Regional impacts of federal milk market policy alternatives

Regional Impacts of Federal MilkMarketing Order Policy Alternatives

William A. Schick

Impacts of alternative federal milk marketing policies which result in reduced fluid (Class I)milk prices were assessed using a simulation model of the U.S. dairy industry. Resultsindicated that milk production, farm milk prices and producer revenues were significantlyreduced in the Southern and Northeast regions of the country under some options. Theregional shares of total U.S. milk production were not significantly altered from those whichwould exist under a continuation of the current policy,

There has been much discussion in recent yearsabout the need for changes in national dairy policy.While the price support program received most ofthe attention in the 1980s, federal milk marketingorders more recently have come under increasingscrutiny. In the autumn of 1990, national hearingswere held in several cities to consider proposedchanges to federal orders. Numerous proposalswere received covering many topics, but the ma-jority pertained to price differentials for Class Imilk including proposals for changes in the level ofClass I price differentials, changes in inter-orderprice relationships, and the establishment of mul-tiple base point pricing (Francis and Novakovic).While the outcome of the hearings resulted in nomajor changes regarding Class I prices, the subjectremains a divisive issue. Recently, the FederalDistrict Court in Minneapolis ruled the USDA’sdecision not to consider changes in the Class Iprice differentials to be arbitrary and capriciousand ordered the Secretary to reconsider changes inthe pricing structure. The issue has been a sourceof regional divisiveness with dairy farm groupsand industry leaders in the upper midwest favoringchanges in the federal order Class I pricing struc-ture, and those in the southern and eastern regionsof the country wanting Class I prices to stay as they

AssistantProfessor in the Department of Agricultural Economics, Pur-due University. Purdue Agricultural Experiment Station Journal PaperNo, 13896, This research was supported in part by a cooperative agree-ment with the Dairy Division, Agricultural Marketing Service, U, S,Department of Agriculture, The Division and its market administratorsprovided much of the data used in this project, much assistarrce, andIMCIYhelpfulcomments.Any opinions, firrdkrgs, conclusions, or rec-ommendations expressed herein are those of the author and do not nec-essarilyy reflect the views of the U.S. Department of Agriculture, Manyhelpful comments and suggestions for improving this paper were pro-vided by anonymous reviewers.

are. Clearly, the federal milk marketing order de-bate is not over. The purpose of this research is toexamine the regional consequences of alternativeproposals concerning Class I prices in federal or-ders,

Federal Milk Order History and Operation

Milk marketing orders have been in existence formore than 50 years, and for much of that time theywe~e not a source of disharmony among dairyfarmers from different parts of the country. Thepurposes of federal orders according to the en-abling legislation, the Agricultural Adjustment Actof 1933 and the Agricultural Marketing AgreementAct of 1937, are somewhat vague but encompassestablishing adequate prices to farmers through or-derly marketing, protecting consumer interests,providing an orderly and adequate flow of milk tomarket, and avoiding unreasonable fluctuations inmilk prices (Babb et al.). Through the years theobjectives that have been used to administer theprogram have included promoting orderly market-ing in fluid milk markets, stabilizing milk pricesand improving the income situation, supervisingthe terms of trade in milk markets in such a manneras to achieve more equality of bargaining betweenproducers and milk processors, and assuring con-sumers of adequate supplies of good-quality milkat reasonable prices (Forrest).

One of the most difficult items to interpret re-garding these objectives is what is meant by or-derly marketing. Traditionally, orderly marketinghas been interpreted to mean compliance to a com-petitive norm in that milk moves to where it isneeded for fluid use at the time it is needed (Ham-

208 October 1994 Agricultural and Resource Economics Review

mend and Harris). When the orders were initiated,producers were at a tremendous disadvantage inbargaining with respect to processors. Thisstemmed in part from the perishable nature ofmilk, the relative size and market power of pro-cessors, the lack of public information regardingprevailing prices, and the highly seasonal nature ofmilk production and demand. Hence, the marketwas not purely competitive. To encourage orderlymarketing, order provisions were designed toequalize the bargaining power between producersand processors, align prices within orders to en-courage raw milk supplies located near a particularprocessor to move there in preference to a moredistant processor, and align prices between ordersso as to encourage the production of fluid milkproducts from the nearest sources of raw milk(Babb et al.). The enforcement of minimum ClassI price differentials and the interorder pricingstructure is intended to be one means to achievethese orderly marketing objectives.

