Milk Pricing in the United States. By Alden C. Manchester and Don P. Blayney.

Market and Trade Economics Division, Economic Research Service, U.S. Department

of Agriculture. Agriculture Information Bulletin No. 761.

Abstract

This report provides a primer on the complex pricing system that has evolved in the

United States to deal with milk production, its assembly (collection), and its distribution to alternative users. All the various government and private institutions making up

the system are expected to work together to ensure that the public gets the milk it

wants, while dairy farmers get the economic returns needed to provide the milk. The

major institutions are the Federal milk price support program and milk marketing

orders, the Northeast Interstate Dairy Compact, State regulations, dairy cooperatives,

and milk and dairy product futures and options markets. Our goal is to provide a

primer on milk pricing that can serve as a steppingstone to other, more detailed works

for those so inclined.

Keywords: Dairy, milk pricing.

Acknowledgments

The authors appreciate the reviews and editorial suggestions of several colleagues: Bill

Thomas at the University of Georgia; Bob Cropp at the University of WisconsinMadison; John Borovies, Cliff Carman, John Mengel, and John Rourke, all of the

Dairy Division, Agricultural Marketing Service, USDA, and Carolyn Liebrand of

Cooperative Services, Rural Business-Cooperative Service, USDA. James J. Miller,

Animal Products Branch, Market and Trade Economics Division, ERS, USDA, provided the box on methods of pricing milk. The authors finally thank Lindsay Mann,

Cynthia Ray, and Victor Phillips of the Information Services Division, Economic

Research Service, USDA, for final editing and production work.

1800 M Street, NW

Washington, DC 20036-5831 February 2001
Contents

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

U.S. Dairy Industry in Brief . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

How the Pricing System Evolved . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Public Pricing Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4

Nongovernment (Market) Pricing Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

The Milk Pricing System in the Future . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Information Sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Appendix A: Federal Milk Marketing Order Price Formulas . . . . . . . . . . . . . . . . . . . . . . . . 20

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Summary

Over the past 125 years, a complex pricing system has evolved to deal with the problems of milk production, assembly, and distribution. The various government and private institutions making up the system are designed to work together to ensure that the

public gets the milk it wants, while dairy farmers get the economic returns needed to

provide the milk. The very complexity of the system, however, has baffled many and

led to numerous misconceptions. 

Economic theory posits that the milk pricing system must balance the supply of milk

with the demand for milk. The physical uniqueness of milk complicates many of the

pricing arrangements that are available for other products or commodities. The complex mix of public and private pricing institutions has arisen as producers, processors,

milk marketers, and consumers have grappled with that uniqueness.

The pricing of milk in the United States involves a wide variety of pricing regulations

based on public policy decisions. Some of these regulations include milk price supports, Federal milk marketing orders, import restrictions, export subsidies, domestic

and international food aid programs, State-level milk marketing programs, and a multiState milk pricing organization. Nongovernment pricing institutions are also important—the dairy cooperative being a major example. As the dairy industry has become

less regulated in recent years, the use of futures markets has engendered considerable

interest. In almost all cases, the major intent of public pricing policies is to somehow

influence producer (farm) milk prices.

For some 50 years, price supports have been the backbone of the pricing system for

milk and dairy products. The support price underpinned the entire price structure for

bulk milk sold by farmers either directly to processors or through cooperatives.

USDA’s Commodity Credit Corporation (CCC) stood ready to buy as much butter,

nonfat dry milk, and Cheddar cheese as manufacturers wanted to sell at specified support purchase prices. These prices were calculated to return at least the announced

milk support price to the farmer. Until the 1996 Farm Act, interest in developing alternatives to the support purchase program was minimal or nonexistent.

Federal milk marketing orders are concerned primarily with the orderly marketing of

raw fluid-grade milk from the producer to the processor. Legal and technical language

makes them complex. Underlying the entire pricing system is the linkage between

prices for various milk classes and the wholesale prices of manufactured dairy products. The 1996 Farm Act required that the Federal milk marketing order system be

reformed.

The 1996 Farm Act offered a concept that had been under discussion in the Northeast

for many years—an interstate compact for dairy market regulation. The proponents of

the compact argued, successfully, that regulatory authority over the dairy marketplace

in the New England States (Maine, New Hampshire, Vermont, Massachusetts, Rhode

Island, and Connecticut) needed to be restored to the six States, acting together. The

compact has proven to be a lightning rod for regional conflict in the industry. 
The authority to regulate intrastate milk markets was denied to the Federal

Government in court decisions early in the New Deal period. These court decisions led

the States to make efforts to assist dairy farmers suffering economic hardships at the

time by implementing State milk controls. State regulations are important from a

national perspective because the States that control milk prices tend to be major milk

producers—California and Pennsylvania, for example. State milk pricing is much less

prevalent today than in earlier years.

Not all of the pricing institutions for milk are based on public policy decisions. The

roles of the dairy cooperatives in both regulated and unregulated milk markets have

changed. Cooperatives still represent member interests in the rule-making processes of

Federal- and State-regulated markets, which can include minimum price issues. But

other roles have become more prominent and claimed more of the public’s attention.

In many cases, the cooperatives have assumed operation of a complete procurement

and distribution system for milk. Assembling milk from the farm, routing raw milk

where it is needed, managing or coordinating movements of processed or manufactured products, and managing surplus milk, defined for our purposes as supplies above

fluid requirements, are all parts of the system. Taken together, these activities are

called “balancing.”

The advent of futures and options contracts for Cheddar cheese, butter, nonfat dry

milk, and raw fluid milk was seen by some as the prelude to a new era in milk pricing.

Were they to be widely used, futures and options contracts could manage price instability. As the role of the price support program has been reduced, milk price volatility

has increased. As long as there is price volatility in cash markets for milk and dairy

products, the dairy industry will continue to evaluate futures and options contracts for

price risk management. 

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Introduction

Over the past 125 years, a complex pricing system has

evolved to deal with milk production, assembly (collection), and distribution (coordinating milk supplies

with the demands of milk users, both intermediate and

final). The various government and nongovernment

institutions making up the system are designed to work

together to ensure that the public gets the milk it

wants, while dairy farmers get the economic returns

needed to provide the milk. The very complexity of the

system, however, has baffled many and led to numerous misconceptions. 

This report aims to dispel misconceptions by explaining how the current milk pricing structure is set up

and how it works. It is neither a history of milk pricing nor a catalog of all the technical or legal aspects

of pricing regulations. But, some history is recounted

and some details are included to give the reader a feel

for the context in which actions occurred. Our goal is

to provide a primer on milk pricing in the United

States that can serve as a steppingstone to other more

detailed works for those so inclined—a short list of

information sources is included. There is also a glossary of terms for readers not familiar with some of the

specialized terms that have grown up with milk pricing institutions.

	
	
		 	
	
	

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The authors are Senior Economist and Economist, respectively, in

the Animal Products Branch, Market and Trade Economics

Division, ERS.
U.S. Dairy Industry in Brief

Milk production in 1999 was just over 162.7 billion

pounds, almost twice the quantity produced in the

early 20th century, when the first concerted efforts to

develop alternative milk pricing institutions were being

made. About 111,000 operations had milk cows in

1999. Milk is picked up at the farm, most often by

tank truck, at least every other day and is moved to

one or more of the 422 fluid bottling plants or 1,258

dairy product manufacturing plants for further processing and manufacturing. Every step of the way, the milk

must be handled under sanitary conditions to guard

against bacterial contamination and either marketed

promptly as fluid milk or processed into storable manufactured products. Milk production fluctuates seasonally—generally expanding during the spring and early

summer (the flush season) and contracting in the fall

and winter (the short-supply season)—making it necessary to coordinate a supply that is rising when fluid

milk demand is falling. In addition, while milk production shows little daily variation, fluid milk sales vary

substantially from day to day. This daily variation in

sales, primarily because of consumer buying patterns,

becomes a significant problem when balancing fluctuating milk supplies with demand and pricing the various uses of milk. Manufactured dairy product demand

also shows seasonal variation—cheese and butter

demands are heavier in the fall and early winter.

