Last decade, a lot of countries, especially the former communist ones, managed a transition from centrally planned command economies to market economies. After these years, it is still an important issue in the countries which are not completely adjusted to market economy style, to manage the transition process in order to experience less socio-economic side effects.
One of the major sources of socio-economic side effects is price dynamic behavior in transition process. As governments usually set prices lower than their equilibrium states, transition to market economy in which price will be set in the market, creates wild fluctuations in price. In a simple word, when government set a price lower than its equilibrium state, there is a gap between supply and demand, and when government starts the transition, it takes time for supply and demand to approach to their long term equilibrium state. In this period, oscillating price gives wrong signals to supply and demand, usually, exacerbating the situation. Wild price fluctuations are not desired as they can affect other prices in short term, make social complains and restraints, and make the whole transition project fail. As a result, managing transition process in order to damp wild fluctuations in price is very crucial.
Price dynamics is studied by different economists using a classical approach known as cobweb model. Cited by Meadows (1970), cobweb model was first developed by Ricci, Schults and Tinbergen all in 1930 and mathematically enriched by Nerlove in 1961. In essence, economists assume demand as a function of current price, and supply as a function of lagged price. These two basic assumptions result an equation for price depended on initial price, supply elasticity and demand elasticity. A simple version of the model suggests that price oscillation converge (diverge), if supply is more (less) elastic to price than demand.
Sterman (2000, p.798) argues that cobweb models are unsuitable for serious modeling of market dynamics. Neglecting stock flow structure of the market, formulating in discrete time, wrong results for oscillation periods which is usually less than what occurs in real life and weakness in explaining multiple oscillatory periods observed in many industries are some of the cobweb models pitfalls.
Price and production oscillation are also studied by system dynamists. In one of the classical System Dynamics works, Meadows (1970) developed a model of commodity price cycles for live stocks. His model shows how some small changes in the system lead the whole system to oscillate. Then he customized his model for simulating oscillation pattern in hog price behavior, showing the model generates the actual observed behavior.
Meadows’ notion has been used and developed by other system dynamists. Sterman (2000, p.p. 791-798) introduced a generic model of supply and demand and applied it to study price cycles in pulp and paper industry. Jones et. al. (2002) discussed capacity sustainability in the sawmill industry in the northern forest by developing a resource-price model, and discussing weak effects of price signal on sustainability of forest resources. Mashayekhi et al. (2006) developed a set of supply demand dynamic models and used them in an interactive electronic environment as a tool to teach Micro Economics.
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