South-Western College Publishing - Economics  
My French-Mocha-Vanilla-Double-shot-Latte-Espressochino with non-fat milk and cinnamon is going to cost HOW MUCH?
Subject Starbucks raises its price for the first time in four years.
Topic Supply and Demand; Elasticity
Key Words

price increase; elasticity; Starbucks

News Story

For the first time in 4 years, Starbucks is raising its prices across its menu by 4-5%. The good thing is - for Starbucks - most people won't care about the additional 10-15 cents that their treats will cost.

Citing increased costs for dairy products and other financial obligations, Starbucks' price increase will amount to about $0.10 on a $2.00 cup of java. Increases in the company's health insurance premiums on all 80,000 employees worldwide also played a role in the price increase.

Given consumers' willingness to shell out $3.50 to $4.00 for a coffee drink, it's not clear that consumers will respond much to this price increase. Economists typically consider products from gourmet coffee sellers like Starbucks and Gloria Jean Coffee to be relatively price inelastic. Conversely, store-bought coffees such as Folgers, Chase & Sanborn and Maxwell House tend to be very price elastic.

Other firms in the industry are waiting to see what happens to Starbucks as a result of the looming price increase. Gloria Jean's coffee stores are probably going to follow Starbuck's lead and raise prices, but Caribou Coffee stores have no plans to raise prices.

(Updated October, 2004)

Questions
1.

Using a graph of supply and demand in the market for Starbucks' coffee, illustrate why the company is being forced to raise prices.

2. Why would store-bought coffee like Folger's tend to be more price-elastic than gourmet coffee like Starbucks? Explain carefully citing examples from your own experience with similar products.
3. What is Caribou Coffee's rationale for holding off on price increases, if it's facing the same input price increases as Starbucks? Does their plan to maintain prices make sense, given what you know about demand for gourmet coffee? Why or why not?
Source Steven Gray and Amy Merrick. "Latte Letdown: Starbucks Set to Raise Prices." The Wall Street Journal, 2 September 2004, http://www.wsj.com.

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