Carley, Dale H.

English

Research Papers in Economics

SOUTHERN  JOURNAL  OF AGRICULTURAL  ECONOMICS  JULY,  1976
ADMINISTERED  PRICING  BY COOPERATIVES:
EFFECT ON PRODUCER AND  CONSUMER  PRICES
AND SALES  OF FLUID MILK
D. H.  Carley
Considerable  controversy  exists  with  regard  to  shifts, in order to control production and thus maintain
pricing  agricultural  commodities,  especially  when  quoted  prices.  Administered  pricing  is a rather recent
pricing  departs  from  classical  market  concepts  de-  occurrence  in  the  pricing  of  agricultural  products,
pendent  on  equating supply and demand  [1,  5,  6].  In  especially at the farm level.
a recent study of alternative  Class I  pricing systems, it  The  objectives  of this study were  to analyze  and
was suggested  that "pricing of milk and dairy products  interpret  the  actions  and  results  of  administered
is  one  of the  major  policy issues to be resolved  in the  pricing  of  Grade  A  fluid  milk.  In  evaluating  timing
1970s" [8].  A different pricing system in federal milk  and  ability  of a regional milk producer cooperative  to
orders  was  considered  urgent  enough that  a  concen-  change  prices  in  line  with  changes  in  estimated
trated study  of pricing alternatives  was pursued by the  production  costs  and  federal  order  prices,  the  study
U.S. Department of Agriculture  [9].  had two ends. These are to analyze the relationship of
Under  the  federal  order  classified  system  for  producer and  retail  prices  of fluid  milk products, and
pricing  milk,  price  supports  have  provided a floor for  to  evaluate  price-quantity  relationships  at  the  retail
manufacturing  grade  milk  prices.  Class  I  prices  for  level.  Determining  linkage  between  changes  in  milk
milk  used  in  fluid  products  have  been  based  on  the  production  and  comsumption, in terms of responsive-
price  for  manufacturing  grade  milk  plus  a  price  ness  to price  changes  within  the  administered  pricing
differential  in each  market.  In recent years, however,  framework,  was the overall objective.
producer  cooperatives  have  negotiated  market-wide
Class I  prices  that  are above the minimum established  DATAANDMETHODOLOGY
by the order. More recently,  Class I prices have become  Data used in the  analysis were monthly prices for
announced  prices  by  the  cooperatives  rather  than  Class I  milk,  estimated  retail  prices  for  fluid  whole
negotiated.  milk,  and  sales of fluid milk,  by  type  of product, in
Milk  pricing  under  federal  orders  has  been  the  Georgia  Federal  Milk  Marketing  Order  area  for
frequently  referred  to  as  "administered  pricing."  1970-1975.  In  addition,  an  index  was  used  to
Present  pricing  by  the  cooperatives  meets  the  defini-  estimate  changes  in  the cost  of producing  milk.  The
tion of administered pricing even  more so than federal  methods and data input for the production cost index
order pricing. Under the former, prices are set by action  are explained in detail elsewhere  [ 2 ].
of the  seller  and  remain the same  for a period of time  Milk  sales,  by  product  types,  within  the defined
and  a  series  of transactions  [7].  Usually  more  of the  milk  marketing  area  were  adjusted  to  pounds  daily
product is offered for sale  than is currently demanded,  average  sales per capita per month. Sales were adjusted
but demand  may exceed supply. In this case, rationing  for  variation  resulting  from  seasonality  and  calendar
may  occur  other  than  through  a  price  change.  day  composition  [3].  For  purposes  of  analysis,  all
