The Income Elasticity Of Demand Economics Essay

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Coffee is a kind of brewed beverage with very strong flavor and unique smell. The coffee was made out of the coffee beans which was roasted and grounded. The coffee was first found in the region of Ethiopia with the name "Kaffee". However, the first official time when coffee was introduced to public is in the middle of the 15th century in Sufi, the shrines of Yemen. So technically, the world first coffee was started in the Muslim world. And after that, the culture has spread out to India and then Italy and now, on over the world. The coffee has its two most commonly type is Arabica and Robusta. It also has a lot of different kind such as the coffee leaf rust, the weasel pub coffee. The coffee is quite famous because of the effect it bring to the consumer, it will help to awake the brain, make us more awake in the morning or stay up late at night time. The fresh coffee bean will be picked up when It ripe, process to make the beans out of the shell, and then they will dry it up till the proper time, the bean then will be roasted in different degree depends on what kind of beans. This will boost up the flavor and the smell of the coffee. And at the final stage, the coffee then will be grounded depends on how fine the consumer wants. In the present time, there are various ways to prepare the coffee: cappuccino, latte, espresso, long black, flat white…. The one that can brewed and make good coffee is the barista, the good barista can make very nice coffee and then they can create a lot of creative picture in the coffee with their milk pouring skill.

There is a lot of research and studies in what way to improve the quality of coffee, and the effects of coffee to the human body. Some indicates the good and the bad of the coffee. But in the end, Drinking coffee is now become the culture in over twenty countries over the world and the supply or demand of this type of product will affect a lot on the price of it and also the drinker. Australia is becoming one of them. This report will generally analysis the important of how supply and demand affect the cost of coffee, also it will indicate the high value of Australian dollar in the effects to the market situation of coffee.

Coffee is one of the most famous drinks in the world at the present time. It has been grown and import or export by a lot of country, and become one of the culture in most of the countries in the world. Among the coffee drinking culture, Australia is the youngest one and now is holding a growing coffee import market in the world. In Australia, the coffee industry has a very good growing, starting with the 1990's when the industry has a very small scale of "hobby" farming activities of coffee and how the Australia has more than 750 hectare of coffee. This shows that how much coffee that the Australian wants. Base on the real statistic, the coffee portion that one Australian can have in 2002 is 2kg per year, and moving to 2011, the portion goes up to 2.4kg per year. This is a very good sign that the coffee drinker has grown fast in Australia and coffee becomes more popular and sophisticated. Base on the Australian Food News, the retail sales of Australia coffee in 2008 is around $752 million and will expected to rise to $798 million in 2013. The demand of coffee in Australian has risen which means that the demand curve will shift to the right of the supply and demand chart as the below demonstration shows.

Based on the statistic of 2010, Brazil is the number one exporter of coffee to the Australia market, the second position belongs to Vietnam. Brazil has been a major coffee producer and Australia become one of the top client from years nearly. Recently, due to a high rain level in Espirito Santo, the biggest Robusta coffee-growing state of Brazil, which will delay the time to harvest toe crop and will reduce the quality of the beans that already harvest because of high moisture and humidity. This will lead to a reduction in supply of coffee to all over the world which included Australia. And as demonstrated in the graph below, the supply line will have to move to the left as well.

And combine the growing demand of Australian and the low in supply at the current point; we will have a shortage in the market, which means that the price will be expected to rise as the following chart.

Very competitive market with a very good customer base on the brand loyalty, the coffee in Australia has now become the more sophisticated in the Australia market. The growing numbers of people who drink coffee has increased in the pure coffee market. The pure coffee market is the one that has only the premium, roast and ground coffee segment. This indicates that more people buying the ground and real coffee than the instant coffee. Based on the statistic, there are more than one billion cups of coffee per year that people consume. The number has been increase 65% over 10 years.

Around 45 thousand tons of dry green beans for the retails with over 636$ million in value in 2011, there is a double in the coffee consumption per capita over the last 30 years. As the proof of the increasing, the amount of coffee has increased from 1.2 to 2.4 kg per capita and the tea decreased from 12kg to 0.9kg per capita. In total of the coffee consumption, about 80% is the instant coffee with value of $516 million, but this percentage has become declining slowly, because more people start to drink more real coffee which is roast and ground segment. The segment is growing with $96 million in total retail sales and 28% increasing over the last 5 years.

