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Demand for Coffee: The Role of Prices, Preferences and Market Power

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 Demand for Coffee: The Role of Prices,
Preferences and Market Power

Dick Durevall
Working Paper in Economics No. 162
Department of Economics
School of Economics and Commercial Law
Göteborg University

February, 2005

Abstract
The purpose of this paper is to evaluate the role of prices in determining demand for
roasted coffee in Sweden. This is of interest because many believe that consumer
prices are high relative to green coffee-bean prices, and that lower consumer prices
would increase demand for coffee beans. Coffee demand is estimated on data for the
period 1968-2002. In the long run, changing preferences appear to determine demand
for roasted coffee, and a reduction in consumer prices would only have a temporary
impact on consumption. Hence a permanent decrease in consumer prices would only
increase exports of coffee beans to Sweden for a couple of years.

Keywords: Coffee exports, Coffee Prices, Market Power, Multinationals, Preferences,

Sweden.

JEL Classification: F14, F23, L13, L66, L81.

* Department of Economics
School of Economics and Commercial Law
Göteborg University
Box 640, SE 405 30 Gothenburg, Sweden
E-mail: dick.durevall@economics.gu.se
1. Introduction

Coffee-bean prices started to decline in the late 1990s and by 2002 they were on

average more than 60 percent lower than in 1997. An illustration of the extent of the

decline is that the US dollar price of Santos coffee beans returned to the same level in

2002 as it had been in the 1960s.1 One consequence of the price collapse was a large

drop in export revenue for several developing countries and the impoverishment of

many coffee farmers.

The sharp price decline has revived interest in the question of market power in coffee

markets. Since large multinational companies are active both as buyers of green

coffee and suppliers of roasted coffee, they are often held responsible, directly or

indirectly, for keeping bean prices down while maintaining high consumers prices,

and thereby limiting demand for green coffee beans (see Dicum and Luttinger, 1999;

Fitter and Kaplinsky 2001; Galiano, 2003; Gooding 2003; Oxfam, 2002; Ponte,

2002).

The issue of market power in commodity markets was analysed in some detail by

Morisset (1997, 1998). He looked at coffee markets, as well as several other markets,

and found symptoms of market power in all of them. Due to asymmetric transmission

of changes in world prices of coffee beans to consumer prices, the average spread

between consumer prices and world prices, in a sample of six industrialised countries,

increased on averaged by 186 percent from 1975 to 1994. To evaluate the

1
The information on prices is from the International Financial Statistics database of the IMF and refers
to the composite indicator of the International Coffee Organization and Santos coffee traded in the New
York market.

1
consequences of the increase in the spread on export revenue in developing countries,

Morisset (1997) simulated the impact of a reduction in the spread due to lower

consumer prices. He found it would increase export earnings significantly, at least in

the order 20-60 percent annually.

Talbot (1997) also addressed the issue of market power in coffee markets using a

different approach, global value chain analysis. He found that the collapse of the

International Coffee Agreement at end of the 1980’s led to an increase in market

power and a massive shift of surplus from coffee producing countries to

multinationals. According to Talbot, multinational companies exercised market power

as buyers by holding down prices of green coffee, and as sellers of processed coffee

by inflating consumer prices.

Although multinational companies, both trading companies and roasters, may have

market power as buyers of green coffee (see Krivonos, 2004 and Ponte, 2002) there is

not strong evidence of market power in national consumer markets. Recent studies

that have attempted to test directly for the presence of market power, such as

Bettendorf and Verboven (1998; 2000), Durevall (2004) and Koerner (2002a), find

that markets for roasted coffee in the Netherlands, Sweden and Germany are quite

competitive, while Koerner (2002b) reports evidence of some market power in the

US.

The objective of this paper is to evaluate the potential gain for coffee growers from a

reduction in Swedish consumer prices. This is done by estimating demand for roasted

coffee with a focus on how much of the variation in demand that can be explained by

2
prices, and what role other factors play. The approach differs from earlier studies of

national coffee markets that estimated oligopoly models since it emphasises the long-

run impact of price changes. Before carrying out the analysis, we illustrate how trends

in consumption, which commonly are found in empirical studies, can provide

information about the presence of market power and how they affect the interpretation

of the impact of price changes in demand functions. This is done with a simple

oligopoly model. The conclusion is that when there is a stochastic or deterministic

trend in the quantity consumed, but not in relative prices, a price change will only

have a temporary impact on demand. Moreover, in this case firms do not control

quantities with prices, or vice versa, in the long run; prices are likely to be determined

by marginal costs and there is no market power. The exception would be when the

trend also is present in marginal costs, which seems to be unlikely in real life.

