Question

In \(2015,\) cocoa prices rose 13 percent from the previous year, the fourth straight year in which prices increased. However, by the end of 2016 cocoa prices fell. Edward George, the head of research at Ecobank, commented, "Everyone's like, wow. There's a lot of cocoa out there." Much of the world's supply of cocoa beans is grown in West Africa. a. Assume that the market for cocoa beans is perfectly competitive and was in long-run equilibrium in 2012 . Draw two graphs: one showing the world market for cocoa beans and one showing the market for the cocoa beans grown by a representative farmer. b. Assume that there was an increase in the worldwide demand for chocolate in \(2013 .\) In the graphs you drew in part (a), show the short-run effect of the demand increase. c. Explain why the supply of cocoa beans increased and the price decreased in \(2016 .\) Show the effect of this increase in supply on the graphs you drew in part (b).

Short answer

In the short-term, increase in demand causes price and quantity to increase. The price increase leads to more suppliers entering the market, which in the long run, increases supply, causing price to decrease back to initial and quantity to increase.

Step-by-step solution

Drawing the Initial Scenario

Draw two graphs: one for the world market and one for the individual farmer. Both graphs should have the quantity of cocoa beans on the x-axis and the price on the y-axis. Mark the initial equilibrium price and quantity as \(P_0\) and \(Q_0\) respectively. The supply and demand curves intersect at this point, indicating long-run equilibrium. In the individual farmer's graph, the horizontal line at \(P_0\) represents his marginal and average costs due to perfect competition.

Short-run Effect of Demand Increase

On both graphs, the rise in demand for cocoa beans shifts the demand curve to the right from \(D_0\) to \(D_1\). On the market graph, this shift causes the price to rise to a new equilibrium level \(P_1 > P_0\) and quantity \(Q_1 > Q_0\). Correspondingly, in the farmer's graph, the farmer raises production to \(Q_1\) to meet the new demand, earning greater profit, since price \(P_1\) now exceeds average cost.

Long-term Supply Adjustment

After 2013, due to higher profits, more farmers enter, the market causing increase in supply. So in the world market graph, the supply curve shifts to the right from \(S_0\) to \(S_1\), which decreases the price level from \(P_1\) back to \(P_0\). Correspondingly, in the individual farmer's graph, with the entry of more suppliers, the price declines back to \(P_0\), and the farmer reduces the output back to \(Q_0\).

Key concepts

Cocoa Market Equilibrium

In a perfectly competitive market like the cocoa market, long-run equilibrium is achieved when quantity supplied equals quantity demanded, ensuring that firms earn a normal profit. Initially, in 2012, the cocoa market was at such an equilibrium point.
Both the market and individual farmers exist in harmony where the intersection of supply and demand determines the equilibrium price, denoted by \(P_0\), and quantity \(Q_0\). These fundamental points indicate the state where the market clears without excess supply or demand.
In the graph representing the world market for cocoa beans, the intersection of broad market supply and demand curves sets this equilibrium. Meanwhile, for an individual farmer, operating within perfect competition means they are price takers, so the market price \(P_0\) is also their marginal and average cost, depicted as a horizontal line in their graph.
This scenario signifies that prices and quantities are balanced, and no incentives exist for firms to either enter or exit the market, resulting in a stable cocoa market environment.

Supply and Demand Shifts

Supply and demand are ever-changing forces that can cause shifts in the equilibrium. In 2013, the global demand for chocolate surged, triggering a demand curve shift to the right from \(D_0\) to \(D_1\).
This increase in demand led to a new, higher market equilibrium price \(P_1\), greater than the original \(P_0\), and an increased quantity of cocoa beans \(Q_1\). For individual farmers, this elevated price translates into higher profits, as \(P_1\) now exceeds their average costs, motivating them to expand production.

• The demand increase is an external market shock, driving a temporary disruption from the previous equilibrium.
• Firms react quickly in the short-run, increasing output to capitalize on higher prices and revenues.
• In the world market graph, this is seen as a new intersection at a higher price and quantity.

The dynamic nature of supply and demand thus unveils the capability of market forces to create fluctuations, emphasizing the agile responses required from producers in a competitive environment.

Long-run Equilibrium

Eventually, the cocoa market adjusts to reach a new long-run equilibrium due to changes in supply. As farmers reap the benefits of higher profits post-2013, new producers enter the market.
This influx causes the supply curve to shift rightward from \(S_0\) to \(S_1\) in the world market graph. Over time, the increased supply pushes prices back down to the original equilibrium level \(P_0\).
For individual farmers, the increase in market supply means that the price they receive decreases back to \(P_0\), compelling them to reduce their output to the initial level \(Q_0\).

• Long-run adjustments highlight the self-correction tendencies of competitive markets.
• New entrants dilute profits, as an increased supply generally results in price reductions.
• Markets naturally guide towards efficiency, where only firms efficient enough to cover their costs remain operational.

This stabilization not only ensures macroeconomic equilibrium but also shapes the industry's competitive landscape over time. The return to the original price reflects the balancing act of market forces, emphasizing the perpetual, dynamic adjustments within perfectly competitive markets.