Transcript Free Slides from Ed Dolan’s Econ Blog http://dolanecon

Free Slides from
Ed Dolan’s Econ Blog
http://dolanecon.blogspot.com/
Chocolate Lovers Keep
Nervous Watch on Volatile
Cocoa Prices
Post prepared October 10, 2010
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The Long Rise in Cocoa Prices
 The world price of cocoa, the
chief ingredient in chocolate, has
been on a long upward trend
 August 2010 data from the
International Cocoa Organization
showed prices down some 13%
from the peak reached in
December 2009, but prices
remained volatile
 Chocolate lovers watched
nervously—will chocolate
become a luxury good?
Post P101010 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
Strong Income Elasticity
 One factor driving chocolate prices
higher has been strong income
elasticity of demand
 In the US, a 10% increase in income
has been estimated to raise per capita
chocolate consumption by 9.2%
 In Europe income elasticity is about
half that, but chocolate is still a normal
good—higher income leads to greater
consumption
The elasticity data in this post are based on a study by Henri Jason, “Trends in Cocoa and
Chocolate Consumption with Particular Reference to Developments in the Major Markets,”
Malaysian International Cocoa Conference, Kuala Lumpur, 20-21 October 1994 (ICCO, ED(MEM)
686). Data from the paper, but not the original paper itself, can be found on line at
http://www.cs.trinity.edu/~agros/factors_of_demand.htm
What could be more luxurious?
Photo by Simon James Kent,
http://commons.wikimedia.org/wiki/File:300x300_choc_rose_cake.jpg
Post P101010 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
Question: How Does Positive Income Elasticity Affect Price?
If chocolate is a normal good, how will an
increase in consumer income affect its
market price?
 Does the demand curve shift? If so, show
the new demand curve as D2
 Does the supply curve shift? If so, show
the new supply curve as S2
 Show the new equilibrium price as P2
Post P101010 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
Answer: How Positive Income Elasticity Affects Price
 If chocolate is a normal good, an increase
in consumer income will shift the demand
curve to the right. The new demand curve
is shown here as D2
 Other things being equal, an increase in
consumer income will not cause a shift in
the supply curve
 The market moves long the supply curve
until a new equilibrium price is reached at
the level P2
Post P101010 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
Short-Run Supply Effects: Growing Conditions
 Cocoa supply, like that of any farm product,
is subject to changes in growing conditions
 For example, in 2010, a virus causing
stunted shoot disease threatened the crop in
the Ivory Coast, the world’s biggest
producer
 The virus causes the leaves to turn red and
fall off, and ruins the pods
 At the same time, in neighboring Ghana, the
second largest producer, favorable weather
indicated good prospects for the harvest
Healthy Cocoa Pods
Photo source:
http://commons.wikimedia.org/wiki/File:Cocoa_Pods.JPG
Post P101010 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
Question: How Do Poor Growing Conditions Affect Price?
Suppose bad weather or a virus damages the
cocoa crop. How will the market price be
affected?
 Does the demand curve shift? If so, show
the new demand curve as D2
 Does the supply curve shift? If so, show
the new supply curve as S2
 Show the new equilibrium price as P2
Post P101010 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
Answer: How Growing Conditions Affect Price
 Poor growing conditions will cause the
supply curve to shift to the left, for
example, from S1 to S2 as shown here.
 Other things being equal, growing
conditions will not affect the demand curve
 The market moves long the demand curve
until a new equilibrium price is reached at
the level P2
Post P101010 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
Inelastic Demand and Short-Run Price Volatility
 Another factor contributing to the
volatility of chocolate prices is very
inelastic demand
 Short-run price elasticity of demand
in the US is estimated at -0.2, and
even less than that in big consumer
countries like France and Germany
 When demand is inelastic, even a
small shift in the supply curve
causes a large change in the market
price
Is there any limit to what you
would pay for these beauties?
Photo by Frank Wouters
http://commons.wikimedia.org/wiki/File:Belgian_chocolates.jpg
Post P101010 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
Example: Did Armajaro Try to Squeeze the Market?
 After dropping from their December
high, cocoa prices spiked briefly in July
 The spike coincided with an extremely
large delivery of cocoa to Armajaro, a
London-based commodity trader and
hedge fund
 Competitors accused Armajaro of
attempting a squeeze by holding
supplies off the market—a charge
Armajaro denied
 Squeeze or no, prices jumped, before
dropping again in August
For details of the Armajaro episode, see Javier Blas, The Financial Times, Jul 21, 2010
http://www.ft.com/cms/s/0/2955a560-94a1-11df-b90e-00144feab49a.html
Post P101010 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
The Bottom Line
 The bottom line? You may have
to get ready to pay more for your
chocolate—or you may not
 The complexities of supply and
demand are likely to keep
chocolate prices volatile
 But look at the bright side—if the
thought of high chocolate prices
depresses you, just remember
that chocolate itself is a reliable
cure for depression!
Post P101010 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/