Demand for roasted coffee in Sweden is estimated for the period 1968-2002. To

model coffee demand, we start by specifying the long-run equilibrium. Then we

develop an empirically stable dynamic model. In estimating the model, we first test

for (and find) stationary vectors using the Johansen maximum likelihood procedure

(Johansen 1988, 1995). The stationary vectors are identified and then included in a

general dynamic model, which is tested in order to make sure that the assumptions

regarding its stochastic properties are fulfilled. Next, the model is reduced in order to

obtain a parsimonious representation. Finally, the stability of the model is investigated

using recursive estimation, and diagnostic tests.

Our main findings are that the long-run evolution of coffee consumption per adult is

determined by differences in preferences across generations in combination with

3
population dynamics, while permanent changes in prices only have short-run affects

on demand. Our results thus indicate that there is a high degree of competition in the

Swedish market for roasted coffee since prices and consumption are unrelated in the

long run. A reduction in spreads, due to lower consumer prices, will not permanently

improve export revenue for coffee-producing countries.

The paper is organised as follows: Section 2 provides theoretical background by

illustrating the importance of trends in consumption and prices using a Cournot

model. Section 3 presents the empirical approach, Section 4 describes the data and in

Section 5 the results from the empirical analysis are reported. Section 6 summarises

and draws some conclusions.

2. The Role of Trends in Oligopoly Models: Some Illustrations

In studies of market power little attention is usually paid to trends in data.2 Although

they sometimes are captured by a deterministic trend, typically there are no comments

about trends when the results are interpreted (see for example, Bettendorf and

Verboven 2000; Genovese and Mullen 1998; Koerner 2002a, 2002b). To show how the

presence of a trend in consumption may affect the impact of price changes, and how

one can evaluate the adequacy of oligopoly models relative to perfect competition by

estimating demand functions, we use a simple Cournot model where firms determine

quantities. The same point can easily be made with the Bertrand model with

differentiated products, where firms set prices.

2
One exception is Steen and Salvanes (1999).

4
To keep the model as simple as possible, assume two firms that have the same

marginal costs, w. They face the demand function,

q = α − p + t, (1)

where q is the sum of output of the two firms (q1 + q2), α is a constant, p is the

relative price, and t is a trend that could be stochastic or deterministic.3 The trend is

usually due to income or population growth, but could also result from different

preferences across population cohorts. We omit the random disturbance term from

Equation (1) for simplicity. Note that there could be a trend in p as well.

Both firms maximize profit by setting marginal revenue equal to marginal costs,

taking the output of the other firm as given. Their first order conditions are,

1 1
MR1 = q1 + t+ α =w
3 3
(2)
1 1
MR2 = q 2 + t + α = w.
3 3

By calculating the response functions and solving for Cournot equilibrium, here q1 =

q2, and plugging in the values in the demand function, we get the determinants of the

price level,

1 1
p = α + t + 2 w. (3)
3 3

3
A time series has a stochastic trend if each shock leads to a permanent change in its conditional mean,
one example being the random walk model. For details see Enders (2004).

5
Equation (3) shows that the price is a function of the constant, marginal costs and the

trend. When t represents a stochastic trend, either p or w, or both, have to contain the

same stochastic trend for Equation (3) to be valid, in other words, t should be

cointegrated with either p or w, or both. When t is a deterministic trend, either p or w,

or both have to be stationary around a deterministic trend.

