Urbanization Shrinking Farmland, and Margins

Have you ever noticed that milk is always located in the back of the grocery store along with the eggs, butter, and bread? Well, little did you know that this milk and butter placement strategy is known by all grocery store chains. Why is it in the back? Before the answer is revealed, let’s consider another question. Do you ever leave the grocery store without milk? Milk is a good that has historically been priced extremely low by grocers. It is placed in the back because the grocery store knows that in order for consumers to get to this staple they will have to pass other goods that have a much higher profit margin. In talking with the manager at Lee’s Marketplace in Logan, Utah, it was explained to me that milk has the lowest markup of any product in the store. This is one of the many reasons that dairy policies have been implemented in the United States.

Over the past few decades our nation has experienced exponential growth. As the population and economy grow, rural farming areas are urbanized which results in a decreased supply of rural farm ground and an increase in food demanded. As rural areas are urbanized, farmable land is depleted and the price of commodities is driven up. As commodity prices grow higher, there is a decreased margin between input feed costs and milk prices; thus, lower profit margins are realized by producers. One of the reasons that the dairy industry has always struggled is because highly variable commodities such as corn and other grains are inputs used to produce commodities such as milk. Because dairies are “price takers”, meaning they have no control of input feed costs and milk prices, the Dairy Security Act was implemented to assist dairy producers who were failing to meet desired margins due to the increasingly high price of input commodities.

The Dairy Security Act provides a Dairy Producer Margin Protection Program (DPMPP). The DPMPP works much like a financial stock option where the dairy eliminates downside marginal risk so long as they pay the premium up front for the protection. The act will eliminate many elements of the current dairy policy including one main point which provides a price floor for milk producers. An article produced by the National Milk Producers Federation weighs the effectiveness of the act here.

For anyone associated with dairy production or simply interested in how efficient and useful this margin protection insurance will be, the margin protection calculator can be located here.


Aaron said...

I love milk! 1%, 2%, Vitamin D, plain, chocolate, strawberry, hot or ice cold. Its refreshing taste lures me in and I love the simplicity of the drink. Not to mention, it'll keep my bones nice and strong!

Before I embarrass myself further, I did some research and found that the dairies that are producing the simple glass of milk I enjoy each morning have way more regulations to abide by than I ever could have imagined. And I thought healthcare was heavily regulated! I applaud producers for doing their home work, moving this work to congress and pushing for action in the form of newly enacted laws. It only makes sense that an industry that provides for so many in our country and particularly in the state of Utah should work as an efficient market where there aren't diminishing or nonexistent marginal benefits driving dairies out of business.

Dr. Tufte said...

-1 on Aaron for a capitalization error.

Lando: our growth has not been exponential. It's just been ... growth.

Also, part of the reason for the low mark-ups on milk is that the price is so high to the groceries in the first place. This is a result of the dairy programs. The total mark-up is available for a product, not for a producer. In this case, retail milk has 2 (or more) producers: the dairy farmer and the store. Each gets some mark-up, but what the dairy farmers have done is capture some of the grocery store's mark-up.

Another thought on this is that I use location in stores to think about cross-price elasticity. Milk is a complement to many goods, so it makes sense to put as many goods as you can "in the way" of getting to the milk.

Aaron is right about the regulations though. Often there is a quid pro quo: we'll regulate a higher price for you, if you put up with our extra regulations.

Also, back to Lando, as to farmers' position, their problems lie more in the prisoners' dilemma. Producing more is a dominant strategy for each farm, but yields a worse outcome when they all do it.