Today, federal order regulation of milk marketsis extensive. There are roughly 40 federal milkmarketing orders which regulate approximately 75percent of all Grade A (fluid grade) milk in thecountry. Milk is priced in these orders according toits use. Milk that is processed and sold in fluidform receives a Class I designation, milk used tomake perishable manufactured products is as-signed Class II use, while milk used to make stor-able products receives a Class HI designation. 1The Class III price for a given month in all federalorders is equal to the Minnesota—Wisconsin (M—W) price for the month. The M—W price is anaverage of prices paid by milk plants in Minnesotaand Wisconsin for manufacturing grade (Grade B)milk. The Class I price is equal to the basic for-mula price (the M—W price from two months ear-lier) plus a Class I differential.

The economic justification for Class I differen-tials is that they represent the added cost of pro-ducing Grade A milk, the higher value that suchmilk has in the marketplace, and the cost of trans-porting raw milk from the source of reserve sup-plies, which is represented by a base point in EauClaire, Wisconsin (Babb). The transportation costcomponent gives rise to the pricing structure whereClass I prices increase with distance from the up-per midwest. The differentials are set by theUSDA through the hearing process in which in-dustry representatives give testimony regarding

1 Recently, most orders have adopted a Clnss IIIa designation formilk used in makhg dry milk puwder. The price for milk used in thismanner has usually been lower than the Class 111price.

their appropriate level. For example, the currentdifferential added to the M—W price to obtain theClass I price is $1.20 per hundredweight in Min-neapolis—St. Paul and $4.18 per hundredweightin Miami.

Producers in each order receive a uniform orblend price equal to the sum of the class pricesweighted by the uses of all milk. This concept ofprocessors and manufacturers paying for milk ac-cording to how they use it, and producers receivinga uniform price based on order utilizations isknown as pooling. In addition to the minimumclass prices that processors must pay for milk,over-order payments are made by processors inmost federal orders to reimburse cooperatives forthe cost of obtaining supplies and providing mar-keting services. Hence, the effective price receivedby a farmer can often be higher than the blendprice. Cooperatives can also apportion losses tomembers and both cooperative and proprietaryfirms can assess transportation charges to produc-ers, so the price received by the farmer can like-wise be lower than the blend price.

Reasons for the Current Debate Over ClassI Prices

Regional conflicts over federal order pricing arenot new (French and Kehrberg), but concernsabout the structure of Class I prices were not in theforefront during the late 1970s and early 1980swhen increases in milk support prices seemed toensure adequate income for many dairy farmers.During the 1980’s however, the debate regardingfederal orders began to resurface with variousgroups divided along regional lines. The resur-gence of regionalism was due to many factors. Thedecline in federal price supports led to fallingprices and put the squeeze on farm incomes (No-vakovic and Jacobson). Also, changes in technol-ogy and the relative costs of concentrate feed re-sulted in the emergence of large-scale dairy oper-ations with low production costs. These systemswere embraced by many producers in the south andwest, but less so in the traditional regions, leadingto regional shifts in the shares of national milkproduction (Jesse and Babb). On top of thesechanges in industry structure, the Food SecurityAct of 1985 mandated increases in Class I differ-entials in most orders, but increases were larger inthe south than they were in the upper midwest.Tensions were exacerbated by these changes be-cause they differentially benefited producers in thesouth, and because they were mandated via thepolitical process rather than through the customary

Schick Impacts of Federal Order Alternatives 209

public hearing process (Novakovic and Jacobson).These events have resulted in some groups advo-eating changes in the current Class I differentials,while others maintain that the current differentialsare appropriate.

Proponents of change maintain that it no longermakes sense to think of the upper midwest as theonly source of reserve supplies (Anderson). Theypoint out that Class I utilizations in many federalorder markets are below 60 percent and questionwhy differentials should be higher in those marketsthan in the midwest (Table 1). Also mentioned isthe argument that regional differences in the dif-ferentials can no longer be justified by cost of pro-duction (McDowell et al. 1988). Another criticismis that differentials have been set too high in manymarkets, as evidenced by regional shifts in milkproduction shares and the fact that supplies ofGrade A miik are well in excess of fluid needs andreserve requirements. Often cited with respect tothis criticism is the case of the Texas order, whichhas seen dramatic increases in production since thedifferentiais were increased in 1986 (Novakovicand Jacobson). Another concern is that the Class Iprice is reflective of a limit price, which may behigher than the competitive equilibrium price forfluid milk in many regions. Such pricing tech-niques, it is argued, differentially benefit produc-ers in regions distant from the upper midwest.

