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What is the Cobweb Model?

Jim B.
Jim B.

The cobweb model is an economic model that attempts to predict the relationship between prices of a particular product and the supply and demand levels of that product. It takes into account that there is not an immediate response between supply and demand because there is a lag involved for production time. Since this lag exists, the equilibrium between supply and demand levels and the price of the product may be difficult to reach. So named because of the cobweb pattern it makes on a chart indicating the quantity produced of a certain product and its price, the cobweb model and its predictions suffer a bit when the producers of a specific good fail to act in accordance with rational expectations.

Many economic theories are based on the simple laws of supply and demand and how price levels respond. If the supply of a certain product falls, then it stands to reason that the demand will be great and the price for the product will rise. By contrast, excess supply of a product will lessen demand and cause the price to fall.

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In reality, production of any good is not immediate, and the cobweb model attempts to take this lag time into account when making its predictions on price. If it takes a year to produce a certain object and there is excess demand for that product, then that demand will continue to grow over the period of that year. During that year, prices will continue to rise as the supply continues to rapidly dwindle.

Once production is ramped up to meet this growing demand, then, according to the cobweb model, the supply will not only satiate the demand but may eventually outgrow it. Price levels, in turn, will plummet down below the level from which they began. Production levels will drop back down in response to this turn of events, supply will decrease once again, and equilibrium between supply and demand will eventually return.

There is an inherent flaw in the cobweb model that comes to light when the actions of the manufacturers of a product are taken into consideration. Most manufacturers will eventually adjust their inventory levels to anticipate the rise in demand for a certain product. This type of behavior, which is based on adaptive expectations of the market as opposed to rational expectations, will affect the price level of the product because the lag time can be reduced and manufacturers can more quickly respond to market demands.

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