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Cobweb Theory

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An Economics AS Level revision presentation looking at cobweb theory and how it applies to market failure in agricultural markets. – PowerPoint PPT presentation

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Title: Cobweb Theory


1
Cobweb Theory
2
Intro
  • Cobweb Theory is used to explain fluctuations and
    instability in price and quantity within certain
    markets - e.g. agricultural markets
  • Demand for agricultural produce is affected by
  • PED which is inelastic
  • YED which is normal but inelastic
  • Population which is roughly constant
  • Supply is determined by
  • Harvest yields which are uncertain due to weather
    etc.
  • PES which is
  • very inelastic in the SR due to time lags
  • More elastic in the LR
  • Expectation of future prices - we assume
    E(Pt1)Pt

3
Stable Cobweb
  • From a position of equilibrium we experience a
    supply side shock such as a late frost.
  • This results in a reduction in Q from Q to Q1
    and a shortage from Q1 to Q2
  • There is no more supply available (due to lag
    time) and so price rises to meet demand. (b)

S

b
D
a
Q
Q
Q1
Q2
4
Stable Cobweb
  • Farmers expect prices to remain constant and so
    plant and harvest accordingly (c)
  • This leads to excess supply and as such the price
    falls until all stocks are sold (d)
  • This process continues.
  • As this is a stable cobweb, prices eventually
    meet equilibrium

S

c
b
d
D
a
Q
Q
Q1
Q2
5
Stable Cobweb
  • Why?
  • Demand is much more elastic than supply
  • This may be due to the presence of substitutes,
    meaning that when the price rises people switch
    to buying something else.
  • Supply is inelastic due to the lag time
  • An e.g. might be bacon, where people can simply
    buy another meat but farmers elasticity is
    limited by the 3 month gestation period of pigs
  • So?
  • After the initial shock to demand or supply price
    will be volatile but slowly settle back to
    equilibrium
  • Farmers expect prices to remain constant and so
    plant and harvest accordingly (c)
  • This leads to excess supply and as such the price
    falls until all stocks are sold (d)
  • This process continues.
  • As this is a stable cobweb, prices eventually
    meet equilibrium

S

c
b
d
D
a
Q
Q
Q1
Q2
6
Unstable Cobweb
  • As before, from a position of equilibrium we
    experience a supply side shock such as a late
    frost.
  • This results in the same reduction in Q from Q
    to Q1 and a shortage from Q1 to Q2
  • There is still no more supply available and so
    price rises to meet demand. (b)


S
b
a
D
Q
Q
Q1
Q2
7
Unstable Cobweb
  • As before, farmers expect prices to remain
    constant and so plant and harvest accordingly (c)
  • This still leads to excess supply and as such the
    price falls until all stocks are sold (d)
  • This process continues, however the unstable
    nature of this cobweb means that prices will
    continue to vary more and more and a stable
    equilibrium will not be reached without
    intervention.


S
b
c
a
d
D
Q
Q1
8
Unstable Cobweb
  • Why?
  • Supply is much more elastic than demand
  • This may be due to the presence of stockpiles
    etc, meaning that when the price rises more are
    released onto the market.
  • Demand is inelastic, perhaps due to lack of
    substitutes
  • An e.g. might be Wheat, it is easy to store and a
    staple part of many peoples diet.
  • So?
  • After the initial shock to demand or supply price
    will be volatile and only increase in volatility.
  • As before, farmers expect prices to remain
    constant and so plant and harvest accordingly (c)
  • This still leads to excess supply and as such the
    price falls until all stocks are sold (d)
  • This process continues, however the unstable
    nature of this cobweb means that prices will
    continue to vary more and more and a stable
    equilibrium will not be reached without
    intervention.


S
b
c
a
d
D
Q
Q1
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