[m] Bureau of Agricultural Bconolnics, Canberra

Occasional Paper No. 84

An Economic Evaluation of Australian Dairy Pricing Policy

Project 2570

Steve Blank

Australian Government Publishing Service Canberra 1983

@ Comnwealth of Australia 1983

ISBN 0 644 02854 8

Printed by C. J . THOMPSON, Commonwealth Government Printer, Canberra

Like many Aus t ra l i an i n d u s t r i e s , t h e d a i r y indus t ry is s i g n i f i c a n t l y influenced by government in te rven t ion i n the p r ice - se t t ing process. The e x t e n t of t h e economic impact of in te rven t ion is a po in t of d i s p u t e i n d i scuss ions concerning d a i r y indus t ry marketing and p r i c i n g arrangements.

This r epor t was prepared a s a con t r ibu t ion t o t h e process of eva lua t ing e x i s t i n g d a i r y p r i c i n g p o l i c i e s . I n p a r t i c u l a r , the s tudy was undertaken to se rve a s a background document f o r t h e BAE1s more d e t a i l e d submission t o the I n d u s t r i e s Assistance Commission's inquiry i n t o the da i ry indus t ry i n May 1983.

The evaluat ion i n t h i s study is l imi ted t o assess ing the economic impact of p r i c ing p o l i c i e s by quant i fying t h e i r c o s t s and b e n e f i t s t o producers and consumers. A l l e s t ima tes a r e meant t o prcvide benchmark i n d i c a t i o n s only, with t h e ana lys i s intended to develop a more informed po in t of view. A s such a n a l y s i s is necessa r i ly t e c h n i c a l i n l a r g e p a r t , readers a r e re fe r red t o the Bureau's IAC submission f o r conclusions, impl icat ions , s p e c i f i c recommendations and a discuss ion of the s o c i a l d e s i r a b i l i t y of e x i s t i n g p o l i c i e s .

ANDY STOECKEL Director

Bureau o f Agr icu l tu ra l Economics Canberra A.C.T.

J u l y 1983

iii

The author would l ike to acknowledge the contributions of several people who assisted in the preparation of th i s study. Dave Collins undertook the considerable quantitative work required in section 4.1. Ian Dalziell and Tim Yapp contributed most of the descriptive material in the subsections on the equalisation and underwriting schemes from a draf t paper they had prepared ear l ier . Ian Dalziell also prepared Appendix B. Helpful comnents from Dave Campbell were gratefully received throughout the duration of t h i s project.

CONTENTS

Page

Foreword iii

Ack nawledgments

Summary and Conclusions

1. Introduct ion

2. Analysis of Exis t ing Dairy Pol icy

2.1 The o rgan i sa t ions 2.2 The profit-maximising model

2.3 The instruments

3. Quant i t a t ive Analysis

3.1 Int roduct ion 3.2 Marginal c o s t - iden t i fy ing t h e ' e f f i c i e n t ' S t a t e s 3.3 Skim milk powder: c o s t s and t r a n s f e r s 3.4 The competit ive outcome 3.5 Cheese: c o s t s and t r a n s f e r s 3.6 Butter : c o s t s and t r a n s f e r s 3.7 Market milk: c o s t s and t r a n s f e r s

3.8 P o t e n t i a l gains f r m i n t e r s t a t e t r a d e a b i l i t y of m i l k and m i l k products

3.9 Losses due t o exports 3.10 Sumnary of annual c o s t s and t r a n s f e r s

4. Assessment of Pol icy E f f e c t s

4.1 Pol icy e f f e c t s 4.2 E f f e c t s of continuing p resen t p r i c i n g t rends

Appendix A: The E l a s t i c i t y o f Demand fo r Manufacturing Milk

Appendix B: Risk of Government Underwriting Payout

References

Figures Figure Page

1 Manufacturing m i l k : t he competit ive equi l ibr ium 2 Manufacturing milk: the profit-maximising ou tpu t 3 Demand for manufacturing m i l k derived from b u t t e r and s k i m

milk powder production i n f ixed proport ions 4 P r i c e d i sc r imina t ion i n skim c i l k powder markets 5 Derived p a r t i a l demand fo r manufacturing milk 6 Skim milk p w d e r : average revenue with p r i c e discr iminat ion 7 Equilibrium i n the manufacturing milk market 8 Demand for cheese wi th f ixed import quota 9 Misal locat ion c o s t s of equa l i sa t ion : b u t t e r f a t 10 Skim milk p w d e r : c o s t s and t r a n s f e r s 11 M i l k : t he competit ive equi l ibr ium 12 Cheese: c o s t s and t r a n s f e r s 1 3 Gains from i n t e r s t a t e t r a d e a b i l i t y of market m i l k quota 14 'Optimal' p r i c e s as a percentage of a c t u a l p r i c e

A . l Demand fo r bu t t e r and s k i m milk powder

Tables Tab1 e

Scenar i o s o f economic e f f e c t s Production and expor t s of d a i r y products: 1981-82

Ratic6 o f Austra l ian p r i c e s t o landed New Zealand p r i c e s Market milk as a proport ion of t o t a l milk production: 1981-82 Skim m i l k pcrwder: production, consumption and p r i c e s Cheese: production, consumption and t r a d e Cheese: wholesale p r i c e s Data f o r bu t t e r e s t imates Sunnnary o f annual costs and t r a n s f e r s : 1981-82

Matrix of farm-level milk p r ice e l a s t i c i t i e s Actual and 'optimal ' m i l k p r i c e s M i l k producer gross revenue under 'optimal ' condi t ions Domestic bulk wholesale p r i c e s o f l e v i a b l e products

A . l E l a s t i c i t i e s of demand

AN ECONOMIC EVALUATION OF AUSTRALIAN D A I R Y P R I C I N G POLICY

S U M M A R Y AND CONCLUSIONS

O b j e c t i v e s o f the s tudy

. The aim i n this paper i s t o p re sen t an econcmic e v a l u a t i o n o f A u s t r a l i a n d a i r y p r i c i n g p o l i c i e s s o t h a t their impact can be as se s sed a g a i n s t s t andards o f economic e f f i c i e n c y .

- The emphasis i n this s t u d y i s on the impact o f government p r i c i n g d e c i s i o n s on t h e a l l o c a t i o n o f i p r o d u c t i v e r e s o u r c e s and the d i s t r i b u t i o n o f income among p a r t i c i p a n t s i n d a i r y marke t s .

- Both t h e o r e t i c a l and emp i r i ca l a n a l y s i s t e c h n i q u e s a r e used t o s p e c i f y the magni tude o f the economic e f f e c t s .

. Of primary concern t e r e i s whether e x i s t i n g forms o f government i n t e r v e n t i o n improve the per f o m a n c e o f A u s t r a l i a n d a i r y product m a r k e t s compared t o t h e c o m p e t i t i v e market which would opera t e i n the absence o f i n t e r v e n t i o n .

A n a l y s i s o f e x i s t i n g d a i r y p o l i c y

. Both Federal m d S t a t e o r g a n i s a t i o n s p lay a c t i v e r o l e s i n the d a i r y p r i c e - s e t t i n g process .

- The A u s t r a l i a n Dairy Corporat ion a d m i n i s t e r s l e g i s l a t i o n d e a l i n g w i t h the marke t i ng arrangements f o r p re sc r ibed manufactured d a i r y p roduc t s , suck a s the l e v y s y s t em which s u p p o r t s domes t i c p r i c e s o f t h o s e p roduc t s .

- S t a t e d a i r y i n d u s t r y a u t b r i t i e s a r e r e s p o n s i b l e f o r o rgan i s ing the produc t ion and d i s t r i b u t i o n o f marke t m i l k - a t a s k t h e y perform b y s e t t i n g market m i l k p r i c e s t o farmers and the margins payable a t z l l s t a g e s o f the marke t i ng s y s t em .

. A t h e o r e t i c a l a n a l y s i s i s used t o e v a l u a t e t h e scope f o r s egrega t ing the d a i r y marke t i n t o s e p a r a t e m a r k e t s i n which d i f f e r e n t p r i c e s can be commanded. I n this a n a l y s i s , the A u s t r a l i a n Dairy Corporat ion and S t a t e i n d u s t r y a u t h o r i t i e s are assumed t o be a g e n t s f o r d a i r y producers a s a group, a c t i n g t o e n f o r c e the c o l l e c t i v e a c t i o n neces sary t o i n c r e a s e revenues .

- The i n d u s t r y can bekave l i ke a ' r e g u l a t e d monopol i s t ' as l ong a s the domest ic l e v y s y s t em ma in ta in s domest ic d a i r y p r i c e s above e x p o r t market p r i c e levels f o r prescr ibed p roduc t s .

. The i n s t r u m e n t s o f d a i r y p r i c i n g p o l i c y a r e mechanisms f o r c o n t r o l l i n g o u t p t produced a t the a r t i f i c i a l 1 y e l e v a t e d domes t i c p r i c e .

- The e q u a l i s a t i o n scheme ensures t h a t manufac turers r e c e i v e an average p r i c e f o r their product ion o f a prescr ibed d a i r y p roduc t , r e g a r d l e s s o f whether the p m d u c t i s consumed d o m e s t i c a l l y o r expor t ed .

. T h i s r e s u l t s i n producers r e c e i v i n g m i s l ead ing p r i c e i n f o r m a t i o n and, c o n s e q u e n t l y , producing more than would b e generated i n a c o m p e t i t i v e marke t .

- The underwr i t i ng scheme, t h e second major p o l i c y i n s t r u m e n t , i s des igned to p r o t e c t t h e d a i r y i n d u s t r y from sharp p r i c e d e c l i n e s w i t h o u t d i s t o r t i n g long-term marke t t r e n d s .

- A u s t r a l i a n d a i r y e x p o r t s can be viewed a s a r e s i d u a l market because t h e i n d u s t r y i s ma in l y d o m e s t i c a l l y o r i e n t e d , w i t h i n t e r v e n t i o n des igned t o g i v e a s t a b l e s u p p l y o f m i l k and product a t s t a b l e b u t i n c r e a s i n g p r i c e s .

. Expor t volumes a r e de r i ved from product ion levels b y s u b t r a c t i n g q u a n t i t i e s demanded on domes t i c marke t s .

- The marke t i ng and p r i c i n g arrangements f o r market m i l k f a c i l i t a t e the o p e r a t i o n o f a r egu la t ed monopoly w i t h i n each S t a t e .

Q u a n t i t a t i v e a n a l y s i s

. A s a r e s u l t o f Federal and S t a t e p o l i c i e s , b o t h m i l k producers and manu fac tu re r s receive a h i g h e r p r i c e t han t h e y would r e c e i v e i n a c o m p e t i t i v e marke t .

- Market milk producers receive a p r i c e premium which h a s averaged 75-80 per cent o f the va lue o f manu fac tu r ing m i l k in r e c e n t years .

. I n V i c t o r i a and Tasmania, a much sma l l e r propor t ion o f t o t a l product ion i s so ld a s marke t m i l k t han i n the o t h e r S t a t e s . T h i s means t h a t producers i n t h o s e S t a t e s r e c e i v e a lower average r e t u r n and t h e r e f o r e must have lower average c o s t s t o c o n t i n u e o p e r a t i n g o v e r the l o n g term.

- The a d d i t i o n a l revenue r e c e i v e d b y manufac turers o f prescr ibed d a i r y p roduc t s c o n s i s t s o f revenue earned b y p r i c e d i s c r i m i n a t i o n on domes t i c marke ts .

. The p r i c e d i f f e r e n t i a l s f o r t h e t h r e e major prescr ibed products - b u t t e r , cheese and sk im m i l k powder - were found t o have c rea t ed consumer t r a n s f e r s ranging from $3m t o o v e r $50m annua l l y . These t r a n s f e r s a re cons idered r e p r e s e n t a t i v e o f the magnitude o f p o l i c y e f f e c t s .

. S t a t e p o l i c i e s concerning milk marke t ing and p r i c i n g have a s i g n i f i c a n t e f f e c t on the s t r u c t u r e o f the n a t i o n a l d a i r y i n d u s t r y and on the r e l a t i v e p r o f i t a b i l i t y o f m i l k product ion between S t a t e s .

- The f a c t t h a t marke t m i l k i s genera l l y n o t t raded acros s S t a t e border s d i s t o r t s the s p a t i a l a l l o c a t i o n o f p roduc t i ve r e s o u r c e s by r e q u i r i n g t h a t d a i r y i n g must exist w i t h i n each S t a t e whether o r n o t it i s e f f i c i e n t .

- Premiums pa id f o r m a r k e t m i l k , w h i c h t o t a l l e d a b o u t $190m d u r i n g 1981-82, a l l o w less e f f i c i e n t p r o d u c e r s to o p e r a t e .

- I n t e r s t a t e t r a d e i n m a r k e t m i l k would c a u s e the r e l o c a t i o n o f a p p r o x i m a t e l y 243 ML o f p r o d u c t i o n in to more e f f i c i e n t S t a t e s and would r e d u c e r e s o u r c e c o s t s b y a b o u t $4.5m a n n u a l l y .

. By s u p p o r t i n g the p r i c e o f m i l k w h i c h i s e v e n t u a l l y e x p o r t e d , the A u s t r a l i a n economy i n c u r r e d a deadweigh t l o s s o f a p p r o x i m a t e l y $40.5m i n 1981-82.

. Annual costs r e s u l t i n g from e x i s t i n g d a i r y p r i c i n g p o l i c i e s a r e e s t i m a t e d t o h a v e t o t a l l e d n e a r l y $59m i n 1981-82. T r a n s f e r s f rom consumers t o p r o d u c e r s , a s s e s s e d i n r e l a t i o n t o the a l t e r n a t i v e o f s e l l i n g m i l k and m i l k p r o d u c t s a t an e x p o r t m a r k e t d e t e r m i n e d p r i c e , amounted t o a b o u t $286m, a p p r o x i m a t e l y 28 p e r cent o f the g r o s s v a l u e o f m i l k p r o d u c t i o n i n t h a t y e a r .

A s s e s s m e n t o f p o l i c y e f f e c t s

. D a i r y p r i c i n g p o l i c i e s h a v e favoured d a i r y p r o d u c e r s and p r o c e s s o r s a t the e x p e n s e o f c o n s u m e r s , b u t , under these p o l i c i e s , the a d d i t i o n a l r e v e n u e s r e c e i v e d b y p r o c e s s o r s amount t o less t h a n those which would h a v e been r e c e i v e d i n an u n r e g u l a t e d monopoly . - I f p r i c e s had been set t o m a x i m i s e p r o d u c e r g r o s s r e v e n u e

( u n r e g u l a t e d monopoly p r i c i n g ) , p r o d u c e r s ' i n c o m e s c o u l d h a v e i n c r e a s e d i n e a c h year from 1962-63 t o 1982-83.

- I f p r i c e s had been set to m a x i m i s e consumer w e l f a r e ( p e r f e c t l y c o m p e t i t i v e p r i c i n g ) , p r o d u c e r s 1 g r o s s i n c o m e s would h a v e been l o w e r than t h e y a c t u a l l y were d u r i n g those same y e a r s .

- T h e a c t u a l we igh ted-average p r i c e r e c e i v e d b y p r o d u c e r s h a s been closer to the weigh ted-average p r i c e w h i d would h a v e been r e c e i v e d i n a p e r f e c t l y m o n o p o l i s t i c m a r k e t t h a n t h a t i n a p u r e l y c o m p e t i t i v e m a r k e t .

. A s a consequence o f a l l o w i n g d o m e s t i c p r i c e s t o move above i n t e r n a t i o n a l p r i c e t r e n d s , d o m e s t i c consumers a r e c u r r e n t l y p r o v i d i n g i n c r e a s i n g l y h i g h e r levels o f a s s i s t a n c e t o the d a i r y i n d u s t r y . I f th is

, t r e n d i s m a i n t a i n e d , it w i l l c o n t i n u e to encourage consumers t o f i n d s u b s t i t u t e s f o r d a i r y p r o d u c t s . A d d i t i o n a l c o n s e q u e n c e s would be i n c r e a s e d p r e s s u r e on r e l a x a t i o n o f i m p o r t r e s t r i c t i o n s and the u s e o f r e s o u r c e s t o produce d a i r y p r o d u c t s s o l d on e x p o r t m a r k e t s a t a deadweigh t loss t o the A u s t r a l i a n economy.

1. Introduct ion

P r i c e s of Aus t ra l i an d a i r y products a r e influenced s i g n i f i c a n t l y by government organisat ions . Government in te rven t ion i n the p r ic ing process e n t a i l s an i m p l i c i t government view t h a t a f r e e market for d a i r y products would not be 'optimal ' . The d e f i n i t i o n of 'optimal ' v a r i e s between ind iv idua l s , however, and o f ten depends on the person 's pos i t ion r e l a t i v e t o the re levan t market. There is a need, the re fo re , t o eva lua te Austra l ian d a i r y p r ic ing po l i cy so t h a t ob jec t ive , q u a n t i f i a b l e conclusions can be reached concerning t h e impact of da i ry p r i c i n g methods and p o l i c i e s .

I n an e f f o r t tc provide such an evaluat ion, t h i s study has the follawing object ives:

- t o a s s e s s the economic e f f e c t o f e x i s t i n g p o l i c i e s on da i ry product p r i c e s by quant i fying the c o s t s and b e n e f i t s of cur ren t p r i c i n g methods; and

- t o determine which market grouF (producers or consumers) has been favoured by e x i s t i n g p r ic ing p o l i c i e s .

The purpose of t h i s paper can be summarised a s an attempt t o develop a model of the da i ry industry i n order to analyse and measure the economic e f f e c t s of cur ren t d a i r y pol icy i n terms of the a l l o c a t i o n of resources and t h e d i s t r i b u t i o n of income.