This example shows that when there is a trend in the demand function, it should

appear in prices, marginal costs, or as a linear combination of prices and marginal

costs. If it does not, the oligopoly model does not describe the data well. Then we

have the alternative, perfect competition, where price is equal to marginal cost and the

trend in demand does not influence prices. Since it seems unlikely that marginal cost

has the same trend as demand while the price variable is stationary, except by

coincidence, these insights can be used to evaluate whether there is market power or

not.4 In coffee roasting and marketing, in the Swedish market as well as in many other

markets, changes in costs seem to be almost completely dominated by variations in

coffee-bean prices, as indicated by the close correlation between consumer prices and

import prices (see Durevall, 2004). In fact, there is a very tight relation between the

amount of coffee beans required to make roasted coffee, and marginal costs are often

considered to be constant (Bettendorf and Verboven, 2000, Sutton, 1991). Hence, to

accept an oligopoly model as a description of the behaviour in the Swedish coffee

market, we require price to have the same trend that we find in coffee consumption. If

it has not, a price change will only have a short-run impact on consumption, while the

long-run evolution is determined by the trend.

4
In general productivity growth, capital formation and variations in input prices are likely to make
marginal costs independent of demand in the long run.

6
3. The Empirical Approach

Demand for non-durable consumer goods is usually assumed to depend on income,

the price of the good modelled, and prices of substitutes. When modelling demand at

an aggregate level we also have to include population, and possibly some other

variables. Equation (4) shows a static linear demand function supposed to represent

long-run equilibrium demand for coffee in Sweden:5

Q = β 0 + β1 P + β 2Y + β3G. (4)

In Equation (4) Q is the quantity of roasted coffee per adult, P is the relative price of

coffee, Y is income, G is a variable capturing other factors influencing demand, and

β0, β1, β2 and β3 are parameters. The relative price of coffee is defined as the nominal

price divided by the consumer price index since it hard to find substitutes or

complements for roasted coffee. Tea is sometimes considered to be a relevant

substitute. However, tea is unlikely to be an important substitute in Sweden where

coffee drinking dominates heavily, though it might be different in tea-drinking

countries such as Great Britain. Other empirical studies have failed to find a

significant effect from tea prices (see Bettendorf and Verboven, 2000, for the

Netherlands, and Feuerstein, 2002, for Germany). It seems that price increases affect

consumption mainly because people reduce wastage of coffee; according to a study in

5
The functional form used in studies of coffee demand varies but linear and log-linear models are the
most common ones, although Bettendorf and Verboven (2000) also estimate a non-linear model, and
Olekalns and Bardsley (1996) estimate a model with forward looking expectations. We tried all four
specifications; the linear and log-linear version did equally well, while there was little empirical
support for the other two.

7
the Netherlands spilling can be as much as 25% of total consumption (Bettendorf and

Verboven, 1998).

The second variable in the demand function is income. In general an increase in

income is expected to increase consumption. Nonetheless, this might not be the case

in a market that is saturated where practically all consumers can afford to by the

product.

Finally we have G, which is supposed to capture population dynamics. Intuitively, a

growing population generates higher demand, given prices. However, consumption

patterns can differs significantly between different age groups. According to the

Swedish coffee industry, there has been a slowdown in coffee consumption due to a

change in preferences; people born around 1960 and later do not drink as much coffee

as those born before the 1960s, who quite often consume about six cups per day.6 This

process seems to have started at the end of the 1970s, and continues as the number of

those born before 1960 declines. We measure this change in preferences in the

population with the variable G, defined as the share of the population at the age of 18

and above who are born before 1960 in total population at the age of 18 and above.

An important aspect of Equation (4) is that it describes the static state of a dynamic

process. Hence, even though the variables do not have time indexes they evolve over

time. Moreover, as most economic time series they are likely to contain stochastic

6
See the homepage of the Swedish National Coffee Association (www.kaffeinformation.se) on the
causes of the decline in consumption.

8
and/or deterministic trends. The model we end up estimating is a restricted version of

the following autoregressive distributed lag model:

k k k
Qt = π 0 + π 1i Qt −i + π 2i Pt −i + π 3iYt −i + π 4Gt + ε t (5)
i =1 i =0 i =0

where π0 contains the constant and a dummy variable capturing the effects of frost in

Brazil in 1977, the variable G is treated as a deterministic variable because it changes

very slowly over time, and εt is a mean zero white noise process. The long-run

solution of Equation (5) gives the static state of Equation (4).