Historically, two grades of milk have been identified:

Grade A and Grade B. The grade depends on the milk

meeting certain health (sanitary) standards. Sanitary

standards, some of which might also be called “quality

standards,” include the somatic cell count and bacterial

count and the conditions of farm facilities, including

the milking parlor, milk storage tank, and water well.

Grade A milk meets the sanitary standards for use in

fluid milk products and can be used for any dairy

product. Grade B, or manufacturing grade, milk meets

slightly lower standards and can be used only for manufactured dairy products. Grades are not the same as

the classes of milk that are used in classified pricing

systems. Prior to World War I, less than half of milk

and cream marketings were Grade A. Only about 3

percent of all milk marketed did not meet Grade A

standards in 1999, even though roughly 60-65 percent

of all milk marketed ended up in manufactured dairy

products.

For many years, cooperatives owned by dairy farmers

have played a prominent role in the U.S. dairy industry. In the early 1900’s, they were organized to bargain

for prices with dealers and handlers, a role they continue to perform today. The cooperatives have also had a

hand in how public dairy pricing policies and programs have evolved. In the 1960’s and 1970’s, the

scope of dairy cooperatives changed as they became

regional rather than local organizations. The trend continues today with some cooperatives operating coastto-coast, though not in all regions. 

Milk possesses characteristics that individually

describe other agricultural products, but taken together

make marketing fluid milk different from marketing

any other agricultural commodity. Milk is produced

every day and must move to market at least every

other day—thus it is a flow commodity. Eggs are also

a flow commodity, but they can be and are stored.

Eggs also do not have the numerous multiple uses at

different values that milk does. Meat can be stored in

carcasses or cuts, vegetables are storable for several

days, and apples and pears can be stored for months.

In the short run (day to day), milk supply is not

attuned to milk demand. The cows produce every day

and the milk must go to market, even if the demand on

a particular day is low. The demand for milk for bottling (packaging) is almost zero on Sundays and small

on Saturdays and Wednesdays, since most plants close

on those days in response to buyer demand schedules.

The milk that is still produced could be discarded only

at a high cost so it goes to manufactured product uses.

Substantial economies of scale exist in managing milk

supplies to deal with these day-to-day variations. A

single manager, a role many dairy cooperatives have

taken on, is more efficient than several individual firm

managers are, which encourages centralization of the

milk supply management functions.

Fluid grade milk can be used for milk and cream products or to manufacture cheese, butter, and other products. But its value in manufactured products is no

greater than that of manufacturing grade milk. The

costs of balancing a fluid milk market must be covered

by some means—which is where classified pricing

comes in. 

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How the Pricing 

System Evolved

There is a wide array of milk and dairy product prices

in the United States: the all-milk price, the minimum

Class prices defined under Federal and State milk marketing orders, the milk support price, wholesale prices

of cheese and other manufactured dairy products, retail

prices for fluid milk and manufactured dairy products,

and others (fig. 1). These prices, and others not mentioned, are either market-determined or administered

through some public dairy policy or program.

Included among the public policies and programs are

Federal milk price support, Federal milk marketing

orders, import restrictions, export subsidies, domestic

and international food aid programs, State-level milk

marketing programs, and a development of more recent

(1996) origin, a multi-State milk pricing organization.

Market pricing institutions include the dairy cooperative and the Chicago Mercantile Exchange where both

wholesale dairy product prices are determined and

futures and options contracts for milk and dairy products are traded. In almost all cases, the major intent of

the public pricing policies and programs that have been

implemented is to influence producer (farm) milk

prices. The market pricing institutions influence both

producer and buyer (consumer) prices.

Soon after the Civil War, milk production in the United

States took on a much different character as dairy farmers began moving more of their milk to both fluid and

manufactured dairy product processors supplying products in the rapidly growing urban areas of the country.

Previously, the largest share of production was used on

the farms—fed to animals, consumed by farm families

as fluid milk, or made into butter and cheese for farm

or very localized use. At the same time, shortrun price

instability associated with seasonal fluctuations in supply and use led to longrun uncertainties for milk producers. The uncertainties and the price instability, taken

together, drove substantial numbers of dairy farmers

out of business—contributing to even greater production and price swings in the short run.

It was observed early on that flow commodities, such

as milk, which were produced and marketed daily,

could not be priced efficiently by the methods

employed for most other commodities. Auctions or

daily negotiations between buyers and sellers of milk

would be costly to operate and result in dramatic daily

price variations. So, farmers attempted to organize to

bargain with processors over milk prices.

As early as 1900, producers in a number of markets

had banded together into cooperative associations to

bargain with fluid milk dealers or handlers for a flat

	
	
		 	
	
	

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1995 1996 1997 1998 1999

0

4

8

12

16

20

All milk Support FMO Class I FMO blend

Dollars per cwt

Figure 1

Selected milk price series, 1995-99

Source: National Agricultural Statistics Service, Farm Service Agency, and Agricultural Marketing Service, USDA.
price, a uniform price for all milk. However, flat pricing would be sustainable only if all fluid milk sellers

bore their proportional share of the costs of maintaining a reserve to cover unanticipated shortrun supply

and demand requirements, something that occurred

only rarely.

By the 1920’s, a classified price system, where handlers paid for fluid grade milk according to its use, had

been adopted in most of the major markets. The price

paid for milk used in fluid products was higher than

that paid for milk used for manufactured dairy products, reflecting the greater costs of handling and marketing perishable milk in fluid form (see box). Despite

the seasonal variability of production, the price to producers was stabilized. Differential pricing (that is, pricing beverage milk higher than milk for manufactured

products) reflected the greater cost of producing and

marketing milk for fluid use.

During the Great Depression, the classified pricing

systems broke down as the demand for milk dropped

drastically, and cooperatives faced intensified pressures

as more producers were cut off from the Class I (beverage milk) market and took any price to get back into

it. Prices at all levels dropped sharply, and farmers

were in great economic distress. The inherent instability of milk prices and the marketing problems that

arose with the Great Depression prompted dairy cooperatives to ask for government intervention to stabilize

milk marketing conditions. The Agricultural

Adjustment Act of 1933 authorized the Secretary of

Agriculture to enter into marketing agreements with

handlers, processors, and others and issue licenses to

handlers and processors to raise the prices of agricultural commodities, including milk. Some attempts

were made to use marketing agreements to assist manufacturing milk producers, principally farmers selling

milk to manufacturers of canned milk.

Congress revised the Agricultural Adjustment Act in

1935, authorizing Federal marketing orders for many

agricultural products that replaced the earlier agreements and licenses. The 1935 Act contained more specific standards for milk than the 1933 Act. The

Agricultural Marketing Agreement Act of 1937 reenacted the 1935 Act and became the foundation for

the modern Federal milk marketing order system.

During World War II, there was a great need for all

kinds of food to feed the United States and its allies.

Demand for milk and dairy products was much greater

due to higher incomes from wartime employment and

military purchases of large volumes of products.

Exports of cheese, butter, canned milk, and dried milk

jumped manyfold in the war years. To meet this

demand, producers of many products, including milk,

were strongly encouraged to increase production

through a number of devices. Milk production was

encouraged through guaranteed higher prices to producers. Under wartime price controls, prices to consumers were kept down by paying subsidies to processors to offset the higher prices they had to pay for

milk—a major shift from efforts to raise producer

prices during the Depression.

The Agricultural Act of 1949 established a permanent

milk price support program following a period of piecemeal extensions of wartime and earlier programs. Milk

marketing orders, which applied only to fluid grade

milk, were continued under the authority of the 1937

Act. Over the next 50 years, there were many changes

in the way these marketing orders were applied as technical and economic developments greatly changed the

way milk was produced, processed, and marketed.

The most recent Federal agricultural legislation (or

Farm Act) in 1996 called for dramatic changes in

Federal dairy policies and programs. The milk price

support program as it had traditionally been operated

was to be eliminated as of January 1, 2000, and the

Federal milk marketing order system was to be

“reformed.” Late in 1999, Congress passed legislation

bearing on these two policy objectives that are noted in

the appropriate sections.

