Arab Academy for Science, Technology & 

Maritime Transport
MBA
Managerial Economics

Answers of managerial economics exam 2020

Submitted to: Dr. Ashraf Helmy

Prepared by: Abdelrahman Abdallah Soliman

[ID] 20121704
Group: 1C (Tuesday - Online)
 MARKET FORCE CASE STUDY

THE GLOBAL COFFEE TRADE

STUDY QUESTIONS:

1. Why does the price of coffee fluctuate so widely?

First of all we would recall some essential notions of market and prices;

Economic theory says that the price of something will tend toward a point
where the quantity demanded is equal to the quantity supplied. This price
is known as the market-clearing price, because it “clears away” any excess
supply or excess demand.
Market clearing is based on the famous law of supply and demand. As the
price of a good goes up, consumers demand less of it and more supply
enters the market. If the price is too high, the supply will be greater than
demand, and producers will be stuck with the excess. Conversely, as the
price of a good goes down, consumers demand more of it and less supply
enters the market. If the price is too low, demand will exceed supply, and
some consumers will be unable to obtain as much as they would like at that
price.

The logic of the model of demand and supply is simple. The demand curve
shows the quantities of a particular good or service that buyers will be
willing and able to purchase at each price during a specified period. The
supply curve shows the quantities that sellers will offer for sale at each
price during that same period. By putting the two curves together, we
should be able to find a price at which the quantity buyers are willing and
able to purchase equals the quantity sellers will offer for sale.
 Here the two curves intersect at a price of $6 per pound (just example)—at
this price the quantities demanded and supplied are equal. Buyers want to
purchase, and sellers are willing to offer for sale, a certain million bags of
coffee per year. The market for coffee is in equilibrium. Unless the
demand or supply curve shifts, there will be no tendency for price to
change. The equilibrium price in any market is the price at which quantity
demanded equals quantity supplied. The equilibrium price in the market for
coffee is thus $6 per pound. The equilibrium quantity is the quantity
demanded and supplied at the equilibrium price.
So there are four main points to emphasize on here;
 The equilibrium price is the price at which the quantity demanded equals
the quantity supplied. It is determined by the intersection of the demand
and supply curves.
 A surplus exists if the quantity of a good or service supplied exceeds the
quantity demanded at the current price; it causes downward pressure on
price. A shortage exists if the quantity of a good or service demanded
exceeds the quantity supplied at the current price; it causes upward
pressure on price.
 An increase in demand, all other things unchanged, will cause the
equilibrium price to rise; quantity supplied will increase. A decrease in
demand will cause the equilibrium price to fall; quantity supplied will
decrease.
 An increase in supply, all other things unchanged, will cause the equilibrium
price to fall; quantity demanded will increase. A decrease in supply will
cause the equilibrium price to rise; quantity demanded will decrease.
Shifts in Demand and Supply

A change in one of the variables (shifters) held constant in any model of

demand and supply will create a change in demand or supply. A shift in a
demand or supply curve changes the equilibrium price and equilibrium
quantity for a good or service. Figure above “Changes in Demand and
Supply” combines the information about changes in the demand and supply
of coffee.
In our case 2 main events occurred to the initial equilibrium price of
coffee:
1- the entry of Vietnam into the coffee business and,
2- Production increases in Brazil.
Those two events caused an increase in supply of coffee in such a way that by
2001-2002, total coffee production was 113 million bags, while world
consumption was just 106 million. In addition, the world coffee stock had an
excess of 40 million bags,
An increase in the supply of coffee shifts the supply curve to the right, as shown
in Panel (c) of the Figure above. The equilibrium price falls down. As the price
falls to the new equilibrium level, the quantity of coffee demanded increases.
It’s to be noticed that the demand curve does not shift; rather, there is
movement along the demand curve.
Possible supply shifters that could increase supply include a reduction in the
price of an input such as labor, a decline in the returns available from
alternative uses of the inputs that produce coffee, an improvement in the
technology of coffee production (the case of BRAZIL), good weather, or a
political decision as in the case of Vietnam.

The Second factor to be taken in account while investigating fluctuation in

coffee prices was the concept of elasticity;
When prices fall, marginal producers leave the industry, the supply curve shifts in,
and prices stop falling. However this mechanism did not seem to operate, in the
market for raw coffee. Prices fell ever lower. As the price plummeted between
1996 and 2002, output actually continued to increase.
That was due to difficulty for farmers to switch to other substitutes (The elasticity
is low because of the absence of close substitutes for coffee).
Economic growth is as well a factor not to ignore , knowing the effect of income
elasticity of demand , that is when income improves that implies response
represented by increase in demand , that increase in demand may readjust to a
certain extent the fall in prices due to oversupply ,Especially when it concerns big
economies like India and china ( that was the case when a trend of consuming
coffee was a statement of young upwardly mobile Indians ) , china as well would
have affected dramatically the demand on coffee worldwide with its 7.3
economic growth in 2001.
There were also some natural factors that caused supply reduction and
consequently prices have gone very high ( e.g. Frosts, pests or disease in large
producing regions that damaged crops) ,
Some cartel behaviors to reduce quantity supplied in market to maintain a good
price as result

Figure showing effect of supply decrease on coffee prices

There are to other reasons left to mention from my point of view,

The formation of some organization like ICO meant to revamp the supply and
demand process of coffee in order to stabilize as much as possible the prices and
protect as well the rights of farmers setting price floors. And the other reason in
the same context was the withdrawal of the united states from supporting this
organization which led in turn to the end of ICA quota system in 1989 and
eventually a rebound of supply increase and prices down .