At the present time, the price for the cup of coffee in any store in Australia has raise from 10% normal price. As express in the chart below:

The price for a cup of coffee has increase at the price of $3.48 per cup. This price indicates that the cost of coffee beans has also increase. The price of raw coffee beans has been recorded high over the last quarter of 2011.

The increasing in price of cup of coffee can be explained because of the shortage in the market when the supply is going down due to the bad weather.

The word "Elasticity" means the quantity of a good to expand and contract. The change in price will affect the change in the quantity of demand. This is called elasticity (Cornet, J.S Mill). However, the quantity of demand is indefinable. Base on the words of Alfred Marshall, "the elasticity of demand in a market is depended on the amount demanded increase much or little for given fall in price and diminishes much or little for a given rise in price". Generally, the elasticity of demand will indicate the ratio of one product if it is affected by the price. The elasticity of coffee will have the same principle. Base on the core principles of elasticity of demand, we have three main types of elasticity, the coffee analysis will base on this

Price Elasticity of Demand:

This is the very popular effects of the elasticity demand. The price elasticity is the reaction of quantity demanded when the price is change. The quantity of demand will change when there is 1% change in price. As C.E.Feguson defines, the price elasticity of demand is the proportionate change in quantity demanded divide by the proportionate change in price.

For instance, if the price for coffee is going up, the demand is going down slightly, which means that the coffee is the inelasticity product. If the price for coffee is going up and the demand is going down dramatically, which means that coffee is an elasticity product

Income Elasticity of Demand

The change of quantity of demanded which based on the change of income. The income elasticity of demand is measure by the percentage change in demand when there is 1% change in customer income. The formula will be income elasticity = quantity (q) over income (y) or

There are two types of income elasticity:

Positive income elasticity (Ey >0): when the quantity of demand increases along with the increase of income. This type of product is called normal goods: cloths, shoes…

Negative income elasticity (Ey <0): when the quantity of demand decreases along with the increase of income. This negative form usually can be found with the cheap goods. When the consumer has more money, they will change to another product to use. For instance: for car, when they have less money, they will try to use diesel instead of good petrol, and when the income increase, the demand of diesel will decrease replacing with the increase of good petrol.

Zero income elasticity: (Ey = 0): when the quantity of demand stay the same whenever the income increasing or decreasing. We can see this with the natural good or the good that play an important part in human life: salt, water, electricity…

Cross elasticity of demand:

The change in quantity of demanded in one product based on the change in price of other product. The change in price of one product can change the demand of other products. The type of elasticity could be found in the substitute product type. The formula for this will be:

So if there is a fall or rise in price of one product can lead to a change of demand of other product. For instance, the price of coffee is related to the demand of tea, when the increase price of tea will also lead to the increase of coffee. There are two types of cross elasticity of demand:

Positive cross elasticity of demand: this only happens when two good are substitute with each other. For instance, tea and coffee, the increase in price of one product will surely increase in demand of other product. When tea increase in price, there will be more people drink coffee, which means that the two goods must be able to replace each other.

Negative cross elasticity of demand: when the two goods are complement with each other, there will be a negative elasticity, which means that when an increase of price in one product will not lead to an increase of quantity of demand in other product such as shoes and shoelaces.

There are also a lot of types of elasticity of demand; there are the three popular and frequently type that can be used to explain the following case. In Australia, the market of coffee used to be really steady and normal and seems to have a bit lower than the market of tea. But since 2006 to now, the coffee market is becoming stronger and coffee drinker seems to react to the trend and begin to seek for different kind of coffees. Based on the Coffee Price Index comment, the coffee is now becoming the sophisticate market in Australia; more people drink coffee and make it become one of their daily life routine. To make a clarification about the elasticity of coffee market in general or espresso market in details; let's have a look at all the facts that will affect as price, consumer income and its substitute good: tea. The reason why the espresso was chosen to make an analysis is because of the net coffee that the espresso content, there is no change milk, sugar or water that can affect the original price of coffee. And the espresso will directly affect by the change of coffee beans price.