This model of the d a i r y indus t ry provides an a n a l y t i c framework fo r i n t e g r a t i n g the behaviour of the re levan t p a r t i c i p a n t s ( t h e Commonwealth Government, the Aus t ra l i an Dairy Corporation, the S ta te - l eve l d a i r y indus t ry a u t h o r i t i e s , m i l k producers, processors , marketing co-operatives, importers and o t h e r s ) a s wel l a s fo r evaluat ing the instruments of da i ry po l i cy (equa l i sa t ion , underwriting, market m i l k p r i c i n g , e tc . ) .

Behavioural assumptions a r e made regarding the motives of the var ious economic agents. A s a s t a r t i n g po in t , by using a base model which examines market performance where producers behave a s i f they attempt t o maximise t h e i r ne t income, important conclusions can be drawn. The model w i l l be compared with the r e a l world t o measure the resource a l l o c a t i o n and d i s t r i b u t i o n a l e f f e c t s of the da i ry program.

The model w i l l be developed by assuming t h a t d a i r y producers behave a s a regulated monopoly. With approximately 17 500 da i ry farms i n 1981-82 (Hunter and Bennett 1983), the d a i r y indus t ry could not independently enforce a c a r t e l . Rather, the Aus t ra l i an Dairy Corporation (ADC) and t h e d a i r y indus t ry a u t h o r i t y i n each S t a t e can be viewed, for the purpose of t h i s ana lys i s , a s s t a t u t o r y agents of the producers, working t o ensure p r i c e s which r e s u l t i n the output t h a t , toge ther , maximise the p r o f i t s of the indus t ry a s a whole. ( I n r e a l i t y , t h e ADC and t h e S t a t e a u t h o r i t i e s o f t en have d i f f e r e n t object ives . ) This model of the d a i r y industry f i r s t considers the manufacturing milk s e c t o r i n i s o l a t i o n . An attempt is made a t a l a t e r s t age t o incorporate the s i g n i f i c a n t i n t e r a c t i o n with the market milk sec to r .

Any assessment of government in te rven t ion is complicated by the f a c t t h a t Governments can never implement a ' f i r s t b e s t ' optimum because t h e i r in te rven t ion is j u s t i f i e d due t o some breakdown i n the economic e f f i c i e n c y condi t ions (Layard and Walters 1978) . The ' theory of second b e s t ' formalised by Lipsey and Lancaster (1957) says t h a t , s i n c e Governments cannot implement a f i r s t b e s t optimum, they must do t h e b e s t they can i n f inding a second b e s t optimum.

A second b e s t optimum is s u b j e c t t o c o n s t r a i n t s necess i t a ted by t h e breakdown i n the op t imal i ty condi t ions (mentioned above). The c o n s t r a i n t s dea l with r e a l world problems of e f f i c i e n c y and/or equi ty . This means t h a t , whi le Governments s e t goals concerning e f f i c i e n c y and equ i ty (Har r i s e t a l . 1974), they must recognise t h a t t h e i r p o t e n t i a l f o r success is l imi ted t o f inding improvements r a t h e r than optimal so lu t ions . This means t h a t eva lua t ions of goverrment p o l i c i e s must recognise t h e opera t ive c o n s t r a i n t s and measure progress toward a r e a l i s t ic (second bes t ) s i t u a t i o n , r a t h e r than an opt imal ( f i r s t b e s t ) solut ion. Therefore, the quest ion of whether or not e x i s t i n g in te rven t ion measures r e s u l t i n improvements over t h e competit ive market which would opera te i n t h e absence of in te rven t ion is the sub jec t of s e c t i o n s 2, 3 and 4.

2. Analysis o f Ex i s t ing Dairy Pol icy

This por t ion o f the study is divided i n t o th ree sect ions . Sect ion 2.1 o u t l i n e s the o rgan i sa t iona l arrangements t h a t w i l l be represented i n t h e model t o f o l l m . I n sec t ion 2.2, a scmewhat a b s t r a c t model of producer and government behaviour is developed. I n s e c t i o n 2.3, the a c t u a l po l i cy instruments used a r e considered i n order t o a s s e s s the ex ten t t o which t h e i r use is explained by t h e model.

2 .l The Organisations

(a) The Austra l ian Dairy Corporation

The ADC was es tab l i shed on 1 J u l y 1975 following an amendment t o the Dairy Produce A c t of 1924. I t replaced t h e Aus t ra l i an Dairy Produce Board and i n h e r i t e d most of the pawers and funct ions of t h a t board. The ADC is p r e s e n t l y involved i n administering l e g i s l a t i o n deal ing with t h e marketing arrangements fo r manufactured d a i r y products. This l e g i s l a t i o n

' came i n t o e f f e c t on 1 Ju ly 1977. (The s p e c i f i c s of the marketing 1 arrangements a r e discussed i n more d e t a i l i n s e c t i o n 2.3).

Membership of t h e ADC Board c o n s i s t s of :

one Chairman t h r e e represen ta t ives of d a i r y farmers t h r e e represen ta t ives of manufacturers of da i ry products two members with s p e c i a l q u a l i f i c a t i o n s one union represen ta t ive one government represen ta t ive

The r o l e of the ACC i n the marketing arrangements for prescr ibed da i ry products ( a s explained i n ADC 1977) is n m ou t l ined b r i e f l y .

Domestic p r i c e s for the prescr ibed d a i r y products (which include bu t t e r and b u t t e r o i l , c e r t a i n cheeses, wholemilk powder (W) , skim milk

pmder ( S W ) and buttermilk pcwder, and casein) are supported through a levy system administered by the ADC. Under existing marketing arrangements, a ' s tabi l i sa t ion levy' is se t separately for each prescribed product a t the difference between the assessed export price and the desired domestic bulk wholesale price. The assessed export price is the estimated average return from a l l export sales of a product manufactured in a particular p e r i d . The A I X makes recommendations to the Government on the level of both s tabi l i sa t ion levies and assessed export prices.

The AM: provides loans t o manufacturers from the Reserve Eank to enable manufacturers to make early payments to producers in anticipation of sales on either the domestic or export market. The loans are financed under government guarantee and are based on the assessed export price. These loans are repayable t o the ADC upon the sa le of the product. The ADC also has the option of purchasing product ( a t the assessed export pr ice) to meet i t s export cormnitments.

Upon the sale of products, manufacturers pay levies into the Dairy Products s tabi l i sa t ion Trust Fund which i s administered by the ADC. Separate accounts are maintained for each of the prescribed products. The ADC makes interim s tabi l i sa t ion payments to manufacturers from the s tabi l i sa t ion fund, usually in anticipation of levy collections.

A l l exports of prescribed dairy products are pooled a t the minimum export (permit) price fixed by the ADC. When the minimum export price is belaw the assessed export price, the AM3 makes the appropriate adjustments to manufacturers; when the assessed export price is belaw the minimum export price, manufacturers pay the difference to the ADC which adds those funds to the export pool.

(b) State dairy industry authori t ies

In each State and the A.C.T. a statutory dairy industry authority or similar body exercises considerable influence on the price of m i l k . A l l industry authori t ies are responsible for the organisation of the purchase, production, supply, manufacture, treatment, storage, transport, packing, sa le and distr ibution of m i l k and dairy produce to ensure the 1 continuous availabil i ty of a l l classes of m i l k . Specifically, the 1 authori t ies se t market m i l k prices to farmers and the margins payable a t 1 a l l stages of the marketing system. A brief description of the operation of the individual authori t ies follows.

. The Victorian Dairy Industry Authority, l ike a l l dairy industry authori t ies, has f i r s t claim to m i l k t o ensure adequate market m i l k supplies. The Victorian authority uses a market m i l k contracting system to guarantee supplies. Contracts for the delivery of m i l k t c factories are surrendered by dairy farmers. Factories compensate dairy farmers for m i l k delivered under contract. Farmers receive the current market m i l k price for the proportion of thei r output surrendered under contract, and they receive the lower manufacturing m i l k price for additional output.

. In New South Wales, the Dairy Industry Marketing Authority uses a market m i l k quota system. The authority grants a minimum quota of 800 L a week to newly registered dai r ies af ter they have produced for 12 months. The authority i s attempting to raise a l l quotas t o a t l eas t 2 kL a week

by giving a d d i t i o n a l quota t o q u a l i f i e d farms each year. For a farm t o share i n the growth of market milk s a l e s , a t l e a s t 110 per cen t of c u r r e n t quota volume must be produce6 i n each of 13 four-week periods. To gain a d d i t i o n a l quota from the pool of surrendered quota, a d a i r y farmer must have producea 120 per cen t of quota fo r 12 months. For production of 100-110 per cen t of quota, no change w i l l be made i n a farmer 's quota , whi le production of l e s s than 100 pe r cen t of quota over a 12-month period w i l l l e a d t o a reduct ion i n t h e s i z e of quota a l l o c a t e d f o r the next year. A s i n V i c t c r i a , milk de l ive red i n f u l f i l m e n t of a quota ea rns a d a i r y farmer t h e market milk p r i c e r a t h e r than t h e lower manufacturing m i l k p r i ce .

. The Tasmanian Dairy Indus t ry Author i ty has p r ice - se t t ing c o n t r o l over white and flavoured milk and f r e s h cream. Milk was obtained through farmers ' quotas u n t i l 1979, when a minim.um five-year t r a n s i t i o n period began during which ind iv idua l d a i r y farmer quotas a r e t o be t rans fe r red t o manufacturers.

. Unlike other d a i r y a u t h o r i t i e s , the Qwensland Milk Board s e t s maximum and minimum pr ices . It s e t s minimum p r i c e s to be paid t o processors f o r m i l k used r i t h i n the Brisbane Milk D i s t r i c t and maximum p r i c e s payable t o vendors and milkshops. A minimum and maximum p r i c e is s e t for r e t a i l s a l e s . Milk is obtained using a quota system, and quotas can be surrendered (sold) t o other producers i n Queensland. The nego t iab le value of surrendered m a r k e t milk en t i t l ement was $50/L during 1980-81.

. The Metropolitan M i l k Board of South A u s t r a l i a draws on m i l k produced i n a l imi ted area and is responsible f o r r egu la t ion of the r e t a i l indus t ry wi th in Adelaide only. A l l farmers receive a premium on market milk and cream s a l e s , which is paid on a f ixed proport ion of t o t a l output i n the S t a t e . The ex ten t of the premium depends on whether the farm is within the Adelaide Zone or the l e s s remunerative South-East Zone. Like t h e Victor ian a u t h o r i t y , the South Aus t ra l i an board is a c t i v e l y involved i n promotional a c t i v i t i e s .

. The Western A u s t r a l i a Dairy Indus t ry Author i ty adminis ters th ree quota systems: a market m i l k quota, a cream quota, and a s p e c i a l milk products quota. The s p e c i a l quota system is a scheme t o ensure the production of m i l k f o r c e r t a i n products; the p r i c e pa id f o r t h a t milk is higher than t h a t fo r manufacturing milk, although lower than the p r i c e paid f o r market m i l k . The s p e c i a l milk products covered by the quota i n Western A u s t r a l i a include flavoured milk except flavoured s k i m milk, yoghurt except non-fat types , and manufacturing cream.

. The EJiilk Author i ty of the A.C.T. ob ta ins m i l k from tenderers . Harket sha res a re a l l o c a t e d t o canpanies according t o t h e tendered p r ices . The a u t h o r i t y s e t s p r i c e s fo r each sec to r of the marketing system up t o and including the r e t a i l l e v e l .

The d a i r y indus t ry a u t h o r i t i e s genera l ly set p r i c e s twice a year. The p r i c e s paid t o farmers f o r market milk d i f f e r from S t a t e t o S ta te . A s an example, t y p i c a l p r i c e s paid during mid-1982 were:

V i c . W.A . S.A. Tas . N.S.W. Qla 26.5c/L 26.6c/L 26.6c/L 27 .OC/L 28.2c/L 31.9c/L

2.2 The P r o f i t-Maximising Model

The following simple ana lys i s of d a i r y product p r i c ing provides, a t one extreme, a model of p e r f e c t producer monopoly p r ic ing a g a i n s t which r e a l i t y can be assessed. The aim of t h i s exerc i se is t o es t imate the p o t e n t i a l p r o f i t s - assuming t h a t e x i s t i n g l e g i s l a t i o n is used t o maximise p r o f i t s . Conclusions a r e drawn about the l e v e l of ou tpu t t h a t d a i r y product producers might choose. Then, by moving t o the appropr ia te demand schedule, the p r i c e assoc ia ted with t h a t decis ion is found - the market c l e a r i n g p r i c e f o r the output chosen. The process followed by the ADC is ra the r the reverse. F i r s t , the ADC c a l c u l a t e s its desi red p r i c e s o f p resc r ibe6 products (using t h e domestic l evy) . Then it i m p l i c i t l y moves to the demand schedules faced by t h e processing industry t o i d e n t i f y the market c lea r ing q u a n t i t i e s fo r those p r ices . However, both processes y i e l d the same outcomes in terms of p r i c e and quan t i ty s ince t h e r e is a unique r e l a t i o n s h i p between these two decis ion var iables . I t is a l s o assumed t h a t a l l ADC p r i c e recommendations a r e approved by the Government.

The in ten t ion here is t o bu i ld a model which a l laws an evaluat ion of da i ry product p r i c i n g instruments and powers i n terms of t h e i r e f f e c t i v e n e s s and c o s t s i n achieving Federal ob jec t ives r e l a t e d t o both t h e da i ry industry and the economy i n general .

To begin with, it is assumed t h a t m i l k and d a i r y product producers, s imi la r t o other economic agents i n soc ie ty , would l i k e t o maximise t h e i r p r o f i t s . By r e s t r i c t i n g Bomestic s a l e s , the indus t ry would be ab le t o keep p r i c e s a t a l e v e l above t h a t which would occur under f r e e l y competit ive condi t ions . Co l lec t ive ly , producers would ga in from r e s t r i c t e d output (as long a s demand is i n e l a s t i c ) . However, each producer would s t i l l l i k e t o inc rease s a l e s a t the higher p r i c e t h a t would r e s u l t . Therefore, a monopolising agent is needed t o enforce the des i red ind iv idua l behaviour f o r the c o l l e c t i v e good.

For the purposes of t h i s model, the da i ry program, a s administered by the AM3 and the S t a t e industry a u t h o r i t i e s , w i l l be viewed a s the mechanism by which a l l da i ry farmers c u r r e n t l y i n the industry gain from concerted act ion. Therefore, the model assumes t h a t the ADC and S t a t e a u t h o r i t i e s a c t a s agents fo r t h e producers a s a group t o enforce the c o l l e c t i v e a c t i o n on each ind iv idua l producer. Thus, p r i c e and supply management goes beyond providing 'order ly marketing' and s t a b l e incomes f o r which some marketing boards s t r i v e . Rather, p r i c e management i n t h i s context keeps domestic p r i c e s higher and domestic consumption lower than would be the case i n i ts absence. T o t a l production is constrained by the inf luence of lower r e t u r n s from expor t markets. Therefore, the behaviour t h a t one would expect from such a model is der ived f i r s t and then t e s t e d aga ins t the observed behaviour.

The model is then extended t o include the l i m i t a t i o n s imposed by the a c t u a l po l i cy instruments on t h e da i ry industry . This l e a d s t o a cons ide ra t ion o f the behaviour o f a constra ined or regulated monopolist (on the domestic market). I t is assumed t h a t t h e ADC a s a regulated monopoly w i l l maximise net incomes t o producers sub jec t t o the c o n s t r a i n t s t h a t they perceive. Under these circumstances, it is poss ib le t h a t ga ins t o some market p a r t i c i p a n t s can be made without imposing c o s t s on anyone e l s e - and y e t a r e not made. This would ind ica te a ne t l o s s t o

s o c i e t y unless such forgone gains can be explained i n terms of o b j e c t i v e s or c o n s t r a i n t s not i d e n t i f i e d i n t h i s study.

Manufacturing m i l k is processed i n t o s e v e r a l types of d a i r y products. The demand fo r manufacturing m i l k is derived from the demand f o r these f i n a l products. The ana lys i s is s impl i f i ed here by assuming t h a t one product - cheese - is processed from whole milk with no s i g n i f i c a n t by-products . The secon6 process, d e a l t with below, simultaneously produces two products i n f ixed proportions: b u t t e r and SMP.

While t h i s is an overs impl i f icat ion, it does capture the essence of the two types of processing in the da i ry industry . It is a l s o noted t h a t b u t t e r , SMP and cheese a r e the most important s i n g l e products. When attempting to measure the e f f e c t s of d a i r y po l i cy , it is necessary t o include other more o r l e s s whole m i l k products i n the ana lys i s used fo r cheese. Hopefully, o rders of magnitude i n es t imates of c o s t s and b e n e f i t s can be es tab l i shed . Given the da ta c u r r e n t l y ava i l ab le , t h e r e is l i t t l e to be gained i n the way of accuracy by t ry ing to disaggregate t h e indus t ry f u r t h e r .

( a ) The s i n g l e product

Considered f i r s t is the case where whole m i l k is used t o produce a s ing le f i n a l product - cheese. It is assumed t h a t no imports a r e allowed i n t o the market. Since the Austra l ian cheese market is somewhat p ro tec ted from fore ign competit ion by 'gentlemen's agreements' and import t a r i f f s , exclusion of imports i n the model is equivalent t o considering the domestic demand f o r cheese n e t of t h e amount suppl ied from abroad.

Figure 1 shows the demand DD faced by domestic producers of manufacturing milk derived from t h e demand f o r cheese. The axes a r e denominated i n terms of the p r i c e s and q u a n t i t i e s of milk, although the curves a r e derived from the demand f o r cheese. DD a l s o shows the cheese p rocessors ' demand fo r manufacturing m i l k . This demand for m i l k r e f l e c t s the demand fo r cheese ne t of processing cos t s .

