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Microeconomic Factors Affecting Coffee Trade
Microeconomic Factors Affecting Coffee Trade
CORE
MICROECONOMICS PROJECT
AN ANALYSIS OF THE COFFEE MARKET
ASHWIN MURALI (I001) | ANIRUDHHA BHATOTIA (I006) | APALA RATH (I063)
CONTENTS
Sr. No.
Topic
Page No.
1.
Research Question
2.
Introduction
3.
4.
5.
Findings
6.
Conclusion
7.
Suggestions
8.
References
Research Question
How does weather drive microeconomic forces to affect the prices of coffee?
Introduction
Coffee is a brewed drink prepared from roasted coffee beans, which are the seeds of "berries" from the
Coffea plant. Coffee is a popular beverage and an important commodity. Tens of millions of small
producers in developing countries make their living growing coffee. Over 2.25 billion cups of coffee are
consumed in the world every day. Over 90% of coffee production takes place in developing countries,
while consumption happens mainly in the industrialized economies.
Coffee has its origins in the Horn of Africa, in the Ethiopian province of Kaffa, where in all probability
the first coffee tree appeared. Its been attested that coffee beans used to be chewed by African slaves
brought to Arab countries and coffee has been cultivated in Yemen since the 15th century.
Coffee was brought to Europe by Venetian traders in 1615, when hot chocolate and tea had already
become fashionable. Europeans then started to cultivate coffee in their freshly acquired colonies. The
Dutch started to grow coffee in India and in Java at the end of the 17th century. Eventually it spread to the
Caribbean islands and to Surinam from where it reached South and Central America. In 1825 coffee
culture started in Hawaii. In two centuries, coffee had spread around the whole world.
Coffee trade has grown since then to become the second or third largest commodity traded internationally,
mainly on the markets of London (London International Financial Futures and Options Exchange or
LIFFE) and New York (Coffee, Sugar and Cocoa Exchange or CSCE, which is a part of the New York
Board of Trade or NYBOT). It earns a lot of foreign exchange in many developing countries and some
countries still rely on coffee for up to 80% of their export revenues. Trade patterns have evolved over
time traditionally benefiting big exporters like Brazil, Columbia and now Vietnam. From 1957 to 1989
the coffee market was regulated by the ICA, which regrouped both exporting and importing countries.
Second only to oil, coffee is the worlds second most traded commodity. As the global third most
consumed beverage, after water and tea, coffee beans are in high demand everywhere. The top producing
nations each produce millions of kilograms of coffee beans that find their way into the hands of eager
consumers.
The top 10 producers of coffee beans in 2014 were:
1. Brazil 2,720,520,000 kg
2. Vietnam 1,650,000,000 kg
3. Colombia 750,000,000 kg
4. Indonesia 540,000,000 kg
5. Ethiopia 397,500,000
6. India 344,750,000 kg
7. Honduras 279,000,000 kg
8. Mexico 240,000,000 kg
9. Uganda 240,000,000 kg
10. Guatemala 210,000 kg
The two most common types of coffee beans used in making coffee are the Arabica bean and the
Robusta bean. These two beans are used more than any other variety of beans, either in their pure form
or in coffee blends.
Manpower-intensive operations
Production of coffee is also has high intensity of labour. Labour costs account for 25-30% of the
total cost of production. Labour requirements vary depending on the type of coffee produced.
Arabica plantations require double the labour requirement per hectare compared to Robusta.
Distribution system
Indian coffee caters to both, the domestic and international markets. Approximately 70% of the
coffee produced in India is exported and the remaining is consumed domestically. Coffee beans
are sold either at farm gates or at auction centers. Only about 5-10% of the production is sold
through auction sales and rest is sold through farm gates (primarily to branded players).
Pricing
Although various varieties of clean coffee seeds are available, the prices quoted on exchanges are
only for Robusta and Arabica. The prices for individual varieties are arrived at by adding a
differential, which is the premium or the discount for that variety. The differentials keep
fluctuating based on various market factors such as demand - supply dynamics and quality of the
bean.
Figure 1: illustrates the leftward shift of the supply curve due to the reduction in supply.
