Transcript price - Department of Economics

Dairy Marketing
Dr. Roger Ginder
Econ 338
Fall 2007
Lecture #17
Over-Production and Low Prices
• Have constantly plagued the dairy industry even before
the Great Depression
• Poor bargaining position for fresh fluid milk
• High price elasticity --- especially for manufactured
milk
• Low price elasticity---for fluid and class II Products
• Market orders were considered one of the possible
strategies
• The Great Depression Served as a Catalyst For Change
HISTORY OF FMMO’S
• In the 1920’s farmer-owned cooperatives were attempting
to deal with the perishable nature of fluid milk and price
impacts of over-production on producer price
• They developed a scheme that exploited the different price
elasticity for milk going to fluid users
• They attempted to establish a classified pricing program
that charged a higher price to fluid users than the price
charged to users in the manufacturing milk market
• Thus when their member producers who delivered milk
into the pool they received a “blended” price based on the
relative amount of the pool going to each
Elasticity
e
e
% Q
Q P
Q P
=

d =% P
Q
P
P Q
% Q Q P Q P
=



s =
% P Q
P P Q
Price
$/#
P1
Po
Demand
Q1
Qo
Quantity
# of milk
Relatively Inelastic Market
Demand
Price
$/#
P1
Po
Demand
Q1
Relatively Elastic Market
Demand
Qo
Quantity
# of milk
DAIRY COOPERATIVE CLASSIFIED
PRICING EXAMPLE
Coop prices:
Class I
=
$10.00
Class II
=
$ 8.00
Average use by coop customers:
Class I
=
50%
Class II
=
50%
Use by Buyer “A”:
Class I
=
Class II
=
Used by Buyer “B”:
Class I
= 10%
Class II = 90%
90%
10%
Average price received by coop and its members =
“Blend” price
= (.5 x $10.00)
+ (.5 x $8.00)
= $9.00
Price paid by Buyer “A”
(.9 x $10.00) + (.1 x $8.00)
=
=
$9.80
Price paid by Buyer “B” =
(.1 x $10.00) + (.9 x $8.00) = $8.20
Thus, there was an incentive and opportunity for Buyer “A” to buy milk directly from the
producer.
PROBLEMS WITH DAIRY
COOPERATIVE CLASSIFIED
PRICING EFFORTS
1. Inability to verify milk weights, tests and usage.
2. Inability to force all producers and milk buyers
to comply with their pricing plan.
3. Efforts failed when deflation forced prices down
during the Great Depression in the 1930’s
ALTERNATIVES FOR DEALING
WITH EXCESS SUPPLY
PROBLEMS IN AGRICULTURE
• Information provision
– How much is being produced
– What expected prices will be
•
•
•
•
Supply control
Demand expansion
Cooperatives
Marketing orders
HISTORY OF FMMO’S
• By 1933 the Agricultural Adjustment Act (AAA 1933) was
passed
• Permitted “marketing agreements”
• Voluntary agreements among processors, handlers, coops, processors
• Supreme Court found AAA of 1933 unconstitutional
• In 1935, the AAA of 1935 enabled the first “orders” to be
formed
• Permitted secretary of ag to establish orders
• Gave powers currently used in FMMO’s today
–
–
–
–
–
–
Classified pricing
Market wide pooling
Checking of weights and tests
Enforcement of base/surplus plans
Providing market information
Block voting by cooperatives
Market Orders Take Advantage of
Differing Elasticity of Demand In
Different Product Markets
They make it possible for farmers to
use price discrimination between
markets with different elasticity
Price
$/#
P1
Po
Demand
Q1
Qo
Relatively Inelastic Market
Demand
Fluid Milk
Quantity
# of milk
Price
$/#
P1
Po
Demand
Q1
Relatively Elastic Market
Demand
Qo
Mfg. Milk
Quantity
# of milk
FEDERAL MARKETING ORDER
Definition:
A regulation, issued by the Secretary of Secretary of
Agriculture, that requires the commodity involved to be
marketed in accordance with procedures spelled out in
the regulation.
Legal Basis:
Agricultural Marketing Agreements Act, 1937
A U.S.D.A. regulation that requires Grade A milk buyers
to pay specified minimum prices for Grade A milk
depending on how that the milk is used.
Federal Milk Market Order
Agreements
The FMMO is an agreement establishing marketing and
payment rules:
For milk marketing in
a defined
geographic area
Federal Milk Market Order
Agreements
The FMMO is an agreement among:
U.S. Secretary of Agriculture