Manufacturing  industries  such  as auto,  steel,  textiles,  prices  were  adjusted  to  a  one-half  gallon  equivalent
etc. have operated successfully  within an administered  unit.
pricing framework.  Production  schedules are adjusted,  Ordinary  least  squares  was  used  to  estimate
from temporarily closing entire plants to working three  relationships  resulting  from  administered  pricing  of
D. H.  Carley is professor of Agricultural  Economics, Georgia Experiment Station,  Griffin, Georgia.
137fluid  milk  at  the  producer  level.  The  following  (5)  a  system  assuring  minimum  prices,  such  as  that
functional relationships were estimated:  under  the  price  support  program  and/or  the  federal
order  program,  if  the  administered  pricing  system
PAPt = f(FOPt)  (1)  should break down.
If  a group  is strong  enough to manage  supply to
PAPt  f(PCIt)  (2)  the  extent  of  obtaining  windfall  profits  through
administered  pricing,  then  the  group  may chose  not
FOPt = f(PCIt)  (3)  to  change  prices  when  economic  conditions warrant.
They  may  ignore  recent  information  in  making
RPt = f(PAPt)  (4)  pricing  decisions.  Administered  pricing  is  a  method
by  which  price  level  of  the supply  produced  can  be
FMSt = f(RPt,T)  (5)  made  to  coincide  with that of inputs in  the produc-
tion  function.  With  the  ability  to  manage  supplies
FMSt = f(PAPt,T)  (6)  (not  so  much  to  direct  production  but  to  direct
where  supplies  produced),  spatially  and  by  product  form,
the  cooperative  is in  a  position  to  announce  its price
PAP  = Producer  administered  Class  I  price  in  in  advance  for supplies  that  will  enter the market  as
cents per one-half gallon (in quarter t for  fluid products.
equations  1-3,  in month  t for  equations  Analysis  of  the administered  pricing system used
4-6),  in  the  Georgia  fluid milk market by regional  coopera-
FOPt = Federal  order  minimum  Class  I price  in  tives was  based  on (1)  differences  in the federal order
cents  per  one-half  gallon  (in quarter  t),  minimum  and  administered  Class I  prices,  (2)  re-
PCIt = Production  cost  index  in  percents  (in  lationship  between  the  two  and  (3)  the  relationship
quarter t),  of  administered  Class I  prices  and  the  cost  of
RPt = Retail  price fluid whole milk in cents per  production.
one-half gallon (in month t),  In  every  month  (January  1970-October  1975)
FMSit  = Fluid  milk  sales  for  product  in  pounds  the  administered  price  for Class  I  milk was  above the
daily  average  per month  per capita (pro-  federal  order minimum  price (Figure  1).  The monthly
duct i in month  t),  differenced  averaged  32  cents  per  hundredweight  in
T = Trend,  monthly  with  origin  January  1970,  increased  to  47  cents  in  1973,  and  averaged
1970;  1,2,3 ...  n.  $1.29 in  1974 and $1.12  in  1975. Difference  in prices
resulted  in  added  returns  to  members  of  the  major
producer cooperative  in Georgia of over $23.4  million
BENEFITS  TO  PRODUCERS  in a 76-month period [4].
In  a previous  study  of milk pricing alternatives  it  A  close  relationship  was  indicated  between  the
was  concluded  that  (1) prices  should  change  when-  administered  Class I  price  and  the  federal  order
ever basic economic conditions affecting  milk produc-  minimum  Class I  price.  Equation  1, using  a log linear
tion  and  consumption  are  substantially  altered,  and  model,  showed  the  following  relationship  of  the
(2) such  price  changes  should  be  based  upon  recent  administered  price  to  the  federal  order  price  on  a