The processing sec to r is assumed t o be competit ive. The evidence ava i l ab le on concentra t ion, e x i t , en t ry , p r i c i n g , t r ade p r a c t i c e s , S t a t e regu la t ions and the r e t a i l e r s ' demand suggests t h a t , genera l ly , the processing sec to r behaves compet i t ively (Blank and Campbell 1982; IAC 1976; I n t e r n a t i o n a l Dairy Federation 1982). Therefore, processing c o s t s can be considered as independent of t h e ou tpu t dec i s ions of d a i r y producers, and it is assumed here t h a t they a r e constant over the re levant range of output. This helps l i m i t t he scope of the ana lys i s .

The curve SS shows the h o r i z o n t a l sum of the marginal c o s t s of production fo r a l l producers in the industry . That is, it represen t s the add i t ion t o c o s t s from producing the l a s t u n i t sold. Without government in te rven t ion , t h i s would be the competit ive supply curve. The c o s t s i m p l i c i t i n t h i s supply curve represen t market p r i c e s for the resources used. In economic terms, t h i s embodies 'normal1 r e t u r n s t o f a c t o r s of production including 'normal' p r o f i t s . Farmers and the resources they employ would be f r e e to en te r or leave the indus t ry i f r e t u r n s to d a i r y farming were, r e spec t ive ly , above o r b e l m the 'normal1 re tu rns t h a t they could earn elsewhere. They would s t a y i n d a i r y farming only i f they could, i n the long run, earn a t l e a s t the opportuni ty c o s t of t h e i r

Figure 1: MANUFACTURING MILK: THE COMPETITIVE EQUILIBRIUM

Figure 2: MANUFACTURING M1LK:THE PROFIT-MAXIMISING OUTPUT

se rv ices . 'Normal' r e tu rns need no t be considered ' f a i r ' re turns . Farmers may continue t o s t a y i n business i n s p i t e of lcw r e t u r n s e i t h e r because of the non-pecuniary benef i t s of farming o r because they have few a l t e r n a t i v e s . Since the main o b j e c t i v e of i n t e r v e n t i o n i n terms of farmers ' incomes is t o ensure a ' f a i r ' r e tu rn , one w u l d argue t h a t t h i s is a higher r e t u r n than t h e f r e e market would give producers i n t h e absence o f government in te rven t ion .

I n a competit ive indus t ry wi th no co l lus ion , ou tpu t cannot be held , i n t h e long run, below t h e l e v e l where p r i c e equa l s marginal cos t . A s long a s p r i ce exceeds marginal costs (above-normal p r o f i t s e x i s t ) , an i n c r e a s e i n output w i l l be encouraged through e n t r y of new producers or through expansion by exis . t ing farms. The equi l ibr ium p r i c e and quan t i ty i n a competit ive indus t ry a re determined a t t h e i n t e r s e c t i o n of the supply and demand curves, a t Pc and Q,, r e spec t ive ly . The oompetitive equi l ibr ium y i e l d s no ex t raord inary p r o f i t s on t h e marginal u n i t of milk produced. A t t h i s po in t , the p r ice covers wsts including 'normal' p r o f i t s and no more. By a c t i n g a s a group t o reduce domestic s a l e s and hold the p r ice above the competit ive l e v e l , the indus t ry a s a whole could inc rease its re tu rns above a 'normal re tu rn ' and ea rn super-normal pro£ its.

Producers, c o l l e c t i v e l y , would &oose t o c u r t a i l production t o the p o i n t where pro£ its would still e x i s t a t t h e margin. By holding output t o a l e v e l where marginal revenue is equal t o marginal cos t , aggregate p r o f i t s t o the producer group a r e maximised. The marginal revenue t o t h e indus t ry - i.e. the e x t r a revenue earned by inc reas ing output by one u n i t - is l e s s than the p r i c e a t which it is so ld because any inc rease i n output reduces the p r i c e received on a l l u n i t s , i f the demand schedule is l e s s than p e r f e c t l y e l a s t i c (i .e. i f it s lopes down). The marginal revenue is the p r i c e received less the reduct ion i n revenue received on a l l previous un i t s . This reduct ion in. revenue on marginal output r e s u l t s from the downward-sloping demand curve.

A t any output o the r than where marginal revenue equa l s marginal c o s t s , pro£ i ts a r e forgone ; where marginal revenue exceeds marginal cos t s , p r o f i t s can be made by expanding output ; and where marginal c o s t s exceed marginal revenue, p r o f i t s can be increased by reducing output.

Maximum domestic p r o f i t s a r e achieved a t p r i c e Pm and q u a n t i t y Q,,, shown i n Figure 2. This monopolist ic output b e n e f i t s producers, a t t h e expense of consumers, by maintaining a p r i c e above the competit ive l eve l . However, t h i s is l a r g e l y a t r a n s f e r from consumers to producers (ABGH) . There is, i n add i t ion t o t h i s t r a n s f e r , a n e t welfare l o s s o f BEG. This a r i s e s because the p r i c e exceeds the marginal c o s t of production. The p r i c e is the value o f the m i l k t o the consumer, and so a s i t u a t i o n e x i s t s i n which the value of m i l k to consumers is g r e a t e r than t h e c o s t of providing it - and ye t more is not provided. An a n a l y s i s of the t r a n s f e r and welfare c o s t s a ssoc ia ted with the ipdus t ry ' s c o l l e c t i v e behaviour w i l l be assessed i n d e t a i l l a t e r i n t h i s paper.

l (b) J o i n t production: the competit ive case

Considered next is the case where the demand fo r manufacturing milk is derived only from t h e demand f o r two products: bu t t e r and SMP, produced i n f ixed proport ions (no cheese demand). Imports a r e excluded

b u t exports , which a re assumed t o be too few t o a f f e c t the world p r i c e , a r e allowed.

The demand fo r each product is a combination of the domestic demand and the demand f o r exports. Thus, each demand schedule becomes hor izon ta l f o r a l l q u a n t i t i e s beyond t h a t q u a n t i t y which can be s o l d domestically a t the world p r ice .

Each h e c t o l i t r e (100 L) o f m i l k is processed i n t o approximately 5.2 kg of b u t t e r and 8.3 kg o f SMP. Since the r a t i o of production is more o r l e s s f ixed, the manufacturing m i l k demand of processors is t h e v e r t i c a l sum of the demands f o r the two f i n a l products. Each a d d i t i o n a l h e c t o l i t r e o f m i l k processed can be so ld f o r the sum of the p r i c e s a t which an a d d i t i o n a l 5.2 kg of bu t t e r a d an add i t iona l 8 . 3 kg o f SMP can be sold.

Figure 3 shows the cons t ruc t ion of the demand fo r milk derived from the demands f o r the two simultaneously produced products, bu t t e r and SMP. The demand fo r m i l k derived from the demand for SMP is shown i n Figure 3C and by Ds i n Figure 3A. This is a combination of the downward s loping domestic demand and the (dashed) hor izon ta l demand from the r e s t of t h e world. The domestic demand schedule is not e f f e c t i v e a t a p r i ce below the world p r i c e s ince producers can export a l l they wish a t the world p r ice . It is assumed t h a t A u s t r a l i a is a p r i c e taker or t h a t exports a r e no t l a r g e enough t o a l t e r the world p r ice . The demand f o r m i l k derived from the demand fo r b u t t e r is shown i n Figure 3B and by Db i n Figure 3A.

By adding these two demand schedules v e r t i c a l l y and then ne t t ing o u t process ing c o s t s , the derived demand for manufacturing m i l k , shown by D,,,, is determined.

Any output Q 1 (measured i n h e c t o l i t r e s ) can be so ld fo r a p r i c e P where P is t h e sum of Pb ( t h e p r i c e of 5.2 kg of b u t t e r ) and PS ( t h e price of 8.3 kg of S W ) .

Two poss ib le supply curves a r e shown f o r t h i s hypo the t i ca l i s o l a t e d market. For a supply schedule such a s S1, i n t e r s e c t i n g t h e demand curve t o the l e f t of the kink a t A, a l l b u t t e r and SMP is consumed domestically. I f a supply schedule (such a s S2) is t o the r i g h t of the kink A, some SMP is exported. For ou tpu t s of m i l k g r e a t e r than Q3, bu t t e r w i l l be exported a lso .

( C ) J o i n t production: the monopoly case with p r i c e discr iminat ion

Extending the ana lys i s of j o i n t production t o the monopoly case adds the complication t h a t the industry , p ro tec ted from foreign competition, can charge d i f f e r e n t p r i c e s i n domestic and fo re ign markets. That is, the indus t ry can behave l i k e a pr ice-discr iminat ing monopolist.

P r i c e d i sc r imina t ion opera tes through the equa l i sa t ion system. SMP which cannot be s o l d f!omestically a t the supported p r i c e is disposed of on fo re ign markets ' a t a l o s s 1 i n the sense t h a t the opportuni ty t o receive the higher domestic p r i c e is l o s t . The d i f f e r e n t p r i c e s serve t o maximise the revenue on t o t a l s a l e s and inc rease the p r o f i t s of the indus t ry a s a whole t o a l e v e l above t h a t which would be earned without p r i c e discr iminat ion. The so-called ' l o s s e s ' on exports a r e incurred t o

Figure 3: DEMAND FOR MANUFACTURING MILK DERIVED FROM DEMAND FOR BUTTER AND SKIM MILK POWDER (IN MILK EQUIVALENT) IN FIXED PROPORTIONS: THE COMPETITIVE CASE: NO IMPORTS

generate add i t iona l p r o f i t s by keeping domestic p r i c e s o f SMP high (p r ice d i sc r imina t ion) . That is, without p r i c e discr iminat ion, the re a re no

l o s s e s . The discr iminatory p r ic ing behaviour of the industry is, i n p rac t i ce ,

not confined t o SMP since export demand f o r a l l l ev iab le products is s t rong enough for it t o be e f f e c t i v e . The demand for SMP, a s shown i n Figure 4, is a combination of the domestic demand (HBGK) and the export demand (FEGJ) a t the world p r i c e Pf. The problem is t o determine where domestic demand is no longer re levant t o t h e pr ice-discr iminat ing monopolist and where world demand takes over t o determine the p r ice a t t h e margin.

F igu re 4: P R I C E DISCRIMINATION I N SKIM MILK POWDER MARKETS ( I N MILK EQUIVALENT) : NO IMPORTS

HBEGJ E f f e c t i v e demand f o r p r i c e d i s c r i m i n a t i n g monopolist HBGJ E f f e c t i v e demand f o r compe t i t i ve i n d u s t r y FEGJ World demand

Qd Q u a n t i t y

For the competit ive industry o r for a monopolist who does no t p r i c e d i sc r imina te , t h i s would be where the domestic demand i n t e r s e c t s t h e world p r i c e ( a t G) . There is no incent ive t o s e l l t o domestic consumers a t a p r i c e below the world p r ice . The e f f e c t i v e demand schedule without p r i c e d i sc r imina t ion is thus shown by HBGJ. The pr ice-discr iminat ing monopolist, however, has no incen t ive t o s e l l t o domes t i c consumers beyond the point a t which marginal revenue is equal t o world p r i c e ( a t E, a q u a n t i t y Q). I n terms of revenue forgorie, the opportuni ty c o s t of a domestic s a l e is the world p r ice . Thus, the e f f e c t i v e demand is t h e in te r rup ted demand curve shown by HBEGJ where a d i s c o n t i n u i t y between B and E occurs a t Qd - the maximum q u a n t i t y a pr ice-discr iminat ing monopolist would s e l l i n the dcmestic market without lowering h i s t o t a l revenue.

I f the profit-maximising ou tpu t of m i l k exceeds Qd, the revenue-maximising l e v e l of domestic s a l e s of SW, Qd, is a l s o the profit-maximising l e v e l . The dec i s ion fo r the o v e r a l l l e v e l of output depends on the derived demacd f o r both products ( b u t t e r and SMP) and the marginal c o s t schedule. This separa te demand f o r SMP is used on its own, not t o determine the profit-maximising output , but t o a r r i v e a t the subsequent revenue-maximising a l l o c a t i o n between domestic and fo re ign markets o f t h a t output. Similar reasoning can be made t o combine domestic and fo re ign demand schedules f o r b u t t e r , and t h i s is done i n t h e d e r i v a t i o n of the t o t a l demand fo r m i l k .

I n Figure 5, the e f f e c t i v e demand schedule f o r milk f o r SMP/butter production is shown by FGHJKL. This is derived from the demand for SMP (UVWX) and the demand f o r bu t t e r (TMKNR). P r i c e d i sc r imina t ion is respons ib le fo r the d i s c o n t i n u i t i e s evident i n the v e r t i c a l por t ions of the demand schedules. The broken l i n e s show the marginal revenue assoc ia ted h i t h each demand schedule.

I n t h i s i s o l a t e d market, where n i l k is produced s o l e l y fo r b u t t e r and SMP, the marginal c o s t s of milk production can be included i n t h e diagram. When consider ing more uses of m i l k , t he marginal cost schedule is appl ied to aggregate, not i s o l a t e d , market demand schedules.

It is important t o recognise t h a t the demand schedule of the d i sc r imina t ing monopolist (shown by FGHJKL i n Figure 5) 6oes not shcm t h e average revenue received on a l l s a l e s . I t shows the p r i c e received on the marginal un i t sold - the marginal p r i ce . Average revenues exceed the marginal p r i c e if s a l e s on some marginal u n i t s a r e made a t a h igher p r i c e .

I n Figure 6 , the demand schedule fo r SMP is reproduced. This a n a l y s i s ' emphasises the marginal p r i c e , the p r i c e of the l a s t u n i t sold. Once SMP

1 is exported, the marginal p r i c e is the world p r i c e .

P r i c e d i sc r imina t ion r a i s e s revenue by t h e shaded a rea ABEF above t h e l e v e l proCiucers would receive i f a l l SMP were sold a t the world p r ice . The ' e x t r a 1 revenue ABEF is equal t o the q u a n t i t y Qd so ld domestically mul t ip l i ed by the d i f f e r e n c e i n domestic and world p r ices . To cons t ruc t an average revenue schedule, it is necessary t o add t o the marginal p r i c e schedule the e x t r a revenue ABEF averaged over a l l output. This increment t o be added is ABEF/Q, where Q is t o t a l output. This average share of e x t r a revenue is a rectangular hyperbola, shown by AR.

Figu re 5: DERIVED PARTIAL DEMAND FOR MANUFACTURING MILK ( I N MILK EQUIVALENT)

Figure 6: SKIM MILK POWDER: AVER9GE REVENUE WITH PRICE DISCRIMINATION (IN MILK EQUIVALENT)

m Surplus on domestic s a l e s

A~ Premium on domestic sa les : surplus averaged over a l l output

H B B ~ Average revenue t o producer: domestic demand t o B plus sh i f ted premium thereafter Premium plus foreign pr ice

p d ~ Price i n i t i a l l y paid t o producer

World demand

Qd Quanti ty

This average share of e x t r a revenue is only re levan t beyond the po in t Qd. There would be no p r i c e d i sc r imina t ion a t lawer l e v e l s of output , and the a c t u a l demand curve would be t h e average revenue schedule. Beyond Qd the average share of e x t r a revenue (AR) is added t o the world p r i c e t o give the hyperbola BR. This , then, combined with the demand schedule t o the l e f t of Qd, g ives average revenue (HB p l u s the s o l i d por t ion o f BR) f o r a l l output.

This a n a l y s i s l eads t o an a l t e r n a t i v e i n t e r p r e t a t i o n of the SEnP levy. The average ' losses ' can be read from the diagram as the d i f f e r e n c e between the average revenue (HBBR i n Figure 6 ) and the domestic p r i c e o f SMP ( the support p r i c e ) Pd. Conversely, and more appropr ia te ly , t h e average premium paid on domestic s a l e s o f SMP can be seen a s t h e d i f fe rence between aver age revenue and the world p r i c e Pf .

By returning t o the demand schedule i n Figure 5 derived from t h e demands f o r the j o i n t l y produced products, it can be seen t h a t the indus t ry maximises its n e t income by producing t o t h e p o i n t a t which marginal cast of supplying t h i s market is equal t o its marginal revenue. For the marginal c a s t curve shown, t h i s is a t with a p r i c e Pm f o r milk. A l l b u t t e r is sold domest ical ly a t p r i ce Pb. SMP is a l loca ted t o achieve maximum revenue by supplying Qd t o the domestic market a t p r i c e Pd, wi th the remainder, Qm-Qd, exported a t the world p r i c e Pf.

I n t h e approach used here , where t h e f i n a l demand f o r milk products and the p r i c e s f i n a l l y received a r e considered, it is poss ib le t o a d j u s t the p r i c e a t the margin (FGHJKL i n Figure 5) by adding the premium ( t h e rectangular hyperbola AR of Figure 6 ) t o g e t the average revenue t o producers from a l l sa les .

I t is i n t e r e s t i n g t o note t h a t t h i s output of milk is the same a s it would be without p r i c e discr iminat ion. Marginal revenue a t the profit-maximising l e v e l is inclependent c f whether a higher p r i c e is charged on domestic s a l e s . The marginal revenue from s a l e s o f SMP has f a l l e n t o the world p r i c e even without p r i c e discr iminat ion. The p r o f i t-maximising output i n t h i s model is independent of t h i s two-pr i c e d i sc r imina t ion , b u t p r o f i t s would be lower without such discr iminat ion.

The e x t r a revenue earned through p r i c e discr iminat ion c o n s t i t u t e s a t r a n s f e r (ABEF i n Figures 4 and 6) from the domestic consumer of SMP t o the producer. Insofa r a s the higher p r i c e reduces consumption domest ical ly , t h e r e is a l s o a net welfare l o s s (EBG of Figure 4 ) which w i l l be discussed l a t e r i n t h i s paper.

