Transcript Suppose we have a crop which takes a year to grow and is grown

Suppose we have a crop which takes a
year to grow and is grown only once
year,
P
e.g. Hops for Beer
SA
P1
a
Suppose now that demand
were to rise but supply cannot
respond immediately
DA
O
Q1
Q
fig
Suppose we have a crop which takes a
year to grow and is grown only once
year,
P
e.g. Hops for Beer
SA
P1
a
Suppose now that demand
were to rise but supply cannot
respond immediately
What will happen to Price?
DA
O
Q1
Q
fig
Since supply is fixed, the price is
determined by the available supply at Q1.
P
SA
P2
So price rises to P2
P1
a
DB
DA
O
Q1
Q
fig
• But next period farmers observe that the price
of hops was very high
• So now they all want to grow hops
• At P2, what will the supply be?
P
SA
At P2, the
following year
supply increases to
Q3
P2
P1
a
DB
DA
O
Q1
Q3
Q
fig
P
SA
But now Supply
exceeds demand so
price must fall to
P3
P2
P3
P1
a
DB
DA
O
Q1
Q3
Q
fig
P
SA
But next period
farmers see lower
price and decide to
supply less: Q4
P2
P3
P1
a
DB
DA
O
Q1 Q Q
4
3
Q
fig
P
SA
Notice here that we
are spiraling
through time to an
equilibrium
P2
P3
This is a stable
Cobweb
P1
a
DB
DA
O
Q1 Q Q
4
3
Q
fig
Suppose instead that the supply
curve was very flat.
P
SA
Now what will
happen to Price?
P1
a
DA
O
Q1
Q
fig
Suppose instead that the supply
curve was very flat.
P
SA
Now what will
happen to Price?
P1
a
DA
O
Q1
Q
fig
Since supply is fixed, again the price
must rise to P2
P
SA
P1
a
DB
DA
O
Q1
Q
fig
Since supply is still fixed at Q1, again
the price must rise to P2
P
SA
P2
But next period farmers
observe that the price of
hops was very high
P1
a
So now they all want to
grow hops
DB
DA
O
Q1
Q
fig
P
At P2, what will the supply be in this case?
SA
P2
P1
a
Now Supply
Increases to Q5
DB
DA
O
Q1
Q5
fig
Q
But again Supply
exceeds demand so
price must fall to
P5
P
SA
P2
P1
a
P5
DB
DA
O
Q1
Q5
fig
Q
But at P5 next
period farmers
decide to supply Q6
P
SA
P2
P1
a
P5
DB
DA
O
Q6
Q1
Q5
fig
Q
P6
But if only Q6 is supplied
demand will exceed supply
and price will rise to P6
SA
P2
P1
a
P5
DB
DA
O
Q6
Q1
Q5
fig
Q
But Now the price and quantity are
gradually spiraling away from equilibrium.
This is an unstable cobweb.
P6
SA
P2
P1
a
P5
DB
DA
O
Q6
Q1
Q5
fig
Q
Summary of Cobweb Effects
• With a demand SHIFT and supply fixed yearly, a
sudden rise in demand will see a big increase in
income.
• The lagged response next year can generate cyclical
fluctuations in prices over the next few years.
• When Q goes up and P fall, income PxQ can also
fluctuate.
• Not all cobwebs are stable
P
SRSA
Supply Side Shock
SRSE
LRS is the long-run
supply curve.
LRS
PA
SRSE is the expected
supply this year.
e
PE
SRSA is the actual
supply this year. e.g.
Bad harvest
D
O
QA
QE
Q
fig
P
Supply Side Shock
SRSA
SRSE
So price rises, what
about income?
LRS
PA
PEeQEO=ab is
expected income
c
e
PE
ac= actual income
a
Overall depends on
size of c relative to b
b
D
O
QA
QE
Q
fig
P
Supply Side Shock
SRSA
SRSE
PA
If demand is more
inelastic, c>b and
income rises.
LRS
c
e
PE
ac= actual income
a
Overall depends on
size of c relative to b
b
D
O
QA
QE
Q
fig
Supply Side Shock
P
SRSE
SRSA
But if it is a good
crop and demand is
inelastic,
LRS
c < b and income falls
e
PE
So variability in
incomes leads to
pressure for
government
Dintervention
b
PA
a
O
c
QE
QA
Q
fig