Auction Experiments and Simulations of Milk Quota Exchanges

Abstract

Abstract Since 2000 Germany has introduced a fairly unique market mechanism to trade milk quotas between dairy farms. The two major features are: (1) a quasi auctioning system that produces excess demands which are covered by state reserves free of charge and (2) a price band that is used to exclude highest bids. For both features an experimental design is developed to study the impact in reference to a regular seller’s sealed bid double auction. Results show that both treatments lead to significant misallocations. These are due to the direct impact of regulations and due to an imperfect adjustment of bidding functions. The major goal of the market design to reduce quota prices is reached, however, at significant trade losses. Introduction In 1984 the European Union introduced a quota system to limit milk production in the Member States. Economies of scale and technical progress have set incentives for competitive farms to grow constantly; thus, there is an inherent need to trade milk quotas between dairy farms. Quota trades between farms were regulated from the start and differed between EU Member States till today; however, at the end of the 1990’s many regulations had been lifted in Germany where in April 2000 a fundamentally new milk quota exchange system was introduced. A quasi double auction was installed at a regional level. All other forms of transactions such as renting, leasing or other contracts to transfer quota between farmers were banned. The new quota exchange system is similar to a single price multiple unit seller’s sealed bid double auction (SBDA). The SBDA serves here as a reference scenario (Treatment 1). Specific regulations were added to limit prices and to reduce problems of excess supply or demand. Three major features describe the characteristics of the market mechanism. First, a single preliminary price is set at the minimum excess demand which is calculated from ordered bids and asks submitted at each of three auctioning dates per year. Second, if there are successful bids that exceed the preliminary price by more than 40 percent (and the price is above 30 Euro cent per liter), then those exceeding bids are cancelled and price calculations start over again for one more time (Treatment 2). Third, local authorities control some state reserves of milk quotas. These quotas can used to fill the excess demands that systematically occur in the auctions. Quotas taken from state reserves are given to bidders free of charge. Every successful bidder receives the same share with respect to his/her bid volume. Thus, if the excess demand makes for example 10 percent of the trade volume, then each bidder gets 10 percent of his/her bid free of charge (Treatment 3). We analyze the two scenarios by comparing their results to the outcome of a SBDA in the first Treatment. In multiple unit bid auctions with sufficiently many bidders on both sides truth telling is a weak dominant strategy (Nautz, 1995; Nautz und Wolfram, 1997; McAfee, 1992). The SBDA auction design severs as a benchmark to analyze the two scenarios for German milk quota exchanges described above. As the optimal competitive bidding functions under Treatment 2 and 3 cannot be derived easily, we use simulations instead to estimate them. In the second step auction experiments are set up in a computer lab to study the real world performance of the market mechanism. Each experiment for the two scenarios is run with 16 student of which randomly assigned 6 serve as sellers and 10 as buyers of milk quota. Each participant receives a willingness to buy or sell in each of the 28 rounds played. In each round bids are placed, prices are calculated, and gains and losses due to transactions performed are assigned and are notified for each participant. Students receive a fixed and a variable payment which on average is about 10 Euro per participant. One experiment with 28 rounds and three test runs takes about 60 minutes. Each design (Treatment 2 and 3) is repeated 5 times with different students. Willingness to pay and to sell are taken from a uniform distribution between 0 and 1 which fits the scale of real quota prices in Germany. These parameters are also used in the theoretical simulations to generate optimal bidding functions.