In: Economics

# The Cobweb Theorem in Economics.

Explain the Cobweb Theorem of pricing. What are the different types of Cobweb in the market?

## Solutions

##### Expert Solution

THE COBWEB THEOREM -

An interesting analysis of supply and demand curves is called the Cobweb-Theorem. This theorem is especially applicable in agriculture, where there is a sufficient lag between the decision to produce and the time when the crop comes in the market and hence, output can not be quickly adjusted to price. We all know that in agriculture, the production decision is made at the time of sowing and production or output is received after the harvesting. For example, in India Rabi crop is sown in October -November but the crop is received only in April-May.

The decision to produce, say, wheat is taken on basis of previous year's price and if the price is high, all farmers increase their crop area to take advantage of this high price. However, this price may not hold good when the crop actually comes in the market. Thus, a gap between expectations and reality creates, an interesting oscillation of prices and output in the market, giving rise to a cobweb like situation. These fluctuations in prices can actually take three patterns ;

(i)  Convergent

(ii)  Divergent

(iii)  Neutral or permanently fixed

These are the three types or patterns of cobwebs, each depending on the demand and supply. If the supply is less than the demand, it results in divergent cobweb. If the supply has greater than the demand, then we have a convergent cobweb and if the demand and supply have the same we have a permanently fixed cobweb. It should be noted that it is only the demand and supply that is important and not their elasticities.

The concept of cobweb is a very important concept that explains why the output and prices of agricultural products keep on fluctuating year after year.

By the cobweb concept, it is clear that the output responds, to prices and hence the prices also fluctuate. Since this concept clearly explains this fact, it is called the cobweb theorem.

An interesting analysis of supply and demand curves is called the Cobweb-Theorem. This theorem is especially applicable in agriculture, where there is a sufficient lag between the decision to produce and the time when the crop comes in the market.

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