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A cobweb model with elements from prospect theory

Author

Listed:
  • Ahmad Naimzada

    (University of Milano - Bicocca)

  • Nicolò Pecora

    (Catholic University)

  • Fabio Tramontana

    (Catholic University)

Abstract

We present a cobweb model to explain price adjustment in a competitive market with homogeneous firms based on assumptions from Prospect Theory. Price changes are evaluated with respect to a psychological reference price which enters directly into the demand function. Accordingly, firms face a downward-sloping demand curve that is kinked at the consumers’ reference price. Differently from the traditional cobweb model, the economy is described by a discontinuous map. Without assuming specific non-linearities and keeping the essential underlying mechanics of the model intact, we find that the implementation of several features from Prospect Theory into our simple cobweb model may significantly influence the market dynamics. Behavioral parameters play an important role for the market stability by reducing fluctuations and by directly affecting consumers’ demand as well as production decisions.

Suggested Citation

  • Ahmad Naimzada & Nicolò Pecora & Fabio Tramontana, 2019. "A cobweb model with elements from prospect theory," Journal of Evolutionary Economics, Springer, vol. 29(2), pages 763-778, April.
    • Handle: RePEc:spr:joevec:v:29:y:2019:i:2:d:10.1007_s00191-018-0595-z
    DOI: 10.1007/s00191-018-0595-z
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    More about this item

    Keywords

    Cobweb model; Reference price; Transaction utility; Behavioral economics; Discontinuous maps; Complex dynamics;
    All these keywords.

    JEL classification:

    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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