Dairy Marketing

Dr. Roger GinderEcon 338Fall 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

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Price$/#

Quantity# of milk

Relatively Inelastic Market Demand

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Quantity# of milk

Relatively Elastic Market Demand

DAIRY COOPERATIVE CLASSIFIED PRICING EXAMPLE

Coop prices:Class I = $10.00Class II = $ 8.00

Average use by coop customers:Class I = 50%Class II = 50%

Use by Buyer “A”: Used by Buyer “B”:Class I = 90% Class I = 10%Class II = 10% Class II = 90%

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” = Price paid by Buyer “B” =(.9 x $10.00) + (.1 x $8.00) = $9.80 (.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

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Price$/#

Fluid Milk Quantity# of milk

Relatively Inelastic Market Demand

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Mfg. Milk Quantity# of milk

Relatively Elastic Market Demand

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

For milk marketing inProducers a defined(Individual geographic areavotes)

Federal Milk Market Order Agreements

The FMMO is an agreement among:

U.S. Secretary of Agriculture

For milk marketing inProducers a defined(Individual geographic areavotes)

Producer cooperatives

(block votes)

Federal Milk Market Order Agreements

The FMMO is an agreement among:

U.S. Secretary of Agriculture

For milk marketing inProducers a defined Grade A(Individual geographic area handlersvotes) processors

Producer cooperatives

(block votes)

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

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

Location Adjustments Within 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. Dubuque, 10-1-36b. Quad Cities, 12-1-51

(1) Quad Cities, 2-1-40(2) Clinton, 10-1-44

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Lee

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Kossut h

Jasper

Lyon

Page

StoryrJones

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Adair

Bent on

Wapello

Pocahontas

Osceola

Jefferson

Audubon

Washington

Buena Vista

Black Hawk

Appanoose

Cerro Gordo

Van Buren

Muscatine

Dickinson

Des Moines

Winnebago

Montgomery

Eastern South Dakota#76, 5-1-65

Upper Midwest#68, 6-1-76

Iowa Marketing Area, #79, 5-1-7(and corresponding zones)

Federal Milk Order Marketing Areas in Iowa as of January 1, 1978

III

I

IIPoweshiekPolk

BooneGreeneCarroll

Crawford

Plymouth

O’Brien

Woodbury

Monona

Harrison Shelby

Wright Franklin

FloydChickasaw

WebsterHardin

Louisa

Emmet

Palo AltoHancock

Worth Mitchell Howard WinneshiekAllamakee

BremerButler

HamiltonGrundy

Buchanan Delaware Dubuque

Jackson

Clinton

Guthrie Dallas Johnson

Marshall

Pottawattamie

Mills

Fremont

Madison WarrenMarion Mahaska Keokuk

Adams Union ClarkeLucas

Monroe

Taylor Ringgold

Cherokee

Calhoun

Decatur Wayne Davis

Henry

Scott

HumboldtClayton

Cedar

Sioux

Cass

Iowa

Western Iowa-Nebr.

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 orderZone 1 = 0 ¢Zone 2 = 7 ¢Zone 3 = 1.7 ¢/10 miles from closest of

Ames, Marshalltown, or Cedar Rapids

Chicago regional order1 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

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Quantity Produced

Inelastic Supply Individual Producer

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Inelastic demand Individual Consumer

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Completely Elastic Demand

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Completely Elastic Supply

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Inelastic Supply Individual Producer

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SupplyPrice

Quantity Consumed

Inelastic demand Individual Consumer

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Completely Elastic Demand

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Completely Elastic Supply

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