Retail Milk Prices

One of the concerns when farm prices rise is the resulting effect on retail prices. When farm prices rose in 2004 there was a great cry about the rapid increases in retail milk prices. In June 2004, the retail whole milk price in Boston hit a record high of $3.64 per gallon, a 23% increase compared to the level in June 2003. At the same time, the U.S. Department of Agriculture announced that the minimum farm price in the New England area would be raised to $ 2.11 per gallon, equivalent to an 86% increase compared to the level in June 2003 (USDA). One might argue that rising prices for a raw product like milk will certainly cause rising prices for the processed product. When the raw product price falls, the retail prices should then follow just as quickly. The question that arises is: “Do firms take advantage of short-run increases in the raw material prices to capture additional short-run profits by not lowering retail prices when the raw price falls? If firms profit by rapidly raising prices in the face of raw product price increases but do not reduce prices as quickly when the raw price falls, then they can gain additional short-run profits. Economists refer to this as asymmetric price transmission, a topic of much research since late 1970s. In addition to economists, the media observed unusual pricing in the New England fluid milk market.¹. For example, the farm milk price in Boston fell from $1.67 per gallon in October 2001 to $1.12 per gallon in April 2003, while the retail milk price remained mostly constant around $3.00 per gallon during the same period. When the farm price started to rise between May 2003 and June 2004, the retail whole milk price responded quickly by rising to $3.64 per gallon.

The Agricultural Marketing Service gathers data on retail milk prices throughout the country. Figure 27 shows how retail and farm prices have changed over the past two decades. While farm prices appear to have varied around $1.25 per gallon, retail prices have risen steadily over the time period. There do appear to be periods of rapid increase in retail prices in response to increases in farm price. There also appear to be decreases when farm prices decrease. These patterns appear through the 1990s. But, at the end of the 1990s and through 2001, when farm prices declined, there was no associated decrease in retail milk prices. Do these trends illustrate asymmetric pricing by either milk processors or retailers?

We have to remember that there are costs associated with processing and marketing milk. Milk must be processed, packaged and transported to the final retail outlet. The USDA Economic Research Service tracks the changes in input costs for processing and marketing agricultural products. While not specific to the Northeast dairy industry, these trends, shown in Figure 28, are at least indicative of cost changes that processors and retailer face. Trends in food marketing costs are compared to a general measure of inflation, the Consumers Price Index (CPI). Both indexes have the same common base period of 1982 (both indexes were set to 100 in that year). We can see that while costs have increased for marketing agricultural products, they’ve increased at a rate somewhat less than that of the CPI.

The result is a growing farm-to-retail price spread for fluid milk. The price spread grew steadily from 1982 through 1991; the average annual growth rate during that period was 11.6 percent. There was a period of relative calm and decline from 1992 through 1997; the average annual growth rate was just 2.4 percent. Since January 1998, the price spread has grown more rapidly, at an average annual rate of 6.2 percent, with increased variability as well. During part of this period, July 1997 through September 2001, the Northeast Interstate Dairy Compact was in effect. Researchers have found that this was a period with asymmetric farm-to-retail price behavior. While increases in farm prices were built into the retail prices, equivalent decreases in farm prices did not have an equal and opposite effect on retail prices.(What's Asymmetric Price Transmission?)

We would conclude that this increasing farm-to-retail price spread represents asymmetry if it cannot be explained by increases in the costs of marketing milk, or increases in the cost of the raw product. A number of studies have been done. One recent study concluded that things have changed in the past 8 years.² Prior to 1997, short-run asymmetry did appear to exist, but over time, retail prices returned to levels consistent with changes in the farm price of milk, when you take into consideration cost changes faced by the processors and retailers. However, the researchers found that after 1997, things changed. Short-run retail price responses to increases in farm prices were greater and retail prices did not return to the same level given equivalent increases and decreases in farm prices. Thus, not only were there apparent short-run gains by delaying decreases, there were also long-run gains as retail milk prices did not fall to a level expected given farm price decreases.

 

¹Mohl, B. (2004) Retail Price of Milk is Quick to Rise, But Slower to Fall. The Boston Globe, August 8, pp. BUSINESS, E 1

²Lass, D. A. “Asymmetric Response of Retail Milk Prices in the Northeast Revisited.” Agribusiness: An

International Journal, 21(2005): 493-508.