and  reliable  information  [9].  Two  questions  emerge  quarterly basis,
with regard  to administered  pricing of milk:  (1)  what
are the  conditions necessary  for administered  pricing  Log PAPt -0.2496  +  1.1805  Log FOPt
and  (2) how  well  does  such  pricing  conform  to  the  (0.0703)
conditions suggested  by the  Advisory Committee?
Conditions  for  a  successful  administered  pricing  R2 =0.937
system  for  an  agricultural  product  are  (1)  manage-
ment of the supply  by some  individual  or group such  where  the number in parentheses  is the standard error
as  a  producer cooperative,  (2)  a product  with contin-  of  the  regression  coefficient.  For  each  10  percent
uous production  or,  if  produced seasonally,  adequate  change  in  the  federal  order  price,  the  administered
storage  and/or  processing  capacity,  (3)  ability  to  price  changed  11.8  percent.  This  strongly  indicates
spatially  shift  supply  among  consumer  markets  that  the  cooperative  followed  a pattern  of announc-
and/or among  products, (4) willingness to  adjust price  ing  price  changes  in  line  with  changes  in the  federal
down  as  well  as  up-depending  on  pressures  from  order price.
adjacent  production  areas  with  regard  to  supply,  Economic  conditions, especially  during late  1972
price,  and  general  supply-demand  conditions  and  and  thereafter,  resulted in  drastic increases  in costs of
13812
11  I
'I  I  _--_ I >
I  I
7  /
I _
5---  D  J
/  \  /  /
of  the  effectiveness  of  dministered Class  1 Price 
quarter  o  th  s  Federal  Orduerd  Class  1 Price  /  h
usually  will  not correspond  with  and  wll  actually  lag  the26  1h  4575  PAP  e  er  passed
9-  I 
=  r  p 
7  -
J  DJ  DJ  OJ  DJ  D
1971  1972  1973  1974  1975
MONTHS
FIGURE  1.  ADMINISTERED  AND  FEDERAL  ORDER  CLASS  I  PRICES,  GRADE  A  MILK,  GEORGIA,
MONTHLY,  1971-1975
feed and other  dairy  production inputs.  One measure  THE EFFECT ON FLUID MILK SALES
of  the  effectiveness  of  administered  pricing  is  its  i With  administered  pricing,  evidence  indicates
ability  to  adjust  to  changing  costs.  Comparison  ofe  e  just 
administered  pricing  and  federal  order  pricing  indi-  p  ,  i higher  production  costs  in  the  form  of higher  Class I
cates  that  administered  prices  showed  a  somewhat  f  1  c  i  o equates  o thatadm  teede  prices  prices.  Also,  the  higher  Class  I  prices  were  passed
closer  relationship  to  production  costs  than  did closper  re  lant  ionship  tcproductalong,  resulting  in  increased  retail  prices.  The  equa-
pfederal  o  rderdpricesu(Tablet1).tion  for the relationship  based  on monthly  prices  was
The  production  cost  index  was  lagged  one
quarter  on  the  basis  that  producer  price  changes
usually  will  not correspond  with and will actually  lag  RPt =  22.2216 +  1.4575  PAPt R 2 =  0.974
production  cost  changes.  The  lagged  equation  shows  (0.0304)
that  for  each  10  percent  change  in  the  production
cost  index,  the  administered  price  changed about 9.8  showing  that  for  a  1.0  cent  increase  per  one-half
percent  in  the  same  direction.  The  corresponding  gallon  in  the  producer  price,  retail  prices  of  whole
equation  for  the  federal  order  price  showed  a  7.6  fluid  milk  increased  1.45  cents.  The  retail  price
percent  change  for  a  10  percent  change  in  the  increase  was  greater  than  could  be  justified  by  the
production  cost  index.  These  relationships  indicate  increase  in  the  raw  product  cost.  Higher  processing,