Output Q, ( i n Figure 5) which maximises p r o f i t s f o r the industry a s a whole can be compared with the equi l ibr ium which would e x i s t under competit ive condi t ions but still with no imports allawed.

For the competit ive outcome, the demand curves may be added a s before , but without the d i s c o n t i n u i t y a t Qd so t h a t the e f f e c t i v e demand is the domestic schedule shown by FGE i n Figure 5. The marginal c o s t curve f o r the indus t ry becomes the competit ive supply curve, and equi l ibr ium occurs where t h i s meets the aggregate demand curve ( a t E). For the assumed marginal c o s t curve, t h i s is a t output QC. The p r i c e s of bu t t e r and SMP a r e lower, and more of each is consumed domestically. Output is higher , bu t the p r i c e received is lawer. Only 'normal' p r o f i t s

a r e earned: the marginal farmer simply covers h i s c o s t s , r e f l e c t i n g h i s a l t e r n a t i v e oppor tun i t i e s .

(d) Aggregation o f the two types of der ived demand

The o b j e c t i v e ncm is t o combine the two types of demand - t h e whole m i l k product, cheese, and the j o i n t products SMP and bu t t e r - t o der ive an aggregate demand schedule f o r manufacturing milk. Such a schedule shows what q u a n t i t y w i l l be s o l d a t a given p r i c e . Already es tab l i shed a r e the q u a n t i t i e s of milk which can be sold a t a given p r i c e i n t h e two markets analysed. The standard procedure would be t o sum the q u a n t i t i e s (i.e. hor izon ta l ly ) demanded i n each market f o r every p r ice .

To combine demand schedules, it is necessary t o consider the terms on which q u a n t i t i e s a re a c t u a l l y supplied. The 'marginal p r i c e q i n t h e j o i n t product demand schedule (FGHJKL i n Figure 5) is no t a v a i l a b l e t o domestic consumers. The SMP component of milk is supported above t h e world p r i c e i n domestic markets. Therefore, imposed on the model is the r e a l i s t i c c o n s t r a i n t t h a t processors i n both subsec to rs (cheese, and bu t t e r and sMP) a r e expected t o pay the same p r i c e fo r the homogeneous product m i l k .

The next s t e p is t o sum hor izon ta l ly t h e q u a n t i t i e s t raded a t t h e domestic supported p r ice . This g ives what is c a l l e d the ' t r a n s a c t i o n s schedule ' f o r manufacturing milk, shown i n Figure 7A a s the do t t ed l i n e AWH.

The demand schedules i n each market a r e shown a s the s o l i d l i n e s l a b e l l e d DD. Unt i l the d i s c o n t i n u i t y a t p r i c e PA where the re is a change i n the p r i c e charged f o r SMP, these demand schedules can be summed h o r i z o n t a l l y t o give amounts demanded a t the s i n g l e domestic p r i ce . Beyond the d i s c o n t i n u i t y , it is assumed t h a t the p r i c e of SMP would be f ixed a t the support p r i ce which maximises revenue i n the SMP market and t h a t t h e p r i c e of bu t t e r is allowed t o vary. The o b j e c t i v e is t o discover the profit-maximising support p r i c e fo r b u t t e r . With the SMP p r i c e supported, t r ansac t ions continue a t p r i c e s which overes t h a t e f i n a l average revenue. The aggregate t r ansac t ions schedule is shown by FEJ i n Figure 7C. Also shown i n the aggregate diagram is the marginal revenue assoc ia ted with the t r ansac t ions schedule (dash-dot l i n e MTR). This overes t imates marginal revenue f i n a l l y received when allowance is made fo r the d i f fe rence between the domestic support p r i c e of SMP and the world p r i c e ( the amount of the domestic levy) . The marginal revenue from f i n a l s a l e s is shown by l i n e MR.

The marginal c o s t of milk production is shown by curve MC i n Figure 7C. The profit-maximising output , given the c o n s t r a i n t s mentioned, is shown a t Q1, t he output where marginal c o s t equals marginal revenue. The i n i t i a l p r i c e Pm paid t o producers on a l l milk is shown on the d o t t e d t r ansac t ions schedule a t the q u a n t i t y Q1 .

Without an e q u a l i s a t i o n scheme, the average p r i c e f i n a l l y received by producers would be l e s s than Pm. P r i c e s paid would be Pm for m i l k used f o r cheese, Pb f o r b u t t e r , PS for domestic SMP and PS£ fo r SMP exports .

F i g u r e 7 : EQUILIBRIUM I N THE MANUFACTURING MILK MARKET

Milk f o r b u t t e r and SMP

Milk f o r c h e e s e T o t a l manufac tur ing mi lk

DD Demand f o r mi lk FEJ & AWH T r a n s a c t i o n s c u r v e MR M a r g i n a l revenue MTR Marg ina l t r a n s a c t i o n s revenue

MC Marg ina l cost DB Demand f o r b u t t e r UWXY Demand f o r SMP VXY World demand f o r SMP

The decis ion v a r i a b l e here (s ince PS has a l ready t een determined) is the p r i c e of bu t t e r . The profit-maximising indus t ry would s e t t h e support p r i c e of b u t t e r a t Pb and i n t h i s way l i m i t t o t a l ou tpu t demanded t o Q1.

(e) Import c o n s t r a i n t s

It has s o f a r been assumed t h a t no imports of milk products a r e allowed. This assumption w i l l now be relaxed. For p r i c e and supply management t o work a t a l l , t h e r e have t o be q u a n t i t y c o n t r o l s on imports or a p r o h i b i t i v e l y high t a r i f f which excludes imports a l toge ther . Otherwise, any reduct ion i n domestic s a l e s due t o monopolist ic behaviour is met by an equivalent inc rease i n imports. The domestic p r i c e cannot be r a i s e d s i g n i f i c a n t l y above the world p r i c e of s imi la r products landed i n A u s t r a l i a ( t h e import p a r i t y p r i c e ) .

While A u s t r a l i a ' s domestic p r i c ing arrangements e f f e c t i v e l y r e s t r i c t i n t e r n a l competition, they permit p r i c e s e t t i n g only up t o t h e p o i n t a t which s i g n i f i c a n t import competit ion is encouraged. I n the absence of r e s t r i c t i o n s on imports, t h i s w i l l correspond t o t h e import p a r i t y p r i c e l e v e l .

Current ly , however, imports a r e r e s t r i c t e d through formal quotas and t a r i f f s on some products, through s p e c i f i c b i l a t e r a l agreement with New Zealand, and more genera l ly through de facto r e s t r i c t i o n s . These l a t t e r r e s t r i c t i o n s genera l ly r e f l e c t t h e expec ta t ion t h a t d i s r u p t i v e l e v e l s of imports would lead t o formal r e s t r i c t i o n s . The e f f e c t of these informal r e s t r i c t i o n s is to f u r t h e r reduce competit ion and to provide scope f o r domestic p r i c e s e t t i n g i n excess of import p a r i t y l eve l s .

When producers r e s t r i c t domestic s a l e s of m i l k ( v o l u n t a r i l y o r i n v o l u n t a r i l y ) , the domestic p r i c e of milk is ra ised. But not a l l the b e n e f i t s of t h i s increase go t o the d m e s t i c producers. The agents involved i n importing a l s o f ind t h e i r s e l l i n g p r i c e has r i sen . They have no need to undercut the domestic p r i c e , and a l l imports can be sold a t t h e p r i c e p reva i l ing i n the domestic market. To the ex ten t t h a t t h i s p r i c e is higher than the c o s t s of production i n the export ing country, t h e r e a r e r e n t s t o be ex t rac ted . These r e n t s accruing t o imports may be captured by the export ing country, the domestic t r a d e r , or t h e r e t a i l e r .

1 Some of these b e n e f i t s a r e l i k e l y t o be eroded through adminis t ra t ion c o s t s , competition t o acquire markets, e t c . Thus, t h e b e n e f i t s of higher I p r i c e s a r e shared between producer and agents involved i n importing. However, the c o s t s of r e s t r i c t i n g volume i n order t o support p r i c e s a r e borne by the domestic producer and consumer.

I n e f f e c t , monopoly power i n the domestic market is reduced by t h e presence of imports. The demand curve t h a t the domestic indus t ry faces , n e t of the demand suppl ied by imports, is s h i f t e d t o t h e l e f t (lower q u a n t i t i e s demanded from domestic producers a t any given p r i c e ) and is more e l a s t i c than i f the industry suppl ied t h e whole market. The l a r g e r the import volume, the more the indus t ry ' s monopoly power is c u r t a i l e d . I f t h e ADC had s o l e a u t h o r i t y t o import d a i r y products , t h e model would suggest t h a t the AM: could p o t e n t i a l l y inc rease indus t ry p r o f i t s by supplying the domestic market and d i s t r i b u t i n g t h e p r o f i t s t o t h e industry . However, the po l i cy of choosing t o forgo these p r o f i t s he lps t o maintain indus t ry s ize .

It is important t o note t h a t some monopoly power (and a s soc ia t ed we l fa re c o s t s ) e x i s t s even when import quo ta s a r e set a t t h e appa ren t ly generous l e v e l o f t he amount which would o the rwise be imported under f r e e t r ade . Such a non-binding c o n s t r a i n t on imports , under f r e e l y compet i t ive c o n d i t i o n s , becomes b inding where monopoly p m e r e x i s t s i n t h e domestic market. Domestic monopoly s a l e s i n t h e presence o f a cons t r a ined l e v e l of ' f r e e t r a d e ' imports would s t i l l r e s u l t i n lower t o t a l consumption than under t r u e f r e e t r ade .

Returning t o t h e e a r l i e r model o f one product , cheese, produced from manufacturing milk, F igure 8 shows t h e demand curve faced by domestic producers o f milk f o r cheese where a f ixed volume M o f cheese is allowed to be imported by agen t s no t belonging t o t h e monopoly. The t o t a l domest ic demand f o r cheese is shown by the l i n e DD. A t any p r i c e P, a q u a n t i t y Q is demanded, a s shown on t h i s demand curve. At any p r i c e P, however, t he domestic producers w i l l be a b l e t o se l l on ly Q-M, where the import q u a n t i t y is M. (Th i s assumes t h a t imports do come i n - i.e. t h a t t h e domestic p r i c e is a t l e a s t a s high a s the world p r i c e p l u s t r a n s p o r t a t i o n c o s t s , t a r i f f etc.) Thus, a t any p r i c e P, t h e demand faced by domestic producers is f o r a q u a n t i t y Q-M. Therefore , t he e f f e c t i v e demand faced by domest ic producers ( t h e l i n e DdDd) is cons t ruc t ed a s a l e f t w a r d s h i f t i n t h e t o t a l demand by an amount M ( t h e volume o f impor ts ) .

The l e v e l of profi t-maximising ou tpu t o f manufacturing milk p roduc t ion f o r cheese occur s where producers ' agg rega te marginal c o s t curve i n t e r s e c t s t h e i r marginal revenue curve, a t Q l , g iv ing a p r i c e on a l l cheese suppl ied (Ql+M) o f P i . I f imports had been t o t a l l y excluded, consumption would have been a lower volume Q2 a t a higher p r i c e P2. Domestic o u t p u t o f Q2 is higher than a t Q1. For the s t r a i g h t l i n e demand curve and a r i s i n g marginal cost curve , t h e increment i n consumption due t o a l lowing M imports is a t l e a s t one h a l f of M. (AF is M and Q2 must c u t AF less than h a l f way along.)

Regardless o f whether t h e demand curve is s t r a i g h t i n t h e r e l e v a n t range, imports a r e bound t o i n c r e a s e the l e v e l o f consumption and reduce t h e p r i c e pa id . Thus, t h e e x i s t e n c e o f imports improves s o c i a l we l f a re over the no-imports ca se . However, it reduces the e f f e c t i v e n e s s o f p r i c e and supply management i n r a i s i n g producers ' incomes s i n c e t h e r e is a s p i l l o v e r t o impor ters who a r e n o t t he t a r g e t group. I n Figure 8 t h e r e n t s acc ru ing t o impor ters and forgone by t h e domestic i n d u s t r y a r e measured by M(P1-P£) o r AFNL.

2.3 The Instruments

A model o f t h e d a i r y i n d u s t r y has been cons t ruc t ed i n which the use o f p r i c e management ( e f f e c t i v e domestic p r i c e c o n t r o l s , informal import c o n t r o l s and e q u a l i s a t i o n ) t o maximise n e t income t o d a i r y p roduc t producers is i l l u s t r a t e d . Abs t r ac t ing from p rocess ing c o s t s has made p o s s i b l e a c o n s i d e r a t i o n o f t h e de r ived demand f o r p roduc t s a s n e t o f uniform c o s t s o f compet i t ive process ing . In t h e model, t h e i n d u s t r y is composed o f two s e c t o r s : one i n which a s i n g l e product , cheese, is made from whole milk, and t h e o t h e r i n which two p roduc t s , SMP and b u t t e r , a r e produced j o i n t l y i n f i x e d p ropor t ions from milk.

Figure 8: DEMAND FOR CHEESE (IN MILK EQUIVALENT) WITH FIXED IMPORT QUOTA

M Import quota DD Total domestic demand MRt Total marginal revenue

DdDd Demand faced by domestic producers

MRd Marginal revnue of domestic producers

PfPf World price

MC Marginal cost

I n aggregating the demand f o r u,ilk derived from the demand faced by producers i n these two subsectors , the study has a l ready incorporated some o f t h e c o n s t r a i n t s t h a t the d a i r y indus t ry faces and the instruments it uses - milk market quota, supported p r i c e s , p r i c e discr iminat ion, e tc . This sec t ion looks a t the major instruments o f d a i r y pol icy i n g rea te r d e t a i l and d i scusses hcm they a r e explained by t h e behaviour predicted by t h e profit-maximising model.

(a) Equal isat ion

. The scheme and its operat ion

The most s ign i f i c a n t aspec t o f Commonwealth arrangements for the manufacturing sector is the process of equal isat ion. This involves pooling - separa te ly fo r each product (or product group) - the re tu rns f r a o domestic and export s a l e s of da i ry products, and means t h a t manufacturers receive an average o r equal ised p r ice for a l l t h e i r production of a p a r t i c u l a r d a i r y product.

Between 1934 and 1977, equa l i sa t ion operate6 on t h e b a s i s of a s e r i e s of voluntary agreements between ind iv idua l manufacturers and the Commonwealth Dairy Produce Equal isat ion Committee Limited. With growing concern about t h e continuing e f fec t iveness of these voluntary arrangements, and i n p a r t i c u l a r t h e s t a b i l i t y o f domestic p r ices , t h e I n d u s t r i e s Assistance Commission recommended i n 1976 t h a t a compulsory marketing scheme be introduced (IAC 1976). Leg is la t ion implementing a new scheme, e s s e n t i a l l y aimed a t p ro tec t ing the domestic p r i c e s t ruc ture , became e f f e c t i v e on l J u l y 1977. Respons ib i l i ty f o r adminis t ra t ion o f the compulsory equa l i sa t ion arrangements was placed with t h e Austra l ian Dairy Corporation.

The l e g i s l a t i o n provides f o r maintenance o f a d i f f e r e n t i a l between the domestic and export p r i c e s of prescr ibed products. (The products i n i t i a l l y covered by these arrangements were b u t t e r , b u t t e r o i l , S W , buttermilk powder, casein, cheddar and Gouda cheese and wholemilk powder. A s provided f o r i n t h e l e g i s l a t i o n , o ther d a i r y products a r e prescribed £ram t i m e to t i m e a s necessary on the recommendation of t h e ADC, a f t e r consu l ta t ion with t h e Austra l ian Dairy Industry Advisory Committee.) The p r i c e d i f f e r e n t i a l is maintained by imposing compulsory l e v i e s on domestic s a l e s o f these products, with each levy equivalent t o the d i f fe rence between the domestic bulk wholesale p r i c e and the assessed export p r i c e o f the product. Levy proceeds a r e c red i ted to separate product accounts within t h e Dairy Products S t a b i l i s a t i o n Trus t Fund and disbursed so a s t o provide each manufacturer with an equalised re turn from domestic and export s a l e s of prescr ibed products. Cer ta in approved c o s t s and allowances i n respec t o f the production, storage, d i s t r i b u t i o n and s a l e o f da i ry products a r e a l s o met frcm levy proceeds.

The levy is payable by the manufacturer o f prescr ibed products which a r e sold f o r domestic consumption or used by the manufacturer i n o ther food products, b u t s t a b i l i s a t i o n payments a r e made uniformly t o a l l producers o f each product i r r e s p e c t i v e of whether it is sold on t h e domestic o r export market. I f required, a d d i t i o n a l funds made ava i lab le through t h e underwriting scheme a r e used t o ' top up' the s t a b i l i s a t i o n funds and so enable payment of t h e f u l l underwritten pr ice . ~ l l s t a b i l i s a t i o n payments must be passed on i n an equi table manner t o

a l l suppliers of the m i l k from which the product was made and must be identified separately on statements forwarded to suppliers. However, the underwriting component i s embodied in s tabi l i sa t ion payments in such a way that it cannot be readily distinguished a t the farm level.

Each of the five leviable product pools i s administered separately. The pools operate for one financial year. The assessed export price is se t for each product before the pool i s opened. The domestic levies are determined three times each year (1 July, 1 November and 1 March) and support the domestic bulk wholesale prices as each wholesale price equals the assessed export price plus the domestic levy. The method by which levies are se t i s discussed la ter in th i s section.

Interim stabil isat ion payments are s e t for each product a t the beginning of the pool year. The ADC pays th i s amount to manufacturers on production of the product. A s the season proceeds, the s tabi l i sa t ion payment is increased progressively across a l l production for the year. Funds for stabil isat ion payments are provided by the domestic levy. However, due to the fac t that the s tabi l i sa t ion payment is paid before the domestic levy is collected, the ADC must borrow the necessary funds in the short term.