Since some or all of the variables in Equation (5) might be non-stationary we start the

econometric analysis by using Johansen’s (1988, 1995) procedure to test whether

some individual variables are stationary and if some of them are cointegrated.7 This is

done by estimating a vector autoregressive model, VAR, in error correction form. The

long-run responses of the system are collected in an n times n matrix defined as Π and

the hypothesis of cointegration is about the rank of Π. When it is of reduced rank we

can write Π = αβ’, and there are r (n-1) cointegrating vectors, where r=rank. The

rank is tested with the trace test, a likelihood ratio procedure, and it amounts to

finding the number of linearly independent columns in Π. By testing for the

significance of the components in β’, the coefficients of the cointegrating vector, we

can then evaluate what variables that enter the cointegrating vector, and by testing the

7
See Juselius (2001) for a very nice illustration of the use of the Johansen approach in a study on
demand for cigarettes.

9
components of α, the adjustment coefficients, we can determine whether there is

feedback between Q and P, that is, whether P is weakly exogenous or not. If it is

weakly exogenous, we only need to estimate a single-equation model.

4. A Look at the Data8

The two core variables explaining demand are usually assumed to be price and income.

In Figure 1, coffee consumption, measured in kilos per person at the age of 18 or older,

is depicted together with per capita income, measured by total consumer expenditure.

Note that the mean and variance of the income variable has been adjusted to highlight

the relation between the two variables. Coffee consumption was stable until the 1975,

when it declined due to a sharp, but temporary, increase in prices. From the end of the

1970s there was a downward trend in consumption until 2002. Income per capita, on

the other hand, grew almost continuously between 1968 and 2002. It is thus obvious

that income did not determine coffee consumption during the period of analysis. The

reason is probably that the level of income was so high already in the 1960s that the

vast majority of the population could afford to buy all the coffee it needed. Hence, there

must be other factors driving coffee consumption in the long run.

Figure 1 about here

Figure 2 illustrates the evolution of coffee consumption per adult and the mean and

variance adjusted relative price of coffee (the retail price of roasted coffee divided by

the consumer price index, set to unity in 1995). The negative relation is visible during

8
Appendix I gives a description of the data.

10
the end of the 1970s and around 1995, but in general the two variables move in the

same direction. It is thus apparent that price and income cannot explain coffee

consumption by themselves.

Figure 2 about here

Since the slowdown in coffee consumption has been attributed to differences in

preferences between those born around the 1960s and later and older generations,

Figure 3 shows the preference variable, G, and per-capita consumption. The

preference effect started at the end of the 1970s and continued as the share of those

born before 1960 declined. Hence, its evolution coincides with coffee consumption.

Figure 3 about here

Finally we graphed the price series and consumption net of the preference effect, that

is, a series obtained by regressing G on Q. As shown by Figure 4, there is a strong

negative relation between the two series. Hence, the change in preferences seems to

capture the long run evolution of coffee consumption well, while the relative price

level explains the movements around the trend.

Figure 4 about here

5. Empirical Analysis

The data analysis is performed in two steps. First, we use the Johansen (1988, 1995)

approach to test for integration and cointegration, and then we estimate a general

11
single-equation autoregressive model, which tested to make sure that the assumptions

regarding its stochastic properties are fulfilled. After that the single-equation

autoregressive model is reduced in order to obtain a parsimonious model. Finally, the

stability of the model is investigated using recursive estimation.

The cointegration analysis was carried out for the period 1968-2002 with Q and P, as

endogenous variables, where Q is coffee consumption per adult, P is the retail price of

roasted coffee per kilo relative to the consumer price index, measured in constant

1995 Swedish kronor. The variable capturing changes in preferences between age

groups, G, was entered as a deterministic variable, and income was included as a

weakly exogenous variable in first differences (∆Y) since, as evident from Figure 1,

the level of consumption does not affect coffee consumption. We also included an

impulse dummy for the sharp increase in coffee-bean prices in 1977. The number of

lags was determined by first estimating the model with two lags over the period 1969-

2002 and testing for misspecification. None of the tests for autocorrelation, non-

normality, and heteroscedasticity were significant at the 5 percent level. Then a

likelihood ratio test for reducing the model to one lag was implemented. It was not

significant so one lag of Q and P seems to capture the dynamics adequately. The first

lag of ∆Y was insignificant so it was also removed. The test statistics for the

likelihood ratio test and the diagnostic tests are reported in Table 1.

