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Cobweb Model

The document describes three models of price expectations in a pigs market: 1) Static Expectations model assumes prices simply repeat from the previous period without incorporating new information. Fluctuations occur around the equilibrium price. 2) Adaptive Expectations model assumes agents gradually correct forecasts based on past forecast errors. The price converges if the adjustment rate is sufficiently high. 3) Rational Expectations model (not described) assumes agents form optimal predictions using all available information.

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Richard Fernando Chaparro
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74 views

Cobweb Model

The document describes three models of price expectations in a pigs market: 1) Static Expectations model assumes prices simply repeat from the previous period without incorporating new information. Fluctuations occur around the equilibrium price. 2) Adaptive Expectations model assumes agents gradually correct forecasts based on past forecast errors. The price converges if the adjustment rate is sufficiently high. 3) Rational Expectations model (not described) assumes agents form optimal predictions using all available information.

Uploaded by

Richard Fernando Chaparro
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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1

The Cobweb Model

Consider the pigs market. Let the demand be linear. Furthermore the demand xd is hit by stochastic t shocks ut : xd = a bpt + ut t a; b > 0

that is ut causes a level shift but not a shift in the slope. The linear supply curve is also hit by a stochastic term vt xs = c + dpe + vt t t c; d > 0

where pe is the expected value of (future) pt : Market clearing: t xd = xs t t For forecasting the next periods price we have three possible ways.

1.1

Static Expectations
pe = pt1 t

Denition 1 We assume

that is we simply expect todays observed price for tomorrow and we do not use any (new) information available today. Market clearing yields: xs t c + dpt1 + vt bpt pt = xd t = a bpt + ut = a c dpt1 + ut vt ac d ut vt pt1 + = b b b

We have a rst order stochastic dierence equation. a c ut vt d + 1 + L pt = b b b 1 d ac ut vt + 1+ L pt = d b b b 1+ b 1 X d i uti vti ac + pt = b + d i=0 b b Let p denote the intersection of the deterministic parts of the demand and supply curves. p = ac b+d

The particular solution of the stochastic model is then given by: pP t


1 X d i uti vti =p + b b i=0

1 1 Since fut gt=1 and fvt gt=1 are stationary processes pP uctuates around p . The homogenous part t of the solution is given by: t d p0 pH = t b

If d < b the solution is converging to the equilibrium price p : If d > b the deviations from equilibrium are getting bigger and bigger.

1.2

Adaptive Expectations
pe = pe + h pt1 pe t t1 t1

Denition 2 We assume 0<h<1

that is agents correct their forecast by h-times the forecasting error. Market clearing yields: c + dpe + vt t bpt pt Plugging in the price forecast: pt = ut vt ac d e + pt1 + h pt1 pe t1 b b b pt1 = Multiply by h 1 yields: (h 1) pt1 = (h 1) d ac ut1 vt1 (h 1) pe + (h 1) t1 b b b (2) ac d e ut1 vt1 pt1 + b b b (1) = a bpt + ut = a c dpe + ut vt t a c d e ut vt pt + = b b b

For t 1 the market equilibrium is given by:

Adding equation (1) and equation (2) yields: pt + (h 1) pt1 = h ac h d (pt1 ) + b b pt = h ac + 1 h h d pt1 + b b
ut vt b ut vt b

+ (h 1) ut1 vt1 b

+ (h 1) ut1 vt1 b

This time the homogenous solution is given by: t d pht = 1 h h p0 b This process is stable if 1 < 1 h h d <1 b

holds. The last inequality implies: 1hh d b d h b d b < 1 < h > 1

This is obviously always true. Regarding the rst inequality 1 < 1 h h h 2 < h 2h > h | {z }
>1

d b

d b

d b

Meaning that even if d > b there are possibilities that the price converges.

1.3

Rational Expectations

see your notes

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