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Students Zone - Answers to Case Study Questions

CASE STUDY 2.2: THE COFFEE MARKET

Show in terms of supply and demand why coffee has fallen so much in price recently?

Answer

The supply of coffee has increased (supply curve has shifted outwards) with countries like Vietnam producing a great deal now, but also the demand has fallen (demand curve shifting inwards) as substitute goods have increased in popularity. Therefore the price has fallen

Why would the ending of the ICA lead to a drop in price?

Answer

Until 1989 the coffee market was managed by the International Coffee Agreement (ICA) – producers and consumer nations agreed supply levels via export quotas for producers and the aim was to keep price high and stable inside a band or corset of £1.20lb to $1.40 lb which could only be exceeded if the price rose above the ceiling level.

But this agreement went the way of most such agreements and disagreement between members led to its breakdown in 1989 – a major factor being opposition from US which left the ICA subsequently. Now although the agreement still exists it has little power to control supply and prices.

For the producers the agreement meant good and stable prices – between 1975-1989 futures prices were rarely below $1.20 floor. But once the agreement broke down prices dropped and apart from 1995/1997 (which were due to frost ruining Brazil crop and causing shortages) – prices have fallen very low sometimes below the cost production.

Prices are now determined on the 2 big futures markets in London and NY – London deals mainly with robusta and NY arabica. The price is controlled by the large number of contracts for coffee which far exceeds the physical amount changing hands. Supply and demand factors are part of these contracts and affected the prices set (see above).

What would happen if producers produced less coffee?

Answer

Basically this is cutting supply and pushing up price. In 1993 coffee growers agreed to hold back from the market and force up the price. But the problem is there are lots of growers and it is hard to keep them all in line – especially with prices rising – the old cartel problem of cheating is shown here. This is what happened in 1989 when the previous agreement broke and the price of coffee dropped by 33% in one week.

Also you cannot actually just stop supply (the bush is growing and need supply later) so have to store and this costs money.

4 What are the alternatives for coffee producers?

Answer

Other crops – should diversify – often there are other crops eg. Uganda has cotton, tea and tobacco and has started to diversify into various other products but the problem is so is the rest of Africa – when one spots a new opportunity, all the others start joining them and so the price collapses.

Alternatives are often also in crisis eg sugar, rice, cotton also have long-term price falls and similar problems to coffee. Also takes time to change and the costs of replacing their coffee tress is high – even if land is suitable, they could lack the skills/training to grow the new crop and also they have little savings so they can wait until the crop bears fruit.

Furthermore there are longstanding problems of rural underdevelopment – poor transport infrastructure, lack of credit, restricted access to markets and so limited information about best prices. Most likely other crop – drugs – in Peru, Colombia, Bolivia conditions for growing coffee are very similar to those for cocaine and have been under high pressure to move from latter to former but fall in coffee price does not help encourage this.

Process own coffee – 2000/1 94% of all coffee exported was green bean state – of the 6% remaining most came from 3 countries Brazil, India and Colombia – problem of low value added. Reason is to process own is difficult in practice. Once you roast a bean then it starts to go off and lose its freshness, which is why coffee is roasted, ground etc in the North. Also need complex machinery which is expensive – to build processing plan for soluble coffee = approx $20m plus – roasting and grinding is cheaper but would still suffer from such things as ability to produce quality packaging locally.

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