Pec1123 Fundamentals Of Economics Assessment Answer

THE COFFEE CRISIS OF 2000 TO 2004 The cultivating, processing and retailing of coffee is a big industry. Yet, the late 1990s and early 2000s marked something of a crisis for coffee producers. During this period the world supply of coffee rose relative to demand, causing a slump in the price. The trend in the average price of coffee (there are many varieties and prices) between 1996 and 2009 was having reached $180 per lb in May 1997 (an imperial pound (lb) is equivalent to 454 grams). It then fell more or less continuously over the next five years, reaching around $44 in 2002: a fall of some 75 per cent. During this period, the supply of coffee increased by around 3.6 per cent a year, outstripping the 1.5 per cent annual increase in demand. The growth in supply was largely caused by new plantings in Vietnam and Brazil. In 2002 world demand was estimated to be around 106 million bags; but production was over 120 million bags with a further 40 million bags held in stock. The effect of the low price on many coffee growers, who are mainly to be found in some of the world’s poorest countries, was catastrophic. Many farmers were driven into debt; others left the land and migrated to cities, worsening the often appalling conditions there. Others switched to growing narcotic drugs, such as coca in Vietnam. As a result, the price of coffee recovered after 2004, peaking in July 2008 at $133 per lb, its highest level since July 1997. In part, this was due to farmers diversifying into other crops; in part, it was due to buoyant global demand, with the emergence of new coffee markets, such as China and Russia, and strong demand in coffee-producing countries themselves. In 2008, however, a combination of good harvests and a recovery in the coffee prices caused supply to increase substantially. Although demand was still growing in developing countries, the onset of recession in developed countries was halting the growth in demand and, as a result, the world growth in supply outstripped the world growth in demand. By the end of 2008 the price had fallen back to $103 per lb. The material in this box has largely been drawn from the ICO website. You might be wondering why the price of a latte or an espresso in your favourite coffee shop did not follow the price received by coffee growers in the early and late 2000s. Well, of the price you pay for a cup of coffee only a very small part is accounted for by the coffee beans. The rest pays for the wages of staff, overheads, advertising and profits. Fine, but why has the price of instant coffee in supermarkets not more closely followed the price of coffee? In particular, why did it not fall more noticeably during the ‘crisis years’ of the early 2000s? The answer here lies in the actions of coffee roasters. About a half of the world production of coffee is bought by just four huge companies – Kraft, Nestlé, Procter & Gamble and Sara Lee. These companies did not, in general, pass on the reduction in the price of coffee to producers but substantially increased their profits. (We will be looking at the behaviour of large firms in Chapter 5, in the section on oligopoly.) JULY2021/PEC1123 Based on the above case, answer the following questions: 1. What do you think caused the large increase in the price of coffee in 1997? Explain your answer. 2. Use supply and demand diagrams to explain each of the situations below: (a) The fall in coffee prices in the late 1990s and early 2000s; (b) The increase in coffee prices from 2004 to 2008