For milk marketing in
a defined
geographic area
Federal Milk Market Order
Agreements
The FMMO is an agreement among:
U.S. Secretary of Agriculture
Producers
(Individual
votes)
For milk marketing in
a defined
geographic area
Federal Milk Market Order
Agreements
The FMMO is an agreement among:
U.S. Secretary of Agriculture
Producers
(Individual
votes)
For milk marketing in
a defined
geographic area
Producer cooperatives
(block votes)
Federal Milk Market Order
Agreements
The FMMO is an agreement among:
U.S. Secretary of Agriculture
Producers
(Individual
votes)
For milk marketing in
a defined
geographic area
Producer cooperatives
(block votes)
Grade A
handlers
processors
MARKETING ORDERS
OBJECTIVES
• To maintain or promote orderly marketing conditions.
• To assure consumers of an adequate and steady supply
of the product. (Mainly by reducing producer price
and income risks)
• To facilitate producer bargaining efforts.
• To provide information about the commodity’s supply
and demand conditions.
FMMO PROGRAM
• The FMMO program was initiated to promote “orderly” marketing
to benefit dairy producers, processors, and consumers in a time on
National Emergency and Extreme Economic Disruption
• In the post World War II period the U.S. had become a world power
and was enjoying a period of “Economic Prosperity”
• New FMMO’s were steadily being formed in 40’s and 50’s
• Some began to question whether market orders were still relevant to
their original goals and purposes
• “Orderly markets”
• Reliable fluid milk supplies
• Stable Pricing
FMMO PROGRAM
• The FMMO program is expected to promote “orderly” marketing
and represent the interests of dairy producers, processors, and
consumers
• Secretary of Agriculture, Orville Freeman, appointed a blue ribbon
committee in 1962 to examine the public interest aspects of milk
marketing orders
• Federal milk market order study committee
– Chair, Edwin G. Nourse
– Studied FMMO authority in AAA 1937
– Desirable equilibrium consistent with optimum allocation of
nations resources
Nourse Committee Identified Four
Broad Purposes in AAA 1935 and AAA
1937
• Bring all fluid distributors and handlers in a prescribed
market area under regulatory authority of the order
• Universal compliance
• Uniform rules and procedures
• Enforce uniform minimum prices among all handlers on
milk used for the same purposes (this places handlers in a
uniform competitive position and discourages price wars)
• Provide uniform producer prices (market wide pooling)
• Promote price stability by extending classified pricing to
all handlers in the prescribed market
FMMO PROGRAM
• Concluded that orders do indeed:
– Extend uniform opportunities in the market to producers
– Enforce uniform responsibilities on the entire market rather than
on a certain subset of handlers
– Provide for rational resource allocation
• The committee report has provided an overall underpinning as the
standard for many of the FMMO decisions and consequences with
respect to
– The public interest
– Resource allocation
– “Orderly” marketing
CONSOLIDATION TO F0RM LARGER
ORDERS BEGAN IMMEDIATELY FOLLOWING
THE GREAT DEPRESSION
• Smaller Orders Were Being Combined to Form Larger Orders
Covering More Geography
• New Orders Were Steadily Being Formed And Tended To Be
Larger Covering Wider Geographic Areas
• Transportation Differentials Started to Become An Issue
• The Use of One Differential For a Larger Area Was Questioned
• The Nourse Report Addressed This Problem Directly Through A
Recommendation For Intra-Order Zones
Location Adjustments
Within Orders

Nourse report specified orders should:
»Provide substantially equal prices to handlers within the order
»Provide different Class I prices within the order to accomplish
it
 Major population centers where bottling plants are located pay the
Class I price for fluid milk
 Zones are established around these centers to account for transport
cost differences from farm to the Population Center

Prices are reduced by cost of transport at points in the zones further
from center

