write a summary and explain by a graph, Case1
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"Buy Low and Sell High"
In 2000, overproduction in the
international coffee market caused the price of coffee to drop below production
costs. In December 2001, coffee prices reached a low of 41.5 cents per pound,
the lowest price in more than 30 years. Farmers in countries such as Angola, Honduras,
Sri Lanka, and Zimbabwe even stopped tending their coffee trees in an effort to
save on spending for fertilizer and maintenance. Part of the problem was the
usual cyclical swings in price caused by the movements of supply and demand.
Recall our discussion of the short- and long-run movements in price. In
response to a high price, supply increases. There is often a tendency for supply
to overshift to the right, causing prices to plummet. The "long-run
adjustment" of supply with demand is rarely, if ever, as smooth as
depicted in textbook diagrams. With coffee prices so low, it is believed that consumers
would benefit with a lower price for a cup of coffee. However, as readers well
know, not all cups of coffee are created equal. While coffee prices kept
falling, specialty coffee retailers such as Starbucks were charging its
customers $3.50 for a "tall skinny latte." Despite the fact that
Starbucks is usually located in high-rent areas, we can imagine that the markup
on these specialty drinks, given the wholesale price of coffee, definitely
helps pay the rent and more. This shows that, although the wholesale market for
coffee may be subject to the vagaries of shifting supply and demand, the retail
market provides a better opportunity for sellers to exert market power by
catering to the tastes and preferences of those who prefer a higher-quality product
and are willing to pay for it. Starbucks is a company that until now has played
with the forces of supply, demand, and market power like a virtuoso: It buys
low in the depressed wholesale market and sells high in the differentiated
specialty retail market.
In mid-2004, wholesale prices
started to move upward, increasing by about 30 percent between May and June.
The effects of the farmers who had stopped or reduced production due to low
prices had started to make an impact on the market.
(Imagine a leftward
"long-run" shift in the supply curve.) There was also a drought and
unusually low temperatures in Brazil, the world's largest coffee producer.1°
(Imagine a leftward "short-run" shift in the supply curve.) Big
coffee sellers, unlike Starbucks and other specialty retailers, had not been
able to raise prices during the past 4 or 5 years because of the overall
depressed market for coffee beans. Now the cost pressures from the higher price
of wholesale beans have finally enabled them to justify the raising of their
prices to restaurants and other away-from-home customers. What will consumers
do in the face of rising prices for nonspecialty coffee. As is explained in great
detail in chapter 4, the demand for coffee is considered to be relative
inelastic. Therefore, industry analysts expect coffee drinkers to consume about
the same amount as they always have. As a 10- cup-per-day consumer interviewed
by a newspaper reporter stated, "I hate that the price might go up, but I
got to have my coffee."11 Interestingly enough, Starbucks actually
welcomes the higher wholesale price of coffee. As explained by its CEO, Rin
Smith, "We are paying higher prices for coffee, which we think is a good thing.
One of the consequences of the low prices is that a lot of farmers have gone
out of business and that threatens our long-run [emphasis added] supply."
This statement shows that sometimes continuity of supply can be as important as
the purchase price. If higher coffee prices help keep coffee farmers in
business, then buyers like Starbucks are willing to pay the higher price.
Moreover, as stated earlier, differentiated sellers such as Starbucks are in
even better positions to raise the price than the processors who sell coffee to
restaurants. In fact, in September 2004, Starbucks announced that it was
raising the average price of its beverages by 11 cents, citing "increases
in the cost of coffee and sugar