When supplies outpace dairy product demand, the industry experiences low milk prices. When demand exceeds milk supplies, high prices are the result. It appears to be a difficult task to find that balance between milk supply and dairy product demand. The pandemic has only added to the difficulty of balancing supply and demand.
Frequently bouncing from record low to record high milk prices can lead to market inefficiencies. All dairy stakeholders should be focused on how to most efficiently move farm-level milk supplies into consumer-ready dairy products. Although dairy producers may enjoy the periods of record high milk prices, if those periods always lead to periods of extremely low milk prices, dairy farmers are likely not better off in the long term.
This volatility in milk prices leads economists to discuss how inelastic demand for dairy products is today. The economist in me also would argue that milk supply is becoming increasing inelastic, and the combination of both supply and demand becoming more inelastic is only increasing the volatility.
However, noneconomists don’t usually think about markets in terms of elasticities. Let’s find another way to describe what is happening.
Demand provides a double bump
I have maintained an economic model of the dairy industry for many years to answer dairy policy questions posed by the U.S. Congress. This economic model is a simplification of the complexities involved in the dairy industry. Yet, it helps gauge the volatility of dairy markets by estimating the price change that comes from additional supplies or growing demand.
The dairy industry produces annually more than 13 billion pounds of cheese. The economic dairy model suggests that adding 100 million pounds of cheese demand leads to a more than 40 cents per hundredweight increase in the annual U.S. All-Milk price.
Stated another way, a less than 1% increase in cheese demand raises the U.S. All-Milk price by more than 2%. And that 100 million pounds of cheese equates to the average consumer elevating cheese use by less than one-third of a pound over the entire year. This small gain in demand gives an additional 40 cents on the U.S. milk price or generates nearly $1 billion more in cash receipts.
Is there a better way?
Unexpected changes in demand, either positive or negative, are amplifying the swings in milk prices today. This adds risk for dairy producers. At times, it provides opportunities to price milk at attractive levels, while at other times it leaves producers unable to cover production costs. If the industry is able to find a better way to handle supply and demand shocks, the reward will be less volatility and a more stable pricing environment.