While Federal policies and programs were changing

over time, State-level public policies and market pricing institutions also evolved. Some of these changes

have been the result of reduced Federal intervention in

or regulation of the dairy industry.

Public Pricing Institutions

Federal and State milk marketing orders have influenced farm milk prices since the 1930’s. Milk price

support was a wartime program that became embodied

in Federal legislation in 1949. The 1996 Act brought a

new public pricing institution into being—a multiState pricing organization, the Northeast Interstate

Dairy Compact. The programs described in this section

are separate—they have different primary objectives so

that when we talk about price regulations or mecha-

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Milk was priced, like most liquids, on the basis of simple volume until the very late 19th century.

However, anyone making dairy products knew that milk was far from uniform. The composition of milk

varied by producer, individual cow, stage of lactation, season, and other less explainable factors. Even

today, some milk can easily contain twice as much fat as some other milk. The Babcock test, developed in

1890, was a simple, fast, and accurate way of measuring the milkfat content of milk. It fairly directly

established the amount of cream or butter that could be produced from milk and also provided a fairly

accurate means of predicting cheese yields. The Babcock test revolutionized milk pricing and was rapidly

adopted by plants buying milk.

As the commercial dairy industry developed, measurement of the quantity of milk shifted from a volume

basis to weight because accurate determination of weight was generally easier. The use of the Babcock

test and the change to weighing milk led to the milk pricing method that would dominate throughout

most of the 20th century: dollars per 100 pounds, adjusted for milkfat content with a butterfat differential. Another pricing method, dollars per pound of milkfat has been used for cream and was sometimes

used for milk. It never was a satisfactory pricing method for many uses of milk and fell entirely out of

favor as skim solids became more valuable.

The intent of the butterfat differential is to represent the difference in value between milkfat and an equal

weight of skim milk. The differential results in prices that reflect the difference in value of milk with different milkfat contents, whether that milkfat content differs naturally or because cream has been added or

removed. (The differential should always be positive as long as approximately 10 pounds of butter has

greater value than a gallon of skim milk.) Milkfat pricing dramatically improved pricing efficiency and, as

a side effect, reduced the incentive to adulterate milk by adding water. 

Prices often are quoted at a standard of 3.5-percent milkfat. The standard is largely arbitrary but is approximately the seasonal low for the average fat test of all milk. If the 3.5-percent fat price is $12.00 per hundred weight (cwt) and the butterfat differential is 13.5 cents, a producer delivering milk testing 3.70-percent fat would receive a price of $12.00 plus 2 times $0.135—or $12.27 per cwt. Milkfat is not the only

milk component that varies to an economically significant degree. For example, the amount of casein has a

sizable effect on cheese yield. 

In recent years, various pricing methods have emerged that recognize differences in value due to milk

components other than just fat. Some have tried to determine a value for each component in 100 pounds of

milk with the milk price being the sum of the values, or used differentials or bonuses for protein or total

solids other than fat. Alternatively, some cheese plants have paid prices based on the predicted cheese

yield from the milk, including quality factors other than milk composition, such as somatic cell count. 

Reflecting differences in values of skim solids in milk prices is difficult because individual components

can have much different values in different uses of milk. And, the level of skim solids components is difficult (and often illegal) to adjust for specific uses. It is therefore difficult to say which pricing method(s)

will become the new norm. Pricing per pound of each component seems to be the most popular concept at

this time. In any case, some form of multiple component pricing would seem inevitable.

Courtesy of Jim Miller, ERS economist.
nisms, they are not the same across programs. On the

other hand, each program is not implemented or

altered in a vacuum, and there have been and still are

linkages between them.

Price Supports, 1949-Present

Although it was not the first Federal dairy policy to be

enacted, milk price supports have been the backbone

of the pricing system for milk and dairy products for

some 50 years. The way that the support price level

was determined has changed over the years and, since

the early 1990’s, support prices have been well below

market prices so as to have little more than a psychological effect. The price support purchase program was

to be terminated at the end of 1999, but Congress

extended the program for 2 more years through

December 31, 2001.

The support price underpinned the entire price structure for bulk milk sold by farmers either directly to

processors or through cooperatives. The support price

was determined annually under provisions of the

Agricultural Act of 1949, as amended by succeeding

farm acts. USDA’s Commodity Credit Corporation

(CCC) stood ready to buy as much butter, nonfat dry

milk, and Cheddar cheese as manufacturers wanted to

sell at specified support purchase prices. These prices

were calculated to assure that farmers received at least

the announced milk support price. The price support

program thus directly provided a floor under wholesale

milk product prices and the price of milk used to manufacture these products, and indirectly provided price

support for all milk in all uses. 

In the past, milk price support purchases made by the

CCC removed significant milk surpluses from the market. However, since the 1990’s, purchases have

declined dramatically with only nonfat dry milk being

acquired in significant amounts. Cheese prices have

been near support levels in 2000 and, while no CCC

purchases have been made, it is likely that the support

price has been sustaining the market price. In lieu of

the former open-ended offer to buy cheese, butter, and

nonfat dry milk at stated prices and then donating the

products to domestic and foreign food aid programs,

the Dairy Export Incentive Program (DEIP) is now the

major surplus-removal program. It uses CCC funds to

subsidize exports of targeted dairy products to targeted

overseas markets, up to a specified quantity. The

United States has committed itself under multilateral

trade agreements to limiting and then reducing all subsidized exports.

Until the 1996 Act, interest in developing alternatives

to the support purchase program was minimal or

nonexistent. Making modifications to the existing program was a different story. Changing the relative

prices of purchased products, the products to be purchased, and the pricing standard have all had proponents. So, too, has establishing some sort of production control program. A major change in the pricing

standard was made in 1981 when parity (see Glossary)

was replaced as the standard; a price related to milk

surpluses and CCC costs was offered in its place. 

The movement away from parity pricing removed the

flexibility the Secretary of Agriculture had in setting

the support price (it was possible to set the price in a

range from 75 to 90 percent of parity). Since 1981,

support prices have been written into legislation, making them somewhat harder to adjust in a timely manner. The 1996 Act established an incrementally downward movement in the support price from $10.35 per

hundredweight (cwt) in 1996 to $9.90 per cwt in 1999.

There is no particular economic foundation for this

process—an initial price existed and a final price was

desired at the end of a specific time period. The two

extensions of the program were at the $9.90 per cwt

level.

Import Policies as Safeguards

The milk price support program maintained prices of

dairy products above international market levels. The

prices of manufactured dairy products in international

trade—primarily butter, cheeses, and dry milk powders—have been low compared with the domestic

prices in producing countries since World War II.

European dairy industries made (and still make) extensive use of subsidies to export dairy products. In such

circumstances, import controls were seen as a means

of preventing the flooding of the U.S. market with foreign products.

Import quotas on dairy and other agricultural products

were authorized by Section 22 of the Agricultural

Adjustment Act of 1933, as amended. Quotas would

be imposed when it was determined that the imports

threatened the operation of the commodity price support programs. Such quotas were first imposed on

dairy products in 1951 under emergency legislation.

Higher supported milk prices in the United States

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could induce some other countries where prices were

lower to ship large quantities of dairy products to the

United States. Were that to happen, the U.S.

Government would be subsidizing milk production and

processing (including manufacturing) abroad through

the domestic price support program. The supplies of

imported dairy products would drive the prices of

those products in U.S. markets below the support purchase price levels. Each further shipload of imported

product would replace U.S.-produced product in the

market that would then be offered for sale to CCC.

Potentially even greater imports could occur when the

exporting countries also subsidized exports.

The United States has participated in multilateral trade

negotiations over the years under the General

Agreement on Tariffs and Trade (GATT). The GATT

came into being in 1947 and continued in existence

until it was superseded by the World Trade

Organization (WTO) in 1994 during the Uruguay

Round (the last round) of GATT. The agreement provided a code of conduct and a framework for periodic

multilateral trade negotiations—a function no different

for the WTO. But the WTO is different in at least two

important ways. First, agricultural trade is now expressly subjected to specific rules. Second, greater powers

for adjudicating trade disputes brought before it by

member nations have been granted to the organization.

