Federal Milk Marketing Order Reform

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

2. Federal Milk Marketing Order Reform • “Milk “ says USDA’s Chief Economist Keith Collins, “can give you a headache.” -Wall Street Journal

3. What is the Federal Milk Marketing Order System? • FMMO’s were established in the late 1930’s • 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”

4. What do FMMO’s do? • FMMO’s 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” • FMMO’s align prices to encourage the movement of Milk

5. 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 The Classified Pricing System

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

8. 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)

9. 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)

11. Milk pricing options

12. Classified pricing changes under the Federal Milk Marketing Order Reform New proposal Old system Class I price = Class I price = Class III price (national price) + Basic Formula Price (national price) + Class I differential (order specific) Class I differential (order specific) Class II price= 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 on Minnesota-Wisconsin Grade B price butter, cheese, and whey prices updated 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 prices the butter fat differential

13. 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

14. Intraorder pricing

15. Class I differentials-effect of the price surface • The basic economic principle behind the FMMO’s 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

16. Discriminatory pricing Se Sd Pd Pe Pdm D Qd Qe Qe Qd

17. 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