The ADC se t s minimum export prices for leviable products which may vary from market to market and may be al tered a t any time. Licences are required to export leviable products. Yet an exporter who receives a premium on the minimum export price specified in the licence may keep it. I f the minimum export price i s above the assessed export price, the exporter is required to pay the difference into an export pool; i f the minimum price is belaw the assessed price, the difference is reimbursed to the exporter. Therefore, a separate export pool is operating for each product. Each export pool must always be in surplus, or the assessed export price is breached and the s tabi l i sa t ion pools must be closed. A t the end of the year, proceeds from export pools are paid into the appropriate stabil isat ion pools.

The fac t that stabil isat ion enables domestic prices to be maintained above export prices has provoked widespread debate over the true valw of such a program. Turnovsky (1978) showed that publicly announced forecasts (such as those made for domestic wholesale prices) can have a price-stabilising impact. Yet Veeman (1982) showed that potential long-term transfer and social costs are substantial when prices are supported above equilibrium levels.

Godden (1978), in attempting to measure the resource misallocation costs associated with the Australian dairy equalisation scheme, found that those costs increase significantly as export prices f a l l (as i s happening now, in real terms). Godden used a simplified form of the model produced by Parish (1962) to i l lus t ra te the costs of equalisation, as shown in Figure 9. Linear supply S and demand schedules were assumed by Godden. D, D, and D, are domestic, export and equalisation demand schedules, respectively. (Godden noted that , even though he assumed linear supply and demand schedules, the equalisation 'demand' schedule would be curvilinear and asymptotic to the export demand curve.) If the domestic price is fixed a t Pd, Qd is sold domestically and (Qe - Qd) is exported. I f exports at tracted the actual export price

Figure 9: MISALLOCATION COSTS OF EQUALISATION: BUTTERFAT

L4 aJ U U 3 m

P d

B u t t e r f a t q u a n t i t y

Source: Godden ( 1 9 7 8 ) .

P,, Q,,, would be produced. Thus, t h e ' r e source m i s a l l o c a t i o n c o s t ' o f e q u a l i s a t i o n is represented by t h e t r i a n g l e xyz.

Concerning t h e common assumption o f l i n e a r supply and demand schedules , J u s t (1977) concludes t h a t an e m p i r i c a l s tudy t h a t s p e c i f i e s t h e form a p r i o r i may be in f luenc ing t h e r e s u l t s obta ined. As Turnovsky (1976) concludes, ' un le s s t h e p o l i c y maker has r e l i a b l e informat ion on t h i s ques t ion , any s t a b i l i s a t i o n p o l i c y may have undes i r ab le e f f e c t s on t h e group it is in tended to a s s i s t ' . The s i g n i f i c a n c e o f t h i s p o i n t is made c l e a r by J u s t e t a l . (1977) a s t hey demonst ra te t h a t an excess ive degree o f n o n l i n e a r i t y is not necessa ry t o o b t a i n a r e v e r s a l i n who g a i n s and who l o s e s , a s compared wi th t h e case where l i n e a r i t y is assumed. S p e c i f i c a l l y , they show t h a t , w i th a high degree o f n o n l i n e a r i t y , producers and an expor t ing coun t ry a s a whole l o s e from s t a b i l i s a t i o n , whereas consumers and t h e i r importing country ga in . C l e a r l y , e v a l u a t i o n o f t h e e q u a l i s a t i o n scheme r e q u i r e s a number o f s e n s i t i v e assumptions which can be debated a t length . Therefore , i n t h i s s tudy, no a t tempt w i l l be nade t o i d e n t i f y t h e r e l a t i v e g a i n s o r l o s s e s between A u s t r a l i a and o t h e r c o u n t r i e s . Although it is expected t h a t some n o n l i n e a r i t y e x i s t s i n A u s t r a l i a ' s v a r i o u s supply and demand schedules , no r e l i a b l e informat ion is a v a i l a b l e on t h e i r t r u e shape. The r e s u l t s o f t h i s s tudy (which assume l i n e a r i t y ) should b e eva lua ted acco rd ing ly .

. Sett ing domestic levies

Domestic levies paid by manufacturers on a l l products to be consumed domestically are a v i t a l ingredient in the equalisation scheme. The levies are se t three times each year by the Government. Before making a decision, the Government considers recornendations on levy amounts made by the ADC and Australian Dairy Industry Advisory Committee. The process used by the ADC in formulating its recommendations is described and evaluated below.

Domestic levy amounts are derived af ter the desired domestic bulk wholesale price has been identified. In fac t , domestic levies are determined by subtracting the assessed export price from the preferred domestic price. Therefore, the ADC's recommendations for domestic levies are based on their expectations of what the appropriate prices w i l l be on domestic wholesale markets.

Under current pricing arrangements, the ADC and the industry advisory committee take account of a l l 10 c r i t e r i a l i s t ed below when making thei r assessments of appropriate future prices. Cr i ter ia 1-9 were adopted by the ADC Board on 8 February 1980 and were amended to include cr i ter ion 10 on 3 December 1981. The c r i t e r i a are:

(1) M i l k production

. Historical, projected and desired levels of m i l k production.

. Level of prices presently being paid by manufacturers for m i l k and assessments of prices needea to be paid to produce the desired m i l k flow.

( 2 ) Market offtake

. Corporation s t a t i s t i c s on the level of domestic sales.

. Commercial measurements of domestic sales.

. Survey of manufacturers and marketers of each product showing type and level of domestic sales.

(3) Price sensi t iv i ty

I . An assessment of the l ikely ef fect on the r e t a i l price of Corporation-initiated price increases.

l 1 . Assessments of consumer reaction to price movements. i l . Assessments of pricing and marketing act iv i ty of competitive products.

( 4 ) Manufacturing patterns

. History of present pattern of manufactured products.

. Effects of variations in production of one product on t o t a l product mix.

l . E£ f ec ts of production trends on manufacturers.

. Indus t ry changes, e.g. r a t i o n a l i s a t i o n wi th in the industry .

(5) Industry revenue

. Likely r e s u l t s on c u r r e n t production p a t t e r n .

. E f f e c t of p r i c e movements on short-term and long-term r e s u l t s f o r a l l s e c t o r s o f the indus t ry (manufacturer/farmer) .

(6) Export p r i c i n g

. Assessment of cur ren t export t r ends i n the world market.

. A s a general r u l e , i n normal circumstances domestic p r i c e should not be l e s s than export p r i ce .

(7) Est imates of i n f l a t i o n

. Pas t t r ends i n i n f l a t i o n a r y movements.

. Pro jec t ions of f u t u r e c o s t movements.

(8) Views of the indus t ry

. Liaison by the ADC management wi th appropr ia te s e c t o r s of the industry , including manufacturers, t r a d e r s , farmers, S t a t e a u t h o r i t i e s and end users , t o determine views on the p r i c i n g s t r u c t u r e of the industry .

(9) Consumer p r i c e index

. An assessment of the c u r r e n t l e v e l of the consumer p r ice index and the food component of t h e index.

(10) P r i c e s o f world t raded d a i r y products

. Assesment of pas t and expected p r i c e s i n world expor t trade.

. A s a genera l r u l e , domestic p r i c e s should mainta in a reasonable degree of r e l a t i v i t y t o import p a r i t y p r i c e s as re f l ec ted by underlying long-term t r e n d s i n p r i c e s genera l ly p reva i l ing i n world export t rade.

Since it was added i n 1981, c r i t e r i o n 10 has been the source o f much debate concerning the d e s i r a b i l i t y of ty ing danes t i c p r i c e s to world p r i c e s i n any way. Much of the debate over c r i t e r i o n 10 has centred on t h e mechanics and s ign i f i cance of using it i n the levy-set t ing process. The two major quest ions i n t h e debate are:

. How should c r i t e r i o n 10 opera te i n the danes t i c d a i r y p r ice - se t t ing process?

. To what ex ten t does c r i t e r i o n 10 over r ide the o the r nine c r i t e r i a ?

To answer these quest ions , simple scenar ios w i l l be used t o study t h e economic e f f e c t s l i k e l y t o r e s u l t i n var ious circumstances. In each

scenar io , the market consequences w i l l be evaluated using t h r e e sets of economic/polit ical concerns: indus t ry welfare e f f e c t s , product ive e f f i c i e n c y e f f e c t s , and consumer welfare.

A person concerned p r imar i ly about t h e d a i r y indus t ry ' s welfare w i l l b e concerned about the s u r v i v a l o f the industry . To such a person, improvements i n indus t ry welfare come £ran inc reases i n t h e number of f i r m s and i n t h e t o t a l volume o f milk produced i n Aus t ra l i a .

A person concerned about product ive e f f i c i e n c y w i l l want an indus t ry made up o f only the most e f f i c i e n t firms and resources. To such a person, producing da i ry products a t t h e lowest c o s t poss ib le w i l l r e s u l t i n an e f f i c i e n t Austra l ian d a i r y industry .

A person concerned about consumer welfare w i l l want the r e a l p r i c e o f d a i r y products i n A u s t r a l i a t o be as low as possible . Therefore, any d e c l i n e i n r e a l p r i c e s w i l l i nc rease consumer welfare , and v ice versa.

The r e s u l t s of the t h e o r e t i c a l scenar io a n a l y s i s a r e swnoarised i n Table 1. A b r i e f d iscuss ion o f the r e s u l t s follows.

Table 1: SCENARIOS OF ECONOMIC EFFECTS

Domestic p r i c e M a r k e t I n d u s t r y welfare Product ive Consumer welfare re1 a t ionsh ip condi t ions effects e f f i c i e n c y effects

effects

( Imports ( r e s t r i c t e d rise f a l l f a l l

Above import ( p a r i t y l e v e l (

( ( Impor ts ( allowed

f a l l rise f a l l

( Imports ( r e s t r i c t e d

A t o r below ( import par i t y ( or level (a) (

( ( Imports ( allowed

r i s e rise r i s e

(a) It is assumed t h a t no imports e n t e r p r o f i t a b l y over t h e long term; short-term dumping/importing may occur i n f r e e market conditions.

I n a s c e n a r i o i n which domestic d a i r y p r i c e s a r e set a t a l e v e l above import p a r i t y while imports a r e r e s t r i c t e d , indus t ry welfare w i l l improve, product ive e f f i c i e n c y w i l l weaken, and consumer welfare w i l l be reduced. Indus t ry welfare (as def ined above) grows a s more resources a r e a t t r a c t e d i n t o da i ry ing by the high r e t u r n s o f f ered. Ef f i c iency d e c l i n e s

a s l e s s p roduc t ive r e sou rces e n t e r t h e i n d u s t r y . Consumer we l f a re (de f ined a s t h e r e a l p r i c e consumers must pay f o r t h e d e s i r e d q u a n t i t y of d a i r y p roduc t s i n A u s t r a l i a ) d e c l i n e s a s l a r g e r q u a n t i t i e s a r e s o l d on t h e less p r o f i t a b l e e x p o r t market. I n t h i s ca se , A u s t r a l i a n consumers a r e be ing asked t o s u b s i d i s e purchases made by A u s t r a l i a ' s f o r e i g n customers. Another f a c t o r i n t h i s s c e n a r i o is t h e problem t h a t A u s t r a l i a would have i n a t t empt ing t o r e s t r i c t impor ts from New Zealand i n t h e f a c e o f t h e agreement on c l o s e r economic r e l a t i o n s . The a d d i t i o n a l A u s t r a l i a n p roauc t ion which cou ld r e s u l t i f t h e s e c o n d i t i o n s con t inue over t h e long term could i n c r e a s e t h e l e v e l o f compet i t ion between A u s t r a l i a and New Zealand i n expor t markets and, t he reby , make t h e agreement less l i k e l y t o succeed.

I n a s c e n a r i o i n which domest ic p r i c e s a r e s e t above import p a r i t y l e v e l s i n an environment which a l l ows impor ts , i n d u s t r y w e l f a r e w i l l weaken and p roduc t ive e f f i c i e n c y w i l l improve, b u t consumer w e l f a r e w i l l still s u f f e r . I n such a s c e n a r i o , imports w i l l flow i n t o A u s t r a l i a , f o r c i n g t h e less p roduc t ive domest ic f i rms / r e sou rces o u t of t h e i ndus t ry . Although s u r v i v i n g A u s t r a l i a n p roduce r s w i l l be t h e most e f f i c i e n t , t h e i r p roduc t ive c a p a c i t y may n o t e q u a l t h a t n e c e s s a r y f o r s e l f - s u f f i c i e n c y . I f t h e A u s t r a l i a n i n d u s t r y c o n t r a c t s below t h e s e l f - s u f f i c i e n c y l e v e l d u r i n g a p e r i d o f above import p a r i t y p r i c e s , A u s t r a l i a w i l l have t o import i f domestic p r i c e s a r e reduced - meaning t h a t domest ic p r i c e s could not be set below import p a r i t y l e v e l s a g a i n u n t i l t h e A u s t r a l i a n i n d u s t r y was r e b u i l t . The re fo re , consumers would be paying for t h e adjus tment toward f o r e i g n s u p p l i e r s (and back a g a i n ) .

I n t h e f i n a l s c e n a r i o , it does no t m a t t e r whether impor ts a r e r e s t r i c t e d o r whether a f r e e market is adopted. I f domestic p r i c e s a r e set a t import p a r i t y l e v e l s , bo th i n d u s t r y w e l f a r e and p roduc t ive e f f i c i e n c y e f f e c t s w i l l be p o s i t i v e and consumer w e l f a r e w i l l be maximised s u b j e c t t o t h e l i m i t a t i o n s of i n d u s t r y we l f a re . I n d u s t r y w e l f a r e is s t r eng thened because domestic p r i c e s set a t import p a r i t y w i l l r e s u l t i n t h e maximum amount of A u s t r a l i a n p roduc t ion t h a t is f r e e of r i s k £ ran p r i c e compet i t ion from impor ts (assuming an open market ) . P roduc t ive e f f i c i e n c y is s t r eng thened because on ly t h e b e s t f i r m s con t inue t o o p e r a t e i n t h e long term. I n f a c t , t h e l a r g e s t and most e f f i c i e n t A u s t r a l i a n d a i r y i n d u s t r y t h a t can e x i s t i n a f r e e market environment is one which w i l l e x i s t i f p r i c e s a r e set a t import p a r i t y l e v e l s . P r i c e s h igher and lower than i n p o r t p a r i t y w i l l r e s u l t i n i n d u s t r y c o n t r a c t i o n i n a f r e e market ( reducing i n d u s t r y w e l f a r e from i ts maximum) .

The f i r s t q u e s t i o n about c r i t e r i o n 10 - how should it o p e r a t e ? - may be answered i n t h e fo l lowing way. Domestic d a i r y p r i c e s should n o t be set above import p a r i t y l e v e l s f o r t h e long term un le s s j u s t i f i e d on t h e b a s i s of c o n s i d e r a t i o n s o the r t han p roduc t ive e f f i c i e n c y , and producer o r c o n s m e r we l f a re . I n t h e s h o r t term, p r i c e s can be set h igher o n l y i f t h e Government is w i l l i n g t o s u b s i d i s e i n d u s t r y growth and r e s t r i c t imports f o r t h a t pe r iod . The i n d u s t r y is s u b s i d i s e d by prolonged t r a n s f e r s from consumers i n t h e form of h igher p r i c e s .

A t p r e s e n t , t h e major i s s u e is the ' d e s i r e d q u a n t i t y 1 of each d a i r y p roduc t - t h e q u a n t i t y needed f o r s e l f - s u f f i c i e n c y p l u s some bu f fe r . I n 1981-82, A u s t r a l i a was a b l e t o produce t h a t q u a n t i t y wh i l e o f f e r i n g p r i c e s below import p a r i t y l e v e l s . I n f a c t , p roduc t ion of a l l p roduc t s

exceeded t h a t quan t i ty , a s evidenced by the l e v e l of exports i n 1981-82 shown i n Table 2. This i n d i c a t e s t h a t Aus t ra l i an consumers have been ' subs id i s ing ' fo re ign consumption, e s p e c i a l l y of cheese, SMP, wholemilk powder and casein.

Table 2: PRODUCTION AND EXPORTS OF DAIRY PRODUCTS: 1981-82

I t e m T o t a l E x p o r t

p r o d u c t i o n E x p o r t s p r o p o r t i on

Butter Cheese ( l ev iab le ) Skim m i l k pclwder Wholemilk powder Case i n ( a )

( a ) Figures a r e rounded.

Therefore, domestic p r i c e s should be s e t a t t h a t l e v e l below import p a r i t y which w i l l r e s u l t i n the production of t h e 'des i red q u a n t i t i e s 1 (assuming t h a t the point remains below import par i t y ) . Import par i t y l e v e l s should be ca lcu la ted using a smoothed (annual) world p r i c e es t imate r a t h e r than a p a r t i c u l a r p r i c e s e r i e s which n igh t be more v o l a t i l e (see the d i scuss ion of import p a r i t y below).

The second quest ion - does c r i t e r i o n 10 over r ide o the rs? - may be answered i n the following way. In a f r e e market environment, c r i t e r i o n 10 t o t a l l y over r ides the other nine c r i t e r i a . This occurs because the r e l a t i o n s h i p of domestic p r i c e s t o import p a r i t y p r i c e s determines t h e t o t a l production volume of a l l Austra l ian firms. I n doing so, it a l s o determines the degree of productive e f f i c i e n c y and indus t ry p r o f i t a b i l i t y .