that  administered  pricing  was  used  to  initiate  price  distribution  and  retailing costs, then, were also passed
changes in  line with cost changes.  on.
139TABLE  1.  ESTIMATED  LEAST-SQUARES  COEFFICIENTS  FOR EXPLAINING  CLASS I PRICE  RELATION-
SHIPS TO COST OF  PRODUCTION,  GEORGIA,  QUARTERLY,  JANUARY 1970-MARCH  1975
Estimated  coefficient  for
Production 
Dependent  variable  Intercept  cost  index  R
(cents  per  one-half  gal.)
FOPt  -0.0690  0.7551  0.841
t  (0.0753)
FOP  c  -0.0779  0.7625  0.836
^~~~~t  ~(0.0776)
PAP  b  -0.4712  0.9576  0.909
t  ((0.0694)
PAP  -0.5086  0.9794  0.927
(0.0632)
aRange  or production  costs index  106.4 to 166.1; 1967=100.
bThe log models were:  Log FOPt and Log PAPt=bo+bl  Log PCIt.
CThe log models  were: Log FOPt and Log PAPt=bo+bl Log PCIt.l.
dNumbers in parentheses  are standard  errors of the regression coefficients.
About  96  percent  of  the  variation  in per capita  highly  inelastic  relationship  to  administered  Class I
daily  sales  of fluid whole  milk was explained by retail  prices.  A  10 percent increase  in  Class I  price resulted
prices  and trend  (Table  2).  For  a  10 percent increase  in  a  2.9 percent decrease  in sales. However,  total sales
in  retail  prices  per  capita,  sales  of  whole  milk  trended  upward.  The  variables,  Class  I  price  and
decreased  about  4.7  percent.  Per  capita  sales  also  trend,  explained  about  two-thirds  of the variation  in
trended  down.  total fluid  milk sales.
Retail  price data were not available for each fluid
milk product,  so quantity-price  relationships  were not
determined  on such  a  basis. The  administered  Class I  IMPLICATIONS
price,  which  was  the  raw  product  price  for  each  of  Class  I  milk  prices  to  producers  were  more
the  fluid  milk  products,  was  used  as  the  price  closely  related  to  production  cost  changes  with  the
variable.  This price  would indicate  the quantity-price  administered  pricing  system  than  with  federal  order
relationship at the producer level.  minimum  Class I  prices.  However,  the  administered
Whole  milk, lowfat and skim milk per capita sales  price  was  undergirded  by  federal  order price,  which
were  negatively  related  to  price.  Sales  of  whole  decreased  the  risk to the producer  cooperative  in its
milk  decreased  2.9  percent  for  each  10  percent  endeavor to obtain higher prices.
increase  in  the  Administered  Class I  price.  Sales  of  With  a  10 percent change  in  the production cost
lowfat  and  skim milk  decreased  3.5  for a  10 percent  index,  the  administered  Class I  price  increased  9.8
price  increase.  However,  flavored milk decreased  over  percent.  This  was  passed  on to the consumer through
11  percent  for  a  10  percnt  t  Class I  price  increase,  a  higher  retail  price.  A  9.8  percent  increase  in  the
indicating  a  much  more  elastic relationship.  Sales  of  administered  Class I price resulted  in a decrease  of 2.9
lowfat,  skim  and  flavored  milk  all  had  significant  percent  in  per  capita  daily  whole  milk  sales,  a  3.4
increasing trends.  percent decrease  in  lowfat  and  skim milk sales, and a
Per capita  sales of total fluid  milk products had a  2.8  percent  decrease  in total fluid milk product sales.
140TABLE  2.  ESTIMATED  LEAST-SQUARES  COEFFICIENTS  FOR EXPLAINING  RELATIONSHIPS  OF FLUID
MILK PRODUCT SALES  TO PRICES, GEORGIA,  MONTHLY,  JANUARY  1970-APRIL  1975
Regression  coefficients  for
Retail  Class  I
price  price
Dependent variable  Intercept  RP  PAP  Trend  R
Per capita sales (lbs.)
Fluid  whole  milk  0.5318  -0.4676  -0.0004  0.957
( 0 .040 5 )  (0.0001)
