Euro debt crisis bites into cocoa
The sovereign debt crisis in Europe has claimed an unexpected casualty the price of cocoa.Europe is the largest consumer of cocoa, the bean used to manufacture chocolate, and worries about a slowdown in the regions consumption combined with a bumper crop in west Africa, the main supplier, has pushed prices to their lowest point in three years.The cocoa bean market is vulnerable to economic contraction, said Keith Flury, commodity analyst at Rabobank, who added that cocoa consumption fell in Europe and the US following the previous financial crisis in 2008.From Belgium to Switzerland, chocolate manufacturers across Europe, which accounts for 40 per cent of global demand, have stepped back from the market in recent months, traders said.The benchmark Liffe March cocoa contract hit a low of 1,414 a tonne on Monday, the lowest level since December 2008, down 42 per cent from last years peak. Consumers would not see a corresponding fall in chocolate prices for several months, if at all, since manufacturers often absorb price swings.At the same time, there was a very good cocoa harvest in the Ivory Coast, the worlds biggest producer, which supplies around 40% of global output.As a result, analysts expect overall supply in the 2010/11 season, which has just ended, to outstrip demand by a record 400,000 tonnes, compared to earlier estimates which ranged from a 100,000tonne supply deficit to a surfeit of 100,000 tonnes.Traditionally, chocolate manufacturers have bought cocoa at this time of the year, but the political turmoil in the Ivory Coast drove most to cover their needs in the futures market much earlier.According to data from the US Commodity Futures Trading Commission, chocolate and confectionary makers started to buy heavily from the second half of last year. Since June 2010, they have boosted their long positions or insurance against a rise in prices almost threefold.For the 2011/12 season which started in October, forecasts range from a small deficit to a small surplus, with analysts and traders hoping that Asian demand will take up the slack left by the US and western Europe.Although the rise in prices last year offered farmers an incentive to fertilise the cocoa trees, helping boost crop yields, the fall in prices could now have the opposite effect, as farmers lose their incentive to produce cocoa. Jonathan Parkman, head of agriculture at brokers Marex Spectron warned: I dont think we are far from the price where it becomes insufficient to encourage farmers to look after their trees.Source: Financial Times, December 2011.Based on the article, explain the causes of the decrease in cocoa prices between February and December 2011 with relevant literature. With reference to the information provided and your own knowledge, access whether the supply of coca is likely to be price elastic or price inelastic.
(50 marks)Suggested Answer :Price of cocoa is determined by the market and changes in demand and supply will cause changes in market price.
Cocoa price decreased due to :
(i) decrease in demand
(ii) increase in supply
Draw diagram to show decrease in demand
Draw diagram to show increase in supply
Discuss the factors that cause demand for cocoa to decrease fall in income due to recession in Europe, .
Discuss the factors that cause supply to decrease very good harvest in Ivory Coast, .Definition of price elasticity of supply, differentiate between inelastic and elastic supply.This could be shown by diagram (depicting price inelastic or price elastic supply curve for cocoa)
Reasons for supply being price inelastic may include:
Resources Fixed inputs in short run such as available land to plant trees.
Duration Takes up to 5 years to grow cocoa / harvest mean supply is inelastic.
Perishability of cocoa difficult to store.Critically examine the consequences of a fall in the price of cocoa for cocoa producers and producers of chocolate products such as Cadburys Dairy Milk bar and Nestles Kit Kat bar.
(50 marks)Suggested Answer :Effects on cocoa producers/farmers :
lower income
reduce incentive to produce cocoa, .
farmers may exit the market / lose land / fall into poverty.
Diversification into alternative crops such as rubber production / depends on mobility of factors.
Discussion of significance of price elasticity of supply of cocoa e.g. inelastic in short run / difficult for cocoa farmers to respond to falling prices.
Time factor: long term trend in commodity prices is upward due to rapid growth of emerging markets in China and India / changing tastes towards chocolate in these countries / can expect significant profits for cocoa farmers in the long run.
Government intervention by setting up minimum price.Effects on chocolate producers :
A decrease in price of cocoa will reduce production costs for companies making chocolate.
Chocolate companies might respond by reducing the price of chocolate bars / increasing supply of chocolate bars
Diagram
Increase in producer profits
Increase in employment in chocolate companies
Increase funds for investment / for example into new chocolate products / advertising / new machinery
Chocolate companies may purchase extra stock of cocoa since it is cheaper and so can use for later
decrease in cocoa price may not be that significant in reducing cost of production if it only forms a small percentage of the price of a bar of chocolate / so firms may simply keep price of chocolate the same.
Other ingredients could be more important in affecting the price of chocolate, for example, milk or sugar.
Other things may not be equal e.g. there could be an increase in labour costs which offset the decrease in cocoa prices.InstructionThe assignment needs to be about 3000 words in length. New Times Roman, 12 font size and 1.5 spacing