Zone charges effectively align Class I prices within and across orders
CONSOLIDATION TO FORM
IOWA FMMO, 5-1-77
1. Cedar Rapids - Iowa City, 9-1-51
2. North Central Iowa, 11-1-57
3. Des Moines, 10-1-58
4. Quad Cities - Dubuque, 1-1-61
a.
b.
Dubuque, 10-1-36
Quad Cities, 12-1-51
(1)
Quad Cities, 2-1-40
(2)
Clinton, 10-1-44
Eastern South Dakota
#76, 5-1-65
Lyon
Upper Midwest
#68, 6-1-76
Osceola
Emmet
Dickinson
Worth
Winnebago
Mitchell
Howard Winneshiek
Allamakee
Kossut h
O’Brien
Sioux
Palo Alto
Clay
Hancock
Cerro Gordo
Floyd
Chickasaw
Clayton
Fayett e
Plymouth
Cherokee
Woodbury
I da
Monona
Sac
Carroll
Shelby
Webster
Calhoun
Crawford
Harrison
Humboldt
Buena Vista Pocahontas
Audubon
Greene
Guthrie
Butler
Wright Franklin
Hamilton
Dallas
III
Black Hawk Buchanan
Hardin
Storyr
Boone
Bremer
Dubuque
Grundy
Jasper
Bent on
Ta ma
Marshall
Polk
Delaware
Jones
Li nn
II
Poweshiek
Clinton
Cedar
Johnson
Iowa
Jackson
Scott
Muscatine
Pottawattamie
Western
Iowa-Nebr.
Mills
Fremont
Cass
Montgomery
Page
Adair
Madison
Warren
I
Adams
Union
Taylor
Ringgold
Clarke
Decatur
Washington
Marion
Lucas
Wayne
Mahaska
Monroe
Appanoose
Keokuk
Wapello
Jefferson
Davis
Van Buren
Louisa
Des Moines
Henry
Lee
Federal Milk Order Marketing Areas in Iowa as of January 1, 1978
Iowa Marketing Area,
#79, 5-1-7
(and corresponding
zones)
Intraorder Class I Location or
Zone Adjustments
=
An amount that is deducted from the order Class I Price to determine
an individual handler’s Class I Price
e.g. Iowa order
Zone 1 = 0 ¢
Zone 2 = 7 ¢
Zone 3 = 1.7 ¢/10 miles from closest of
Ames, Marshalltown, or
Cedar Rapids
Chicago regional order
1 1/2 ¢/10 miles from City Hall
Rationale: To encourage/permit efficient movement
of milk for fluid purposes within
an order
CONSOLIDATION TO FORM
UPPER MIDWEST FMMO, 6-1-76
1. Duluth - Superior, 5-5-41
2. Minneapolis / St. Paul, 11-3-45
3. MN / ND, 11-1-67
4. SE MN / N IA, 5-1-69
FMMO CONSOLIDATION
The Secretary of Agriculture is instructed to
consolidate milk marketing orders from 33 to
10-14 within three years of the enactment of
the Federal Agriculture Improvement and
Reform Act of 1995 (FAIR ACT). (Passed in
1996)
Past
Source: California Department of Food and Agriculture, August, 2000.
Source: California Department of Food and Agriculture, August, 2000.
KEY FMMO PROVISIONS OR
REGULATIONS
Have been more or less the same since the
AAA was passed
Remained the same after the reforms
dictated by the FAIR Act of 1995 were
implemented
Despite changes in boundaries and multiple
basing points there is little fundamental
change
KEY TOOLS USED BY FMMO’s TO
CREATE “ORDERLY MARKETS”
1. Pricing
2. Pooling
3. Diversion
4. Allocation
KEY FMMO PROVISIONS OR
REGULATIONS
1. Classified Pricing
2. Market-wide Pooling
3. Diversion to Higher Classes
4. Allocation of Milk from Outside
PRICING UNDER FEDERAL MILK
MARKETING ORDERS (STEPS)
1. Determine minimum class prices that
must be paid by handlers regulated by
that order
2. Determine total dollar payment
(obligation) required for each regulated
handler
3. Determine blend or uniform price to be
paid to producer
APPENDIX FOR SUPPLY AND DEMAND
Individual Supply/Demand vs.
Market Supply Demand
• The individual firms and consumers in the
economy face supply and demand situations
• The market supply and demand is the SUM of all
individual supply and demand curves
• Individual and firms may have different elasticity
of demand than the consolidated supply and
demand curves---especially in a market where
there are large numbers of actors
Price
Demand
Q
Price
Quantity
Consumed
Inelastic demand Individual
Consumer
Q
Quantity
Produced
Inelastic Supply Individual Producer
Price
Price
P
Supply
Demand
Quantity
Consumed
Completely Elastic Demand
P
Supply
Quantity
Produced
Completely Elastic Supply
Price
Demand
Q
Price
Quantity
Consumed
Inelastic demand Individual
Consumer
Q
Quantity
Produced
Inelastic Supply Individual Producer
Price
Price
P
Supply
Demand
Quantity
Consumed
Completely Elastic Demand
P
Supply
Quantity
Produced
Completely Elastic Supply