Recently, the cost of coffee beans has been raised due to a short of supply from the number one country importer: Brazil. This is due to a late heavy rain that affect the time for harvesting and cropping of all Brazil, and it will increase the moisture in the air and will affect the quality of the harvested coffee. This will lead to a very strong drop down of supply and increase in price of coffee beans. And as the result, the increase in coffee beans will lead to an increase in espresso coffee price.

As you see in the graph above about the coffee price in Australian Dollar, the coffee price still at the high position compare with the period from July 2009 to July 2010. So with the price going up, obviously the demand of coffee will going down


The second factor that will affect the elasticity will be the income of the consumer. Income plays an important part that affect the demand for coffee, especially in low income country. For many years, the coffee still considered as the luxury items. There is proof that state the consumption is strongly dependent mainly on the real income levels. Australia is considered as the high income level country, so that the change in income will have less effect on consumption than other less income country. Base on the above theory about income elasticity, Coffee will be in the positive income elasticity segment. The change in consumption will be less when the income increase.

The third factor that will affect the demand rate is the coffee substitute good: tea. Because tea is the coffee substitute, it means that the coffee is in the positive cross elasticity of demand, which means that if there is a change in price of tea will make a change in demand for coffee.

As you can see in the graph above, the tea price has a significant high position that the coffee price in the above graph, which means that the coffee demand, will have a great change and will have a bigger market than tea.

So finally, the Australian Coffee market in general and espresso market in details seems to be elastic when the price of the coffee is increasing and having a shortage in supply, but when look at the second details of income, Australia is a country with good high income and having a tradition coffee drinking for a long time, so that create a culture when drinking coffee and make the demand for coffee bigger. Besides that, the substitute good of coffee have a higher price than coffee which will strengthen the market for coffee. Generally, as the opinion of the author, with all of the above analysis, at the present time, the coffee is an inelasticity good, which means that doesn't matter if the price for coffee is increasing, the demand of coffee will stay the same. But, coffee stays in an imperfect elasticity of demand, which means that at the point the demand for coffee will change, if the price continue to increase or the income of the consumer is going down and following with the present of the product that can alternative replace the coffee, the inelasticity of demand of coffee will change to elasticity.

Question 4: effect of higher coffee prices on total espresso coffee sales expenditure the coffee still going higher on the price doesn't change because of the high demand in coffee.

4. What will be the likely effect of higher coffee prices on total espresso coffee sales expenditure in Australia? Illustrate with appropriate diagrams.

As the above conclusion, the demand of coffee is inelastic, which means that the demand will not be affected by the increasing of price

5. As a result of the higher Australian dollar would you expect the impact of higher coffee bean prices to be greater in Australia or in the USA? Explain why.

At the present time, the Australia dollars is higher than the American dollar, one Australian Dollar equal to 1.05 U.S. Dollar. As you can see on the graph below, the value of Australian dollar and U.S. Dollar into Euro, which the middle currency exchange. This graph base on the value of one Euro into the Australian or US dollar

As you can see in the graph above, one Euro can exchange to 1.19 AUD at the closest time, but one Euro can exchange to 1.22 USD at the closest time, which means that Australian Dollar is more valuable than U.S. Dollar. As shown in the graph, the Australian Dollar tends to increase in the future and the U.S. Dollar tends to slightly change during the long time. Besides that, the increasing in price of Coffee recently due to a shortage

Question 4: effect of higher coffee prices on total espresso coffee sales expenditure the coffee still going higher on the price doesn't change because of the high demand in coffee.

Question 5: coffee beans prices related to Australian and US dollar

When $ AUD price is higher, the US dollar still the same than the cost of coffee beans will become cheaper.

5. As a result of the higher Australian dollar would you expect the impact of higher coffee bean prices to be greater in Australia or in the USA? Explain why.

6. What type of industry structure is the retail espresso coffee industry in Australia? What does this mean about the possibility of cafes making supernormal profits in the short run and in the long run? Illustrate with appropriate diagrams.

Citation International Coffee Organization (2012) Monthly Coffee Market Report. July 2012. CMR 07/12 [ICO Document]. London: International Coffee Organization (ICO). (CMR, 07/12).

Rudiger Dornbusch, 1987.

"Exchange Rates and Prices,"

NBER Working Papers 1769, National Bureau of Economic Research, Inc.