The Uruguay Round brought agricultural trade issues

to the forefront, as had no previous round. Signatory

nations embraced the conversion of non-tariff trade

protections to tariff-based systems. To meet that obligation in the case of dairy, a tariff-rate quota (TRQ)

system replaced the section 22 dairy import quotas on

January 1, 1995. The TRQ system is a two-tier tariff

system with a low-tier tariff rate applied to imports up

to a specified quantity and a high-tier rate applying to

any import quantity in excess of the specified level.

The TRQ rates and quantities vary by product. Another

objective of the Uruguay Round was increasing import

access, which could be accomplished by reducing

high-tier tariff rates, increasing the quantities subject

to the low-tier rates, or a combination of the two during the implementation period (1995-2000) of the

agreement, and beyond.

The United States also concluded the North American

Free Trade Agreement (NAFTA) covering trade among

Canada, Mexico, and the United States. The agreement

was signed late in 1993 and its provisions went into

effect January 1, 1994. The NAFTA dairy provisions

are laid out in a set of bilateral agreements. Inclusion

of more countries in NAFTA and preparations for the

next round of multilateral trade negotiations under

WTO are current issues which are likely to have a

bearing on future U.S. dairy trade. Changes of import

policies to date have altered the method of establishing

border protection, not the intent of shielding the U.S.

dairy industry, to some degree, from international

dairy market influences.

Federal Milk Marketing Orders, 1937-Present

Federal milk marketing orders are concerned primarily

with orderly marketing of raw fluid-grade milk from

the producer to the processor. Legal and technical language makes them complex. Classified pricing and

pooling are the two key elements of the orders. As

required by the Federal Agriculture Improvement and

Reform Act of 1996, Federal milk marketing orders

were changed in 1999 in some fundamental ways.

Attempts to simplify order issues can always be criticized in some quarter or another but that does not

imply that such attempts should be abandoned. One

approach for addressing milk marketing orders is to

lay out in general terms what they, as legal instruments, can (could) and cannot (could not) “do.”

What They Do Promoting orderly marketing is a fundamental objective of Federal milk marketing orders.

To reach that goal, pricing rules that move milk

smoothly from the farm to processors then on to consumers in desired quantities at the desired times are

defined. A major function of Federal milk marketing

orders is setting minimum prices for raw fluid-grade

milk that regulated handlers, often processors, must

pay to dairy farmers (usually through dairy cooperatives). Three key facets of orders are sometimes lost in

discussions of them:

	

		

		





	
	


		

	

		



	








	



 		

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"

A classified pricing system exists in the orders based

on the end use of the milk sold under them. Over time,

the number of classes has varied by order, from at least

	
	
		 	
	
	

 ❖ #
2 to 7 or 8. Class I use has been defined as the milk

going into beverage milk products. The other classes

have represented aggregated or disaggregated uses for

other products which have varied at times. The minimum prices to be paid for milk used in each class are

specified in each order. Underlying the entire classified

pricing system is the linkage between class prices and

the wholesale prices of manufactured dairy products.

The minimum price received by the farmers or their

cooperative from the regulated handler is not any one

of the class prices; rather, it is what is called the uniform or “blend” price. The blend price is a weighted

average of the class prices, with the weights being the

utilization (percent) of milk in each class in the specific market. Marketing orders provide the legal authority

for auditing regulated handlers to determine how their

milk is used and to make sure that they are paying the

appropriate minimum class price. The auditing authority also results in other valuable market information

such as “test” weights and sales of the different types

of beverage milks, e.g., whole and lowfat. Under this

system, each milk producer supplying the regulated

handlers in an order receives a price based on both the

higher priced fluid market and the lower priced other

product markets in that order. 

The prices established by orders are computed on a

pre-determined schedule designed to reflect the

dynamic nature of milk supplies and demand. We will

return to the question of setting prices in the section

describing the reformed Federal milk marketing orders

called for in the 1996 farm legislation. First, we consider the other half of order basics.

What They Don’t Do Orders do not do anything that is

not related to setting minimum prices at the handler

level and determining that the regulated handlers pay

at least the minimum blend prices to producers. 

First, orders do not directly restrict the individual production or marketings of milk producers. The orders

do not regulate producers at all. In a similar vein, the

orders do not guarantee a market for an individual producer’s milk with any regulated handler. These statements do not imply that the Federal milk marketing

orders do not have some influence on these activities.

Second, the regulated handlers are only regulated as to

the minimum prices they pay—how they use the milk

they receive is up to them. Handlers respond to known

or anticipated purchases by their customers for fluid

milk, which generally has first call, and then use the

remainder either for balancing or for storable manufactured products. Thus, Federal orders do not guarantee

a fixed price to producers, not even a fixed minimum

blend price. The fact that utilization can change for

regulated handlers precludes such a guarantee.

In earlier times, numerous barriers to milk movement

arose due to the actions of State and local health

authorities that established sanitary regulations, product specifications, and other rules. Such regulations

effectively protected local producers from competition.

Legal and legislative actions have eliminated the ability of such regulations to restrict milk movements by

establishing uniform regulations and specifications.

Federal milk marketing orders do not restrict milk

shipments from other Federal orders, although the

order prices undoubtedly have some effects—handlers

and cooperatives control milk movements, from producers to processors, among processors and manufacturers, and from one geographic area to another.

Finally, the Federal milk marketing orders do not set

wholesale or retail milk and dairy product prices.

Wholesalers and retailers react to the demands placed

upon them by their customers and to internal business

decisions with regard to pricing. However, some Statelevel laws regulate prices at the two levels.

Federal Order Reform

The 1996 Act required that the number of Federal milk

marketing orders be reduced from the 33 then in existence to no less than 10 nor more than 14, including

one for California if that State’s producers decided to

switch from their State pricing system to the Federal

system. The act also gave the Secretary of Agriculture

authority to examine pricing provisions. After reviewing proposals made by many groups and individuals,

USDA published a proposed rule in winter 1998. The

proposed final rule was published April 2, 1999, in the

Federal Register with a target date of October 1, 1999,

for implementation. Congress stepped in to modify the

USDA plan, and that congressionally modified plan

was implemented January 1, 2000. 

All facets of the Federal milk marketing orders are

covered by the modified USDA rules with emphasis on

four components:

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The concept of a price mover (noted above in 2 and 3)

needs to be developed more fully. It is this price that

links the milk price support program to the Federal

milk marketing orders so that changes in one program

are reflected in the other. This price mover was chosen

to reflect prices in unregulated milk markets and align

the unregulated and the regulated markets. This link

represents a fine point that is sometimes lost in the

debates concerning public dairy policies and programs—the public programs were not intended to

replace unregulated market price determinations but to

work along with them.

From 1968 to about the middle of 1995, the mover

was the M-W (or a modified version of it) price—the

price of manufacturing grade milk in Minnesota and

Wisconsin, where most of the manufacturing grade

milk was produced. Early in the 1990’s, USDA decided that the M-W should be replaced. The most common argument put forward for replacing the M-W rested on the relatively small and declining volume of

milk being used to compute the price (the thin market

argument).

The Basic Formula Price (BFP) was introduced in

1995 as a temporary replacement for the M-W (which

	
	
		 	
	
	

 ❖ %

Figure 2

Federal milk marketing order areas, January 1, 2000

Pacific

Northwest

Southwest

Upper

Midwest

Central

Mideast

Southeast

Western

ArizonaLas Vegas Appalachian

Northeast

Differences in shading merely serve to

differentiate between marketing areas.

Source: Dairy programs, Agricultural Marketing Service, USDA

Florida
was still being made available) to determine the minimum Class III price regulated handlers would be

required to pay. It used the prices of butter, cheese, and

nonfat dry milk in formulas to adjust the M-W price.