These were most of the reasons and different phases of fluctuations of prices in
coffee during the period covered in this case study .
 2. How can farmers respond to a chronic oversupply problem?
How do policies of consuming nations impact the potential
exporting-country responses?
Oversupply problem as we’ve seen leads to prices to decrease and the first
segment of the market of coffee to be undermined are farmers who already
suffers in poor exporting countries, So as to respond to oversupply problem
farmers should:
1- Focus on growing best quality beans to impose a minimum quality
accepted towards exporters so that bad quality products would be kicked
out of market
2- Form cooperatives or growers cartels parallel to roasters cartel to set
theirs prices themselves in a fair way
3- Find some substitutes to coffee so that they don’t have to accept low
prices from exporters , and try to develop new techniques in growing such
crops to create diversity of their production ( That economically means
that they would turn their supply responsiveness into Elastic supply )

-How do policies of consuming nations impact the potential exporting-

country responses?
Consuming nations policies towards theirs farmers include giving generous
subsidies facilitates their own farmers job in competition with other farmers
from poor countries (coffee growers) , eventually exporting – country farmers
don’t tend to any diversification in crops and focus always on growing coffee
even though prices don’t seem to cover their costs and that causes the problem
of oversupply in coffee to exacerbate .
 3. Can supply and demand be overruled by a suitably designed
international organization, or is an organization like the
International Coffee Organization doomed to failure?
International organizations mat take some adequate measures to revamp supply
and demand such as:
- Call for price floors to be paid to coffee growers to protect the rights of
farmers and encourage them in return to grow high quality products only to
avoid oversupply.
- They may as well encourage withhold an excess in production by
destructing these quantities , and this destruction process to be funded by
consumer governments and big roaster companies
- Help low productivity farmers find other substitute crops or even organize
programs to develop their agricultural literacy to improve their crops
quality.
But,
All these measures will not guarantee 100% the control of supply of
demand due to some reasons, among them:
- There always be other producers that can’t join these organizations so may
sell the products out of the organization umbrella and rules , so well always
be small roasters without the ability to meet these organizations criteria
then they would perform their purchases out of these rules .
- Some big companies would not like to lose a good profit of the inelastic
margin of the price to the interest of farmers in a faraway continent.
- Some countries and governments might withdraw from these organizations
if they found they don’t need it anymore, as the case of the United States,
while resuming its focus on free markets and no longer trying to prop up
the Latin American economies, withdrew its support for the ICA and
dropped out of the ICO. The ICA quota system ended in 1989, at which
point the ICO composite indicator price dropped 27 percent in one month
and continued to fall, resulting in a price slump that lasted five years and
caused serious economic damage for exporting countries.

Eventually WE can’t defeat Demand and Supply Law.

4. Evaluate the NGOs’ proposals for improving the market. Are
they workable?
The main reason behind the entry of NGOs in coffee trade was the unfair
prices given to farmers and market domination by giant corporates trading
in coffee like Nestle, Starbucks, and Kraft...Etc.  because of which, it has
been a long time period that coffee farmers can just earn a very meager
profit from selling their coffee to those giant corporations, which caused
the ethical issue that those giant companies make a lot of profit on coffee
products but the planters--who provide the basic materials--not able to
share the benefit from products made of their coffees. Many organizations
started a campaign called Fair Trade coffee.
The basic objective of fair trade coffee was that companies or coffee store
straightly buy coffee from the farmers and pay more to them to ensure
they can have a reasonable profit and companies or stores will charge a
little more to customers on the final product because the rise of cost.
Evolution of these organizations has led to other goals in favor of not only
farmers but also corporates, individual coffee consumers and market of
coffee as a whole, these goals were among others :

- companies committed to pay a decent price to farmers (that insures that

farmers cover their growing costs and have a fair margin of profit helping
them keep a human livelihoods )
- companies trading only in coffee that meets concerned NGO quality
standards( that insures that only good quality beans would enter the
market cycle , thus the oversupply problem might be confronted ,
similarly big corporates and consumers of coffee would profit from a good
product )
- Creation of a diversification fund to help low productivity farmers create
alternative livelihoods ( that is to overcome one of the basic issues of
oversupply in coffee due to inelastic supply hence it’s difficult for famers
to alter their crops and find substitutes especially with strong competition
from other countries farmers getting generous subsidies from the
government)
 - Establish mechanisms to correct imbalances in supply and demand to
ensure reasonable prices to producers. Farmers should be represented in
these discussions.
- Support for producer countries to capture more of the value in their
commodity products

