Allocating Methods

The traditional costing method implies that all manufacturing costs of products consist of

three big categories, such as direct materials, direct labor and manufacturing overhead. Direct

materials and labor cost are straightforward in the case of coffee beans.However, the third

category of manufacturing overhead may not always be as accurate as it is applied based on a

weighted average for the products.

The second method of costing used to evaluate the coffee bean products’ costs and

profitability is the Activity Based Costing (ABC) method. This method will reveal the link

between performing particular activities like purchasing, materials handling, quality control,

processing beans which consist our indirect costs, and the demands those activities make on the

organization’s resources.

The fundamental difference between the two costing systems is the assumption in

traditional costing that cost objects consume resources whereas in ABC it is assumed that cost

objects consume activities. Therefore, high prices of coffee beans in our scenario may be also

caused by inappropriate allocation method.

Supplier and Consumer Surplus

When we assume that all consumers pay the equilibrium price Peq, there are consumers

who arepaying less that they were willing to pay. If each consumer bought the commodity at the

maximum price they were willing to pay, the total amount spent is represented by the area under

the demand curve from zero to Qeq. The difference between this amount and the amount spent

at the equilibrium price is called the consumer surplus. It can be viewed as the consumers’ gain

from the trade.

According to Index Mundi (2011), green coffee total supply was 267,305,000 60 KG

BAGS. The current market equilibrium price for coffee is $302.7. According to consumers’

estimations, the maximum price they are willing to pay is $5 for a cup ($398.3 per pound).

However, it is important to notice that demand for coffee is price inelastic. Many people used to

this beloved beverage so they will buy it even at a higher price. But using the previous

estimations, consumer surplus equals to:

𝐶𝑆 =1

2𝑄𝑒𝑞 𝑃𝑚𝑎𝑥 − 𝑃𝑒𝑞

𝐶𝑆 =1

2∗ 267,305 ∗ 5 − 3.80 = $160,383 𝑝𝑒𝑟 𝑝𝑜𝑢𝑛𝑑

When the commodity is sold at the equilibrium price, there is a gain to the producers a

well.Various producers were willing to supply the goods at the price given by the supply curve.

However the supply price is always less than or equal to the equilibrium price Peq. The

differencebetween the amount received by the producers and the amount they would have

received at the price level determined by the supply curve (the area under the supply curve from

zero to Qeq ) is called the producer surplus. Given the lowest price Pmin producers are willing to

sell coffee and the actual price of green beans, we will have:

𝑃𝑆 =1

2𝑄𝑒𝑞 𝑃𝑒𝑞 − 𝑃𝑚𝑖𝑛

𝑃𝑆 =1

2∗ 267,305(3.8 − 3)= 106,922 per pound

The sum of the consumer surplus and the producer surplus is called the total trade gain,

andconsidered by economists to be a measure of the benefit to society of the transaction at

theequilibrium point.

With consideration to the environmental impacts on green coffee beans crops in Brazil,

the largest supplier, the availability of beans significantly dropped thereby affecting the

consumer and producer surplus. This causes an inward shift in supply, a higher price and a

decrease in the quantity traded in the market.

In addition, cafes were also facing increased rent and electricity costs, while the supply of

milk was at risk due to the major supermarkets artificially driving down prices. As a result, the

costs of production increase and businesses cannot supply as much at the same price and this

also causes an inward shift of the supply curve. Consequently, all these circumstances lead to a

decline in consumer welfare shown by a decrease in consumer surplus.

Demand

Supply 1

Peq 1

Peq 2 Consumer surplus

Producer surplus

Supply 2

Exhibit 1. Consumer and Producer Surplus

Q1 Q2

References

Index Mundi. (2011, May 30) Coffee, Other Mild Arabicas Daily Price. Retrieved May 31, 2011

from http://www.indexmundi.com/commodities/?commodity=other-mild-arabicas-

coffee&months=60

Nicholson, W. & Snyder, C. (2008) Microeconomic theory: basic principles and extensions.

Thomson Learning, pp.165-176.

Trenwith, C. & Preiss, B. (2011, May 17) Coffee prices set to jump amid shortages. The Sydney

Morning Herald. Retrieved May 31 from http://www.smh.com.au/small-

business/trends/coffee-prices-set-to-jump-amid-shortages-20110517-

1eqjt.html#ixzz1O4E1Zg00