COBWEB MODEL:
Concept of dynamic stability: A market equilibrium is said to dynamically stable only when disequilibrium price and quantity move and over time reach to any equilibrium, otherwise it is dynamically unstable. Movement of price and quantity in disequilibrium over time depends on behaviour of the market. Hence, analysis of dynamic equilibrium and stability depends on behavioural assumption of the market. Dynamic analysis is of two types. Here we consider discrete time analysis. Below we discuss Cobweb model in details.
Cobweb model analyses dynamic equilibrium and stability of a competitive market with the following behavioural assumptions:
• We consider linear demand and supply functions for simplicity.
• Both demand and supply functions depend on time, where time is a discrete matter (in that sense it is a dynamic model).
• Supply quantity at any time, t, depends on previous period's price and
St = c +d Pt-1 ------------------ (i)
But demand quantity at any time, t, depends on the price at that time
Dt = a + b Pt ----------------- (ii)
That means demand quantity is instantaneously determined at the existing price but there is a lag in supply quantity with respect to price since supply of output requires some amount of time.
• Behaviour of the market is such that as soon as supply quantity comes into the market, entire quantity is demanded at that period by adjusting price so that market is clear in each period. Thus, at any time,
t, St = Dt ----------------(iii)
Since demand and supply functions are linear, a, b, c and d are constant. On the basis of these we now analyse dynamic equilibrium and stability.