Baiartced against these assertions are the argu-ments of those who believe that the current systemis both working well and reflective of a competi-tive solution. They point out that federal order

Table 1. Average Class I Utilizations andMinimum Class I Differentials for SelectedFederal Order Regional Aggregates

prices in most cases are not the effective Class Iprices and that market forces are acting to adjustprices through over-order payments (Jesse andBabb). Another argument in support of the currentstructure addresses the limit price issue, noting thatthe federal order Class I price structure is not a truelimit price because it represents only about 60 per-cent of actual transportation costs. Furthermore,some studies have indicated that the current federaiorder price structure is generaily consistent withcompetitively determined prices, given the currentregional distribution of production and consump-tion (Babb; Novakovic and Pratt). A finai pointmade is that the Class I differential question isdeclining in importance, as such differentials rep-resent a much smaller percentage of the total milkprice than was the case in prior years (Novakovicand Jacobson).

The Secretary of Agriculture made no majorchanges to the level and interregional alignment ofClass I differentials as a result of the 1990 hear-ings. Since then, pressure has been building for theSecretaxy to reconsider possible changes. Againstthis backdrop, this research analyzes the impact ofsome of the proposals regarding the Class I differ-entials. While proposed changes have impacts inalI orders, the magnitude of such impacts can ob-viously vary on a regional basis. Changes in therelative price levels would change the total incomefrom dairying accruing to a particular order or re-gion. The objective of this analysis is to determinethe impacts of alternative federal order policies onregional milk production, milk prices, and pro-ducer revenues, taking into account the dynamicand spatial aspects of the market.

Model Development

Class I Class 1Region Utilization Differential

dollars perpercent hundredweight

Northeast 45 3.00Middle Attantic 50 2.67Corn Belt 48 1.85Kentucky-Tennessee 76 2.61Southeast 85 3.37Florida 85 4.85Deep South 76 3.26Lake States 16 1.81Northern Plains 35 1,54Southern Plains 47 2.37Texas 53 3.11

Source: McDowell, H., A. Fleming and R. Fallert. FederalMilk Marketing Orders: An Analysis of Alternative Policies.Washington, DC: Economic Research Service, U.S. Depart-ment of Agriculture, September 1988.

The regional impacts of alternative federal orderpolicies were simulated using a capacitatedtransshipment model of the dairy industry knownas the Dairy Market Policy Simulator (DAMPS).DAMPS was developed to simulate the impact ofalternative policies on various response variablesin federai and state miik marketing orders and un-regulated areas (Novakovic et al. 1980; 1991).Model components include: supplies of Grade Aand Grade B milk, processing activities, demandfor fluid and manufactured products, commercialand government stocks of manufactured products,and transportation activities. In the model, eachfederal and state milk marketing order has a supplyand demand center associated with it. The inclu-sion of state regulated areas is important because

210 October 1994

California, the largest milk-producing state, doesnot have a federal order.

The model’s objective function is to minimizethe sum of the costs of milk assembly, processing,and product distribution subject to available milksupply, plant capacities, and consumption require-ments. The transshipment model is formulated as anetwork and is solved using a primal-simplex al-gorithm (Bradley et al.). A representation of thenetwork model is shown below.

(1) Min Z CkXk, keA

subject to:x x~ E x~

(a)ketl with tail i – kei with head i

= bi, id

(b) 1~ ~ Xk == Uk, kcA,

where:

bi =

A=N=c~ =Xk =

lk =Uk =

supply if i is a supply node;negative of demand if i is ademand node; O otherwiseset of all defined arcsset of all nodescost along arc Kamount of product moved alongarc klower bound on arc kcapacity of arc k.

