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5/14/13
1
Economic Formula for Milk Price Discovery
Mark Stephenson, Ph.D. Director of Dairy Policy Analysis
What are Today’s Dairy Problems?
! Milk & feed price volatility for the producer
! Maybe milk price volatility for the processor
! Dissatisfaction with product price formulas used in FMMOs and state orders
! Are these issues related?
5/14/13
2
Options for Setting Milk Prices
! Regulated Grade A manufacturing price series
! Deregulated Grade A manufacturing price series
! Product price formula
! Economic formula
! Administratively determined
1989 Study
Options for Setting Milk Prices
! Competitive Pay Price ! Gold standard, but almost impossible to achieve
! Product Price Formulas ! Reverse engineering cost-plus pricing
! Competitive Pay Price moving one step up the marketing chain
! Economic Formulas ! Always discussed, seldom employed
! Dairy Price Support Program
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3
Economic Formulas
! Most common version takes a starting point value and moves prices with an index
! They have been used before in milk pricing ! Dairy Price Support Program
! California state order pricing for many years
! Federal order class I pricing in the late 1940s-50s ! Boston, New York and other orders
! All discontinued by the late 1960s
! Major problem is price inflation over time
Economic Formulas
! Usually include factors for the ability and willingness of consumers to pay
! Often a measure of general economic conditions such as CPI or Consumer Sentiment
! Always cost of production such as feed, etc.
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4
One Example…
! During the 1990s debate, Wisconsin Farmer’s Union requested Ed Jesse to develop an economic formula price.
! The devil is in the details…
! His formula is resurrected after lying dormant for 15 years.
Cost of Production Sub-Index NASS Indices ’90-92
! Feed
! Fuels
! Supplies & Repairs
! Farm Machinery
! Farm Services
! Interest
! Taxes
! Wage Rates
! Prices Paid
Weights
41%
3% 6% 10%
7%
12%
2%
15%
4%
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5
Consumption—Per Capita Disposable Income Sub-Indices
50#
100#
150#
200#
250#
300#
1995# 1996# 1997# 1998# 1999# 2000# 2001# 2002# 2003# 2004# 2005# 2006# 2007# 2008# 2009# 2010# 2011# 2012#
Consumption—Product Price Sub-Indices
50#
100#
150#
200#
250#
300#
1995# 1996# 1997# 1998# 1999# 2000# 2001# 2002# 2003# 2004# 2005# 2006# 2007# 2008# 2009# 2010# 2011# 2012#
CME#Bu1er#Index#(15.5%)#
CME#Cheese#Index#(69%)#
NFDMACentral#States#Index#(15.5%)#
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Composite Index
75.00%
95.00%
115.00%
135.00%
155.00%
175.00%
195.00%
215.00%
1995%1996%1997%1998%1999%2000%2001%2002%2003%2004%2005%2006%2007%2008%2009%2010%2011%2012%
Composite%Index%Equally%weighted%ProducEon,%Income%and%Product%Prices%
Productivity Deflated Composite Index
75.00%
95.00%
115.00%
135.00%
155.00%
175.00%
195.00%
215.00%
1995%1996%1997%1998%1999%2000%2001%2002%2003%2004%2005%2006%2007%2008%2009%2010%2011%2012%
Composite%Index% Adjusted%Composite%Index%
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7
Economic Formula for BFP
$8.00%
$10.00%
$12.00%
$14.00%
$16.00%
$18.00%
$20.00%
$22.00%
1995% 1996% 1997% 1998% 1999% 2000% 2001% 2002% 2003% 2004% 2005% 2006% 2007% 2008% 2009% 2010% 2011% 2012%
Economic Formula versus BFP
$8.00%
$10.00%
$12.00%
$14.00%
$16.00%
$18.00%
$20.00%
$22.00%
1995%1996%1997%1998%1999%2000%2001%2002%2003%2004%2005%2006%2007%2008%2009%2010%2011%2012%
BFP%
Adjusted%Formula%Price%
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8
Observations…
! Economic formula captures all major turning points
! Economic formula does not suffer greater lags than MW, BFP, or Product Price Formula
! It is less volatile than current and previous Class III
! It is transparent and can be readily calculated with current data
! It is somewhat price inflationary (+$1.12)
Revenue Neutral Economic Formula
$8.00%
$10.00%
$12.00%
$14.00%
$16.00%
$18.00%
$20.00%
$22.00%
1995%1996%1997%1998%1999%2000%2001%2002%2003%2004%2005%2006%2007%2008%2009%2010%2011%2012%
BFP%
Adjusted%Formula%Price%
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9
In Summary…
! Ed’s formula tracks demand changes well ! Look at 2007-08, 2009
! The formula tracks producer cost of production quite well ! Look at 2011-12
! The formula has a productivity governor that can dampen inflationary tendencies ! Might want to include indices for farm size and plant
size as other measures of increasing economies
! We have learned from volatility modeling that if the highs aren’t as high, the lows don’t have to be as low.
One More Thing…
$8.00%
$10.00%
$12.00%
$14.00%
$16.00%
$18.00%
$20.00%
$22.00%
1995%1996%1997%1998%1999%2000%2001%2002%2003%2004%2005%2006%2007%2008%2009%2010%2011%2012%
BFP%
Adjusted%Formula%Price%
Adjusted%+%IrraAonality%Factor%
5/14/13
10
Maybe I Was Too Hard on Ed
Nah…It doesn’t really fit.
Questions?