Table 2 reports the main results from the application of the maximum likelihood

procedure. The first row lists the estimated eigenvalues of the Π−matrix, the matrix

with the coefficients of the long-run solution of the model. The smallest one is 0.35,

12
so both of them are all clearly larger than zero, indicating the rank is two. On the

following lines the trace test for the rank of the Π−matrix and critical values are

reported. Since the trace test has low power in small samples, the 90 percent critical

values were used, and since G behaves as a deterministic variable, the critical values

are based on the asymptotic distributions for restricted trend and unrestricted constant.

The null hypotheses of a rank of zero and one are clearly rejected. Information about

the rank of the Π-matrix is also provided by the adjustment coefficients. In both

columns of the α−matrix, reported in the lower panel of Table 2, there are entries with

high t-values. This is support for the presence of two stationary relations in the data.

Since visual inspection of graphs of the cointegrating vectors9 also indicates that there

are two stationary relations, we proceed under the assumption that the rank of the Π-

matrix is two.

The importance of including G for the stability of the system, and the finding of two

cointegrating vectors, is indicated on the last two lines in the upper panel of Table 2.

The largest root of the companion matrix process is 0.60 when G is included in the

VAR, while the largest root is 1.02 without G.

To identify the stationary vectors, the significance of each individual variable was

first tested; all three tests statistics were highly significant as shown by the last line in

Table 2. Then we tested if Q and G form one stationary relation, while P is stationary

by itself. The test was not significant at the 10% level. Table 3 reports the test

statistics for the restricted cointegrating vectors, the standardized eigenvectors, β, and

9
The unrestricted cointegrating vectors are not reported, but Figure 4 shows the restricted ones.

13
the adjustment coefficients . The first long run relation is Q = 13.5G while the other

one is made up of P only. Since 11 is negative and highly significant, coffee

consumption adjusts to changes in G, as expected. Furthermore 12 is also negative

and significant, showing that the price level affects coffee consumption. However,

there is no feedback from coffee consumption on prices since 21 is insignificant. This

implies that we can treat prices as weakly exogenous and model coffee demand using

single-equation analysis.

In the second step we estimated a single-equation model. To ensure that all variables

are stationary Q was replaced by Q* = Q - 13.5G. Moreover, an impulse dummy for

1976 was added to capture the rise in consumption preceding the price increase.10 By

including two impulse dummies (Dum76 and Dum77) we allow the effect of the price

shock to be transitory. First a general model was estimated (see Table 1a in Appendix

II) and the variables with insignificant coefficients were removed, e.g. lagged Q*. The

model obtained is,

Qt* = 2.5 - 0.017 Pt - 0.013Pt -1 + 0.074∆Yt + 0.98 Dum76 - 1.5 Dum77

(0.24) (0.005) (0.004) (0.029) (0.36) (0.48)

(6)
R 2 = 0.866 σˆ = 0.331 T = 1968 - 2002 Far (2, 27) = 0.59 [0.56]
Farch (1, 27) = 0.468 [0.50] Fhet (8, 20) = 0.26 [0.97] χ norm
2
(2) = 3.99 [0.14]
Freset (1, 28) = 0.15 [0.70] Qt* = Qt -13.5Gt

where coefficient standard errors are shown in parentheses, σˆ is the residual standard

deviation, and T is the sample period. The diagnostic tests are for serial correlation of

10
The increase in consumption in 1976 is likely to be due to hoarding.

14
order 2, Far, autoregressive conditional heteroscedasticity of order 1, Farch,

heteroscedasticity, Fhet, nonlinearity, the RESET test, Freset, and a chi-square test for

normality, χ Norm
2
(2) (see Hendry and Doornik, 2001, for details).

In equation (6) both contemporaneous and lagged prices enter with negative, and

clearly significant, coefficients, income growth has a positive coefficient, and the

dummy variables have opposite signs. Hence, the model appears to make economic

sense. Since all the diagnostic tests are insignificant the model is statistically well-

specified.

By estimating the model recursively its empirical constancy was assessed (see Hendry

and Doornik, 2001 on recursive estimation). The output from this exercise is

summarized in graphs for the period 1980-2002. The four graphs in the upper panel of

Figure 5, depict the recursively estimated coefficients and their ±2 standard errors.