This formula~ion is equivalent to the standardlinear programming (LP) representation of thetransshipment problem. The objective function ofminimizing the sum of assembly, processing, anddistribution costs is defined as minimizing the sumof total costs over all arcs. The first constraintencompasses the supply, demand, and balancingconstraints found in traditional LP formulations.The second constraint defines upper and lowerbounds for movements along particular arcs;hence, this represents constraints on plant capac-ity. The network formulation requires that allow-able arcs are predefine by the set A; therefore,unrealistic linkages are not considered. Unlike thesimplest transshipment models, DAMPS allowsfor milk supply and dairy product demand to re-spond to changes in prices by incorporating elas-ticities in a recursive simulation structure. Achange in relative prices in one period will impactsupply and demand quantities in the subsequentquarter; thus, the model is price responsive anddoes not assume fixed quantities for supply anddemand.

DAMPS was modified to include dynamic re-gional milk supply response parameters for eight

Agricultural and Resource Economics Review

regions (Schick 1991). The basic form of the sup-ply response model is shown in below.

(2) mpd, =(3) ypct =(4) fins, =(5) Cpft =

where:mpdt =ypct =

Cpft =

frost =

L=

mfrt =E(rnd,) =

E(md,) =

t =

ypc, * cpft * fins,f(ypc(L), fins,, cpft, mfrt, t)g(fms(L), YPC,,cpft, E(mrdt), t)h(cpf(L), ypc,, frost, E(~dt), t)

annual milk production in year tannual milk yield per cow inyear taverage herd size (cows perfarm) in year tnumber of farms with milk cowsin year tlag operator where x(L) is Xt_ ~and X(L2)is xl_ zmilk-feed price ratio in year texpected relative profitability ofdairying compared to otheractivities in year texpected profitability of milkproduction in year ttime trend.

The estimated supply response model is an er-ror-correction formulation (Engle and Granger)where the dependent variables are yield per cow,farm numbers, and cows per farm, Milk produc-tion is the product of the three dependent variables.The model is dynamic and includes lagged valuesof the endogenous variables, as well as price ex-pectations variables. The supply response param-eters were estimated using iterative seemingly un-related regressions (Judge et al.). A dynamic ap-proach to supply modeling is necessary because itmay take a number of years for the full impact ofa price change on production to be realized. Fordairy farmers, price changes in previous periodsaffect their expectations about current-periodprices, future prices, and the profitability of dair-ying. Based on these expectations, dairy farmersmay expand or contract the size of their operations,or even exit the industry. Likewise if price expec-tations are favorable, new producers may enter theindustry. Static supply models and dynamic mod-els which do not incorporate firm numbers do notfully capture these relationships (Veloce and Zell-ner). Another reason for specifying a dynamicmodel of this type relates to arguments that recentincreases in Class I price differentials have beenpartially responsible for regional shifts in milk pro-duction. A dynamic model that allows for firmentry and exit provides a vehicle for addressingthis issue.

A milk-composite input price ratio is included to


represent the profitability of dairying on a per cowbasis. The composite input price is a weighted av-erage of feed prices, hay prices, and agriculturalwage rates. A milk-labor price ratio is used as aproxy for the profitability of dairying, relative toother enterprises in which the owner-operatorcould be employed. The expectations for the milk-composite input price were assumed to be a singleaverage of the previous four years’ price changes,while expectations for the milk-labor price ratiowere determined by identifying the autoregressive-moving average (ARMA) process in the series,and using the estimates of the ARMA model asprice expectations. A summary of the regionalown-price elasticities generated by this model ispresented in Table 2.

The regional supply response estimates were in-corporated in DAMPS and the simulation model issolved recursively. Regional milk production isdetermined according to the supply responsemodel. These results become the milk productiondata used by DAMPS to determine the cost-minimizing solution to the transshipment problem,Average farm milk prices are computed byDAMPS based on milk utilization in each regionand these data are used by the regional supplymodels to determine the next period’s production.

Policy Simulation

For the purposes of poIicy simulation, it is neces-sary to establish a baseline to serve as a compari-son for various scenarios. Five years were simu-lated for the baseline and for each policy altern-ative.While results were generated for all federaland state milk marketing orders, only annual sum-

Table 2. Cumulative Own-Price Elasticitiesof Milk Production Through Year 5by Region

----------------------Year ----------------------Region 1 2 3 4 5

Corn Belt 0.06 0.11 0.10 0.13 0.18North Centrat 0.04 0.12 0.13 0.19 0.24Northeast 0.09 0.12 0.18 0.23 0.28Pacific 0.05 0.05 0.14 0.28 0.35South Central 0.08 0.07 0.10 0.17 0.07Southeast 0.10 0.13 0.14 0.17 0.17Southwest 0.00 0.12 0.20 0.33 0.47Mountain 0.07 0.12 0.25 0,39 0.47

