suppose we have a crop which takes a year to grow and is grown only once year,
DESCRIPTION
Suppose we have a crop which takes a year to grow and is grown only once year,. P. e.g. Hops for Beer. S A. Suppose now that demand were to rise but supply cannot respond immediately. P 1. a. D A. Q 1. O. Q. - PowerPoint PPT PresentationTRANSCRIPT
fig
Suppose we have a crop which takes a year to grow and is grown only once
year,
DA
P1
Q1
P
Q O
a
SAe.g. Hops for Beer
Suppose now that demand were to rise but supply cannot respond immediately
fig
What will happen to Price?
Suppose we have a crop which takes a year to grow and is grown only once
year,
DA
P1
Q1
P
Q O
a
SAe.g. Hops for Beer
Suppose now that demand were to rise but supply cannot respond immediately
fig
So price rises to P2
Since supply is fixed, the price is determined by the available supply at Q1.
DA
P1
Q1
P
Q O
a
DB
P2
SA
• 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?
fig
DA
P1
Q1
P
Q O
a
DB
P2
At P2, the following year supply increases to Q3
Q3
SA
fig
DA
P1
Q1
P
Q O
a
DB
P2
But now Supply exceeds demand so price must fall to P3
Q3
P3
SA
fig
DA
P1
Q1
P
Q O
a
DB
P2
Q3
P3
Q4
But next period farmers see lower price and decide to supply less: Q4
SA
fig
DA
P1
Q1
P
Q O
a
DB
P2
Q3
P3
Q4
Notice here that we are spiraling through time to an equilibrium
This is a stable Cobweb
SA
fig
Suppose instead that the supply curve was very flat.
DA
P1
Q1
P
Q O
a
SA
Now what will happen to Price?
fig
Suppose instead that the supply curve was very flat.
DA
P1
Q1
P
Q O
a
SA
Now what will happen to Price?
fig
Since supply is fixed, again the price must rise to P2
P1
Q1
P
Q O
a
DA
DB
SA
fig
Since supply is still fixed at Q1, again the price must rise to P2
P1
Q1
P
Q O
a
DA
DB
SAP2
But next period farmers observe that the price of hops was very high
So now they all want to grow hops
fig
DA
P1
Q1
P
Q O
a
DB
P2
Now Supply Increases to Q5
Q5
SA
At P2, what will the supply be in this case?
fig
DA
P1
Q1
P
Q O
a
DB
P2
Q5
SA
But again Supply exceeds demand so price must fall to P5
P5
fig
DA
P1
Q1
P
Q O
a
DB
P2
Q5
SA
But at P5 next period farmers decide to supply Q6
P5
Q6
fig
DA
P1
Q1
P6
Q O
a
DB
P2
Q5
SA
But if only Q6 is supplied demand will exceed supply and price will rise to P6
P5
Q6
fig
DA
P1
Q1
P6
Q O
a
DB
P2
Q5
SA
P5
Q6
But Now the price and quantity are gradually spiraling away from equilibrium. This is an unstable cobweb.
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
fig
Supply Side Shock
D
PE
QE
P
Q O
e
LRS
LRS is the long-run supply curve.
SRSE is the expected supply this year.
SRSE
PA
QA
SRSA
SRSA is the actual supply this year. e.g. Bad harvest
fig
Supply Side Shock
D
PE
QE
P
Q O
LRS
So price rises, what about income?
PEeQEO=ab is expected income
SRSE
PA
QA
SRSA
ac= actual income
Overall depends on size of c relative to b
e
a
b
c
fig
Supply Side Shock
D
PE
QE
P
Q O
LRS
If demand is more inelastic, c>b and income rises.
SRSEPA
QA
SRSA
ac= actual income
Overall depends on size of c relative to b
e
a
b
c
fig
Supply Side Shock
D
PE
QE
P
Q O
LRS
But if it is a good crop and demand is inelastic,
SRSE
PA
QA
SRSA
c < b and income falls
So variability in incomes leads to pressure for government intervention
e
a
b
c