Cobweb model: A theoretical model of an adjustment process that on a price/quantity or supply/demand graph spirals toward equilibrium.

The cobweb model or cobweb theory is an economic model that explains why prices might be subject to periodic fluctuations in certain types of markets. It describes cyclical supply and demand in a market where the amount produced must be chosen before prices are observed. Producers' expectations about prices are assumed to be based on observations of previous prices. Example: Suppose the equilibrium labor market wage for engineers is stable over a ten-year period, but at the beginning of that period the wage is above equilibrium for some reason. Operating on the assumption, let's say, that engineering wages will remain that high, too many students then go into engineering. The wage falls suddenly from oversupply when that population graduates. Too few students then choose engineering. Then there is a shortage following their graduation. Adjustment to equilibrium could be slow.

Model: In the basic model of supply and demand, the price adjusts so that the quantity supplied and the quantity demanded are equal. The precise mechanism that achieves this equilibrium is not always explicit.

The Cobweb Model shows how achieving a supply and demand equilibrium might be so automatic if, as seems reasonable, the suppliers set the price and the consumers react with a quantity demanded. For some slopes of the demand and supply curves, the equilibrium can be unstable. The Cobweb Model is the classic demonstration that dynamic behavior by economic agents might not converge to a stable equilibrium with supply equal to demand. This application provides two ways to graph the outcome and lets you experiment with the key parameter that determines whether the outcome is stable or not. The mechanism featured in the Cobweb Model is a lagged response of supply to the market price. For example, in an agricultural crop this periods supply might depend on the amount planted in the previous period and, hence, the previous periods price. An unusually high price in period 1 can lead to a large supply in period 2, which then causes a low price in period 2 and smaller amounts planted. The stage is then set for a higher price in period 3 and an oscillation between low and high prices. Deeper analysis of this process than the simulations here ventures into the issues raised by rational expectations. At that level, it is not obvious that farmers who find themselves in a cobweb pattern of oscillations would not see that their supply strategy leads to systematic mistakes