Evidence and the Cobweb
Some critics went so far as to say that the cobweb cycle could not occur at all in an economy populated by rational beings. Such rational economic creatures would not make the mistake of basing their decisions on current prices. Instead, rational farmers, having studied economics, would know that prices are determined by supply and demand in agricultural markets. So they would estimate that the price for the coming year would be the average supply-and-demand price in the conditions. They would take the supply for average values for weather and other unpredictable circumstances, and set it equal to demand. That gives an equilibrium price, and that's the price the farmers would plan for.
Of course, the averages don't change from year to year -- that's what makes them averages. Thus, prices in agricultural markets would be more stable than supply, not less. (And to the extent that farmers might not be able to guess the averages accurately, professional speculators would have an interest in figuring it out and buying and selling to profit as the prices moved toward the average. In a world of perfectly rational economic men, it was argued, speculation would stabilize agricultural markets).
This was the first proposal of the hypothesis of "rational expectations." This hypothesis has seen its most important applications in macroeconomics, and a Nobel Memorial Prize has been awarded for those applications -- but not to the discover of the Rational Expectations Hypothesis, Dr. Richard Muth.
Even so, it may not necessarily be "irrational" to base supply decisions on the current price, at least in part. As we have seen, there are many causes of price fluctuations in agriculture -- technological changes, which are largely irreversible, weather changes, which reverse themselves as often as not, and demand changes and other influences, which may or may not reverse themselves -- who knows? And farmers know all this, and taking it all into account, current prices may contain some information about probable future prices. If so, then it is "rational" to base supply decisions partly on current prices.
So what does the evidence tell us?
Evidence and the Cobweb
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