I n an environment where imports a r e r e s t r i c t e d , c r i t e r i o n 10 is equa l ly a s important. To whatever e x t e n t domestic p r i c e s exceed import p a r i t y l e v e l s , Austra l ian consumers must subs id i se i n e f f i c i e n t production; t o the e x t e n t t h a t production exceeds the des i red q u a n t i t i e s , they a r e a l s o subs id i s ing exports . Consumers a l s o s u f f e r when resources a re misal located i n t o da i ry products, due t o the reduced supp l ies o f

I a l t e r n a t i v e products.

Another quest ion ra i sed by the above d i scuss ion is what is import p a r i t y . P r i c e s fo r var ious products imported i n t o A u s t r a l i a from d i f f e r e n t coun t r i es can d i f f e r consic?erably. Therefore, choosing what is t o be c a l l e d ' t h e import p a r i t y p r i c e 1 f o r each product is d i f f i c u l t . The p r i c e changes cons tan t ly with v a r i a t i o n s i n t r a n s p o r t c o s t s , exchange r a t e s and fo re ign supply and demand ( see Table 3 ) .

The most r e levan t import p a r i t y p r i c e s for A u s t r a l i a a r e those fo r products from New Zealand because of its c lose proximity, the s i z e o f its export ing indus t ry and the p o t e n t i a l long-term e f f e c t s of c lose r economic r e l a t i o n s . Due t o the f a c t t h a t the f i r s t imports t o a r r i v e , should p r i c e s exceed import p a r i t y p r i c e s , would probably be from New Zealand,

Table 3: RATIOS OF AUSTRALIAN PRICES TO LANDED NEW ZEALAND PRICES(a)

Date Wholemilk Skim milk

Butter Cheese powder powder Casein

J u l y 1980 November 1980 March 1981 J u l y 1981 November 1981 March 1982 J u l y 1982 J u l y 1983

(a ) The values a r e the r a t i o s of Aus t ra l i an domestic bulk wholesale p r i c e s t o New Zealand f.o.b. expor t p r i c e s p lus t r a n s p o r t c o s t s ( a l l expressed i n Aus t ra l i an d o l l a r s ) . A value above 1.0, the re fo re , means t h a t t h e Aus t ra l i an p r i c e exceeds the import p a r i t y l eve l .

Source: Campbell and Blank (1983).

the New Zealand import p a r i t y p r i c e can be used a s a proxy f o r short-term analysis . Nevertheless, a smoothed world p r i c e should be used f o r annual planning. The use o f an annual ind ica to r o f expected p r ice movements ins tead of a s i n g l e country 's import p a r i t y p r i c e avoids t h e poss ib le need fo r f requent adjustments.

. The e f f e c t s o f changing domestic prices

The above discuss ion r a i s e s concerns about the s ign i f i cance o f changes i n d a i r y p r i c e s brought about by changes i n domestic l evy l eve l s . For 1961-82, f o r example, it is est imated t h a t i f domestic p r i c e s o f l e v i a b l e products were to chanqe by 15 per cent , d a i r y farm cash opera t ing su rp luses would change by an average of 9 pe r cen t ac ross A u s t r a l i a and 11 per cent i n Vic to r ia (due to t h a t S t a t e ' s g r e a t e r dependence on manufacturing m i l k ) . This es t imate is based on the r e a l i s t i c assumption t h a t 50 per cen t of manufacturing milk is consumed a s l e v i a b l e products on the domestic market. A p r i c e change o f 15 per cen t was used because t h a t amount approximates the margin between imp& and export p a r i t y p r i c e l e v e l s . Hence, i f Comestic p r i c e s (which a r e c u r r e n t l y near import p a r i t y p r i c e s ) were dropped to expor t p a r i t y l e v e l s , t h e r e would be about a 9 per cen t dec l ine i n average d a i r y farmer incomes.

(b) The underwriting scheme

The scheme began with an agreement between Commonwealth and S t a t e Governments to underwrite the equal ised value o f SMP produced i n t h e 1975-76 season. I n subsequent seasons the scheme was extended t o include other products. But ter , casein and cheese were added i n 1976-77 and WMe was f i r s t included i n the second ha l f o f 1977-78.

Government con t r ibu t ions t o a s t a b i l i s a t i o n fund a r e neeeed when the equal ised p r i c e of a product is below its underwritten p r ice . By f a r t h e l a r g e s t underwriting payments have been required on behalf of the s t a b i l i s a t i o n fund f o r b u t t e r , which required government con t r ibu t ions i n a l l seasons up t o 1979-80, when the equal ised p r i c e exceeded the underwritten p r i c e f o r t h e f i r s t time. The equal ised p r i c e f o r cheese has c o n s i s t e n t l y exceeded i ts underwritten p r ice s o t h a t no government con t r ibu t ions t o the cheese s t a b i l i s a t i o n fund have been necessary. WMP required government con t r ibu t ions i n each period s ince its inclusion i n the scheme u n t i l 1980-81. For SMP, a s s i s t a n c e has been required i n 1976-77 only. Casein required underwriting a s s i s t a n c e i n 1976-77 and 1977-78.

Underwriting was o r i g i n a l l y introduced a s a short-term measure. Its purpose was to place a lower l i m i t on the e q u a l i s a t i o n value o f SMP and t o provide immediate ass i s t ance t o the d a i r y indus t ry following the col lapse of world markets f o r t h a t product. The scheme was extended i n the follcwing season, 1976-77, s o t h a t the Commonwealth Dairy Produce Equal isa t ion Committee could make higher i n i t i a l payments t o manufacturers than would otherwise have been poss ib le , and manufacturers i n t u r n could make e a r l i e r and higher payments t o d a i r y farmers experiencing the e f f e c t s of depressed market condi t ions . I n 1976-77 the Commonwealth accepted f u l l r e s p o n s i b i l i t y f o r t h e c o s t of underwriting b u t t e r and cheese, b u t the underwriting o f case in and SMP was s u b j e c t t o an agreement t h a t S t a t e Governments meet some of the cos t s .

I n 1977-78 the compulsory marketing arrangements ou t l ined i n the s t a b i l i s a t i o n sec t ion (2.3a) were introduced, and underwriting became p a r t of these arrangements. However, a p a r t from new underwriting l e v e l s , the underwriting commitment continued b a s i c a l l y unchanged u n t i l t h e add i t ion o f WMP i n the second h a l f o f the season. Since WMP was not being pooled under the new revenue r e d i s t r i b u t i o n arrangements a t t h a t time, the commitment t o WMP was based on the d i f fe rence between the underwritten p r i c e and t h e p r i c e of approved expor t con t rac t s .

For the 1978-79 season, the Commonwealth Government proposed t h a t the S t a t e s sha re the c o s t of underwriting a l l products. When t h e S t a t e s r e j e c t e d t h i s proposal, the Commonwealth agreed t o bear the f u l l cost of underwriting a l l products but a t a lower l e v e l than o r i g i n a l l y proposed. The Vic to r ian Government independently supplemented the Commonwealth commitment with its own underwriting scheme t o r a i s e r e t u r n s f o r Victor ian m i l k producers.

An important developnent i n 1978-79 was the implementation o f a l i m i t on the q u a n t i t y of bu t t e r e l i g i b l e to rece ive s t a b i l i s a t i o n payments and t h u s underwriting. This r e s t r i c t i o n was introduced i n an attempt t o br ing production i n t o l i n e with oppor tun i t i e s f o r s a l e s i n more remunerative markets and acknowledged t h a t , by support ing f actory- level r e t u r n s t o bu t t e r , the scheme had discouraged movement towards a more f avowable product mix. I n 1979-80, following the i n i t i a t i o n o f s u b s t a n t i a l investment i n production capac i ty fo r cheese and other high-value products, underwrit ing continued without the imposition of q u a n t i t a t i v e l i m i t s on any product. The same products were underwritten a s i n t h e previous season, and the Commonwealth was respons ib le f o r the f u l l c o s t of the scheme. The supplementary Vic to r ian scheme was discontinued.

For 1981-82 and 1982-83, t h e nominated farm g a t e r e t u r n was e l imina ted , and t h e underwri t ing l e v e l s f o r each product were set independent ly . These l e v e l s a r e now determined by a formula which is 95 per c e n t o f t h e average of e s t ima ted pool r e t u r n s f o r t h r e e y e a r s ( a f o r e c a s t f o r t he year i n ques t ion and a c t u a l va lues o f t he two p rev ious y e a r s ) . The scheme is up f o r review aga in i n 1983.

The assessment o f t h e c u r r e n t scheme is t h a t it has a po tho l ing e f f e c t , i n t h a t it is designed t o p r o t e c t t h e d a i r y i n d u s t r y a g a i n s t unexpected and sha rp p r i c e d e c l i n e s wi thou t masking long-term market t r ends . Appendix B shows t h a t i n t h e s h o r t term t h e r e would be a chance o f government payout o n l y i f t h e e l a s t i c i t y o f demand on the domestic market were cons ide rab ly g r e a t e r than one and i f t h e domestic p r i c e exceeds the expor t p r i c e . I n the longer term, t h e same r e s u l t s a r e o b t a i n e d when s u p p l i e s a r e allowed t o respond t o p r i c e s rece ived.

( C ) Promotional a c t i v i t y

Promot ional a c t i v i t i e s (and t o some e x t e n t market r e sea rch ) can i n c r e a s e e f f e c t i v e demand f o r an i n d u s t r y 'S ou tpu t and r a i s e t o t a l revenues. An i n 6 u s t r y a c t i n g on its own behal f w i l l a d v e r t i s e up t o t h e p o i n t where marginal a d v e r t i s i n g c o s t s a r e equa l t o t h e marginal revenues t h e y gene ra t e .

The d a i r y i n d u s t r y is l i k e l y t o a d v e r t i s e beyond t h e l e v e l one would p r e d i c t f o r a profi t-maximising monopolist because t h e i n d u s t r y does n o t bear a l l the c o s t s . So long a s the Commonwealth Government i n d i r e c t l y pays p a r t o f t h e ADC's and d a i r y i n d u s t r y a u t h o r i t i e s ' promotional a c t i v i t i e s ( through t h e i r suppor t o f p lanning a c t i v i t i e s ) , a d v e r t i s i n g is encouraged beyond t h e p o i n t where t h e a d d i t i o n a l revenues a r e j u s t i f i e d by the a c t u a l t o t a l a d d i t i o n a l c o s t s o f a d v e r t i s i n g . From the Commonwealth Government's p o i n t o f view, t h e r e is a second problem i n de termining t h e opt imal amount o f a d v e r t i s i n g . I f a d v e r t i s i n g expands consumption, it i n c r e a s e s t h e amount s p e n t on imports.

(d ) The expor t program

I n A u s t r a l i a , a s i n n e a r l y a l l o t h e r expor t ing n a t i o n s , d a i r y e x p o r t s c o n s t i t u t e a r e s i d u a l market because e x p o r t volumes r e p r e s e n t a sma l l p ropor t ion o f t o t a l product ion . The ADC has a g o a l o f keeping A u s t r a l i a s e l f - s u f f i c i e n t i n a l l major d a i r y products . Therefore , product ion is encouraged t o remain a t t h a t l e v e l p l u s a b u f f e r s t o c k t o guard a g a i n s t s h o r t f a l l s c r e a t e d by shocks t o the p roduc t ive system (ADC 1983). Th i s means t h a t any product ion above t h a t se l f -suff ic iency-plus-buffer l e v e l w i l l be a v a i l a b l e f o r expor t .

A profi t-maximising i n d u s t r y e x p o r t s on ly i f revenues cover the c o s t s of t he expor t s . Once o u t p u t is s u b s i d i s e d , a wedge is c r e a t e d between marginal revenue rece ived by t h e producer (which inc ludes e q u a l i s a t i o n payments) and the marginal revenue o r i g i n a t i n g from t h e buyer. The s u b s i d i s e d i n d u s t r y w i l l expor t i ts o u t p u t u n t i l marginal c o s t s exceed t h e marginal revenues from t h e f o r e i g n purchaser. The value of a p r i c e e q u a l i s a t i o n scheme is d i s s i p a t e d i n e x t r a c o s t s of product ion a s o u t p u t expands u n t i l marginal c o s t is equa l t o marginal revenue from abroad p l u s t h e e q u a l i s a t i o n payment.

This ana lys i s shows t h a t foreign consumers b e n e f i t from domestic equa l i sa t ion . It was assumed t h a t the world market fo r milk is l a r g e enough t h a t Austra l ian exports have no inf luence on foreign p r i c e s . Foreign consumers pay the same f o r Aus t ra l i an output a s they would have for s u b s t i t u t e s i f t h e r e had been no subsidised Austra l ian exports , bu t s u p p l i e s a v a i l a b l e increase i n fo re ign markets a s a r e s u l t of equa l i sa t ion .

The decis ion t o export m i l k products a t a l o s s does not n e c e s s a r i l y i n d i c a t e a depar ture from the profit-maximising model. So long a s t h e Commonwealth Government i n d i r e c t l y s u b s i d i s e s m i l k fo r exports by allowing equa l i sa t ion , the indus t ry i t s e l f does not f a c e the s o c i a l l o s s i n terms of c o s t s exceeding revenues o r i g i n a t i n g from foreign buyers.

(e) Border measures

A discuss ion of a l t e r n a t i v e market border measures was included above i n the ana lys i s of the profit-maximising model. A s would be expected, the d a i r y indus t ry a t tempts t o keep import volumes law. The pro£ it-maximising model, a s i l l u s t r a t e d i n Figure 3, however, p r e d i c t s t h a t producers could choose t o import some products a t the world p r i c e s (Pbf) which it could s e l l domestically a t a p r o f i t , maintaining revenues ( a t Pb) a t the same time a s reducing c o s t s of supply ( t o Pbf ) . The indus t ry does not do t h i s , perhaps because it a l s o seeks t o mainta in i ts s i z e (not simple aggregate profit-maximising bu t constra ined profit-maximising behaviour). The problem may a l s o be i n the i n a b i l i t y t o d i s t r i b u t e the b e n e f i t s or the d i f f i c u l t y i n deciding how t o share them. Some S t a t e s wculd b e n e f i t more than o the rs , and agreement on p r o f i t d i s t r i b u t i o n (such a s equa l i sa t ion) would be necessary.

Border measures a l s o e x i s t wi th in the market m i l k s ec to r . The market milk quota system (or its equ iva len t ) opera t ing i n each S t a t e ensures t h a t , genera l ly , no market m i l k is 'imported' from o ther S t a t e s . Although t h e Commonwealth Government has the a u t h o r i t y t o in tervene i n t h e market milk s e c t o r , it has chosen t o allaw each S t a t e t o administer its own supply system. This act ion has , i n e f f e c t , c rea ted a regulated monopoly f o r market m i l k i n each S t a t e .

(f) Is prof it maximising r e a l i s t i c ?

I n r e a l i t y , c o n s t r a i n t s a r e imposed on the indus t ry which l i m i t the e x t e n t and ways i n which it can use i ts monopoly power. The o b j e c t i v e of a 'normal re tu rn ' r a the r than a maximum c e t r e t u r n r a i s e s a problem

1 regarding the e f f i c i e n c y of the industry . I f it sought maximum r e t u r n s f o r its members, it would have every incen t ive t o keep c o s t s t o a minimum. However, i f it were regulated and d i r e c t e d t o achieve a 'normal' r e t u r n , it would be l i k e l y t o d i s s i p a t e some of its p o t e n t i a l profit-making power i n other ways - f o r example i n maintaining o r expanding the s i z e of the inuustry .

To adapt the monopoly model t o a model o f regulated monopoly, i t is necessary t o look a t the consequences, i n p a r t i c u l a r , of a 'normal' r e t u r n ins tead of a maximum r e t u r n t o producers. Current p r i c i n g arrangements may prevent the pro£ it-maximising p r i c e from being reached. I n t h i s case one would e G e c t p r i c e s and output t o l i e between the monopoly l e v e l s derived a t the o u t s e t and the competit ive l eve l .

Present domestic p r i c ing arrangements a c t t o s i g n i f i a n t l y reduce the l e v e l of competit ion between domestic s u p p l i e r s of d a i r y products. Th i s is achieved through the market m i l k quota system and the compulsory levy/disbursement process which a r t i f i c i a l l y r a i s e s the a t t r a c t i v e n e s s of the export market and e s t a b l i s h e s a f l o o r p r i c e i n the domestic marke't.

The e f f e c t s of t h i s reduced l e v e l of competition a r e t o r a i s e t h e domestic (equilibrium) market p r i c e and t o c r e a t e the capac i ty t o e f f e c t a t r a n s f e r from consumers t o producers. An a r t i f i c i a l market p r i c e has been c rea ted , the re fo re , a consequence of t h e s p e c i f i c instruments chosen.

It is f o r t h i s reason t h a t c o n t r o l over the l e v e l of consumer t r a n s f e r lies no t wi th t h e indus t ry b u t wi th t h e Government. There is a need t o balance the s t ab i l i sa t ion / suppor t ob jec t ives of the indus t ry a g a i n s t the consequent c o s t s t o consumers. There is no reason t o bel ieve, a p r i o r i , t h a t (monopoly) revenue-maximising p r i c e l e v e l s w i l l correspond t o t h i s balance point .

3. Q u a n t i t i a t i v e Analysis

3 .l In t roduc t ion

I n t h i s sec t ion , the economic e f f e c t s of currept d a i r y pol icy a r e estimated by using the model descr ibed i n sec t ion 2.2. P r i ces paid by consumers a r e compared with marginal c o s t s of production and with the competit ive outcome.

Manufacturing milk p r i c e s a r e used a s rough es t imates c f marginal c o s t s of production i n order t o make a comparison between cur ren t p r i c e s and marginal costs i n the markets fo r cheese and for b u t t e r . Appendix A shows how an es t i i i a t e of the e l a s t i c i t y of aggregate demand f o r manufacturing m i l k is derived from the components of der ived demand. The e f f e c t of the da i ry program on t h e market f o r SMP (as one example) where t h e domestic p r i c e is maintained above the expor t price is a l s o estimated.

