Cobweb Cycle

The Cobweb Cycle is an economic theory that describes fluctuations in prices and quantities in certain markets due to time lags between supply decisions and market responses. This phenomenon is most commonly observed in agricultural markets, where production adjustments often depend on previous price signals. The theory is based on the idea that producers make supply decisions based on past prices, assuming these prices will persist in the future. However, because production in such markets often involves a time delay—such as the time it takes to grow crops or raise livestock—market dynamics can lead to cyclical patterns of overproduction and underproduction. The idea was proposed by Hungarian economist Nicholas Kaldor.

For instance, when prices are high in one season, producers may respond by increasing supply, expecting similar profitability. By the time this increased supply reaches the market, prices may fall due to oversupply, leading to reduced profitability. In response, producers may cut back on supply in the next cycle, potentially causing prices to rise again. This alternating pattern can create a cyclical fluctuation in prices and production levels, forming what is known as the cobweb cycle.

The cobweb model can be classified into three types: convergent, divergent, and continuous cycles. In a convergent cycle, the oscillations in prices and quantities gradually stabilize over time. In a divergent cycle, the fluctuations grow larger and lead to market instability. In continuous cycles, the price and quantity oscillations persist indefinitely without stabilization. The outcome depends on the elasticity of supply and demand. If demand is more elastic than supply, the cycle tends to converge, while if supply is more elastic than demand, it may diverge.

While the cobweb cycle provides a simplified framework for understanding price and quantity fluctuations, it has limitations. The model assumes that producers are naive and base decisions solely on past prices, without considering future expectations or external factors like technological advancements, policy changes, or global market trends. Despite its limitations, the cobweb theory remains a valuable tool for analyzing market behaviors, particularly in industries with significant production delays and price volatility.