Figure 3 shows the linkage between the milk price

support program and the Federal milk marketing

orders as they were defined on January 1, 2000. The

formulas that are used to determine the class prices

now incorporate component prices. The use of component pricing is not “new”—it had been used in some of

the previously existing 31 orders. Under the new 11

orders, more milk came under such pricing. Under the

old rules, Class I and Class II prices were determined

by adding differentials to the BFP (which was the

Class III price); the current method is much changed

(Appendix A).

The reform of the Federal marketing order system has

been characterized as a move toward a more marketoriented dairy industry. However, the basic purpose of

the system is unchanged—to provide orderly market

conditions so that producers are assured of stable markets and consumers have an adequate supply of milk

and dairy products. To that end, the minimum prices

that handlers must pay will continue to be established

using a classified pricing system that incorporates

national market prices for dairy products and recognizes the higher costs associated with supplying fluid

milk markets.

Compacts

The 1996 Act brought to the national stage a concept

that had been under discussion in the Northeast for

many years—an interstate compact for dairy market

regulation. Congress granted its consent to the formation of the Northeast Interstate Dairy Compact (the

Compact) in the 1996 Act to include six States—

Maine, New Hampshire, Vermont, Massachusetts,

Connecticut, and Rhode Island, if certain conditions

were met. The conditions included a finding of “compelling public interest” by the Secretary of Agriculture,

which was issued in August 1996.

The proponents of the Compact argued that regulatory

authority over the dairy marketplace in the New

England States needed to be restored to the six States,

acting together. This is a key fact—the compact gave

the States powers to regulate a commodity that was

moving in interstate commerce. States are not permitted this role unless granted the authority by Congress.

The possibility that other States might join the

Compact existed, but has not yet happened. A

Compact Commission established to implement the

Compact pricing authority met for the first time in

September 1996.

The Compact Commission regulates only the farm

price of Class I milk. Through formal rule-making, the

Commission arrived at a Compact over-order Class I

price of $16.94 per cwt that was set in July 1997 and

has been unchanged since. Compact pricing was to

work in conjunction with Federal milk pricing in the

region. The 1996 Farm Act originally linked the duration of the Compact to the implementation of the

Federal milk marketing reform.

Compact-regulated handlers are obligated to pay the

$16.94 per cwt minimum Class I price. If the Federal

minimum Class I price in the Compact area is $16.94

or above, the producer price is calculated using the

Federal order procedures. When the minimum Class I

price in the Compact area is below $16.94, a two-step

price calculation occurs. First, the Federal order price

is calculated using the minimum Class I price. Second,

an “over-order” obligation per cwt is defined as the

difference between $16.94 and the minimum Class I

price. Each regulated handler pays an amount into a

pool operated by the Compact Commission equal to

the over-order obligation multiplied by Class I sales.

Under the terms of the Compact, monies are set aside

to meet certain requirements, for example, to reimburse CCC if there are increases in production in the

Compact area that wind up as CCC product purchases.

The balance of the pool proceeds (in dollars) is then

divided by the total pounds of producer milk in the

region to determine what is called the Compact producer price. All producers supplying the Compact area,

including those outside it, receive the Compact producer price (per cwt) payment in addition to the price

calculated on the basis of the Federal order pricing

rules. To reiterate, the price received by the producer

consists of two parts when the Compact over-order

obligation is present. Detailed information on the

Compact and how it operates may be found on its web

site—the address is included in the list of information

sources.

The Compact has proven to be a lightning rod for

regional conflict in the industry. Over 20 legislatures

in the South and elsewhere have passed enabling legislation to join future compacts, if the opportunity arises.

Southern dairy farmers have been particularly vocifer-

& ❖ 	
	
	

 	
	
		
ous in calling for approval of a compact in that region.

Whether the political environment will ever allow consideration of dairy compacts again is questionable,

especially since there is resistance to “reopening” farm

legislation before 2002. Even so, the enthusiasm for

establishing compacts has not weakened.

The Congress added to the debate by extending the life

of the Northeast Compact by 2 years, but not authorizing any others. The extension of the Northeast

Compact essentially broke the link between the life of

the Compact and the implementation of Federal order

reform that had been written in the 1996 Act. Debates

about the Compact have tended to be waged outside

the order reform question.

State Regulations

The authority to regulate intrastate milk markets was

denied to the Federal government in court decisions

early in the New Deal period. These court decisions

led the States to make efforts to assist dairy farmers

suffering economic hardships at the time by implementing State milk controls, a power they clearly

enjoyed. Some States went beyond producer price regulation to regulate wholesale and retail dairy prices as

well. Both direct and indirect regulation was applied to

wholesale and retail prices. 

Many States fixed prices at the producer, wholesale,

and retail levels during the Depression. State regulation has declined in recent years but many of the States

retain the authority to control milk markets. State regulations are important from a national perspective

because of which States do control milk prices.

California (discussed in a following section) and

Pennsylvania, two of the top five producing States in

1999, are the prime examples.

	
	
		 	
	
	

 ❖ 

Figure 3

Linkages between the milk price support program and the Federal milk marketing orders

Milk Use

Milk price support program Blend

price

Milk support price

Support purchase Class I

prices for products Class II

Class III

Class IV

Federal milk marketing orders

prices

Milk production

(marketings)

Milk production

costs

Farm milk price

Other effects on 

farm milk price

Wholesale product

Source: Economic Research Service, USDA.
Producer Prices

About three-quarters of the 50 States have tried producer price regulation at some time since 1933.

Various methods have been used to establish the price:

• Direct relationships to measures of cost of production or changes in those costs,

• Connections to prices in nearby Federal milk marketing orders,

• Economic formulas, and

• Hearing processes where all interested parties, producers, processors, and consumer groups, present

their cases and some price is recommended and ultimately approved or not. When a recommendation is

not approved, more hearings may be called. 

Some recent State legislative attempts to regulate

prices arose from dissatisfaction with the system in

place. Many of those attempts were overturned in the

courts. While not setting prices, several States have

established producer security trust funds to provide

compensation to farmers should their milk handlers go

bankrupt without payment to them. California has

gone further. Under an exception granted in the 1996

Act, that State has set composition standards for beverage milk at higher levels than Federal standards, an

action that has been challenged.

Consumer Level

Several States regulate either the wholesale or the

retail prices of fluid milk products, or both. States differ in the regulation of resale prices—some set minimum prices, some set maximum prices, and some set

both minimums and maximums. For example,

Pennsylvania essentially sets minimums at every market level for milk produced and marketed in the State.

Minimum prices are set at a stop-loss level (conditions

based on the estimated average cost of production),

and market prices are generally above them. Other

States, such as Nevada, set prices that retailers must

pay for milk, but do not restrict the price the retailer

charges consumers. State milk pricing regulations are

much less prevalent than they used to be.

There are many reasons for maintaining resale price

control of milk—not the least of which is the desire to

retain the backing of handlers for control at the producer level by giving them guaranteed margins. From

a public policy standpoint, however, the primary argument is that retail pricing is inherently unstable and

frequently leads to destructive price wars. The changing structure of the milk production and marketing

sectors along with the accompanying change in the

nature of the pricing process have substantially weakened this argument.

Under the typical milk marketing system of the 1950’s,

handlers provided full service to retail stores, including

pricing milk and milk products, display case arrangement, and daily delivery. A typical store had two to six

brands of milk, each serviced by a different handler. In

practice, the handlers effectively determined prices,

and the store received a fixed margin. While the handler did not have absolute control over prices, as did a

gasoline company in its leased stations, the control

was still strong. If one handler reduced retail prices,

other handlers with milk in the same store were under

strong pressure to follow.

In the present market, retailers generally exert a

stronger control over pricing. Larger chain stores often

have their own bottling and distribution plants. There

is typically no more than one brand per store in addition to private label, and often there is only private

label. Also, chain stores purchase for a large number

of stores at the division level rather than at the local

level. Under these circumstances, resale price control

no longer serves the function it once did.