These were some pros of NGOs, however there are always Cons to
be mentioned:
- No official control on big corporates that some companies charged the
extra money but didn't return the money to farmers, which make the
problem to become an ethical problem related to honest and conscience
- Fair Trade may cause damage to other farmers who didn't involve in the
process and some people say it didn't follow the spirit of free market.
- Domination of some countries , governments or entities on these NGOs to
work and legalize rules to its economic favor
- No absolute guarantee that big corporates would respect regulations
driven by a NGO despite the fact that Big corporates may say that in
commercials.
Finally NGOs in any field -not only in coffee trade can help strengthen
communities and can set them up for future success, but this requires working
with multiple individuals and organizations to ensure sustainability and stability.
Organizations can help Coffee growers and Coffee market by finding local
champions who care deeply about the issues and who can be held accountable
for working with local Government officials, businesses, organizations, coffee
roasters and big companies like Starbucks , Kraft and Nestle , etc. Multiple NGOs
could greatly maximize their impact if they spent some time working together to
design larger networks of individuals who are benefitting communities in different
ways so that aid is not doubled or wasted, but helps directs funds and resources
appropriately so that people get what they need. That’s how they would
Workable .
 5. Viewing yourself as a technocrat whose job is to revamp the
global green-coffee market so that it operates more in the
growers’ favor, what changes to the rules of the marketplace
and/or national policies would you recommend?
If I were a decision maker concerned with green-coffee market and seeking
farmer’s favor I would not prefer setting a price floor for coffee in the market
and let instead the price be set by the natural force of supply and demand, I
would rather:
- Encourage farmers to enhance their crops quality so that only high quality
crops could enter the market then the consumer wouldn’t accept any lower
quality , consequently big corporates would be enforced to pursue these
high quality crops and pay them more
- I would call for educational programs for farmers to emphasize on the
importance of diversification in crops and learn them not to rely on only
coffee all the time but rather find other substitutes that will turn their
responsiveness of supply to prices from inelastic to elastic so that they
don’t be victims for low prices of giant corporates anymore .
- I may call for constitutional reforms putting farmer’s life on top priorities of
the government giving them and their families access to better education,
health care, good water and services that they don’t have to accept
pressures from big corporates and not to be taken advantage of.
- I would be in favor of production quota , an annual quota of coffee in the
market for every producer country to overcome the problem of oversupply
This quota is to be discussed and determined in function of the
consumption rates which could be evaluated periodically and predicted in
advance.
- I will call for forming a coffee conference. This conference is to be held
annually and whose members would be the main producer, importing and
consuming countries to discuss the main issues and difficulties confronting
the industry, like farmer’s wages and profits, quality of beans, the quota of
the year for every country, world prices of kg or pound according to the
 market. the main difference of this conference from any other NGO
concerned with coffee is that the conference would be officially recognized
and formed under the umbrella of UN ( for instance ) so that its decision
must be respected and enforceable . Like the international petroleum
congress.
- Taxes might be levied on giant corporates ( we might name it agricultural
Taxes ) to be used as subsidies to farmers to grow certain crops to be
subsidies of coffee in case they are not able to provide the standard quality
of coffee determined by the conference decision makers and different
representatives.
This was a bundle of measures I personally would have taken had I been in a
position of decision making in the industry of coffee.
 Production and Costs Analysis

Fill in the missing parts in the following tables to illustrate the behavior of
production and costs in the short-run; then determine the optimal level of
production according to the number of inputs you are intending to use.
Output Land Capital Labor
Units Square Meters Egyptian Pounds Units
0 150 130 000 0
1000 150 130 000 20
1600 150 130 000 25
2100 150 130 000 30
2500 150 130 000 35
2600 150 130 000 40

Fc= land area * land price per m2 + 10%* Capital

Output FC VC TC MCL MPL AVC AFC ATC

0 16000 0 16000          
1000 16000 30000 46000 30 50 30.00 16 46.00
1600 16000 37500 53500 12.5 120 23.44 10 33.44
2100 16000 45000 61000 15 100 21.43 7.62 29.05
2500 16000 52500 68500 18.75 80 21.00 6.4 27.40
2600 16000 60000 76000 75 20 23.08 6.15 29.23

Despite the fact that at level of production of 2100 the marginal production starts to decrease indicating
that the law of diminishing return starts to take place, The optimum level of production is 2500 units as
at this level of production average total cost is at its minimum level (27.4) and marginal cost MC (18.75)
is below both average variable cost( 21.00 ) and average total cost (27.40 ).
 50
45
40
35
number of labor 30
25 marginal cost
20 Average fixed cost
average varied cost
15
average total cost
10
5
0
0 500 1000 1500 2000 2500 3000
output