Hedonic Pricing of Milk Components at the Farm Level

Abstract

Raw milk derives its value from the products made from it: fluid milk, ice cream, yogurt, butter, cheese, nonfat dry milk, and other condensed dairy products. The key components of milk used to make these products are butterfat (BF), solids-not-fat (SNF), and water (W). Since these products use the components in different proportions, each component has an implicit value. These implicit values can be derived either from the retail market for dairy products (Lancaster; Ladd and Suvannunt) or from the farm market where raw milk is sold to dairy processors (Ladd and Martin). If the dairy marketing system efficiently transmits price signals, then the values implicit in prices paid to the farmer will equal their value to the dairy processor, as derived from the retail market. The problem of interest is whether the milk marketing system efficiently transmits milk component values from the retail market for dairy products to the farm market for raw milk. Federal Milk Marketing Orders control approximately 70 percent of all milk marketed in the United States. Thirty-five of the 33 Milk Marketing Orders use the volume-butterfat differential pricing system to pay milk producers in the farm market. Many have argued that the volume-butterfat differential pricing system is inefficient (Jacobson and Walker; Ladd and Dunn; Perrin; Graf; Kirkland and Mittelhammer; Gillmeister et al.; Lenz, Mittelhammer, and Hillers). Multiple-component pricing has been identified as an alternative system that would pay explicit prices for all three milk components. The issue of efficiency of the butterfat differential price formula arose for two reasons.