Agricultural supply and demand dynamics in the global coffee market

Coffee Market

My good is coffee beans, which are an agricultural commodity. The first factor that goes into the supply of coffee is weather. Coffee is a relatively fussy plant, and grows well only in the tropics, at a certain altitude, and in volcanic soil (CoffeeResearch.org, 2006). As a result, there is a limited range in the world where coffee can be grown. The world's leading producers are all countries where coffee has been introduced, as the plant spread out from Ethiopia and Yemen. While coffee is grown around the world, there are a handful of major producers, so agricultural conditions are a major determinant of supply. In the case, it was a bad year for Brazilian coffee that threatened to increase the price of coffee beans, since Brazil is the world's number one producer. Climate conditions are actually threatening the global coffee supply in the long run (Carrington, 2014).

The number of suppliers is also a consideration for the price. This is mitigated somewhat by the fact that a coffee plant will not be productive right away, but then will remain productive for 50-60 years. This contrasts with annual crops, where the supply can change drastically from one year to the next. However, producers typically have good soil, which means that they can produce many other crops, should they so desire. Over the (very) long run, if coffee prices were low, producers would surely switch to other crops.

2.

Coffee demonstrates inelastic demand (Perez & Doan, 2014). Coffee is not technically addictive, but it is habit-forming. Thus, coffee drinkers are likely to consume their coffee in relatively similar ways each day, as part of the habitual actions of their daily lives. This keeps coffee demand relatively stable over time, growing largely with the population, and with increased prevalence. Coffee also has a social dimension that brings with it new demand from people joining in existing social rituals.

The main drug, caffeine, can be readily substituted, but research has shown that the habit-forming, ritualistic nature of coffee consumption means that few consumers are willing to switch from coffee to either tea or caffeinated sodas as a matter of substitution in the long run. It is possible, but unlikely, unless the price differential between coffee and tea became much, much greater than it is now. This is also the case for availability -- only if there was no coffee would people look to alternatives (Perez & Doan, 2014).

3.

Supply and demand is a concept that discusses the relationship between the two. In general, supply will meet demand, where this is physically possible. Thus, if global coffee demand doubled, the unconstrained version of the model would show that coffee supply would also double. The key here is that the unconstrained model does not exist with coffee. Coffee's relative fussiness as a plant means that it cannot simply be grown anywhere, so it is entirely subject to the whims of both weather and politics. Perez & Doan (2014) note that all coffee today comes from two or three mother strains from Ethiopia 2000 years ago. There are a further 1000 types of coffee plant in Ethiopia, and with greater exploration of those, and modern gene-splicing techniques there might yet be significant potential for coffee to grow in supply. But at present, demand growth is outstripping supply growth. This means, under any reasonable economic model, that the price of coffee is going to increase in response, as buyers essentially compete for supply.

Price is determined by the equilibrium point between supply and demand. The Perez and Doan article, however, notes that the price is rising, but that is not hurting demand much. Such is the condition of price inelasticity. Normally, when the price of a good increases, demand for that good decreases as consumers either substitute or do without. Given that coffee drinkers are unlikely to do either, the price continues to rise and demand declines little. The result is that the demand line shifts upward so that the price level for a given level of demand is increasing.

Consumers do still have a choice, of course. Tea is usually the major substitute, because it has both the caffeine and the ritualistic nature. But there are other caffeinated products, as caffeine itself is relatively easy to produce. So consumers see something in coffee that is difficult to substitute. Many cultures use tea in the same way, so it is a good substitute, but culturally most places are either majority coffee drinkers or majority tea drinkers. In a coffee-drinking culture there is much less propensity to substitute tea, because the ritual and social elements of consumption will be lacking.

4.

A price floor in the coffee market will not affect demand much. Ok, first we should state the assumption that the government is question is from a coffee-producing nation wishing to deliver a target earnings level for coffee farmers. So the farmers have more incentive to produce, to find new land to bring under cultivation. They might chop down banana trees or whatever to find that land. More land is under coffee cultivation than would otherwise exist under equilibrium conditions. Production of coffee therefore not only increases, but increases more than it should. Except for one problem.

Let's say Guatemala sets the price floor. Mexico and El Salvador and Honduras do not. At that point, Guatemalan coffee is going to suffer. Those other countries will win all of the business, eliminating any production surplus in those nations. Guatemala will have a higher production surplus. First, it is already uncompetitive. Second, the price floor has encouraged in increase in production, even though it resulted in a decrease in demand. All of the excess production in the industry has been shifted to/created in Guatemala as the result of the policy. A country with a genuinely superior product for which no consumer would substitute -- let's be real, Ethiopian coffees cannot be substituted -- can institute a price floor without this happening, but most countries cannot institute a price floor without consumers substituting to another producer.