Sunday, September 21, 2014

Will they force you to give up chocolate this year?

The price of cocoa has started to rise on commodity markets this year, because of the risk of ebola affecting the supply.

Obama's strong actions on ebola might prevent that, but it is still a serious worry -- and the cocoa price started rising AFTER Obama made his announcement. What does the market know that
most of us don't?

Of course, they know that about 60% of the world chocolate (cocoa) supply comes from Ghana and Ivory Coast. They know that those borders are porous, that Ghana and Ivory Coast are not
all that much superior in medical care. And they also know some basic eocnomics.

The URL above gives some basic facts, which are very sobering, and which remind me a lot of the economics of gasoline and driving. In fact, the similarity to the economics of gasoline in the US
is very striking to me, because I measured tose elasticitie smyself back when I developed thge "TED" (Transportation Energy Demand) model which was used by DOE it its official Annual Energy OUtlook, until I left DOE, around 1989. That model had the greatest accuracy of any model ever developed to predict US gasoline demand over 15 years into the future -- and it was intended to be that way. Befor doing it, I read the literature on all previous models, their sources of error,
and did very careful analysis of the data.

In TED, I found that a 10% increase in income would cause a 10% increase in driving,
at all levels of income. (Many had predicted this would level off, but it never did, in any data we had.) I also found that a 10% increase in fuel cost per mile would lead to about a 2% decrease in driving, no more.

When people in Congress said "Don't worry about the world supply of oil. If OECD supply gets cut in half, say, because of a change in policy in the MKiddle East, the markets will adapt and take care of it." Yes, but what would the markets have to do? How high would the price of gasoline have to go, to get YOU to cut in half the total number of miles you drive? (e.g. to stop driving to work or to stores, which for many of us are the main source of miles.)

In fact, a "doubling" turns out to be equivalent to 72 1% increases in price, because of compound interest. (Some of you may know what "e" is.) If a 10% increase in price reduces gasoline use
by only 2%, then a doubling of gasoline price only gets you a 14% reduction indriving. To make the average person cut gasoline use in half, it would seem to require three or four doubling.
So form $3 per gallon to $30. Yes, $30 per gallon will take care of it, so why worry?

Now as Chris says, tings can become nonlinear. These elasticities have help up over a very wide range of price fluctuations in the past, but we haven't yet seen $30/gallon, so of course many structural changes would occur. And not just people riding on bicycles! Probably the income effect would come into it, as anew recession... well, let me not go on. It really is quite serious, and it is amazing we have still not done anything serious to harden the US economy, even after the incredibly obvious risks in the Middle East (and the very limited lifetime of the oil part of fracking).

Now... the weird thing is that the elasticities for chocolate are very similar! The same 10% for 10% income effect in the US as for driving, and the same 2% or less for 10% price. Amazing.
So if Ghana and Ivory Coast stop producing chocolate for awhile due to ebola, the market will have to raise prices enough to cut demand in half. If chocolate prices go up by a factor of ten, will THAT be enough to stop you and me from buying any?

But chocolate is less necessary to us than driving, so maybe we'll just give it up. Have to give it up. Until ebola (and oil dependency) are overcome.

Later, Luda pointed out: the price of chocolate was ALREADY rising before ebola.
True. When demand is as inelastic as chocolate or gasoline, doubling the demand base is just as hard to accommodate as cutting the supply base in half.  (By the way, the usual models here are log-linear, not linear.) When China becomes "a whole new developed world," that already causes rises in price. But the recent growth in cacao price is IN ADDITION to the previous trends. So the price outlook is even a bit stiffer than what I portrayed.... **IF** ebola is not stopped before it does anyting to Ghana and Ivory Coast. Fortunately, that's a big if.

Another person might say: "Hey, if the price of crude oil or the price of cacao goes up by a factor of ten, that's not as bad as it sounds, because what we pay isn't just the raw material cost." Sorry. What matters is that ultimate consumer demand mUST drop enough to accommodate supply. When the elasticity at the consumer level is 20%, it's three or four doublings needed AT THE CONSUMER LEVEL to balance supply and demand.

But in both cases, after one or two doublings, to new territory, I agree that things might change.
Some of us will cut back on chocolate by more than half. With gasoline, a lot of folks may hear:
"There's good news and bad news.  You won't have to pay $30 per gallon to drive to work. It will only go up to $10 for now. The bad news is that you won't have to go to work, because you won't have a job." In other words, the effect of higher gasoline prices will be augmented by the effect of income decreases, which provide another way to bring supply and demand in line.

In the discussion above, I talked about income and price elasticities of DRIVING. We found the same numbers to work not only for predictions three months ahead, but for fifteen years. But there is a third factor --what about the mpg of the cars we use to do that driving? New car mpg was a whole other variable, and we started to develop a model for that which would rightly be more complicated than the whole rest of the transportation demand model. GIven the 16 year turnover time for the fleet of cars, it takes a long time for that variable to have an effect -- but new car mpg AND FLEXIBILITY would be our best hope of avoiding total world disaster here in the years to come.
Even the oil folks would lose a lot in such a disaster, but their strategists don't seem to be looking that far ahead. They are currently very determined and very effective in keeping us locked in the box.
It does remind me at times of that scene in the garbage room in Star Wars Episode IV, the first movie of that series. (But episode III also comes to mind, re recent DC politics.)