What causes price fluctuations for the supplier in an agricultural market such as coffee/tea?
Coffee and tea are agricultural products, and therefore supply can be variable depending on several factors behind the control of producers (weather, disease). Furthermore, because demand and supply are inelastic, any change in supply can cause a significant change in price.
Factors which cause variable supply
1. Weather conditions
For example, an early frost can harm supply (causing a rise in prices). This is a problem for agricultural products like coffee and bananas – plants susceptible to frost.
Good weather can lead to an unexpectedly large increase in supply (which can lead to glut on the market and falling prices.
Also, disease and pests can affect the supply. If potatoes are affected by blight, it can cause potato prices to rise.
2. Inelastic demand
Demand for coffee and tea are relatively price inelastic. If the price of coffee falls, there will be a smaller percentage rise in demand. This is because there are few close substitutes to coffee/tea. Also, coffee/tea accounts for a small percentage of income and therefore a change in price doesn’t make much difference to overall demand.
With inelastic demand, a change in price causes relatively large change in the price.
3. Inelastic supply
In the short term, the supply of coffee and tea is inelastic. If price rises, farmers can’t respond by increasing supply overnight. You have to clear the ground and plant more coffee plants. It will take 3-5 years before new coffee plants start to produce beans. Therefore, there is a big delay in responding to changing prices.
4. Global market
In recent years, the number of countries producing coffee has increased. Traditional producers like Colombia have faced increased competition from new countries seeking to enter the market. More countries make it harder for coffee producers to influence prices through the use of minimum prices and buffer stock schemes.
Diagram showing price of coffee
This shows the price paid to Colombian growers for coffee. – in US cents/lb
It shows significant fluctuations in the market price.
Link between supply and price
The link between price and production is not always what we would expect.
In theory, we would expect to see a rise in supply causing a fall in price.
- For example, between 1997 to 2000, we see production rise from 90,000 to over 13,000. In this period the price falls from about 130 cents per Pound to 60 cents per Pound.
However, from 2002 to 2010, we see a rise in both price and global production. After 2010, the growth in supply finally leads to a fall in price.
One factor may be that the rise in price 2002, encouraged an increase in supply. When prices started to fall in 2011, the increased planting of coffee plants can’t be reversed so we see the continued increase in supply because of previous years planting.
What could explain a rise in production and rise in price?
There could be a strong rise in global demand. For example, new markets for coffee in China and India; rising incomes in developing countries enable it to become more affordable. In the West, there has been strong growth for coffee as it becomes a more fashionable drink. During the day, coffee has replaced alcohol as a drink of choice for workers and businessmen. If demand rises, then we can see a rise in price, despite rising production.
Coffee retail price and global production
The retail price of coffee mirrors the price paid to suppliers. With a peak in price during 2012.
Why is the price of Starbucks less volatile than the actual price of coffee beans?
If you buy a cappuccino from Starbucks, the price of coffee beans only accounts for a small percentage of the final price. One estimate puts the cost of coffee beans, close to a few cents. Most of the cost is labour costs, rent and other raw materials. Therefore, even if coffee beans double in price, it may only affect the retail price by a few cents.
Source of coffee bean statistics
- Price of raw coffee beans on commodity markets
- What explains the volatility of oil prices?
- Is the price of Starbucks fair?