The world price of coffee has declined in real terms over the past 50 years. In
ID: 1161723 • Letter: T
Question
The world price of coffee has declined in real terms over the past 50 years. In 1950, coffee was priced at just under U.S. $3 per pound (in 1994 dollars), whereas by 1995 the world price had fallen to just over $1 per pound. On July 29, 1995, The Economist magazine reported that
On July 26 the Association of Coffee Producing Countries agreed in New York to limit exports to 60m bags for 12 months. The current level is 70m bags… Coffee prices rallied a bit on the news, but few expect the pact to last; some big coffee producers such as Mexico have not signed up, and even those who have will probably cheat.
Explain why “few expect the pact to last” in situations like this when producers form a cartel.
By 2001, the price of coffee was approximately U.S. $0.65 per pound. Was the cartel successful?
Explanation / Answer
(a)
In general, producers form cartel to regulate the supply of good that they are producing so that prices can be influenced.
In given situation, producers has decided to restrict the supply of coffee by forming a cartel so that price of coffee can be increased on back of decreased supply.
However, such artificial increase in price due to restriction of supply also create incentive for cartel members to cheat as they can earn more profit by supplying more at the higher price.
This inducement of earning higher profit make some cartel members to cheat and supply more. As this behavior spreads to other members, cartel aggrement becomes non-operational and useless.
This kind of behavior as observed in many cartel agreements has led many to believe that this pact of coffee producers will last long and sooner than later, it will broke down.
(b)
The cartel was formed to raise the price of coffee in world market so that each member of cartel can gain from this high price.
However, the world price of coffee has fallen from over $1 per pound in 1995 to approximately $0.65 per pound in 2001.
This was contrary to what cartel was formed for.
So, it can be said that cartel was not successful.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.