AS Micro Revision: Banana Prices

This revision note covers supply and demand factors that help to determine the world and domestic retail price of bananas. Despite rising world prices, the UK retail price of bananas has actually fallen in recent years. Can students explain why? What effect does intense competition within the UK food retail sector have on the prices we pay?

Data from Timetric.

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Ave price - Bananas, per kg from Timetric

World Price

Data from Timetric.

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Bananas, US, $/mt, current, World from Timetric

World prices will fluctuate when there are changes in the conditions of market demand and/or supply.

Demand factors include:

1. Income growth – e.g. rising per capita incomes in many countries – tied in to estimates of income elasticity of demand for fruits such as bananas
2. Population growth in consuming countries
3. Changing consumer preferences – for example attempts by governments to encourage healthier eating may cause a rise in market demand
4. Import tax regimes that affect the market prices of fruits and their affordability by consumers

Supply factors include:

1. Weather conditions such as flooding which hit Ecuador in 2008 and the adverse effects of hurricanes on producers in the Eastern Caribbean in 2009 that caused much of the banana crop to be destroyed
2. Diversified supply sources – for any one country, prices will be influenced by the availability of supply at different prices from a variety of countries. For example the EU draws banana supply from different regions of the world. Supply shortages in one area might be offset by finding fresh supplies elsewhere
3. Land area available for banana production – land is in competitive demand. For example if banana prices fall some farmers may choose to switch production to other crops
4. Changes in productivity / yields in banana growing industries – linked for example to investment in farm machinery and improvements in irrigation
5. Fuel and fertiliser costs affecting production costs and also distribution costs

Data from Timetric.

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Bananas, US, $/mt, constant 2000$, World from Timetric

The balance of demand and supply forces in the market

Which factors – supply or demand – do you think have most impact on the prices that consumers face when they buy bananas in the supermarkets? Demand conditions tend to be relatively stable, for example the income elasticity of demand for bananas is positive but fairly low, meaning that demand does not change much from one year to the next as we move through an economic cycle.

On the other hand, supply conditions are subject to change and this helps to make prices volatile. There are often big differences between planned supply and actual supply in the market. Remember too that the short run supply of agricultural products is price inelastic and this will help to make prices more volatile

Demand causes:
1. Cyclical demand (i.e. high income elasticity of demand) Many commodities are used in producing other goods and services
2. Peak/off-peak demand differences and seasonal changes in demand
3. Speculative demand from investors who treat commodities as financial assets
4. Low price elasticity of demand (Ped) – e.g. when there are few close substitutes and where the raw material is essential in providing other products

Supply causes:
1. Unstable conditions of market supply including uncertain yields in farming because of volatile climate. This leads to changes in actual versus planned supply and thus changes in stock levels
2. Artificial limits on supply e.g. Export quotas / bans introduced by a government
3. Low price elasticity of supply e.g. due to limited capacity or a low level of stocks. Fresh fruits are expensive to store and refrigerate and may deteriorate if held as part of a buffer stock scheme

Consequences of price volatility

World banana prices are volatile and this can have negative effects for producers – especially smaller-farmers who have less scope for switching to alternative crops and who have no ability to influence the world market price. Some of the main effects are:

1. Risk and uncertainty: Volatile prices makes incomes and profits for producers unpredictable and this can limit capital investment spending from producers
2. Poverty and unemployment:
a. Sharp and unexpected falls in prices and incomes can cause deep poverty
b. Increases in unemployment are a waste of scarce resources
3. Incentives - Collapsing prices may cause farmers to switch crops or take land out of food supply
4. Trade (Balance of Payments) and GDP growth:
a. Big swings in prices affect revenues for exporters and has a knock-on effect on their ability to finance imports of food and new technology
b. Declining export prices damages GDP growth with negative multiplier and accelerator effects. For St Lucia nearly 20 per cent of their total export earnings come from bananas and food exports account for over 40 per cent of their total exports.

In short, price volatility can undermine growth and development in some of the world’s poorest countries and lead to higher unemployment and deeper, persistent poverty and big strains on government finances