Coffee Market

The following passage is based on newspaper articles and refers to the market for coffee.

Supermarkets recently ended ten years of cheap coffee when some raised the price of their own brands of instant coffee by up to 12%. Major producers of ground coffee said that their prices would also increase, but probably not for some weeks.

 

Reports of severe frost damage to Brazilian coffee plantations sent the open market price of coffee beans for September delivery up from $3,100 a ton to $4,000 a ton — the highest level since 1986. The price has risen five-fold since 1993. Even before the frost damage, the price had been rising because some coffee farmers, discouraged by the previous low price of coffee, had moved to other, more profitable crops. The depressed price of coffee before 1993 was partly due to the collapse of the international Coffee Agreement. This Agreement, effectively a cartel, had kept prices artificially high. When the Agreement broke down, supplies flooded into the market and the price of coffee fell.

 

The current price increases will end a golden age of cheap coffee for consumers. From 1986 to 1993, the retail price had fallen by more than 15%; given that these years were ones of rapid inflation, the real price of coffee fell even more steeply. This caused a boom in coffee drinking and the sales of coffee in the UK exceeded those of tea. Now it looks as if there may be a switch back to tea. This may be similar to the switch to tea which happened in the 1970s — the last time when coffee prices rose sharply. During that period, many coffee drinkers, especially young people, switched their consumption to tea.

 

Requirements:

Using BOTH your knowledge of economic theory AND information in the passage

(a) (i) Identify and explain TWO reasons why the price of coffee has risen recently, using an appropriate diagram

(ii) explain the concept of 'price elasticity' and 'demand' AND show how it isimportant in determining the size of the rise in coffee prices

(iii) Explain the meaning of the statement 'the real price of coffee fell even moresteeply'.

(b)Explain the concept of 'cross elasticity of demand' AND use it to explain therelationship between the level of coffee prices and the demand for tea.