In the perfectly competitive market, the producers make supernormal profits if price exceeds average cost or total revenue is greater than total cost. Knowledge that supernormal profits can be earned attracts new producers to the market or existing producers will increase the scale of their operations. The industry supply curve will shift to the right, leading to a fall in price because of the increase in supply and competition. The producers have to take the lower price and its demand and marginal revenue curves shift down. Price continues to fall until all the supernormal profits have been competed away. Freedom to enter the market leads to price falls and the elimination of supernormal profits. Supply will go on increasing and price falling until farmers are only making normal profits in long run equilibrium. This will be where the demand and marginal revenue curves for the producers touch the minimum or lowest point of its average cost curve. This can be seen in the diagram below. The old market price was Po but has fallen to the new and lower price of Pn, this price reduction was the result of the shift of the supply curve to the right (S’). The increase in market supply was due to the existence of supernormal profits at the old price Po. The new market clearing quantity is (Qn). The producers take the new market price (Pn) and their demand (D’) and marginal revenue (MR’) curves shift down. Producers are profits maximiser and equates the new marginal revenue(MR’) and marginal cost to make the profit maximising output (Qn). The average cost (AC) of producing the profit maximising output (Qn) is at its lowest. Supernormal profits have been eliminates as price Pn now equals to average cost (ACn). The producers are making a return equal to entrepreneurial opportunity cost. At this stage, producers have no incentive to enter or leave the industry. However if the price falls below the average cost of producing the coffee then farmers will make a loss and will leave the industry. If producers leave the industry supply will decrease and the price will rise until producers are just making normal profit.
When average revenue is equal to average variable cost the firm stops producing and incurs a loss equal to its total fixed cost.
That is the process of coffee growing market has experienced. A combination of oversupply and a lack of price controls mean that coffee prices are currently at the lowest level for 35 years. Price on world markets, which averaged around 120 US cents/lb in the 1980s, is now around 50 cents. The fall in prices over the last five years has been dramatic and it’s expected to fall still further. In addition, new technology lower costs, increases the industry supply, and in the long run the market price falls and the quantity sold increases. Producers those are slow to change make losses and eventually go out of business. Producers that are quick to change make profits initially, but eventually they will make zero profit
This price collapse left millions of coffee farmers destitute and forced to sell their coffee below the cost of production. Farmers sell at a heavy loss while branded coffee sells at a hefty profit. With no access to international markets, these farmers were at the mercy of the extremely low prices that many local buyers offered. This is not only matter of price, but excessively low prices lead to lower quality. Because coffee farmer who wants to make better quality at a higher cost than normal standard has found it increasingly hard to stay in business, if the good farmer all gave up the market, this market will end up by poor quality, then nobody will win.
Coffee retailing is imperfection competitive, and it’s dominated by few giant organisations, their effective way to increase the consumption is by advertising to make coffee branded. From the demand curve we know that for identical product more expensive product will be sold 0, but after branded products are highly different thus it can influent price to increase. However this method doesn’t work in the perfect competition, the firms cannot advertise effectively as the consumer knows the product and the homogeneous product cannot be differentiated. Advertising would be a waste of money and would reduce profits.
To conclude, because coffee-growing market is very close to perfect competition, if there is excess supply then price falls to clear the market. Supply equal to demand is the desire. The continual drop in prices, caused by the over-supply of produce, the decline in consumption, and weak trading controls. To solve the imbalance between demand and supply, coffee producer should reduce their output; retailers should take their responsibility to increase the demand of coffee, therefore increase the price. The government should encourage additional or alternatives activities and greater coffee product segmentation. Also there should be an information centre to keep the balance of trade. To help with developing country’s exporting, the barriers should be eliminated. Another important thing is producer should also build on highly effective promotion activities and pay more attention on production’ quality than quantity.