5.2 The Cobweb theorem

One reason for deviations from the market equilibrium can be the timing of decisions. If, for example, a production cycle is very long, producers decide to produce a certain quantity of goods corresponding to the current price of goods, which might have changed by the time the good is actually offered on the market. In this case, supply determines the quantity that is sold and demand determines the price at which this happens.

A typical example of this process is the so-called pig cycle. A typical example is the labor market. The decision for a certain apprenticeship is often determined by the current demand on the labor market. A few years later this often leads to an oversupply of workers.

This is illustrated in the figure above.1

Let us start this analysis at the point marked "Start" on the aggregate supply curve: Based on their expectations, the suppliers have produced the offered quantity. The consumers push down the price due to the high quantity produced (vertical line, intersection with demand curve). At this low price, it is only for a few suppliers worthwhile to continue producing (horizontal line). According to this supply, the demand pushes the price upwards again (vertical section), which in turn causes the suppliers to produce more (horizontal section) etc. (If the point "supply" is below equilibrium, the cycle starts with the price increase).

Although this sequence of action between consumers and suppliers is essentially always the same, it can lead to different results: Either the market equilibrium settles at the intersection of the demand and supply curve, or no equilibrium at all is achieved. The decisive factor for the result is the slope2 of the demand and supply function: If the supply curve is steeper in value than the demand curve, an equilibrium is established. If, however, it is flatter and the stability condition is therefore not met, no equilibrium is achieved; this is known as an "explosion" of the system. By shifting the demand and supply curve in the above figure, this situation can be illustrated.

1This graph is a so-called intertemporal or dynamic illustration, i.e. events at different points in time are shown within one graph. This approach makes it possible to see the development over time.

2Instead of the term slope, the term elasticity is often used. These are not identical, but the following connection applies: the steeper a curve is, at a given point, the less elastic it is.

(c) by Christian Bauer
Prof. Dr. Christian Bauer
Chair of monetary economics
Trier University
D-54296 Trier
Tel.: +49 (0)651/201-2743
E-mail: Bauer@uni-trier.de
URL: https://www.cbauer.de