Source: Schick, W.A. Regional Farm Structure Impacts of Llo-vine Soma?orropin Adoption. Staff Paper No. 94-16, Depart-ment of Agricultural Economics, Purdue University, West La-fayette, IN, August 1994.

mary data for regional aggregates are reportedhere. The regions used in this study are shown inFigure 1. These regional delineations differ fromthose usually used by the USDA. Attempts weremade to make these state groupings more consis-tent with respect to trends in average herd size,milk production, yield per cow, and the dominanttype of milk production system in use. Percentagechanges in milk production, production share,farm milk price and gross producer revenue underthe baseline after 5 years are shown in Table 3.

Federal Order Policy Scenarios

While a number of issues were considered at thenational hearings on Federal Milk Marketing or-ders, many of the proposals regarding Class I dif-ferentials are reflected by the four policies exam-ined here. These alternatives represent proposalsthat were submitted prior to the 1990 hearings(Francis and Novakovic). The scenarios analyzedinclude the following: multiple base point pricing,reinstatement of Class I price differentials that ex-isted before 1986, the elimination of the Grade Adifferential and the establishment of uniform(fixed) Class I price differentials in all orders.

Multiple base point pricing. In this scenario, itwas assumed that the Class I differential was equalto $1.20 per hundredweight in all orders havingadequate milk production to satisfy fluid use re-quirements (Class I sales plus a necessary reserve).The exceptions to the $1.20 differential rule areorders that must acquire supplemental milk to meetfluid consumption requirements. In these ordersthe minimum Class I differentials were set in ac-cordance with a competitive model at levels thatwere required to attract supplemental milk suppliesduring deficit periods (McDowell et al. 1990).These differentials ranged from a high of $5.03 perhundredweight in Florida to a low of $1.57 in Lou-isiana, Mississippi, and Arkansas. Californiawhich does not have a federal order was assigneda Class I differential of $0.87 per hundredweight,the applicable level during the year (Table 4). Inaddition to the minimum differentials, the cost ofintraregional fluid milk marketing was added to theClass I prices to reflect the minimum over-orderpremiums that would prevail. These costsamounted to an additional $0.65 per hundred-weight in orders east of the Rocky Mountains and$0.45 per hundredweight in orders west of theRockies.

1985 Class I differentials. Some of the propos-als submitted at the federal order hearings in theautumn of 1990 called for a reinstatement of the


Figure 1. Milk Production Regions Used in This Study.

Class I differentials in effect prior to the changesthat were made in 1986 under the 1985 farm bill.The level of the 1985 Class I differentials wereobtained from Federal Milk Market Order Statis-tics (USDA 1985). For the purposes of this simu-lation, it was assumed that over-order premiumswould continue at base-year levels. In reality, theover-order premiums could be expected to changewhen the minimum differentials change. However,there was no basis for predicting how much thepremiums would change.

Table 3. Baseline Simulation Results,Five-Year Percentage Changes in SelectedVariables by Region

GrossMilk Production ~% Producer

Region Production Share Price Revenues

Corn BeltNorth CentralNortheastPacificSouth CentralSoutheastSouthwestMountainUs.

percentage change from base year4.1 -0.6 –0.2 3.93.0 –2.1 –0.0 3.05.3 –1.2 –0.5 4.7

25.4 2,2 –0,6 24.62.2 –0.5 0.2 2.3

13.7 0.1 –2.0 11.554.5 2.0 –5.2 46.513.9 0.1 –0.5 13.410.9 . –0.8 10.0

Elimination of the Grade A differential. Theelimination of the Grade A differential has beendiscussed. This differential is supposed to reflectthe added cost of Grade A milk production and thehigher value of such milk in the marketplace.Modeling the impact of eliminating this differen-tial would involve reducing Class I differentials inall federal and state orders by a fixed amount. Thisscenario was simulated by reducing Class I differ-entials in all orders by $0.50 per hundredweight(Schwart et al), Over-order premiums were as-sumed to continue at base-year levels.