Most States with resale price-fixing authority, and

many without, have authority to regulate trade practices. State trade practice laws usually prohibit all or

most of the following: free merchandise, unreasonable

extension of credit, secret rebates and discounts, free

signs, unearned advertising allowances, loaning of

money, free equipment, free repairs and services, sales

below cost at the wholesale or retail level, price discrimination, and purchase price discrimination. Also,

several States require a minimum markup, particularly

by retailers, while others require that prices be filed

with the State agency. By prohibiting many forms of

nonprice competition, such as those listed above, there

is some tendency to force competition more strongly

into the price arena.

California Milk Pricing

Like milk markets everywhere, the markets in

California were in disarray as the full weight of the

Depression was felt. Californians first looked to the

Federal Government for assistance. Based on the

Agricultural Adjustment Act of 1933, the Federal

 ❖ 	
	
	

 	
	
		
Government issued milk marketing agreements for Los

Angeles, Alameda County, and San Diego in

November and December of 1933, with expectations

to do likewise in other markets. The courts declared

Federal regulation of a local market illegal because no

interstate commerce was involved and the Los Angeles

and other agreements were terminated in 1934. In view

of this problem with the Federal regulation, milk producers and distributors in California moved to draft

and secure passage of State laws.

Producer price regulation was contained in the Young

Act of 1935. The legislation designated a third party,

the Director of Agriculture, to establish minimum

prices to be paid for fluid milk and cream to producers

by distributors. Three “standards” were to be considered in establishing the price:

 

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A classified pricing system with Class 1 milk for beverage use was the foundation of the minimum price.

The 1935 law did not require pooling, so producers

with contracts serving high Class 1 utilization distributors had a great advantage. It was not until the 1950’s

and 1960’s that action was taken to address disparate

prices paid to producers for milk that was essentially

the same compositionally. The Gonsalves Milk

Pooling Act of 1967 established the mechanisms for

pooling and allocating revenues among California producers that are in effect today.

Unlike Federal milk marketing orders, which came to

use component pricing recently, California regulations

have recognized values for butterfat and solids-not-fat

(SNF) for many years. Under today’s system of five

classes, Classes 2, 3, 4a, and 4b are priced on the basis

of fat and SNF through product price formulas. Class 1

milk has an added component, the fluid carrier (water)

which is given a small value. California producers also

have a system of quotas that are incorporated into their

pricing plan, the quota being for “market” milk or

fluid grade. Quota can be bought and sold, and it may

be increased by the State if necessary.

Resale price regulation in California is authorized

under a separate law, the Desmond Act, drafted in late

1936 and enacted in September 1937. The law gave

the California Director of Agriculture the authority to

establish minimum wholesale and retail prices for fluid

milk and cream throughout the State for all wholesale

sales to stores and restaurants, retail store prices, and

home delivery prices. Price cutting and secret rebates

between distributors and retail stores were the primary

targets of the regulations. As the Desmond Act became

operational, some sellers attempted to circumvent its

rules. One approach was to discount other dairy products’ (other than fluid and cream products) prices. This

practice led to further regulation of trade practices to

eliminate such indirect price-cutting.

The California pricing system has been operating since

the 1930’s on the set of rules that were written at the

time, with alterations to adapt the laws to changing

economic developments. In recent years, as Federal

milk marketing orders have come under increasing

pressures for change, so too has the California system.

Even though two pricing systems are operating, there

are attempts to reduce friction between them. For

example, California law requires that the Class 1 price

in the State be aligned with the Class I prices in adjacent Federal milk marketing orders. 

Nongovernment (Market) 

Pricing Institutions

As noted earlier, not all of the pricing institutions for

milk are based on public policy decisions. The longstanding cooperative presence in the dairy industry has

played a major part in pricing. The development of

milk and dairy product futures markets has provided

milk producers another way to address their concerns

about price movements and risk management issues.

The Role of Cooperatives

Dairy cooperatives broadened the scope of their operations in the 1970’s when they became regional rather

than local organizations. Mergers, consolidations, and

acquisitions are again altering the structure of dairy

cooperatives today—some have “gone national.” Each

cooperative has chosen its own particular approach to

the question of how, if at all, to restructure. 

Regardless of their size, the roles of the dairy cooperatives in both regulated and unregulated milk markets

have changed. The cooperatives still represent member

interests in the rulemaking processes of Federal- and

	
	
		 	
	
	

 ❖ 
State-regulated markets, which can include minimum

price issues. But other roles have become more prominent and claimed more of the public’s attention. In

1997, dairy cooperatives sold 61 percent of the milk

they handled as raw milk to buyers; the remainder was

processed or manufactured in cooperative plants. 

In many cases, the cooperatives have assumed operation of a complete milk procurement and distribution

system. Assembling milk from the farm, routing raw

milk where it is needed, managing or coordinating

movements of processed or manufactured products,

and managing surplus milk, defined for our purposes

as supplies above fluid requirements, are all parts of

the system. Taken together, these activities are called

“balancing.”

Procuring and coordinating a fluctuating supply to

meet varying demands is costly to individual handlers.

A full-supply arrangement with a cooperative can

reduce the cost. Cooperatives supply the exact needs

of the handler for fluid use and/or ice cream and cottage cheese production and manage the remaining milk

for other uses. Full-supply arrangements do not eliminate fluctuations, but they do provide a relatively simple, routine way of balancing supply and demand with

minimum effort or expense to the processor.

Cooperatives can achieve significant economies of

scale by coordinating supplies with demands using

full-supply arrangements and can reduce the uncertainties for handlers, fluid milk processors, and dairy product manufacturers. The reserve supplies that must be

carried to meet the fluctuating demands of an entire

market are smaller and less variable for a cooperative

servicing the entire market than the sum of individual

fluid handler reserves. A single agent moving milk

between producers and users and among the users is

more efficient also. Savings from a centralized supply

and surplus management operation can be shared

among the cooperatives providing the services and the

fluid milk processors.

Full-supply agreements are not always a plus for the

cooperatives. If members cannot produce enough milk

to meet commitments that have been made, the cooperative may have to buy milk from sources in other

Federal milk marketing orders, sometimes at a substantial premium, to make up the shortage. This ultimately is an added cost to the cooperative that its producer members absorb. The economies of scale that

cooperatives can achieve by adopting a full-supply

arrangement can be large enough so that both cooperatives and handlers benefit, but there are instances

where this is not the case. One example is the high utilization markets of the Southeast—the cooperative

may have to purchase milk at unattractive prices to

meet commitments under full-supply contracts.

Cooperatives have influenced price making in the regulated milk markets. Changes in the bargaining relationships in the procurement markets and centralized

management of milk movements have meant lower

operating costs for cooperatives. The resulting environment has fostered cooperatives’ ability to bargain for

and obtain payments above the minimum prices established in Federal milk marketing orders to help defray

some of the costs of servicing those markets. These

“over-order” payments were paid in nearly all Federal

orders in recent years. The over-order payment is

reflected in the price to members only of the cooperative that obtained it.

Futures and Options Contracts 

Many commodities, including agricultural ones such as

live cattle and hogs, are being priced at least partially

on the basis of futures contracts. The advent of futures

and options contracts for Cheddar cheese, butter, nonfat dry milk, and raw fluid milk was seen by some as

the prelude to a new era in milk pricing. Were they to

be widely used, futures and options contracts could be

used to manage price instability. 

In June 1993, Cheddar cheese and nonfat dry milk

futures and options contracts were introduced on the

Coffee, Sugar, and Cocoa Exchange (CSCE, now

known as the New York Board of Trade). Previously,

only butter futures had existed on the Chicago

Mercantile Exchange (CME) since 1919, but they were

used to a great degree only in the late 1940’s and early

1950’s. Interest in butter futures was low since the

milk price support program, with its product purchases, greatly limited downside price risk for milk and its

products. Why would anyone be interested in managing butter price risk when there was so little?

