Question

While sipping a cup of coffee, CEO William Corke began to reminisce. It seemed like yesterday, but it was actually more than 10 years ago when he had convinced the board of directors of National Foods, Inc., to go into the soft drink business. Here he was a decade later, sampling a product that his VP of Marketing, Samantha Gordon, was telling him would be an even stronger “growth engine” for the company than bottled water. She had pointed out to him that in 2003 Caribbean consumers spent $1 billion on coffee. Although this amount was far less than the $3 billion spent annually for tea, it was five times as much as people spent on coffee a decade ago. “It’s obvious,” she told him, “National Foods must get into the coffee business.” As he poured his second cup of coffee, Bob had to admit that even he had begun to prefer coffee over tea. He decided to call Samantha into his office to discuss the matter further. “Okay, Samantha,” Bob began, “You’ve always had a good instinct for what’s new in the market. But before we leap into this, I want a report on exactly why you believe coffee will be the real spark to our company’s growth in the coming 5 years. After all, in our business it’s all about ‘share of stomach.’ If people are drinking more coffee, then they might be drinking fewer soft drinks and bottled water, so we’d be cannibalizing our own products. I’d feel much better if you could help me understand why this wouldn’t be the case. Furthermore, what are the key determinants of the demand for coffee? Could this be just a fad? Already people are starting to tire of their low-carb diets.

Required

a. Based on the scenario, prepare a response to the CEO describing how five key demand determinants that could affect the demand for coffee.

b. Based on your response to question 1 above, write the expression for the following for coffee: a. Demand function ( 5 marks) b. Demand curve

c. How might people respond to changes in the price of competing products such as bottled water and carbonated soft drinks?

d. Explain the factors that would determine if coffee is a ‘luxury’ good, or a necessity.

Answer 1

a) five key determinants that could affect the demand for coffee are as follows:

• Price of coffee: It is the price of coffee itself that determines its demand.
• Price of bottled water: Price of competing products such as bottled water affect the demand for coffee.
• Price of soft drinks: Price of soft drinks also affects the demand for coffee as they are competing products.
• Income of the consumer: Incomes of the consumers also affects the demand for coffee as more the income, people might consume more coffee.
• Taste and preference: It is again one important determinant as its all about people's preferences and tastes about whether they would like to consume tea or coffee or vice-versa.

b)

• Demand function:

D = f ( price of coffee, price of softdrinks, price of bottled water, income of consumers, tastes and preferences)

which tells that demand for coffee is function of above 5 determinants.

• Demand curve formula:

Q = a - b P

Here Q represents amount of quantity demanded of coffee.

P represents price of coffee.

Since there is inverse relation between demand and price of coffee, demand curve is downward sloping as depicted by the demand curve equation.

c) Carbonated soft drinks and bottled water can be seen as the substitutes to coffee. Thus, if price of any of these increases, demand for coffee will increase or vice-versa.  Here, cross price elasticity will be positive.

d) To determine if coffee is luxury good or necessity good can be depicted by income elasticity of the good. Income elasticity refers to the change in quantity demand due to increase in the income of the consumer. In case of luxury good, Income effect is positive. As with increase in income people buy more of their luxuries which is not so in necessity case. Here coffee is a luxury good. Coffee consumption depends upon rising incomes.