I n the long run, the burden of maintaining the r e t u r n t o producers above a 'normal1 one is borne by the consumer. The d i f fe rence between c u r r e n t p r i c e s and those assoc ia ted with t h e competit ive outcome a r e c a l c u l a t e d t o f i n 6 how ad jus t ing cu tpu t t o the competit ive (but s t i l l p ro tec ted) equi l ibr ium would a f f e c t marginal cos t s .

3.2 Marginal Cost - I d e n t i f y i n g t h e ' E f f i c i e n t ' S t a t e s

A producer maximises h i s ind iv idua l n e t r e tu rns ( a s opposed t o the r e t u r n s of the group a s a whole) by producing t o t h e p o i n t a t which t h e p r i c e he rece ives on h i s l a s t u n i t of m i l k is equal t o na rg ina l cos t s . When p r i c e and supply management cons t ra ins output i n the i n t e r e s t s of producers a s a group, it prevents most producers from reaching t h i s point.

I n S t a t e s which have r e l a t i v e l y l a r g e market m i l k quotas, producers a r e allowed t o expand beyond the po in t a t which p r i c e equals 'normal1 marginal cost . I n these S t a t e s , p r o f i t s a r e earned a t t h e margin. The producer ea rns the opportuni ty c o s t of the resources he employs, including h i s own labour. He a l s o g e t s a 'super-normal1 r e t u r n above t h e r e t u r n t h a t the market would generate wi thout p r i c e and supply management

i n the d a i r y sec to r . Insofar a s t h i s super-normal re tu rn includes p r i c e b e n e f i t s of the da i ry program, t h e r e is some waste of resources. The market milk subsidy and o the r r egu la to ry b e n e f i t s a r e se rv ing t o recover costs and more f o r these producers.

I n S t a t e s where market milk quotas a r e r e l a t i v e l y smal l , pror.?uction is kept nearer t h e po in t a t which marginal c o s t equa l s p r i c e and 'normal' r e t u r n s a r e earned. The equal ised p r i c e is the same t h e r e a s i n the S t a t e s with no s c a r c i t y of market milk quota, but output is held to a l e v e l where c o s t s a r e lower. I n these constrainec? S t a t e s , a r e t u r n is maintained near t h e 'normal' r e t u r n generated i n a competit ive market.

S t a t e s i n which l e s s than the n a t i o n a l average ( a s shown i n Table 4) o f 29 per cen t of t o t a l milk production is so ld a s market milk a r e assumed t o be constra ined by market milk quota: V i c t o r i a and Tasmania a r e i d e n t i f i e d a s having marginal c o s t s constra ined near t h e competit ive l e v e l (even though most producers do receive some a d d i t i o n a l p r o f i t from market milk s a l e s ) . It is noteworthy t h a t these two S t a t e s con t r ibu ted 65.1 per c e n t of t o t a l Aus t ra l i an milk production dur ing 1981-82, wi th 59.4 per c e n t coming from V i c t o r i a alone.

Table 4: MARKET MILK AS A PFtOPORTION OF TOTAL MILK PRODUCTION: 1981-82

South Western New South Vic to r ia Tasmania A u s t r a l i a Queensland A u s t r a l i a Wales A u s t r a l i a

S t a t e s which consume more than the n a t i o n a l average of t h e i r t o t a l milk production a s market milk a r e assumed t o have enough market m i l k quota (or its equivalent) s o t h a t a major i ty of producers b e n e f i t s i g n i f i c a n t l y £ran super-normal re tu rns . Therefore, producers i n South Aus t ra l i a , Queensland, Western A u s t r a l i a and New South Wales a r e not s i g n i f i c a n t l y constra ined by the competit ive l e v e l of marginal c o s t s , on aver age.

C lea r ly , it is t o a m i l k producer 's b e n e f i t t o ga in market milk quota. A s an ind ica t ion of haw valuable farmers perceive market milk quota t o be, i n Queensland - the only S t a t e i n which quota can be s o l d - the negot iable value of surrendered weekly market milk quota was $50/L dur ing 1980-81. For a producer c u r r e n t l y opera t ing a t the margin, t h i s p r i c e represen t s an investment requ i r ing a payback per iod of approximately s i x y e a r s . ( l )

(1) This was ca lcu la ted by f ind ing the average p r i c e per l i t r e a year t h a t a b id of $50/L ( a week) represented, 50 + 52 = 96.2c/L, then d iv id ing t h a t amount by t h e Queensland d i f f e r e n t i a l between market and manufacturing m i l k p r i c e s (31.9-15.6 = 16.3c/L) t o g e t an average payback of 96.2 - 16.3 = 5.9 years.

The average p r i c e d i f f e r e n t i a l between market n i l k and manufacturing milk has been s i g n i f i c a n t i n r e c e n t years . As shown below, t h e d i f f e r e n t i a l has been 75-80 per c e n t o f t he value o f manufacturing mi lk , on average , a c r o s s A u s t r a l i a . (2)

Market milk 28.1 30.9 Manufacturing milk 15.6 17.6 D i f f e r e n t i a l 12.5 13.3

3 . 3 Skim Milk P o w d e r : C o s t s and T r a n s f e r s

One o f t he f e a t u r e s o f t h e d a i r y program is p r i c e d i s c r i m i n a t i o n i n t h e market f o r SMP (and o the r p r e s c r i b e d p roduc t s ) . The domestic p r i c e o f powder is maintained above t h e p r i c e a t which t h e so-ca l led ' s u r p l u s ' is s o l d on world markets. The mechanism through which t h i s p r i c e d i s c r i m i n a t i o n is e f f e c t e d is t h e e q u a l i s a t i o n scheme.

A s noted i n s e c t i o n 2.2, a compet i t ive market could n o t s u s t a i n a d i f f e r e n t i a l between domestic and expor t p r i c e s ( a p a r t from t r a n s p o r t a t i o n c o s t s ) even where such a market was p r o t e c t e d from imports . Competi t ion among producers would b i d t h e domestic p r i c e down t o t h e world p r i c e o r t o t h e p r i c e a t which a l l powder produced could be s o l d domes t i ca l ly , whichever is h ighe r .

I t is shown i n t h i s s e c t i o n t h a t a l l powder produced could no t be consumed domes t i ca l ly a t a p r i c e above t h e world p r i c e ; and s i n c e no producer need accept less than he could g e t on t h e world market , t h e domest ic p r i c e would n o t f a l l below the world p r i c e . A domestic p r i c e above t h e world p r i c e could no t be s u s t a i n e d because those who had t o o the rwise sel l abroad a t t h e law world p r i c e would undercut any producer s e l l i n g domes t i ca l ly a t a h igher p r i c e . Thus, t h e compet i t ive p r i c e f o r SMP which is compared wi th t h e c u r r e n t regime is t h e world p r i c e .

(a) Data and assumptions

Consumption and p r i c e s f o r ca l enda r yea r s 1977-78 t o 1981-82 a r e g iven i n Table 5. P r i c e s have been conver ted to 1981-82 d o l l a r s u s ing t h e consumer p r i c e index. Average volumes and p r i c e s ( i n r e a l terms) have been used to reduce t h e e f f e c t s of year-to-year f l u c t u a t i o n s p a r t l y due t o s t a t i s t i c a l r e p o r t i n g methods.

The e l a s t i c i t y o f domest ic demand f o r SMP used he re is -0.28, taken from Song and Hal lberg (1982). Although t h i s e l a s t i c i t y comes from American s t u d i e s , it is expected t h a t an A u s t r a l i a n f i g u r e (none e x i s t s a t p r e s e n t ) would be s i m i l a r . This e x p e c t a t i o n a r i s e s from t h e f a c t t h a t r e s u l t s o f A u s t r a l i a n s t u d i e s o f f l u i d m i l k ( S t r e e t 1974; Nelson 1977) have been very s i m i l a r to r e s u l t s o f American (George and King 1971) and

(2 ) The va lues used h e r e f o r market and manufacturing milk a r e average u n i t va lues c a l c u l a t e d us ing t h e g r o s s va lue o f product ion and t o t a l product ion f i g u r e s from BAE (1982).

Canadian (Lu and Narshal l 1973) s t u d i e s . S t r i c t l y , t h i s e l a s t i c i t y is appl ied t o farm p r i c e s but has been used with respec t t o wholesale p r i c e s . This may produce a s l i g h t underestimate o f the consumer response t o changes in p r i c e s t h a t a re ca lcu la ted here. However, Nelson (1977) notes t h a t i f the re is a constant percentage mark-up between the two, wholesale and farm p r i c e e l a s t i c i t i e s w i l l be the same.

Table 5 : SKIM MILK POWDER: PRODUCTION, CONSUMPTION AND PRICES

Year Average World Domestic

who1 e s a l e p r i c e (a ) (b) consumption Production p r i c e ( a )

Annual aver age 1977-78 t o 1981-82 (875) (749) 44.5 69.8 1980-81 t o 1981-82 (1012) (945) 39.3 69.5

(a ) Constant 1981-82 d o l l a r s i n parentheses . (b) Average Aus t ra l i an f.o.b. export p r i c e s a r e used a s a proxy because they most c l o s e l y represen t the p r i c e s received by Aus t ra l i an producers. I f A u s t r a l i a were a n e t importer, c . i . f . import p r i c e s would be t h e most appropr ia te proxy f o r t h e re levan t 'world' p r i c e faced by the domestic industry .

Sources: BAE (1981a, 1983).

A s noted previously , the processing sec to r is t r e a t e d a s competit ive so t h a t changes i n wholesale p r i c e s r e s u l t i n t h e same absolute changes i n p r i c e received by the producer. Theore t i ca l ly , t h i s means t h a t t r a n s f e r s £ram the consumer, because of p r i c e s higher than t h e competit ive l e v e l , accrue wholly t o producers and a r e not sharec? wi th processors. (Of course, t h i s is not r e a l l y the case - processors do b e n e f i t from consumer t r a n s f e r s , d e s p i t e the degree of competit ion and government in te rven t ion .)

There is a good d e a l of v o l a t i l i t y i n the world p r i c e of SMP. The average world p r i c e fo r the years being considered ($945/t i n 1981-82 d o l l a r s ) is assumed t o r e f l e c t the long-run expected world p r i c e i n r e a l terms.

(b) Calcula t ions

I f the q u a n t i t y consumed domest ical ly a t the domestic p r i c e is s i g n i f i c a n t l y l e s s than t o t a l c u r r e n t ou tpu t , then competit ion among producers would d r ive the domestic p r i c e down t o the world pr ice . Since the e l a s t i c i t y of demand, n, equa l s -0.28, t h e inc rease i n q u a n t i t y consumed domest ical ly which would r e s u l t from lowering the p r ice t o the world p r i c e is:

This would increase consumption t o about 34 k t fo r 1981-82. With output i n 1981-82 a t 78 k t , a l l production could not be consumed domest ical ly and, the re fo re , the wor I d p r i c e would p r e v a i l under competition.

The t r a n s f e r s and welfare e f f e c t s of p r i ce discr iminat ion a r e i l l u s t r a t e d i n Figure 10. Psd is the domestic p r i c e , Psc is the

Figure 10: SKIM MILK POWDER: COSTS AND TRANSFERS

- -

Qd Quantity

0 Net welfare loss to consumers . . . . . . . .

Transfer from consumers to producers

- Domestic demand

competit ive p r ice and Qd domestic consumption. The a rea ABCF shows the annual t r a n s f e r of revenue £ran domestic consumers t o producers due t o the maintenance of the higher support p r i ce . The t r i a n g l e CFE shows the ne t welfare l o s s due t o r e s t r i c t i n g consumption below t h e competit ive l e v e l QC. These a reas a r e ca lcu la ted using annual averages of the da ta f o r 1980-81 t o 1981-82 i n Table 5. The average annual t r a n s f e r from consumers t o producers has been:

The n e t welfare l o s s is approximately equal to :

I n other words, SMP p r i c e d i sc r imina t ion has imposed on consumers an average annual c o s t of approximately $2.7m, of which $2.6m accrues t o the d a i r y indus t ry and about $24 000 is n e t s o c i a l l o s s . The t r a n s f e r from domestic consumers t o producers of SMP is $2.6m more revenue than a competit ive market (even one p ro tec ted from imports) would generate and is the re fore p a r t of the r e c e i p t s a t t r i b u t a b l e t o government in te rven t ion .

3.4 The Competitive Outcome

So f a r , p r i c e d i f f e r e n t i a l s have been measured r e l a t i v e t o marginal c o s t s a t c u r r e n t l e v e l s of output. I n t h i s s e c t i o n the change i n c o s t s a ssoc ia ted with an expansion t o the competit ive outcome together with continued p ro tec t ion from imports is considered. The purposes a r e , f i r s t , t o e s t a b l i s h the p r ice t h a t consumers would pay and, second, t o compare the c o s t s they c u r r e n t l y expect t o f a c e with t h e revenues producers expect t o receive under p r i ce and s u ~ p l y management i n excess of the competit ive outcome.

I t is assumed t h a t V i c t o r i a ' s and Tasmania's marginal c o s t of production a t c u r r e n t l e v e l s of output would be near ly t h e same following a r a t i o n a l i s a t i o n of the indus t ry due t o competit ion. That is, t h e r e is l i t t l e adjustment f o r the e f f e c t s of r e loca t ion due t o removal of market m i l k c o n t r a c t cons t ra in t s . This poss ib ly b iases marginal c o s t s downwards, though the b i a s is small s ince t h e r e l a t i v e l y e f f i c i e n t S t a t e s (constra ined by quota) dominate the indus t ry , producing about 65 per cen t of Aus t ra l i an output , and f u r t h e r r a t i o n a l i s a t i o n could poss ib ly genera te f u r t h e r economies of s c a l e (Samuel and Shaw 1983).

I t is shown i n Appendix A t h a t the e l a s t i c i t y of the aggregate der ived demand scheaule f o r domestic manufacturing milk is approximately -0.82. The e l a s t i c i t y of the marginal c o s t of production schedule with respec t t o changes i n c o s t s ( i . e . the e l a s t i c i t y of the competit ive supply schedule) is assumed t o be 1.0, taken from a range of e s t imates considered by Godden (1978), the IAC (1975) and Pandey e t a l . (1982).

A s noted i n Figure 11, the change i n amount demanded, A Q , due t o a f a l l i n p r i c e , L@, is equated t o the change i n supply, AQ, accompanied by a r i s e i n cos t s , AC, which would r e s u l t £ran a move t o the competit ive p r i c e Pc and q u a n t i t y QC.

F i g u r e 11: MILK: THE COMPETITIVE EQUILIBRIUM

Quant i ty

a,

.rl U P.

P d

Pc

The change i n c'emand (AQ) is approximately:

Der ived demand f o r m a n u f a c t u r i n g m i l k

-AQ-

M a r g i n a l c o s t s c h e d u l e ( s u p p l y c u r v e f o r

c o m p e t i t i v e i n d u s t r y w i t h i m p o r t p r o t e c t i o n )

where n is the e l a s t i c i t y o f aggregate demand (-0.82) fo r domestic milk products wi th respec t t o the wholesale p r i c e P, ( f o r which the average 1981-82 p r i c e o f m i l k i n cheddar is used - 25.9c/L). The p r i c e Pw exceeds the Pd shown i n the diagram by the c o s t of processing, bu t the change in p r i c e w i l l a f f e c t the wholesale p r i c e and the p r i c e paid by processors by the same amount AP.

The change i n supply A Q is approximately:

where n' is the e l a s t i c i t y of the c o s t schedule (1.0) and C 1 is marginal c o s t a t output Qd and has been estimated above, f o r V i c t o r i a and Tasnania, a s 15.6c/L.

Given t h a t t he c u r r e n t d i f f e r e n t i a l ( 3 ) between Pc and C1 is es t ima ted a t A P + AC = 3.7c/L, it is p o s s i b l e t o s o l v e t h e s e t h r e e equa t ions f o r AC, lb and &. The r e s u l t s a r e

An adjus tment t o the compet i t ive outcome would cause marginal c o s t s t o rise by 1.4c/L from t h e i r c u r r e n t l e v e l a s ou tpu t i n c r e a s e s by 379 ML (7.3 p e r c e n t ) , and would cause compe t i t i ve consumer p r i c e s t o d rop t o 2.3c/L belcw c u r r e n t l e v e l s . ( 4 ) With e x i s t i n g i n f l a t i o n , t h e 3.7c/L e s t ima ted above w i l l rise t o 5.96c/L by 1987-88. I n a long-term comparison, t h e e x i s t i n g d a i r y program would y i e l d consumer p r i c e s 4.54c/L above t h e compet i t ive l e v e l (i.e. 5.96c/L - 1.42c/L).

3.5 Cheese: Costs and Transfers

( a ) Data and assumptions

A l l cheese is considered a s a s i n g l e homogeneous product e q u i v a l e n t to cheddar. Cheddar and v a r i e t y cheeses a r e aggregated by weight, and a convers ion f a c t o r o f 9.35 kg/hL is used t o conve r t t o milk equ iva len t s .

