Cobweb Theory

Written by Matt Pringle
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Nicholas Kaldor was a Hungarian-born Economist who spent much of his working life at LSE and advising the British Government. He is credited with being one of the first to propose VAT. Amongst his other contributions was an explanation for wildly fluctuating and unstable prices in pork markets. This has since been broadened to include other markets and is known as Cobweb Theory.

Kaldor observed that pig prices fluctuated greatly and suggested that this might be related to a combination of very inelastic short term supply (due to the 4 month gestation period) and what economists call 'adaptive expectations'. The presentation below will lead you through step by step but simply put Kaldor suggested that farmers will adapt their expectation of the price of pork and expect it to continue at it's current level, hence if there is a shortage of pork, prices rise. Farmers expect this to continue and so breed more pigs. Unfortunately this leads price to fall. Now expecting this price to be the norm, farmers breed to few pigs leading to a shortage. There is no reason why these wild fluctuations should stabilise and hence the market may fail to reach a stable equilibrium price and some form of government intervention, such as guaranteed prices of a buffer stock scheme may be required.

While seldom specifically examined at A Level (AS or A2) Cobweb Theory can be used when discussing market failures in agricultural markets. It is also a great example of how a small understanding of Economics can actually make matters worse: According to the theory, if farmers had no understanding of prices and simply assumed they would return to where they were before then the problem would be solved as soon as demand and supply returned to normal.

 
Read 5039 times Last modified on Tuesday, 03 December 2013 18:21
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