Question

Explain the cobweb model.

Answer 1

The cob-web model is a model of economics theory which explains why price may be the subject of periodic fluctuation of some markets. It shows the cyclical supply and demand in a market where the amount produced should be selected before the prices are observed. Producer's prices expectations are based on the price of the past year prices. This theory was given by the Nicholas Kaldor in 1934 and this theory were became famous by the name of Cobweb theorem.

In agriculural model the cobweb model can be applied because there is time lag between planting and harvesting. For example, the agricultural crop rubber and corn. suppose if there is less production of rubber due to bad weather this year, when the farmers reach in the market with less quantity of rubber but demand for the same quantity of rubber is more compare to the supply. This leads to high prices for the rubber. Therefore the farmer next year produces more in the expectation of high prices and when the farmers reach in the market then there is large supply of rubber and the demand is same, As a result the price of the rubber will go down this year due to large supply compare to demand. If they expect that the price will continue low next year, then the farmers decrease the production next year which causes high prices next year again.

This model can be described by the above diagram. the initial equilibrium was detemined by the intersection of supply and demand for rubber. But due to bad weather the supply of rubber declined to Q1 and prices rises to P1. but when the farmers in the second period expect high prices and increase the supply of rubber at Q2, then at Q2 the supply is higher than demand, therefore the prices comes down to P2. As can be observed this process repeats itself, oscillating in the period of low supply with high prices and high suppy with low prices. The outcome of the cobweb model is 2