Fluid  whole  milk  0.1184  -0.2931  -0.0006  0.961
(0.0235)  (0.0001)
Lowfat  and  skim  -0.6428  -0.3520  0.0071  0.984
(0.0527)  (0.0002)
Flavored  milk  -0.0379  -1.1136  0.0091  0.603
(0.3169)  (0.0012)
Total  fluid  products'  0.1789  (0.0269)  (0.0001)
aThe  model used was:  Log Yit--bo+bl  (log RPt or log PAPt) +b2T.
bNumbers  in parentheses  are standard errors of the regression  coefficients.
CIncludes whole milk, lowfat and skim milk, flavored milk and buttermilk.
Administered  pricing  is  a  method  for  increas-  sale  changes.  The  study  implies  a  need  for  addi-
ing  prices  to  producers  corresponding  with  produc-  tional  analysis  concerning  relative  price  levels,
tion  cost  increases.  This  analysis  shows  the  linkage  timing  of  price  changes  and  the  problems  concern-
of  changes  in  milk  production  costs,  producer  ing  milk  supplies  that  are  not  sold  in  the  fluid
prices.  It  also  indicates,  indirectly,  prices  to  retail  milk  market.
REFERENCES
[1]  Carley,  D.  H.  "Discussion:  Agricultural  Prices  in  the  1970's,  How  Will  Value  Be  Established,"  Southern
Journal of Agricultural Economics,  Volume  6,  Number  1,  pp.  33-34,  1974.
[2]  Carley,  D.  H.  "Economic  Factors  Affecting  Milk  Production  Costs  and  Prices  in  Georgia,"  University  of
Georgia  College  of  Agriculture  Experiment  Stations,  Research  Bulletin  155,  April  1974.
[3]  Christ,  Paul  and  Anna  Schlenker.  "Adjusting  In-Area Sales  Data for Calendar  Composition,"  Federal  Milk
Order  Market  Statistics,  AMS,  U.S.  Department  of  Agriculture,  FMOS-158,  February  1973,  pp.
28-30  and FMOS-171,  May 1974,  pp.  31-34.
[4]  Dairymen, Inc. Division News,  Georgia Division,  July 1975.
[5]  Forker,  Olan  D.  "Agricultural  Prices  in the 1970's:  How  Will  Value  Be  Determined,"  Southern Journal of
Agricultural  Economics, Volume  6, Number  1,  pp.  27-32, 1974.
[6]  Mayer,  Leo  V.  "Experiences  with Recent  Price Stabilization Programs  for Agriculture,"  Southern Journal  of
Agricultural  Economics, Volume  6,  Number 1, pp.  1-5,  1974.
[7]  Means,  Gardiner  C.  "Simultaneous  Inflation  and  Unemployment:  A  Challenge  to  Theory  and  Policy,"
Challenge, September-October  1975.
[8]  Riley,  John  B. and  Leo  V.  Blakley.  "Impact  of Alternative  Class I  Pricing  Systems  on  Fluid Milk  Prices,"
American Journal of Agricultural  Economics, Volume  57, pp. 67-73,  1975.
[9]  U.S.  Department  of  Agriculture.  "Milk  Pricing  Policy  and  Procedures:  Part  II  Alternative  Pricing
Procedures,"  Report of the Milk Pricing Advisory  Committee,  March  1973.
141

Adjusting In-Area Sales Data for Calendar Composition,&quot; Federal Milk Order Market Statistics,

Agricultural Prices in the 1970's: How Will Value Be Determined,&quot;

Department of Agriculture. &quot;Milk Pricing Policy and Procedures: Part II Alternative Pricing Procedures,&quot; Report of the Milk Pricing Advisory Committee,

Discussion: Agricultural Prices in the 1970's, How Will Value Be Established,&quot;

Division News, Georgia Division,

Economic Factors Affecting Milk Production Costs and Prices in Georgia,&quot;

Experiences with Recent Price Stabilization Programs for Agriculture,&quot;

Impact of Alternative Class I Pricing Systems on Fluid Milk Prices,&quot;

Simultaneous Inflation and Unemployment: A Challenge to Theory and Policy,&quot; Challenge,

ADMINISTERED PRICING BY COOPERATIVES: EFFECT ON PRODUCER AND CONSUMER PRICES AND SALES OF FLUID MILK

ADMINISTERED PRICING BY COOPERATIVES: EFFECT ON PRODUCER AND CONSUMER PRICES AND SALES OF FLUID MILK

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