Considering the small number of observations and the long time period, they are there

are quite stable, in particular during the period 1985-2002. The one-step residuals and

their ±2 standard errors are depicted in the fifth graph; since all the estimates are

within the standard error region there is no indication of outliers. The last three graphs

report test statistics from three Chow tests, one-step, break-point and forecast Chow

tests. They are graphed such that the straight line matches the 1% significance level.

Only one Chow test statistic is significant, and it is just about significant at the 1%

level, while all the others are insignificant.

15
To relate Equation (6) to, our theoretical model, Equation (4), the static solution of (6)

was calculated, yielding

Q = 2.6 - 0.029 P + 0.072∆Yt + 13.28G − 0.53Dum

(0.38) (0.004) (0.03) (0.48) (0.67) (7)

where coefficient standard errors are shown in parentheses. Equation (7) shows that

the price variable is negative and highly significant; its t-value is -7.9. A decline in

coffee prices by one krona per kilo increases demand by 29 gram per adult,

controlling for all the other variables. In 2002 this would correspond to a total

increase of 2.3 ton, which should be compared to an actual consumption of 66000 ton;

the impact of a change in price is thus very small. Equation (7) also shows that the

sum of the two dummy variables is not statically different from zero, indicating that

the price shock in 1977 did not have a lasting effect on coffee demand. Moreover, the

generation variable, G, has the same coefficient as in the cointegration test, and

growth in per capita income is significant but the t-value is only 2.4.

To obtain more information on the role of the prices, we calculated the price

elasticity. Its mean is -0.19 and the standard deviation is 0.058. Figure 6 shows how

the elasticity has varied over time; the minimum value is -0.38. It is thus evident that

competition in the coffee market keeps the elasticity well above -1, which is the

maximum we would expect if there was perfect collusion among the roasters, i.e., as

in the case of a monopoly. Our finding that the elasticity is well above -1 is consistent

with other studies on coffee demand such as Bettendorf and Verboven, (2000),

16
Durevall (2004), Feuerstein (2002), Koerner (2002b) and Olekalns and Bardsley

(1996).

An interesting question is how demand would respond to a reduction in the spread

between green coffee-bean prices and consumer prices. Morisset (1997) found that a

reduction in the spread of some primary commodities, including coffee, due to a drop

in consumer prices in U.S. and some European countries, would have a strong impact

on export revenue in developing countries. However, in our case, the trend in coffee

demand makes the impact of a permanent decrease in coffee prices temporary. This is

illustrated by the recent decline in real coffee prices; they went from 76 SEK in 1998

to 51 SEK in 2002 while consumption dropped from 9.6 kg per adult to 9.4 kg.

To further highlight the role of prices, we simulated the response of coffee

consumption to a permanent decline in consumer prices from 51 SEK in 2002 to 35

SEK in 2003. We assumed that G continued to decline at the rate it had during the

period 1993-2002, that is at 2.13 percent per year, and that ∆Y was constant at the

average value it had over the same period, 2.13. Furthermore, we used the fitted value

for the base year 2002. The result of the decline in prices would be an increase in

coffee consumption by 3.6 percent in 2003 and a small increase in 2004. However,

consumption would decline in 2005, and in 2006 it would be below the 2002 level.

Our analysis thus shows that the preference effect is the dominant factor in

determining demand, since it explains the trend. It is possible that Morisset obtained a

strong effect on export revenue because he disregarded the dynamics of demand.

17
6. Conclusion

The objective of this paper was to evaluate the role of prices in determining demand

for roasted coffee in Sweden. This is of interest because it can shed light on the

functioning of coffee markets, and how demand for coffee beans is likely to respond

to changes in consumer prices.

Demand for roasted coffee was estimated using market data from Sweden over the

period 1968-2002. In the long run, demand is determined by differences in

preferences across generations in combination with population dynamics; those born

before the 1960s consume more coffee than younger generations. This result is in

accordance with industry wisdom. The relative consumer price of coffee also

influences demand but it only explains deviations from trend. Consequently a

reduction in coffee prices can only have a temporary impact on demand.

Since the evolution of coffee consumption is independent of prices, there appears to

be a high degree of competition in the Swedish market for roasted coffee, at least in

the long run; coffee prices are likely to be determined by marginal costs and firms do

not seem to control prices or quantities. This implies that market power does not

explain the level of the spread between bean prices and consumer prices. A corollary

of the lack of market power is that a permanent reduction in the spread between world

prices and consumer prices, due to lower consumer prices, would not lead to a

permanent increase in demand for coffee beans; a price decrease would only improve

export revenue for coffee-bean producing countries during a short period.

