UC Davis

Since the passage of the Agricultural Marketing Agreement Act of 1937, the Federal Milk Marketing Orders (FMMOs) have overseen sales of milk within regions comprising the majority of milk production and processing in the United States. The stated objective of the FMMOs is to support milk producers by establishing minimum prices for farm milk across four end-use product classes and by ensuring farmers are paid a weighted average of the minimum class prices. To the extent that prices paid for farm milk are higher due to FMMO pricing rules than they otherwise would be, milk production is also higher than it would be in the absence of the FMMOs.

This dissertation investigates the impact of FMMO pricing rules on the geographic distribution of milk production, inter-regional shipments of farm milk, and the value of manufactured dairy products and dairy product exports. Chapter 1 provides an introduction and Chapter 2 outlines the history of U.S. dairy policy and introduces the regulatory structure of the FMMOs. Chapter 2 also explores regional milk supply and demand through a graphical model based on the foundational literature that describes the incentives to ship raw milk created by FMMO regulations. Chapter 3 introduces methods for calculating inter-regional trade flows in dairy products and feed crops from available data. Finally, Chapter 4 expands on the analysis in Chapter 2 and the data developed in Chapter 3 by developing and calibrating a simulation model of the dairy supply chain in the United States.

Milk marketing orders use a system of classified pricing to define minimum prices that buyers must pay based on the intended end use of the milk purchased. This system uses a price differential intended to set the minimum price paid by beverage milk processors above the prices paid for milk used in more heavily processed dairy products. High transportation costs lead to local markets for beverage products with relatively inelastic demand, which allows for this price discrimination to generate additional revenue for dairy farmers. This additional revenue is redistributed through a blend price, a weighted average of the classified prices that ensures all participating dairy farmers in a marketing order region receive a uniform minimum price.

These two mechanisms, classified pricing and revenue pooling, were explored in a series of papers in the 1960s and 1970s to show the impact of FMMO regulations on milk production and social welfare. In Chapter 2 I extend these models by incorporating the bilateral trade relationship between two regions, with and without marketing order pricing rules in place, to demonstrate the incentives that lead to farm milk shipments between regions. The model shows that FMMO regulations lead to increased milk production in both regions, greater shipments of farm milk between regions, and more milk used in more heavily processed dairy products rather than beverage products. To the extent that manufactured dairy products are more easily traded internationally, increased production of these products leads to an increase in exports.

While some of the data I use in more intensive modeling of regional dairy markets are readily available, detailed information on bilateral trade within the United States is not. Chapter 3 details a method used to interpolate the value of inter-regional trade in dairy products and feed crops using a gravity approach and available data on regional production and consumption. Survey data provides some information on inter-regional shipments but is often unavailable. Gravity models are commonly used in the international trade literature to model bilateral trade between countries, and they have been extended to develop regional trade flow matrices and input-output tables at a sub-national level. Chapter 3 develops and explains substantial data on dairy product and feed crop production, consumption, and inter-regional trade.

Chapter 4 develops, calibrates, and presents simulation results from a multi-market equilibrium trade model that shows empirically the extent to which FMMO pricing rules affect the quantity of milk produced in each region, shipments of farm milk between regions, the value of regional production of dairy products, and the value of dairy product exports from each region. The model allows for calculation of welfare impacts after removal of the FMMO pricing rules, from which I determine the impact on buyers of dairy products in the U.S., buyers of U.S. dairy products in the rest of the world, and crop producers. Due to the longstanding nature of the milk marketing order policies, the simulation approach reflects the impacts of removing FMMO pricing rules rather than adding regulation to a previously unregulated system. The model is calibrated to a baseline scenario with FMMO pricing rules in place, then used to explore a counterfactual scenario where the FMMO pricing rules are eliminated, removing classified pricing in each FMMO region.

Chapter 4 has four main results addressing the primary research questions investigated in this dissertation. First, milk production declines in each region and falls by 1.3 percent nationally. Second, the total quantity of farm milk shipped between regions declines by 3.1 percent, but with a range of impacts regionally. Third, the value of U.S. dairy products falls by 0.2 percent and the value of dairy product exports falls by 0.3 percent. Finally, buyers of dairy products in the U.S. gain $323 million due to the decline in dairy product prices.