Cyclical Patterns in Markets

 Producers determine production quantities in response to market conditions, but there is often a lag between when production decisions get made and when output is ready for sale. As a result, cyclical patterns can appear where markets oscillate around an equilibrium point. The “cobweb model” analyzes this pattern by dividing market activity into discrete periods and assuming that the quantity produced in each period is the quantity that would have been profit-maximizing in the previous period. The process goes like this:

 -          Suppliers bring some quantity Q1 to market.

-          Based on the demand curve, consumers are willing to pay a price P1 for this quantity.

-          Suppliers relate price P1 to their supply curve, and determine the quantity Q2 they will bring to the next market.

-          Repeat.

 This model assumes that producers always believe that the current market price will remain in effect, and are always surprised when it doesn’t. In the real world, producers would be more sophisticated in their analysis. In the real world, there may also be speculators, who buy quantities of the good at low prices and then re-sell at high prices, which will affect the stability of the market.

 Price and quantity are expected to move towards the equilibrium level. However, they can also diverge from equilibrium. This occurs when the supply curve is steeper than the demand curve. For each adjustment that suppliers make, purchasers make a much larger adjustment, throwing the next period further and further from equilibrium.