No rain in Spain leads to olive oil pain

The Financial Times reported yesterday (paywalled):

A lack of rain in Spain has pushed prices for olive oil to record levels, with analysts warning that a particularly dry summer could lead to even lower crop yields later this year.

Olive oil prices have surged almost 60 per cent since June to roughly €5.4 per kilogramme, on the back of a severe drought in Europe that last year ruined olive crops across the continent.

Spain, the largest olive oil producer, was hit particularly hard. The country’s farmers typically produce half of the world’s olive oil, though annual supplies have roughly halved to about 780,000 tonnes in the past 12 months.

This provides a timely example, given that my ECONS101 class has been covering the model of demand and supply this week. Consider the effect of the lack of rain on the market for olives in Spain, shown in the diagram below (we'll come to the market for olive oil a bit later). The olive market was initially in equilibrium, where demand D0 meets supply S0, with a price of P0 and Q0 olives are traded. A lack of rain in Spain reduces the amount of olives available to harvest, decreasing supply to S1. This increases the equilibrium price of olives to P1, and reduces the quantity of olives traded to Q1.

Now consider what that means for the market for olive oil. Olives are the main input into the production of olive oil (duh!). The price of olives has increased, which makes producing olive oil more costly. Higher production costs reduce the supply of olive oil. The diagram for the market for olive oil looks the same as the market for olives shown above - a decrease in supply, leading to an increase in price (to a price of €5.4 per kg in the article), and a decrease in the quantity of olive oil traded (to 780,000 tonnes in the article).

So, Spain's lack of rain will be passed onto olive oil consumers, in the form of higher prices.