Establishment of uniform (’fixed) Class I differ-entials. Some proposals at the federal order hear-ings called for the establishment of uniform ClassI differentials in all federal orders. Several levelsfor the uniform differential were proposed, with$1.80 per hundredweight being the most frequentchoice, For the purposes of this simulation, allClass I differentials were reduced to $1.80 perhundredweight plus the applicable over-order pre-miums that were in effect during the base year.

National Impacts

For each of the federal order policies examined,the Class II and Class III prices and all input prices


Table 4. C1ass I Differentials in Federal and State Milk Orders Under a Multiple Base PointPricing Plan

Order Differential Order Differential

Upper Florida 5.03 Central Arkansas 1.57Tampa Bay 5.03 Lou-Lex-Evans. 2.05S.E. Florida 5.03 Paducah 2.05Alabama-W. Florida 2.95 Nashville 2.05Georgia 2.95 Memphis 2.05North Carolina 2.95 Tennessee Valley 2.05South Carolina 2.95 California 0.87Greater Louisiana 1.57New Orleans-Miss. 1.57 All Others 1.20

Source: McDowell, H., A. Fleming and F. Spinelli. U.S. Milk Markets Under Alternative Federal Order Pricing Policies,Washington, DC: Economic Research Service, U.S. Department of Agriculture, November 1990.

were maintained at base-year levels. The resultsare reported as changes in the year 5 projectedvalue from the projected year 5 baseline value.Hence, references to decreases or increases in aparticular response variable are expressed relativeto what would have occurred in the absence of thepolicy change. Such responses are not increases ordecreases relative to the initial state (year O).

The aggregate impact of the four federal orderpolicy alternatives on selected variables is shownin Table 5. Milk production decreases slightly un-der each of the four scenarios. This result wasexpected since under the assumptions employedhere, all of the policies involve reductions in milkprices. Producer revenues also fall, as do con-sumer expenditures and government removals.Fluid utilization increases as a result of the com-bined effect of decreased production and increasedconsumption caused by lower milk prices. Impactsare greatest under the multiple base point pricingplan since this scenario involves the greatest aver-age price reduction from base run levels (2.7 per-cent). However, the national-level impacts onthese variables are small in all cases.

Regional Impacts

Regional milk production declines under each ofthe federal order policies in almost every case (Ta-ble 6). The exception is the Pacific region, whichshows a modest increase in production relative tothe baseline under multiple base point pricing, andthe North Central region, which shows an increaseunder fixed differentials. The reductions in re-gional production are greatest in the Northeast,Southeast, and Southwest. Such results are not sur-prising because these regions experience greaterprice reductions than other regions under the pol-icies examined (Table 7). However, note that thereductions in milk production in the South Centralregion are relatively small, even though this regionhas the second greatest decrease in milk price (Ta-bles 6 and 7). Dairy farmers in the South Centralregion, which includes Tennessee and Kentucky,probably have fewer alternative uses for their landand other inputs than farmers in the Southeast,Northeast, and Southwest. Hence, many farmersin the South Central region may continue dairyingeven in the face of declining prices because few

Table 5. Federal Order Policy Simulation Results for Selected Response Variables

NetMilk Milk Producer Consumer Government Fluid

Production Price Revenues Expenditures Removals Utilization

billion dollars billion billion percent percentpounds per cwt. dollars dollars (fat basis)

BaselineYear O 145.01 12.24 17.75 31.12 6.3 40.6Year 5 160.75 12.14 19.51 35.59 8.7 37.1

percentage change in simulated Year 5 valuesrelative to Year 5 Baseline values

Multiple Base Points –0.7 –2.7 -3.4 –1.2 – 0.6 1.91985 Differentials –0.2 –0.9 –1.1 –0.5 –0.2 0.8No Grade A -0.4 –1.4 -1.9 –0.8 -0.4 0.8Fixed Differentials –0.5 –1.8 –2.3 –1.1 -0.5 1.4


Table 6. Federal Order Simulation Results for Regional Milk Production, Percentage Changefrom Baseline Values

Corn North SouthBelt Central Northeast Pacific Central Southeast Southwest Mountain

billion poundsBaselineYear O 14.72 43.49 35.09 24.36 8.75 5.62 7.47 5.50Year 5 15.33 44.79 36.95 30.54 8.94 6.40 11,54 6.26


