The Sharp Rise in Coffee-Bean Prices, and the Significance of Elasticities for Producer Revenue

Answer

Part (a)

The price of coffee beans is set by the interaction of demand and supply. The events shifted both, and a sharp price rise follows from a dominant supply contraction acting on inelastic demand.

Supply factors (the dominant force). Rising freight costs raise the unit cost of producing and shipping coffee beans, lowering potential profit per unit, while dry weather in Brazil — a major producer — disrupts harvests. Both reduce supply, shifting the supply curve leftward.

Demand factors (offsetting and smaller). Demand for coffee beans is a derived demand from the demand for coffee. The global recession lowers incomes and purchasing power, reducing demand for coffee (a normal good) and hence for beans. Working against this, the lockdown lifted demand as people drank coffee to improve their mood — a favourable change in tastes and preferences. The net demand shift is small and ambiguous.

Why the rise is sharp. With the supply fall outweighing any demand change, price rises — but the magnitude depends on elasticities. Demand for coffee beans is price-inelastic (few substitutes; an essential input to coffee), so the supply contraction raises price more than proportionately. Supply is also price-inelastic in the short run — coffee plants take time to grow and harvest — so any demand increase, too, raises price sharply. The combination of a dominant supply fall and price-inelastic demand explains the sharp rise.

Part (b)

Total revenue is price times quantity, and the sharp rise in coffee-bean prices feeds into coffee-beverage producers’ revenue through their costs. My thesis is that PED is the most significant elasticity for explaining revenue effects in the short run, but YED matters too given the recession, and XED least — though significance ultimately depends on which factor drives the change.

PED is significant. Higher bean prices raise the unit cost of producing coffee beverages, reducing their supply, raising their price and lowering quantity. Whether revenue rises or falls depends on PED. For beverages with close substitutes — hawker-centre coffee, with rival stalls nearby — demand is price-elastic: a price rise causes a more-than-proportionate fall in quantity, so revenue falls. For differentiated artisanal coffee offering a unique experience, demand is price-inelastic: the price rise causes a less-than-proportionate fall in quantity, so revenue rises. PED thus explains divergent revenue outcomes across producer types.

Against this: if the price change is driven mainly by demand factors rather than the cost pass-through, PED is less central — a large taste shift toward coffee, or a recession-driven income fall, would make demand-side elasticities more relevant.

YED is significant. Because the recession lowers incomes, YED shapes how demand — and hence revenue — moves across beverage types. Hawker coffee may be an inferior good (negative YED): as income falls, its demand rises, so its sellers see revenue rise or fall less. Premium chains differ — a luxury beverage with high positive YED (> 1) suffers a more-than-proportionate demand fall, so revenue falls sharply, while a higher-necessity premium coffee (YED < 1) sees only a small revenue fall.

Against this: if income is not the dominant driver — say a strong taste shift toward coffee among younger consumers dominates — YED is less significant.

XED is least significant. XED measures how the demand for one beverage responds to the price of another. Here the price shock originates in a shared input — coffee beans feed all coffee-beverage producers — rather than in the price of a single substitute or complement, so XED adds little to explaining revenue changes across coffee producers.

Judgement. The significance of each elasticity depends on which factor drives the price change and on the time period. If the rise in beverage prices is driven chiefly by the higher cost of beans — and beans are a large cost share — then PED is the most significant elasticity in the short run for explaining producers’ revenue. Over time, as freight disruptions ease and farmers adopt more resilient methods, the cost shock fades and PED’s relevance diminishes; if the dominant driver is instead falling income, YED becomes paramount. A practical caveat qualifies all three: elasticity values are hard to measure and shift as substitutes and tastes change, and the ceteris paribus assumption rarely holds, so no single elasticity fully determines revenue. On balance, PED is the most significant for these events in the short run, with YED a close second given the recession, and XED largely immaterial.