18
Although our results are obtained from the Swedish market, they are likely to apply to

several other markets for roasted coffee as well. Most industrialised countries have a

market structure that is very similar to the one in Sweden, where the market share of

the multinationals was 57 percent, and the share of the four largest roasters was 87

percent in 2002 (Durevall, 2004). In almost all consumer markets there are some large

multinationals present and the concentration of the four largest firms is very high (see

Clarke, et al., 2002; Durevall, 2003; Sutton, 1992). Moreover, trends are often present

in coffee consumption, see Koerner (2002b) and Olekalns and Bardsley (1996) for the

US, Feuerstein, (2002 and Koerner (2002a) for Germany. In addition, the technology

used in coffee roasting is fairly simple and similar in most markets.

It is possible that large roasters have market power as buyers in the market for green

coffee, as argued by, among others, Ponte (2002). We have not analyzed this issue but

if they influence prices of green coffee, increased competition would have a beneficial

effect on export revenue of coffee producing countries. It is also possible that roasters

have some market power as sellers of roasted coffee, but in Sweden, at least, it seems

to be of a short-run nature since firms do not appear to be able to influence the

evolution of coffee-bean imports.

19
Appendix I: Description of Data

The following variables are used in the empirical analysis:

Consumer price of coffee

Price per kilo of roasted coffee. The price is based on 500-gram packets. Source:
Statistics Sweden.

Consumer price index (CPI)

CPI is from the International Financial Statistics database of the IMF.
The base year is 1995.

Consumption of Roasted Coffee

The quantity of yearly consumption is published by the Swedish Board of
Agriculture.

Income
Income is measured as household expenditures. Source: International Financial
Statistics database of the IMF.

Population
The demographic data are from The International Data Base (IDB), U.S. Bureau of
the Census, and Statistics Sweden.

20
Appendix II: Regression Results

Table 1a: General model for coffee demand,

1968-2002
Equation for Q* Coefficient Std. Error t-value
Q*t-1 -0.092 0.162 -0.568
Pt -0.017 0.005 -3.160
P t-1 -0.016 0.007 -2.350
∆Y t 0.085 0.034 2.450
Dum76t 0.979 0.369 2.650
Dum77 t -1.330 0.602 -2.210
Constant 2.768 0.506 5.470

R 2 = 0.867 σˆ = 0.335 T = 1968 - 2002 Far (2, 26) = 0.20 [0.82]

Farch (1, 26) = 1.01 [0.32] Fhet (10,17) = 0.29 [0.97] χ norm
2
(2) = 3.46 [0.17]
Freset (1, 27) = 0.49 [0.48] DW = 2.12 Qt* = Qt -13.5Gt

21
References

Bettendorf, L., and F. Verboven, (1998), “Competition on the Dutch Coffee Market”
Research Memorandum No. 141, Central Planning Bureau, The Hague.

Bettendorf, L., and F. Verboven, (2000), “Incomplete Transmission of Coffee Bean

Prices: Evidence from the Netherlands” European Review of Agricultural Economics,
Vol. 27, (1).

Clarke, R S., Davis, P. Dobson, and M. Waterson, (2002), Buyer Power and
Competition in European Food Retailing, Edward Elgar Publishing, Cheltenham.

Dicum, G. and N. Luttinger, (1999), The Coffee Book: Anatomy of an Industry From
Crop to the Last Drop, New York: New Press.

Durevall, D., (2003), “Competition and Pricing: An Analysis of the Market for
Roasted Coffee” Chap. 5 in High Prices in Sweden – a Result of Poor Competition?
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Enders, W., (2004), Applied Econometric Time Series, John Wiley & Sons.

Feuerstein, S., (2002), “Do Coffee Roasters Benefit from High Prices of Green
Coffee?”, International Journal of Industrial Organization, Vol. 20, pp. 89 – 118.

Fitter, R. and R. Kaplinsky, (2001), “Who Gaines from Product Rents as the Coffee
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Företagaren Direkt (2002), No. 3, Nordea, Stockholm.

