An Application of Experimental Economics to Agricultural Policies: The Case of U.S. Dairy Deregulation on Farm-Level Markets

Abstract

Current dairy regulations in the U.S. are the result of over 80 years of regulatory activities. Through the 1920s and 1930s the U.S. government passed various acts designed to increase the share of market surplus captured by sellers, which at the time was judged insufficient. Lately, budget constraints and commitments to freer trade agreement have let the government and some dairy sector leaders contemplate different levels of dairy deregulation. The elimination of the Federal Milk Marketing Orders (FMMOs), a cornerstone of U.S. dairy regulation, has emerged as a possibility. The thought of eliminating the FMMOs was particularly disturbing to milk producers because of uncertainty regarding what might happen to the farm price, the volume of raw milk supplied, market stability and price efficiency, and to the distribution of market surplus between dairy farmers and dairy processing plants. These particular questions have not been extensively studied before due to data availability problems. Data from the era prior to the establishment of FMMOs would be difficult to obtain, and probably not meaningful because FMMOs have been around since the late-1930s. Experimental economics is used to simulate U.S. dairy market conditions and the effect of the elimination of FMMOs. The experimental task is a simple 2 X 2 matrix laboratory game. The treatments are oligopsony and regulation. Perishability is represented by an advance production decision with no carry-over and is kept constant across the experiments. Experimental sessions comprised 12 periods and a practice period. Sellers made production decisions and received a pool price, while buyers made a price (bid) and quantity decision. The allocation of units produced is made by the monitor on a highest bid basis. The game is computer assisted. Experimental results indicate that, in the absence of regulation, buyers are successful in reducing market price below the perfectly competitive price and in capturing a larger share of market surplus than a competitive solution predicts. Regulation reduced the market power of buyers and the price fluctuation of raw milk, in an oligopsonistic market, and had no significant impact on the overall price efficiency of the market.