Multiple Base Point –0.3 –0.1 –1.6 0.4 –0.4 –2.0 -3.0 –1.11985 Differentials –0.2 –0.1 –0.2 0.0 –0.2 –0.5 –1.2 -0.3No Grade A –0.3 –0.2 –0.5 – 0.5 –0.1 –0.4 -0.9 – 0.8Fixed Differentials –0.2 0.1 –1.1 0.0 –0.4 –1.3 –2.2 –0.6

alternatives are available. As was the case for na-tional aggregate results, multiple base point pric-ing had the greatest impact of any policy on re-gional production,

When compared to the baseline, milk prices arelower under the federal order policy alternatives inalmost all cases. Again, the exceptions are the Pa-cific region under multiple base point pricing andthe North Central region under fixed differentials(Table 7). The greatest price impacts are in regionswhich currently have high Class I differentials orhigh fluid utilizations, such as the Northeast,Southeast, South Central, and Southwest. Anyplan that lowers differentials would have thestrongest impact in these regions. In all cases, theSoutheast and South Central regions experiencethe greatest change in milk prices. However, undera multiple base point policy, the impact in thesoutheast is magnified because the high over-orderpremiums which existed in the base year were notcarried forward in the simulation. The level ofprices under this scenario were determined to bethose required to induce adequate supplies of milkto move during deficit periods (McDowell et al.1990).

Table 7. Federal Order Simulation Results forBaseline Values

Impacts in the Pacific region are heavily influ-enced by impacts on California. The increase inthe Class I price in California under multiple basepoint pricing is due to the inclusion of interregionalmarketing costs in the effective Class I price whichwas not assumed under the baseline. This assump-tion was made under the multiple base point sce-nario to maintain consistency with an earlier study(McDowell et al. 1990). Under the elimination ofthe Grade A differential, California was treated thesame as federal orders and received a 50 cent re-duction in its Class I price, something whichwould not necessarily occur if this policy wereadopted, as only those areas regulated by federalorders would be required to comply.

The impact on regional producer revenues mir-rors that of milk prices. The Southeast, Southwest,South Central, and Northeast regions experiencethe greatest decreases in gross producer revenueswhen compared to the baseline (Table 8). Multiplebase point pricing generally has the greatest impact(0.5 to 14.1 percent) followed by the uniform dif-ferential policy (O.1 to 8.9 percent). A return to1985 differentials and the elimination of Grade Adifferentials have more modest effects, although

Regional Milk Price, Percentage Change from

Corn North SouthBelt Central Northeast Pacific Central Southeast Southwest Mountain

dollars per hundredweightBaselineYear O 12,06 11.92 12.71 11.21 13,18 14.78 12.88 11.84Year 5 12,04 11.91 12,65 11.14 13.20 14.49 12,22 11.78


Multiple Base Points –1.4 –0.4 –5.3 1.0 –5.5 – 12.3 -4.6 –1.91985 Differentials –1.2 –0.2 –0.8 0.0 –3,4 –3.0 –1.9 –0,5No Grade A –1.4 –0.8 –1.8 –1.3 –2.3 –2.5 -1.4 –1.5Fixed Differentials –0.8 0.6 –3.6 –0,1 –5.5 –7,7 –3.5 –1.3


Tab1e8. FederalOrder Simulation Results for Regional Producer Revenues, PercentageChange from Baseline Values

corn North SouthBelt Central Northeast Pacific Central Southeast Southwest Mountain

billion dollarsBaselineYear O 1.78 5.18 4.46 2.73 1.15 0.83 0.96 0.65Year 5 1.85 5.34 4,67 3.40 1.18 0.93 1.41 0.74

percentage change in simulated Year 5 valuesfrom Year 5 Baseline values

Multiple Base Points -1.7 – 0.5 – 6.8 1.4 –5.8 – 14.1 -7.4 –3.01985 Differentials –1,4 –0.3 –1.0 0.0 -3.7 –3.5 -3.0 –0.8No Grade A –1.7 -1.0 –2.3 –1.8 –2.4 -3.0 –2.3 -2.3Fixed Differentials –0.9 0,7 –4.7 –0.1 –5.8 -8.9 –5.6 %1.9

eliminating the Grade A differentials has a propor-tionately greater impact than a return to 1985 pric-ing in the Mountain and Pacific regions whereClass I differentials are already small. In these re-gions, the Grade A differential represents a largerpercentage of the Class I milk price. In general, theimpact of a return to 1985 differentials is larger inregions distant from the upper midwest (east of theRocky Mountains) and in regions with high fluidutilizations. The impact of eliminating the Grade Adifferential varies directly with the regional Class Iutilization percentage. One should note that underthe fixed differential, the North Central region isthe only one to experience an increase relative tothe baseline in milk production, prices and reve-nue. Given this, it is not surprising that this optionwas put forward and supported by a coalition ofcooperatives and processors in the upper midwest,

