Question

Consider the following editorial that appeared in the Wall Street Journal in the late 70’s, after a significant freeze in Latin America that destroyed a number of coffee plants:

Coffee prices, it seems, are coming down again, after hitting a record high of $4.42 last year. As Agriculture Department economist, who had predicted $5 a pound coffee this year, says he “underestimated the power of the consumer movement.” Perhaps, or maybe, as with so many economists these days, he simply forgot his freshman economics, which has nothing to do with “movements.” The coffee market is behaving the way the basic textbook says the market behaves: Prices go up, demand falls, and prices come down.

Suppose coffee had started out at an equilibrium price of $1 per pound prior to the freeze. Draw a demand/supply graph and show the initial equilibrium. Label all axis, curves, and equilibrium price and quantity.

Show graphically the effects of the freeze in your graph from part a. Let the new equilibrium price = $4.42. Does either the demand or supply change (that is, actually move)? Why or why not? Which direction?

Based on your answers in parts a and b above, critique the WSJ’s editorial. What’s wrong with their analysis?

Answer 1

Coffee market starts at the equilibrium where E shows the equilibrium and the equilibrium price is $1 per pound and quantity is Q0 prior to the freeze. Demand slopes down and supply slopes upward.

A freeze leave detrimental effects in the supply by destroying the coffee crop. Because there is a change in non price factor, we experience a (leftward) shift in the supply curve. This is shown by the new supply curve S'S' which is now at a lower quantity supplied per dollar. The new equilibrium is at F where the new equilibrium price is $4.42 and quantity is Q1.

This analysis shows that it is the supply change and an actual change in leftward direction. The analysis is wrong because it assumes a wrong preposition that Prices go up, demand falls, and prices come down. It ignores the supply effect and explains that when price is high, demand shifts leftwards and this reduces the price which is incorrect.