Cobweb Phenomenon: Types, Economic Effects, Mechanisms & More | UPSC Notes

The Cobweb Phenomenon is an extremely popular economic theory describing cyclical patterns of supply and demand fluctuations, assumed in markets where there exist production time lags or lags in replenishing stocks, such as agriculture. It means that the producers' decision to produce depends on the prices of past periods or cycles of surpluses and shortages. Because a period always exists between when a decision is made to produce something and that product comes to market, the market will never actually reach equilibrium, and the price and quantity fluctuations it causes graphically create a "cobweb" pattern.

About Cobweb Phenomenon

The Cobweb Phenomenon frequently appears in markets where the supply cannot adjust instantaneously to the demand because of the time it takes to produce the goods. But one of the most common examples of agricultural markets is farmers who decide what to plant based on prices from the previous season. The effect of which would be that many farmers will grow the crop if prices were high, resulting in overproduction and subsequently price dropping the following year, and if prices were low, fewer farmers will grow that crop, thus leading to underproduction and subsequently a price increase. This cycle of oscillation in price and quantity will embody the very essence of the Cobweb Phenomenon.

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Mechanism of the Cobweb Phenomenon

The main factors responsible for the Cobweb Phenomenon include the imperfections in information and the lagged response in terms of production as compared to market results. The farmers or the producers, who are working on previously determined prices, will not be in a position to determine subsequent demand; therefore, errors in production occur in cycles.

For instance, consider the wheat market. If the price of wheat is unusually high in a given year, farmers have profit expectations and plant more wheat the following year. High production leads to an oversupply that brings the prices down in the following season. Thereafter, with low prices, farmers reduce the production of wheat. That reduces production becomes an oversupply in the following year and drives the prices up again. This cycle continues to repeat as long as the producers keep basing their decisions on the past prices due to Cobweb Phenomenon.

The Cobweb Phenomenon can be graphically presented, showing the patterns over time where price and quantity move. It can either converge, diverge, or become continuous depending on the characteristics that define supply and demand elasticity in the market.

Types of Cobweb Patterns

These are the following types of cobweb patterns:

• Convergent Cobweb: This scenario involves a decrease in the oscillation of price and quantity over time and that, consequently, converge to their equilibria. This occurs if price elasticity of supply is greater than the price elasticity of demand-that is, producers are more responsive to a change in price-and the market corrects over time with increasing magnitudes of fluctuations.
• Divergent Cobweb: When the price elasticity of demand is higher than the price elasticity of supply, then the cyclical fluctuations in price and quantity will continue to increase with time. At each cycle of surplus or shortage, the system will swing increasingly more, which leads towards a higher instability and more significant price gyrations. The market can start spiraling out of control.
• Continuous Cobweb: Sometimes, the price and quantity oscillations tend to be cyclical and constant in time. This occurs when the price elasticity of supply equals the price elasticity of demand. As a result, cycles of surplus and shortage repeat without the oscillations growing or shrinking. Equilibrium is never reached, and the market tends to get locked into a cycle of constant oscillations of price and quantities.

Use of Cobweb Effect in Farming

The Cobweb Phenomenon mainly characterizes the agriculture sector. This phenomenon can be explained by the time-lag that crops entail during production. Price changes cannot be implemented in the same instant by farmers to vary their crop supply since, like everybody, farmers know that planting and harvesting a specific crop requires a definite period before its ripening. Therefore, by harvest time, market conditions may have changed quite dramatically from when the decision to plant was actually made.

For example, if farmers have increased sugarcane or cotton production during one season because of high prices, the market will subsequently be oversupplied the following season and prices will be lower. This can be very destructive in agricultural markets where farmers will often make decisions on what crops to plant based on price signals in the previous season. Consequently, there could be alternating periods of financial difficulties due to price crash and windfall profits from price spikes.

Economic Effects of Cobweb Phenomenon

The Cobweb Phenomenon shows how the inefficiencies can occur in markets characterized by delayed responses in the production side. This therefore serves to show the theoretical proposition that market prices may not accurately map the underlying supply and demand balance, thereby leading to instability and uncertainty in the market. An application of this scenario to agriculture indeed raises a lot of challenges for farmers who tend to experience volatile income levels from one year to the other due to these unpredictable price movements. The Cobweb Model is used in policy issues management by managers in the agricultural markets. This phenomenon can be stabilized by the government employing any of the following: minimum support prices, buffer stock policies, or forward contracts against adverse impacts of cyclical price fluctuations.

Cobweb Phenomenon in Non-Agricultural Markets

While it is most frequently related to agriculture, the Cobweb Phenomenon can also occur in other areas in which time lags exist between production and sale, including the assembly of manufactured goods where lead times can extend for several years. Where it takes several years to build new factories or introduce new products to market, it is possible that firms here will follow similar patterns of overproduction and underproduction based on outdated information.

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Conclusion

The Cobweb Phenomenon explains how response lags in the production chain can cause cyclical responses of prices and quantities, particularly in markets such as agriculture. If producers make production decisions depending on past prices, they risk causing a chain reaction that has the tendency to create instability in the market. The Cobweb Model is an important tool in the understanding of price volatility and problems producers face in the market, especially in the market with long periods of production.

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