Times have clearly changed with respect to the price

risk situation. As the role of the price support program

as a floor under prices has been reduced, milk price

volatility has increased. In the current price environment, one would expect a growing interest in risk

management tools such as futures and options, but to

 ❖ 	
	
	

 	
	
		
date one must conclude that the high hopes for dairy

product futures and options contracts have been unmet.

The manufactured product contracts never really took

off, nor did the markets gain the broad liquidity that

characterizes other successful futures and options markets. The BFP (Basic Formula Price) futures were

more successful, and, if a futures market develops that

represents the new Class I mover, either the Class III

or Class IV price, it too could be viable.

The Commodity Futures Trading Commission

approved a Grade A milk futures and options contract

in October 1995 that proved difficult to understand. A

BFP futures and options contract was begun on the

CME in 1997 that reached a market milestone in

March 1999 as open interest in it surpassed 5,000 contracts. The open interest indicates participation has

grown to levels that are likely to make the contract a

viable one. As long as there is price volatility in cash

markets for milk and dairy products, the dairy industry

will continue to evaluate futures and options contracts

for price risk management. Both Class III and Class

IV futures and options contracts began trading on the

CME in the first half of 2000.

In January of 1999, USDA started the Dairy Option

Pilot Program (DOPP) to introduce milk producers to

the futures and options approach for managing risks.

DOPP is a cost-sharing program that allows dairy

farmers, meeting certain requirements, to gain handson experience with options trading for a period of 6 to

8 months. USDA pays 80 percent of the premium (or

cost) of each option and broker fees up to $30 per

option—the farmer is responsible for the other 20 percent of the premium or cost. The first farmers in the

DOPP program were located in designated counties in

California, Minnesota, New York, Pennsylvania, Texas,

Vermont, and Wisconsin.

In July 1999, the Secretary of Agriculture announced a

“second round” of the DOPP that expanded the program in the original 7 States by adding 12 more counties and extending the program to an additional 49

counties in 25 other States. Almost 1,700 put options

were purchased by the 425 producers who participated

in the first round of the program. The put option gave

the producers the right, but not the obligation, to sell a

futures contract, thereby establishing a price floor for

their milk. This hedging alternative can protect producer income in the event market prices fall below the

put option price. If market prices exceed the put option

price, the option can expire unused. Further program

expansion to 300 counties was included in legislation

signed by President Clinton in June 2000.

The development of the dairy futures and options contracts has given milk producers an opportunity to

negotiate forward price contracts with the buyers of

their milk. Congress directed the USDA to establish a

pilot program to examine the issues related to forward

contracting under Federal orders. In July 2000, the

final rules for this pilot program were issued. The

Agricultural Marketing Service has provided detailed

information and frequently asked questions and

answers on its web site (see information sources).

Producer risk is not totally eliminated by the forward

pricing—producers can lock in a price that ends up

being below the prevailing market price in the future

period. However, these types of arrangements do

remove uncertainty and that can be advantageous for

producers as they make decisions about their futures.

	
	
		 	
	
	

 ❖ !
The Milk Pricing System

in the Future

Economic theory posits that the role of pricing is to

balance the supply of a product with the demand for it.

We have shown that the pricing system that has evolved

for milk in the United States is a complex set of market

and public institutions. Many of the pricing arrangements that have arisen can be tied to the unique physical properties of milk. Creating a balance between supply and demand for milk requires establishing and

maintaining a balance among the following:

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The milk pricing system has been responsive to

changes in the economic and political forces affecting

dairy farming. The fact that one can trace the various

changes through legislative histories illustrates this

facet of the system. There is pressure currently to continue making changes—with the elimination of public

pricing institutions as a stated goal of some. Whether

that happens remains to be seen but further changes in

the system will likely be forthcoming. International

trade negotiations carry the potential for further import

and export regulations of some significance. The continuing restructuring of dairy cooperatives and proprietary dairy companies (such as Dean Foods and Suiza)

has included and will likely continue to include joint

ventures that could alter milk pricing relationships. We

have used the term “evolved” in several instances in

the text; that term will continue to describe the milk

pricing system into the future.

" ❖ 	
	
	

 	
	
		
Glossary

Bacteria count. A measure of milk quality. There are

some organisms capable of surviving milk pasteurization or refrigeration processes. Keeping the level of

these organisms low is a quality standard.

Balancing. A service usually provided by dairy cooperatives to tailor milk supplies to each handler in a

market to that handler’s needs. It involves directing

milk movements between farms and handlers’ plants

and among plants, managing imports from outside the

region and stocks, and diverting supplies in excess of

handlers’ needs to alternative outlets, such as manufacturing plants.

Basic Formula Price (BFP). An adjusted competitive

pay price for manufacturing grade milk used as the

mover of most Federal milk marketing order class

prices from mid-1995 to January 1, 2000. The adjustment to the competitive pay price was a formula based

on the month-to-month change in the prices of manufactured dairy products. It also established the current

Class III price under the orders.

Blend price. A minimum weighted average price in

Federal milk market orders based on the proportion of

Grade A milk allocated to each use class. Producers

receive the blend price with adjustments for butterfat

content and plant location if so specified.

Class I differential. The amount added to the class

price mover (see BFP) in a Federal milk marketing

order to obtain the given order’s minimum Class I

price. The same procedure is used in State marketing

programs, but the nomenclature might be different.

Classified pricing. A structure of prices that differ

according to category of use. In Federal and some

State orders, regulated processors are required to pay a

minimum price for Grade A milk according to the

class in which it is used. States, like California, have

price structures analogous to the current Federal milk

marketing orders (as of January 1, 2000) that have four

classes (uses):

Class I. Grade A milk used in all beverage milks.

Class II. Grade A milk used in fluid cream products,

yogurts, or perishable manufactured products (ice

cream, cottage cheese, and others).

Class III. Grade A milk used to produce cream cheese

and hard manufactured cheese.

Class IV. Grade A milk used to produce butter and any

milk in dried form.

Composition (of milk). Milk components are usually

defined as fat solids, solids-not-fat (SNF), and fluid

carrier (water). The SNF include proteins, minerals,

and sugars. Milk pricing can be based on the values of

the components and their proportions in producers’

milk. This is generally called component pricing.

Cooperative. A firm that is owned by its farmer-members, is operated for their benefit, and distributes earnings on the basis of patronage (volume of milk).

Dairy Export Incentive Program (DEIP). A program

that provides cash bonuses (subsidies) to exporters of

U.S. dairy products to sell targeted dairy products in

targeted overseas markets. Under recently implemented trade policy agreements, this program is being

downsized in terms of both quantities to be exported

and expenditures.

Economies of size. Increasing returns as use of factors

is expanded in least-cost combinations. A situation

where efficiently operated larger firms (farms) are

more profitable than efficiently operated smaller firms

(farms). The advantage can arise from lower production costs, volume premiums for products (outputs), or

volume discounts for inputs. Once an operation reaches a certain size, the marginal cost of producing additional output begins to decline.

Federal milk marketing order. A regulation issued by

the Secretary of Agriculture specifying minimum

prices and conditions under which regulated milk handlers must operate when selling fluid milk products

within a specified geographic area.

Fluid grade (Grade A) milk. Milk produced under

sanitary conditions that qualify it for fluid consumption. Only Grade A milk is regulated under Federal

milk marketing orders.

Fluid milk. Packaged dairy products used as beverage

milks.

Fluid products. A term traditionally used to define the

products including beverage milks, fluid cream items,

and yogurts.

	
	
		 	
	
	

 ❖ #
Fluid utilization. The proportion of Grade A milk in a

market used to produce fluid (Class I) milk.

Interstate compact. A formal agreement between or

among States, enacted through State and Federal legislation, which allows the combined States to exert

authority not granted to them by law.

Manufacturing grade (Grade B) milk. Milk not meeting the fluid grade standards. Less stringent standards

generally apply.

Manufacturing milk. Grade B milk or the Grade A

milk used in the production of manufactured dairy

products.

Manufacturers. Generally refers to the producers of

cheese, butter, nonfat dry milk, and other storable

dairy products.

