Welfare effect of eliminating commodity price volatility: Evidence from Tanzania coffee farmers

Abstract

This paper investigated the welfare consequences of reducing coffee price volatility in Tanzania. GARCH (1,1) model is fitted with monthly coffee prices from 1998 to 2017 to estimate the conditional and unconditional variance of the residual. The coefficient of relative risk aversion and unconditional variance of GARCH (1,1) model are applied in a typical Lucas-like representative argent model to examine the welfare consequences of eliminating price volatility using the case of coffee farmers in Tanzania. The empirical finding shows that the welfare gain from eliminating price volatility for coffee farmers in Tanzania is small. Taking into account the effects of reforms in coffee industry and economic crisis, the welfare gain remains at 1.139% of revenue from coffee sales per year. Given that coffee market is under oligopoly stage still there is some degree of monopoly in terms of regulations thereby rising a need of “check and balance” to ensure that bureaucratic challenges are addressed. Nonetheless inclusive hedging strategies, improving production and quality of coffee, provide the next step in improving the welfare of the coffee producers where reducing coffee price volatility at a cost might not be a desirable choice.