With Arabica coffee, which is more prone to crop disease and is more sensitive inclement weather,
suffering a 40% loss of crop due to roya or coffee rust in Columbia and 30% loss of crop in Central
America; the prices of Arabica Coffee rose up as is illustrated in Figure1. The Supply curve moved from
S0 to S1 and this caused the price for Arabica coffee to just from P0 to Pt.
Figure 2: illustrates the effect of a change in price of Arabica (Y Axis) have on the quantity demanded of
Robusta(X axis)
With the traditional Arabica coffee markets of North America and Western Europe already saturated and
with consumers of emerging markets of India, China and Brazil, where coffee is an affordable luxury for
the middle class, moving to the less expensive Robusta Coffee bean; we see a substitution effect in
motion. Even major food firms such as Kraft and Nestle have responded to the price rise by blending the
cheaper Robusta beans with Arabica in their products.
Figure 2, shows us how the rise in price of Arabica caused the units consumed of Arabica (illustrated on
the Y axis) to fall and the unit consumed of Robusta Coffee to increase (illustrated on the X axis).
Figure 3: illustrates the effect of income effect on Arabica bean (Y Axis) with respect to Robusta bean(X
axis) in the long run
However with the rapid economic development in the emerging markets of India, China and Vietnam, we
are also witnessing a rise in the disposable incomes of its citizen. As illustrated in Figure 3, we see that in
the long run with the rise in the income level of the affluent class in these emerging markets from U1 to
U2 will cause the consumes to shift their consumption preferences and demand the more luxurious and
aromatic variety of coffee: Arabica. This will cause a rise in the quantity demanded of Arabica (A to B)
and fall in the quantity demanded of Robusta.
Indian scenario
During 2013-14, Karnataka recorded an 8% YOY decrease in coffee production to 211 million kg
as coffee areas witnessed a long period of drought after receiving blossom showers, followed by
an extremely harsh monsoon.
Adverse effect of weather was less pronounced in Kerala where production declined by 0.9%
YOY to 64 million kg in 2013-14.
Even though there was a 4.3% decline in India's coffee production in CS 2013-14, production in
CS 2014-15 rose about 8.5% to 331 million kg.
The production decreased in CS 2013-14 because of Robusta production (70% of
India's production) slipping 7.5% due to an extended drought followed by a heavy monsoon
season, especially in Karnataka.
In CS 2014-15, Robusta production grew 14-15% due to favourable weather conditions in
Karnataka and additional areas sown in CS 2006-07 being harvested; the plant has an 8-year
gestation cycle.
As compared to the other states, the share of Tamil Nadu in the country's total production is fairly
small. This region is known more for the Arabica variety of coffee. During 2013-14, coffee
production marginally declined by 1 million kg to 18.7 million kg.
Conclusion
We can conclude that weather does affect the pricing of coffee.
Bad weather decreases production which affects the supply of coffee which in turn increases the
equilibrium price of coffee. This causes a substitution effect, wherein people will consume another
beverage like tea in place of coffee.
Similarly, good weather will ensure better yield, thus, increasing supply and bringing about a decrease in
equilibrium price.
Suggestions
In order to maintain the demand for coffee and to maintain the price at an affordable level, the following
can be done:
Usage of better fertilizers, pesticides and other cultivators to further support growth and increase
yield, thus, bringing down prices
Government led initiatives to ensure farmers use optimal farming practices to increase production
in light of unfavourable weather conditions
REFERENCES
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http://www.economist.com/news/finance-and-economics/21581727-plenty-coffee-too-fewdrinkers-brewed-awakening
4. Kohler, P. (2007, June 1). The Economics of Fair Trade Coffee: For Whose Benefit? An
Investigation into the Limits of Fair Trade as a Development Tool and the Risk of CleanWashing. Retrieved August 23, 2015, from
http://graduateinstitute.ch/files/live/sites/iheid/files/sites/international_economics/shared/internati
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5. Roya flushed. (2014, July 26). Retrieved August 23, 2015, from
http://www.economist.com/news/americas/21608642-how-colombia-fought-fungus-roya-flushed
6. Hallam. (n.d.). Retrieved August 23, 2015, from
http://www2.econ.iastate.edu/classes/econ101/hallam/Income_Substitution.pdf
7. Rising coffee production to lower prices (2015, May 29), CRISIL Report