Minnesota-Wisconsin (M-W) price. A monthly average price per hundredweight paid by plants for manufacturing grade milk in Minnesota and Wisconsin. The

price is obtained from a survey of cheese and butterpowder plants conducted in the two States by USDA’s

National Agricultural Statistics Service.

Over-order payment. Payment above Federal order minimum prices negotiated between buyers and sellers to

cover the cost of providing market services or attracting

adequate milk supplies for both fluid and manufacturing

uses. Over-order payments also could result from market power or regulation (see Compacts section, p. 10).

Parity price. Originally defined as the price that gives

a unit of an agricultural commodity the same purchasing power today as it had in a base period, traditionally

1910-14. In 1948, parity procedures were modified to

adjust for changes in relative farm prices between the

base period and the most recent 10 years.

Perishable manufactured dairy products.

Manufactured dairy products with limited storage life,

including ice cream, cottage cheese, and bulk condensed milk.

Pooling. With a classified pricing system such as that

used in Federal and State orders, processors pay different prices for milk in each category of use. Producers

are paid a weighted average, or “blend,” price for all

uses of milk in a particular order or market. Processors

pay into or draw out of the pool on the basis of their

utilization of milk relative to market average utilization. Producers participating in the pool receive identical uniform blend prices, with adjustments for butterfat

content and location of the plant to which the milk is

delivered. In markets with multiple component pricing,

adjustments also are made for protein and other solids.

Price system (mechanism). An expression referring to

the role of prices in a market economy in conveying

information and providing incentives.

Processors. Generally refers to firms that process raw

Grade A milk into fluid products.

Somatic cell count. A measure of milk quality based

on the number of somatic cells that appear in the milk.

Somatic means “of or related to the body” so that

almost any body cell is included. The number of the

white blood cells (infection-fighting cells) is relevant

here. High levels of these cells appear in response to

inflammations that can be a sign of mastitis. The composition of milk can be influenced by somatic cell

counts.

Storable manufactured dairy products. Manufactured

dairy products, including butter, nonfat dry milk, and

hard cheeses, that can be stored for relatively long

periods of time.

Support price for milk. When a support purchase program is in operation, the price of manufacturing grade

milk that the Government must ensure is received, on

average, by farmers.

Support purchase prices. Announced prices at which

the Government will purchase any offered manufactured dairy products meeting its specifications. They

are set at levels where plants will pay the support price

for milk.

Surplus. The difference between commercial milk

supplies and the amount demanded by the market at a

given price. CCC net removals (price-support purchases plus DEIP shipments minus domestic sales for unrestricted use) approximate the surplus during a particular period.

Test. Commonly in the phrases “at test” or “test

weight,” the measure of fat in milk. The predominant

method used in the United States is the Babcock test,

developed in 1890.

$ ❖ 	
	
	

 	
	
		
Information Sources

Bailey, Kenneth W. 1997. Marketing and Pricing of

Milk and Dairy Products in the United States. Ames, IA: Iowa State University Press.

Blayney, Don P., James J. Miller, and Richard P.

Stillman. 1995. Dairy: Background for 1995 Farm

Legislation. AER-705. U.S. Dept. Agr., Econ. Res.

Serv.

California Department of Food and Agriculture.

Accessed 6 June 2000

<http://www.cdfa.ca.gov/dairy/>. 

Manchester, Alden C. 1983. The Public Role in the

Dairy Economy—Why and How Governments

Intervene in the Milk Business. Boulder, CO:

Westview Press.

Manchester, Alden C., and Don P. Blayney. 1997. The

Structure of Dairy Markets: Past, Present, Future.

AER-757. U.S. Dept. Agr., Econ. Res. Serv.

Accessed 19 May 2000

<http://www.ers.usda.gov/epubs/pdf/aer757/>.

Northeast Dairy Compact Commission. Accessed 6

June 2000 <http://www.dairycompact.org/>. 

Novakovic, Andrew, Craig Alexander, and Mark

Stephenson. 2000. Glossary of Dairy Marketing

Terms. Accessed 6 June 2000

<http://www.cpdmp.cornell.edu/publications/>.

Price Instability and Risk Management in the Dairy

Industry. Proceedings of a conference sponsored by

the Pennsylvania State University and the Economic

Research Service, USDA. August 20-21, 1998.

Accessed 6 June 2000

<http://www.psu.edu/dept/aers/risk>.

U.S. Department of Agriculture, Agricultural

Marketing Service. Accessed 6 June 2000

<http://ams.usda.gov/dairy/>.

________, Agricultural Marketing Service. Accessed 6

June 2000 <http://www.ams.usda.gov/fmor/>. 

________, Economic Research Service. Livestock,

Dairy, and Poultry Situation and Outlook. Various

issues. Accessed 19 May 2000

http://usda.mannlib.cornell.edu/reports/erssor/livestock/ldp-mmb/.

_______, Foreign Agricultural Service. The World

Trade Organization and U.S. Agriculture. Accessed

6 June 2000 <http://www.fas.usda.gov/info/factsheets>.

________, National Agricultural Statistics Service.

Agricultural Prices. Various issues. Accessed 6 June

2000 <http://www.usda.gov/nass/>. 

________, National Agricultural Statistics Service.

Dairy Products. Various issues. Accessed 6 June 2000

<http://www.usda.gov/nass/>. 

________, National Agricultural Statistics Service.

Milk Production. Accessed 6 June 2000

<http://www.usda.gov/nass/>. 

Weimar, Mark R., and Don P. Blayney. 1994.

Landmarks in the U.S. Dairy Industry. AIB-694. U.S.

Dept. Agr., Econ. Res. Serv.

	
	
		 	
	
	

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Appendix A: Federal Milk Marketing

Order Price Formulas1

Note: Milk prices are per 100 pounds or cwt, rounded

to the nearest cent. Component prices are per pound,

rounded to the nearest one-hundredth cent. Cheese,

dry whey, butter, and nonfat dry milk prices are

weighted averages of weekly NASS survey prices.

Class I

Class I price = (Class I skim milk price x 0.965) +

(Class I butterfat price x 3.5).

Class I skim milk price = Higher of advanced Class III

or IV skim milk pricing factors + applicable Class I

differential.

Class I butterfat price = Advanced butterfat price +

(applicable Class I differential divided by 100).

Note: Advanced pricing factors are computed using

applicable price formulas listed below, except that

product price averages are for 2 weeks.

Class II

Class II price = (Class II skim milk price x 0.965) +

(Class II butterfat price x 3.5).

Class II skim milk price = Advanced Class IV skim

milk pricing factor + $0.70.

Class II butterfat price = Butterfat price + $0.007.

Class II nonfat solids price = Class II skim milk price

divided by 9.

Class III

Class III price = (Class III skim milk price x 0.965) +

(butterfat price x 3.5).

Class III skim milk price = (protein price x 3.1) +

(other solids price x 5.9).

Protein price (true protein) = ((cheese price – 0.165) x

1.405) + ((((cheese price-0.165) x 1.582) – butterfat

price) x 1.28).

Other solids price = (dry whey price – 0.140) divided

by 0.968, snubbed at zero.

Butterfat price = (butter price – 0.115) divided by

0.82.

Class IV

Class IV price = (Class IV skim milk price x 0.965) +

(butterfat price x 3.5).

Class IV skim milk price = nonfat solids price x 9.

Nonfat solids price = (nonfat dry milk price – 0.140).

Butterfat price = See Class III.

Producer Prices:

Butterfat price = See Class III.

Protein price = See Class III.

Other solids price = See Class III.

Somatic cell adjustment rate = cheese price x 0.0005,

rounded to fifth decimal place. Rate is per 1,000

somatic cell count difference from 350,000.

& ❖ 	
	
	

 	
	
		

1Formulas have been modified by a tentative decision that took

effect January 1, 2001. However, the Agricultural Marketing

Service (AMS) accepted comments on the changes until early

February. Further changes may be made based on those comments.

Further details of the tentative decision can be found on the AMS

Dairy Program web site,

http://www.ams.usda.gov/dairy/index.htm.