The alternative policies result in very littlechange in the regional production shares relative tothe baseline (Table 9). The forces at work causingregional shifts in milk productions appear to gobeyond the influences of federal order pricing.These results suggest that changes in the Class Iprice differentials will not stem the exodus of milk

producers or the decline of milk production in theNorth Central and Corn Belt regions, nor will theystop the expansion of milk production in the South-west and Pacific regions.

Conclusions

Given the assumptions used in this study, the fed-eral order policies examined do not substantiallyimpact aggregate U.S. milk production, prices, orproducer revenues. The average U.S. milk pricefalls at most by about 2.6 percent under multiplebase point pricing and 1.8 percent under uniformClass I differentials. The differences in the impactson regional production, milk price, and producerrevenues were more striking. Clearly the biggestlosers under any of the proposed changes are theSouthern regions and the Northeast as they sufferthe biggest reductions in average milk prices andaggregate producer revenues. The Southeast expe-riences the most severe consequences and is par-ticularly hard hit under the multiple base pointpricing policy with a milk price decrease of over12 percent and an aggregate revenue decrease of

Table 9. Regional Shares of U.S. Milk Production Under Baseline and Federal OrderPolicy Alternatives

Corn North southBelt Central Northeast Pacific Central Southeast Southwest Mountain

Baselinepercent of U.S. milk production

Year O 10.2 30.0 24.2 16.8 6.0 3.9 5.2 3.8Year 5 9.5 27.9 23.0 19.0 5.6 4.0 7.2 3.9

production shares in Year 5 under alternativefederal order policy scenarios

Multiple Base Point 9.6 28.0 22.8 19.2 5.6 3.9 7.0 3.91985 Differentials 9.5 27.9 23.0 19.0 5.6 4.0 7.1 3.9No Grade A 9.5 27.9 23.0 19.0 5.6 4.0 7.1 3.9Fixed Differentials 9.6 28.0 22.8 19.1 5.6 3.9 7.1 3.9


over 14 percent. It is important to mention thatthese results carry the implicit assumption thatover-order payments do not adjust under the newpolicy, which is obviously unrealistic. Given thehigh Class I utilization in the Southeast, periodicdeficits in milk for fluid use are likely to occur. Atsuch times, the effective Class I price might be bidup to reflect transportation costs and prices in theclosest milk exporting region. Hence, the actualimpact in the Southeast and South Central regionsmay not be as large as projected here.

The regions which fare the best under these pol-icies are the North Central and Pacific regions. TheNorth Central region is perhaps a bigger long termgainer because of its proximity to the marketswhere production is reduced. Because the NorthCentral region is the residual supplier of fluid milkto the southern markets, it will likely experience anincrease in its share of fluid milk sales in thosemarkets when production there is reduced. It istherefore understandable why the North Central re-gion’s dairy cooperatives are advocates of chang-ing the federal orders in the direction of reducingor eliminating inter-order price differences. How-ever, depending on how over-order premiums ad-just, such policy changes may result in little over-all benefit for producer groups in the North Centralregion. Furthermore, it does not appear that theywill reverse the shifts in regional production thathave already occurred, nor will they halt the con-tinuation of these trends.

This research examined the impact of variousproposals for changes in Class I differentials infederal orders on regional milk production, farmmilk prices, and producer revenues. These resultsdo not make any claim about the overall economicefficiency of the various alternatives compared tothe current policy, but merely addresses the distri-bution of producer benefits among regions. All ofthe options analyzed reduce Class I prices in mostorders. The most obvious economic justificationfor them is that they reduce regulated minimumprices, allowing market forces to have greater in-fluence over the actual market price, and reducingany arbitrary enhancement of prices in some re-gions over others. Reducing regulation may allowconsumers greater latitude in demonstrating de-mand and generating value for milk and milk prod-ucts and producers are better able to respond withany comparative or cost advantage they may have.

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