over time are plotted on a graph, hence the name “cobweb model.”

Example

Consider the market for wheat as an example. Assume it takes a full year to grow and harvest a wheat crop. If the price of wheat is high this year, farmers may decide to plant more wheat, expecting high profits. However, because all farmers respond similarly, the market ends up with an oversupply of wheat next year, causing prices to fall. In response to the lower prices, farmers plant less wheat, leading to underproduction and higher prices in the following year, and so on. This cycle can continue, creating a cobweb effect on a graph where the supply and demand curves intersect.

Why the Cobweb Model Matters

The cobweb model is significant for economists and policy-makers because it highlights the importance of expectations in economic decision-making and the potential for market instabilities. It shows how incorrect or outdated expectations about the future can lead to inefficient market outcomes, such as wasteful overproduction or harmful shortages. Understanding this model can help in designing policies to stabilize markets, such as providing farmers with better forecasts, subsidies for storage to smooth out supply, or policies that stabilize prices.

Frequently Asked Questions (FAQ)

What conditions lead to the cobweb model’s convergence or divergence?

The convergence or divergence of the cobweb model depends on the relative elasticities of supply and demand. If the demand curve is more elastic than the supply curve, the cycles of over- and under-production will gradually diminish over time, showing a converging cobweb pattern. Conversely, if the supply curve is more elastic than the demand curve, these cycles will become increasingly volatile, leading to a diverging pattern. This highlights the model’s dependency on the behavior of producers and consumers in response to price changes.

Can the cobweb model apply to modern markets with advanced forecasting methods?

Yes, the cobweb model can still apply to modern markets. While advanced forecasting methods and technology have improved producers’ ability to predict future prices and demand, uncertainty and time lags in production still exist. Markets for agricultural commodities, for instance, remain susceptible to the cobweb phenomenon due to their dependence on growing seasons and weather conditions. However, modern technology can mitigate the model’s effects by enabling quicker adjustments and better-informed decision-making.

Are there real-world examples where the cobweb model has been observed?

Real-world occurrences of the cobweb model have been observed in agricultural markets, as with the earlier example of wheat. Another notable example is the pork cycle in livestock farming. When pork prices rise, farmers increase their herd sizes. Since it takes time to breed and raise pigs, the market eventually experiences an oversupply, leading to a drop in prices. Farmers then reduce their herd sizes, causing a future under-supply and a subsequent increase in prices, perpetuating the cycle. These cycles are well-documented instances of the cobweb phenomenon.

What role do government interventions play in the cobweb model?

Government interventions can play a significant role in mitigating the cyclical fluctuations predicted by the cobweb model. Through subsidies, price controls, production quotas, and stockpiling, governments can help stabilize prices and quantities in markets susceptible to cobweb dynamics. For instance, by offering price guarantees or subsidies for storage, governments can reduce the risk faced by producers, encouraging a more stable production level that aligns closely with demand and reducing the magnitude of the cyclical price and quantity variations.