The Long Rise in Cocoa Prices

1. Free Slides fromEd Dolan’s Econ Bloghttp://dolanecon.blogspot.com/Chocolate Lovers Keep Nervous Watch on Volatile Cocoa PricesPost prepared October 10, 2010 Terms of Use: These slides are made available under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics, from BVT Publishers.

2. 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/

3. 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 What could be more luxurious? Photo by Simon James Kent, http://commons.wikimedia.org/wiki/File:300x300_choc_rose_cake.jpg 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 Post P101010 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

4. 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/

5. 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/

6. 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/

7. 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/

8. 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/

9. 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 Woutershttp://commons.wikimedia.org/wiki/File:Belgian_chocolates.jpg Post P101010 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

10. 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/

11. 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/