Cobweb Theory

Understanding Price and Supply Fluctuations

Introduction

The cobweb theory is an economic model that explains the cyclical fluctuations in prices and supply in markets where there are time lags between supply and demand.

The Cobweb Model

The cobweb model assumes that suppliers set their output based on current prices. When prices are high, suppliers will increase output, leading to a surplus. When prices are low, suppliers will decrease output, leading to a shortage. This creates a cycle of overproduction and underproduction, which can lead to price fluctuations.

Limitations of the Cobweb Model

The cobweb model is based on simplified assumptions, such as perfect competition and no market imperfections. In reality, these assumptions may not always hold true. Additionally, the cobweb model can lead to unrealistic price fluctuations.

Conclusion

Despite its limitations, the cobweb theory provides a useful framework for understanding the potential for price and supply fluctuations in markets with time lags. It can be used to analyze market equilibrium and the effects of government policies on supply and demand.