Federal Milk Marketing Order Reform By Richard P. Stillman USDA-ERS August 26, 1999

Federal Milk Marketing Order Reform Milk says USDAs Chief Economist Keith Collins, can give you a headache. - Wall Street Journal

What is the Federal Milk Marketing Order System? FMMOs were established in the late 1930s –Farmers had few outlets for their milk –Poor roads –There was little or no refrigeration – Milk moved in 10 gallon cans –The concerns at the time were market power and equity

What do FMMOs do? FMMOs set monthly minimum prices paid by first handlers of milk, by use. Handlers are required to pay these minimum prices into a pool A weighted average (blend) price, based on use, is paid to farmers from this pool FMMOs align prices to encourage the movement of Milk

The Classified Pricing System Class I =Class III + a regional differential Class II=Class III + a national differential Class III (market clearing price) Class III-A (market clearing price) Fluid milk products soft products (ice cream, yogurt) Cheese and butter Nonfat dry milk

What did Congress direct USDA to do? Required: –Consolidate the present order system into no less than 10 and no more than 14 orders

What did Congress direct USDA to do? Allowed: –California may join the order system –Change in Class I price surface –Use utilization rates and multiple basing points in establishing Class I differentials –Use component pricing in establishing one or more Basic Formula Price (BFP)

What has AMS done? Consolidated the 31 orders into 11 orders Proposed 4 options on the price surface Changed the Classified pricing system Proposed uniform regulations ( these are different in each order)

Milk pricing options

Classified pricing changes under the Federal Milk Marketing Order Reform New proposalOld systemClass I price = Class III price (national price) +Basic Formula Price (national price) +Class I differential (order specific)Class II price= Class IV price(national price) +Basic Formula Price + $0.70 (national)$0.30 (national) Class III price (national)= Basic Formula Price (national)= formula based onMinnesota-Wisconsin Grade B price butter, cheese, and whey pricesupdated by butter and cheese price formula Class IV price (national)=Class III-A (national)= formula based on butter and formula based on nonfat dry milk prices and nonfat dry milk pricesthe butter fat differential

What are the economic impacts of order reform Change in the utilization rates-effect of consolidation –Merged orders may change the utilization rates of different classes Intra-order zone pricing-effect of consolidation –within orders locations (plants) have different blend prices, based on distance from the main demand point

Intraorder pricing

Class I differentials-effect of the price surface The basic economic principle behind the FMMOs is price discrimination –Fluid milk has the most inelastic demand and is assigned the highest price in the system. –Manufacturing milk is more elastic therefore additional milk is moved onto this market. –The higher the Class I differentials, the higher farmer income and the higher consumer costs

Discriminatory pricing Pd Pe Pdm QdQe Qd Se D Sd

Formula pricing input markets and price discrimination Class I and II prices are based on fixed differentials added to the Class III and IV prices. Class III and IV prices are formula driven based on output prices Rule 1 of price discrimination: –allow at least one market to clear