Genesove, D., W. P. Mullin, (1998), “Testing Static Oligopoly Models: Conduct and
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23
Table 1: Determination of lags and diagnostic tests, 1969-2002
Multivariate tests
AR 1-2 test F(8,46) = 0.846 [0.567]
Normality test χ²(4 ) = 7.280 [0.122]
Hetero test F(18,54) = 0.945 [0.531]
Hetero-X test F(27,47) = 0.881 [0.631]
Schwartz Criteria Two lags One lag
10.07 9.53
Tests of model reduction,
2 to 1 lag: F(4,48) = 0.394 [0.812]
1 to 0 lag of ∆Y: F(2,26) = 0.731 [0.491]

Table 2: Cointegration analysis, 1968-2002

Eigenvalue of Π-matrix 0.62 0.35

Null hypothesis r=0 r=1
Trace test 48.75 14.79
90% critical value 22.76 10.49
Roots of process 0.60 0.16
Roots without G 1.02 0.61
Variable Q P G
β’1 1.000 0.028 -13.42

β’2 4.80 1.00 -113.06

α1 -1.47 0.005
(0.18) (0.004)
α2 1.20 -0.48
(5.39) (0.12)
Test of significance a given variable
Q P G
χ²(3) 31.83** 26.54** 33.23**
Note: The estimation period is 1968 - 2002. The vector
autoregression includes one lag on Q and P, and Gt, ∆Yt
, a constant and an impulse dummies that takes a value of
unity in 1977. Critical values are for the trace tests are
from Johansen (1995). They are based on the asymptotic
distributions for restricted trend and unrestricted constant.
Standard errors are reported in parentheses, and ‘**’
indicate significance at the 1% level.

24
Table 3: Restricted cointegrated vectors and adjustment coefficients
Variable Q P G
β’1 1.00 0.00 -13.49

β’2 0.00 1.00 0.00

-1.09 -0.03
α1 (0.18) (0.007)

-3.19 -0.46
α2 (5.56) (0.21)

Test for restricted cointegrating vectors χ²(1) = 2.30 [0.13]

Standard errors are reported in parentheses and p-values in brackets.

25
15

14

13

12

11

10

1970 1975 1980 1985 1990 1995 2000

_______
Figure 1: Coffee consumption, kilo per adult , and mean and variance
adjusted income •−−•−−•.

16

15

14

13

12

11

10

9
1970 1975 1980 1985 1990 1995 2000
Figure 2: Coffee consumption, kilo per adult ______, and mean and variance
adjusted price of coffee in 1995 Swedish kronor •−−•−−•.

26
 15

14 1.0

13
0.9

12

11 0.8

10
0.7

0.6
1970 1975 1980 1985 1990 1995 2000

Figure 3: Coffee consumption per adult (left scale), ______, and the share of
adults born after 1959 in total adult population (right scale), •−−•−−•.

140

120

100

80

60

40

20

1970 1975 1980 1985 1990 1995 2000

______
Figure 4: Price of roasted coffee, , and coffee consumption net of
preference effect, G, mean and variance adjusted, •−−•−−•.

27
 0.025 P × +/-2SE
4 Constant × +/-2SE
0.000
3
-0.025
2
-0.050
1980 1985 1990 1995 2000 1980 1985 1990 1995 2000
Pt-1 × +/-2SE DY × +/-2SE
0.00 0.2
-0.02
0.0
-0.04
1980 1985 1990 1995 2000 1980 1985 1990 1995 2000
One-step residuals 1.0
0.5 One-up CHOWs 1%

0.0 0.5
-0.5
1980 1985 1990 1995 2000 1980 1985 1990 1995 2000
N-down CHOWs 1% 1.0
N-up CHOWs 1%
1.0
0.5
0.5

1980 1985 1990 1995 2000 1980 1985 1990 1995 2000

Figure 5: Recursive estimates of the coefficients with ± 2 standard error (top

four graphs), one-step residuals with ± 2 estimated standard errors (left in
third row), one-step (right in third row), break-point (left in bottom row) and
forecast (right in bottom row). Chow statistics scaled with their 1% critical
values. The straight line at unity shows the 1% critical level.

-0.15

-0.20

-0.25

-0.30

-0.35

1970 1975 1980 1985 1990 1995 2000

Figure 6: Price elasticity, 1968-2002.

28

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