The p r i c e used f o r a l l cheese is t h e domestic bulk wholesa le p r i c e o f cheddar a s a t J u l y 1982. Th i s s i n g l e p r i c e assumption may b i a s c a l c u l a t i o n of t h e t r a n s f e r from consumers t o importers. (The model assumes t h a t a change i n domest ic supply has the same a b s o l u t e e f f e c t on t h e p r i c e o f a l l cheeses inc lud ing imported cheese. I t could be argued t h a t t he same p r o p o r t i o n a l p r i c e change is more l i k e l y because an i n c r e a s e i n p r i c e s of cheaper domestic cheeses causes a s u b s t i t u t i o n of demand towards more expensive imported v a r i e t i e s , b idding t h e p r i c e of impor ts up f u r t h e r . I f t h i s is the case , t h i s a n a l y s i s underes t imates t h e t r a n s f e r from consumers t o importing a g e n t s ) . For domest ic cheeses , t h e s i n g l e p r i c e assumption is n o t l i k e l y t o have a s e r i o u s e f f e c t on e s t i m a t e s o f c o s t s and b e n e f i t s a s s o c i a t e d wi th t h e d a i r y program, a s t h e s e a r e based mainly on changes i n p r i c e s r a t h e r than a b s o l u t e p r i c e s . The on ly b i a s which might be expected is due t o us ing t h e demand e l a s t i c i t y a s t h e measure of responsiveness t o wholesa le p r i c e changes r a t h e r than r e t a i l p r i c e changes. The assumption t h a t t h e p rocess ing and r e t a i l s e c t o r s a r e compet i t ive is maintained s o t h a t changes i n t h e p r i c e o f manufacturing milk r e s u l t i n t h e same a b s o l u t e p r i c e changes a t both t h e wholesale and t h e r e t a i l l e v e l s .

(3 ) Th i s d i f f e r e n t i a l is es t ima ted by s u b t r a c t i n g t h e average p r i c e o f manufacturing milk (15.6c/L i n 1981-82) from t h e average value of a l l milk (19.3c/L i n 1981-82). The average value o f milk is simply g r o s s va lue of product d iv ided by t o t a l milk product ion (both f i g u r e s a r e quoted i n BAE 1982).

(4 ) Th i s e s t ima ted i n c r e a s e i n q u a n t i t i e s demanded and produced assumes t h a t aggregate demand (domestic and e x p o r t ) i n c r e a s e s and t h a t t h e ADC wishes t o s a i n t a i n expor t markets. I f mainta in ing e x p o r t market c o n t a c t s is no t of concern, it is p o s s i b l e t h a t a d d i t i o n a l q u a n t i t i e s demanded by domest ic consumers w i l l be provided by reducing e x p o r t s and, t h e r e f o r e , product ion and product ion c o s t s w i l l no t i nc rease .

An unpublished BAE study o f Aus t ra l i an demand fo r cheese i n 1978 gave a value of -0.5 f o r t h e p r i c e e l a s t i c i t y of cheese. More recent e s t imates by the I n t e r n a t i o n a l Dairy Federat ion (1982) give an e l a s t i c i t y i n the range -0.12 t o 0.7 f o r EEC members. I n t h i s case , -0.5 is used because it is considered t o be most r epresen ta t ive of the Austra l ian market.

The r e s t r i c t i o n of imports through import quotas o r informal gentlemen' s agreements r a i s e s t h e domestic p r i c e of importee cheese and competing domestic products by reducing the o v e r a l l supply. No attempt is made here t o measure t h i s e f f e c t . What is measured is the a d d i t i o n a l c o s t t o consumers of both domestic and fo re ign cheese due t o constra ining domestic consumption and production through the p r i c e management program.

A f u r t h e r q u a l i f i c a t i o n is made here with respec t t o importers. The r e s t r i c t i o n of the supply of cheese t o domestic consumers necessa r i ly r a i s e s t h e i r pr ice . I n t h i s paper, the e f f e c t of higher p r i c e s f o r imports is measured a s a ' t r a n s f e r from consumers t o importing agents ' . This is c e r t a i n l y a c o s t to consumers, but it is not c l e a r who b e n e f i t s and whether they b e n e f i t by the whole amount. The economic r e n t s a ssoc ia ted with the r i g h t t o import cheese i n t o Aus t ra l i a may accrue to a d ive rse group of economic agents: the r e t a i l e r , the importing agent, o r agents i n the coun t r i es from which the cheese comes. Furthermore, some of these r e n t s may be eroded by the c o s t s of adminis ter ing o r acquir ing fo re ign sources of imports and i n the diseconomies of small s c a l e assoc ia ted with importing small q u a n t i t i e s of many v a r i e t i e s of foreign cheese. Thus, ' importers ' is herea f te r used g e n e r i c a l l y t o re fe r t o a l l o f these agents , and t h e r e is no a t tempt to d i s t r i b u t e t h e b e n e f i t s among them.

I n the ca lcu la t ions which fol law, the b a s i s of a l l es t imates is the d a i r y program's e f f e c t on consumer p r ices , der ived i n s e c t i o n 3.4. I n t h a t sec t ion it was estimated t h a t p r i c e and supply management generates a consumer p r i c e of about 3.7cfi above the marginal c o s t s of production f o r V i c t o r i a and Tasmania.

(b) Calcula t ions

The welfare c o s t s and t r a n s f e r s c f maintaining producer p r i c e s above marginal c o s t s of production of the e f f i c i e n t S t a t e s a r e ca lcu la ted f o r the market f o r cheese. The e f f e c t s on the b a s i s of average volumes a r e ca lcu la ted without ad jus t ing f o r poss ib le reduct ions i n consumption which could occur a s the burden of the higher than 'normal' r e t u r n t o producers is inc reas ing ly borne by consumers.

This in t roduces some inconsis tency i n t o the methodology by neglect ing a con t rac t ion i n consumption which is never theless expected to occur and the magnitude of which is estimated. The purpose of the s impl i f i ca t ion is to a r r i v e a t orders of magnitude f o r the s i z e of t h e market while still being a b l e t o es t imate the dev ia t ions from the competit ive equi l ibr ium generated by p r ic ing policy. By assuming t h a t the market s i z e w i l l p e r s i s t a t the average l e v e l of consumption f o r the period 1980-81 t o 1981-82 (101.3 k t ) , the a n a l y s i s i m p l i c i t l y assumes t h a t demand must be graving (say, because of population, a d v e r t i s i n g e tc . ) t o maintain c u r r e n t l e v e l s of consumption i n s p i t e of higher p r i ces .

The t r a n s f e r s and welfare c o s t s a r i s i n g i n the domestic cheese market a r e i l l u s t r a t e d i n Figure 12. The f i g u r e shows the demand faced by producers, der ived from the consumers' demand fo r cheese. Here the s tudy r e f e r s t o p r i c e s paid by the consumer t o the producer, which a r e t o be i n t e r p r e t e d a s bulk wholesale p r i c e s paid by the consumer i n the f i n a l p r i ce . Consumer responses t o p r i c e a re ca lcu la ted using the e l a s t i c i t y of demand fo r cheese. These responses must be expressed i n terms of changes i n t h e f i n a l p r i c e of the processed product, not shown i n the diagram. The t r a n s f e r s between consumers and prcducers, however, a r i s e from the d i f f e r e n t i a l between the p r i c e s of cheese under the d a i r y program and those t h a t would p r e v a i l under competit ive conditions.

Figure 12: CHEESE: COSTS AND TRANSFERS

Net welfare loss to consumers

Transfer from consumers to producers

l m . . . . . . . . Transfer from consumers to importers

..

The s o l i d l i n e i n Figure 12 is the domestic demand f o r cheese faced by domestic producers. The broken l i n e is the t o t a l domestic demand including t h a t suppl ied by imports. The two demand schedules a re a h o r i z o n t a l d i s t ance M a p a r t , where M is the volume of imports. Consumers pay the p r i c e Pd p l u s r e t a i l marketing c o s t s fo r a l l cheese, and a t t h a t p r i ce wnsume a q u a n t i t y Qd which is supplied domest ical ly and M which is suppl ied by imports.

Qd Qt Quantity

-M- imports M

The producer r e c e i v e s Pd which is more than Pc by approximately t h e amount o f t he domest ic l e v y ($600/t o f cheese i n 1981-82). Pc is t h e compe t i t i ve p r i c e l e v e l which is c l o s e t o ( b u t l e s s t han ) V i c t o r i a ' s c u r r e n t margina l c o s t s of product ion . ( I t is assumed t h a t Pc approximates the as ses sed e x p o r t p r i c e because t h a t p r i c e is t h e e s t i m a t e d average r e t u r n from a l l expor t s a l e s o f a p roduc t manufactured du r ing a p a r t i c u l a r p e r i o d .)

The d a t a f o r t h e s e c a l c u l a t i o n s a r e shown i n Tables 6 and 7. Annual average volumes and p r i c e s have aga in been used f o r t h e y e a r s 1980-81 and 1981-82. I t is assumed t h a t p r i c e management r a i s e s t h e p r i c e s of domestic and imported cheese by t h e same a b s o l u t e amount. The c o s t s and b e n e f i t s c a l c u l a t e d h e r e a r e i l l u s t r a t e d i n F i g u r e 12.

Table 6 : CHEESE : PRODUCTION, CONSUMPTION AND TRADE

Year P roduc t ion Consumption Impor t s Expor ts

Annual average 1977-78 t o 1981-82 139.9 96.1 12.9 53.4 1980-81 t o 1381-82 143.9 101.3 14.6 55.1

Source: BAE (1983).

The a r e a ABCH shows t h e t r a n s f e r from consumers t o domest ic producers which c u r r e n t l y amounts to:

The a r e a BCEG shows t h e t r a n s f e r from consumers to cheese impor ters which c u r r e n t l y amounts t o :

$600/t (14.6 k t ) = $8.8m

Th i s t r a n s f e r is r e l a t i v e l y s m a l l because volumes al lowed t o be imported have been smal l r e l a t i v e t o consumption.

The diagram does n o t show t h e a d d i t i o n a l c o s t t o consumers o f e x p o r t i n g cheese. At c u r r e n t l e v e l s o f e x p o r t s (55.1 k t average f o r t h e p e r i o d 1980-81 t o 1981-82), t h i s c o s t amounts to :

$231/t (55.1 k t ) = $12.7m

Th i s sum r e p r e s e n t s t h e amount A u s t r a l i a n cheese consumers a r e paying t o ' s u b s i d i s e ' cheese expor t s . It is es t ima ted by c a l c u l a t i n g t h e amount by which c u r r e n t margina l c o s t s exceed those t h a t would e x i s t i f product ion were reduced t o e l i m i n a t e a l l e x p o r t s ($231/t) and m u l t i p l y i n g it by

c u r r e n t expor t volumes. (This change i n prociuction costs is es t ima ted us ing t h e same method a s t h a t used i n s e c t i o n 3.4. The t o t a l o f $231/t r e p r e s e n t s t he i n c r e a s e i n c o s t s i ncu r red when cheese producers i n c r e a s e product ion wi th t h e e x p e c t a t i o n of i nc reased revenues £ ran e q u a l i s a t i o n . ) I n o t h e r words, t h e resource m i s a l l o c a t i o n c o s t of producing cheese which is e v e n t u a l l y expor t ed is S12.7m.

T a b l e 7: CHEESE: WHOLESALE PRICES

Y e a r A c t u a l p r i c e P r i c e i n 1981-82 ( a ) d o l l a r s

Annual average 1977-78 t o 1981-82 1980-81 t o 1981-82

(a) Midpoint of t h e p r i c e range was used f o r each year . Source : BAE (1983) .

I n a d e i t i o n t o t h e t r a n s f e r s a l r e a d y c a l c u l a t e d , it is p o s s i b l e t o e s t i m a t e the n e t we l f a re l o s s t o t h e consumer a r i s i n g from r e s t r i c t i n g consumption t o a l e v e l where t h e va lue t o t h e consumer (Pd) exceeds t h e marginal cost o f cheese. Th i s is shown i n F igu re 1 2 a s t h e roughly t r i a n g u l a r a r e a EFG. I t is approximately e q u a l to :

where Q is t o t a l consumption, a t t h e wholesa le p r i c e Pd. For Pd t h e average 1980-81 t o 1981-82 wholesa le p r i c e of cheese is used.

The n e t w e l f a r e l o s s is c a l c u l a t e d as :

3 .6 B u t t e r : C o s t s and T r a n s f e r s

The d a t a f o r product ion , d isappearance and p r i c e s of b u t t e r a r e g iven i n Table 8. The method f o r c a l c u l a t i n g t r a n s f e r s and welfare c o s t s i n t h e b u t t e r market is s i m i l a r t o t h a t desc r ibed f o r cheese.

The t r a n s f e r f ran consumer t o producer r e s u l t i n g from consumer p r i c e s exceeding marginal c o s t s o f product ion is c u r r e n t l y e s t ima ted as :

$550/t (62.9 k t ) = $34.61~1

Table 8: DATA FOR BUTTER ESTIMATES

Year Production Consumption Exports Average wholesale pr ice(a)

Annual average 1977-78 t o 1981-82

1980-81 t o 1981-82

(a) Prices i n parentheses a re i n 1981-82 dol la rs . Actual p r ices quoted a r e the midpoint of the range for each year. Source : BAE (1983).

Estimates a r e maae with respect t o the competitive l eve l of pr icing where the average d i f f e r e n t i a l (AP) between consumer pr ices and marginal cos t s is assume6 t o approximate the 1981-82 domestic levy of $550/t. For t h i s comparison it is a l so possible t o est imate the net welfare l o s s i n consumers ' surplus due t o maintaining pr ices above the competitive level :

The net welfare l o s s t o consumers is cur ren t ly equal to , approximately:

3.7 Market Milk: Costs and Transfers

Volume ar,d gross value of production data for 1981-82 (BAE 1982) is used t o calculate annual consumer t ransfer and welfare cos t s related t o market m i l k .

The consumer t ransfer t o market n i l k proaucers is estimated t o be the difference between the average un i t values of market m i l k and manufacturing milk ( the market milk premium) multiplied by the volume of market m i l k , which is:

This estimate is based on the f a c t t ha t some m i l k could be supplied t o consumers a t the manufacturing m i l k pr ice - 3673 ML were supplied a t

t h a t p r i c e du r ing 1981-82. One common j u s t i f i c a t i o n f o r t he premium is t h a t milk p roduc t ion is seasona l , r e q u i r i n g a d d i t i o n a l product ion c o s t s t o mainta in milk s u p p l i e s du r ing t h e ' o f f season ' . I t was d iscovered , however, t h a t , d e s p i t e h igher costs, t h e premiums paid dur ing 1977-78 r e s u l t e d i n n e t r e t u r n s per u n i t o f milk which were about 20 pe r c e n t h igher f o r market milk than t h a t . f o r manufactur ing milk (BAE 1981b). Therefore , it is l i k e l y t h a t a s i g n i f i c a n t p o r t i o n o f the c u r r e n t market milk consumer t r a n s f e r can be cons idered g r o s s p r o f i t s to producers. T h i s is not e n t i r e l y s u r p r i s i n g s i n c e the market milk quota scheme i n most S t a t e s r e q u i r e s a producer to d e l i v e r milk c o n s i s t e n t l y f o r a t l e a s t a year before being g ran ted a quota. Th i s imp l i e s t h a t t he producer must be a b l e t o a t l e a s t break even a t t h e manufacturing m i l k p r i c e (un le s s he is gambling t h a t he w i l l r e ce ive a quota a t t he end o f an u n p r o f i t a b l e y e a r ) .

One impor tant imp l i ca t ion of t h e above a n a l y s i s is t h a t S t a t e d a i r y i n d u s t r y a u t h o r i t i e s , i n t h e i r e f f o r t t o ensu re a s t e a d y supply o f market milk, may be s e t t i n g market milk p r i c e premiums a t a l e v e l which is high enough t o cover a l l excep t iona l s easona l p roauc t ion costs incu r red a t t he m o s t c o s t l y t i m e of yea r r a t h e r than a t an average l e v e l f o r t h e e n t i r e yea r .

The n e t we l f a re l o s s t o market milk consumers can be e s t ima ted us ing t h e same method a s t h a t used f o r b u t t e r i n t h e p rev ious s e c t i o n . I t is approximately e q u a l to :

The market milk p r i c e e l a s t i c i t y of demand used above, -0.15, was chosen from a range o f A u s t r a l i a n e s t i m a t e s (Tedesco 1980; C o l l i n s 1981).

3.8 Potential Gains from Interstate Tradeability of Milk and Milk Products

The c u r r e n t adminis tered a l l o c a t i o n o f market milk quota (or its e q u i v a l e n t ) has given r i s e t o a d i s p a r i t y between S t a t e s i n marginal costs of product ion and a consequent waste o f r e sources used i n the product ion of t h e t o t a l A u s t r a l i a n milk output . E f f i c i e n t producers i n V i c t o r i a an8 Tasmania cannot, g iven the l e v e l o f market m i l k quota , produce more milk p r o f i t a b l y . I n t h o s e S t a t e s t h e average r e t u r n covers compet i t ive marginal c o s t s and l i t t l e more. I n S t a t e s where market milk quota is not a b inding c o n s t r a i n t , average r e t u r n s a r e allowed t o exceed compet i t ive marginal c o s t s , and a d d i t i o n a l pro£ its a r e earned.

The impl i ca t ion of t h i s d i s p a r i t y i n marginal c o s t s is t h a t t h o s e S t a t e s i n which quota is sca rce could produce some c f t he milk produced i n t h e o t h e r S t a t e s a t l e s s c o s t . With i n t e r s t a t e t r a d e a b i l i t y o f quota , e f f i c i e n t S t a t e s would be prepared t o buy some o f t h e market milk quota £ ran t h e S t a t e s which hold r e l a t i v e l y more quota. Even tua l ly a f r e e market i n quota would r e s u l t i n a t r a n s f e r o f quota (X i n F igu re 13 ) such t h a t t he S t a t e s i n group A would expand t o Q'A and the S t a t e s i n group B wculd c o n t r a c t tc Q'B t o t h e po in t where t h e i r marginal c o s t s were e q u a l a t C'.

The ne t s av ing i n r e sources used t o produce milk is the d i f f e r e n c e between t h e va lue of r e sources r e l eased i n S t a t e s B ( t h e shaded a r e a ) and

the value of the e x t r a resources used t o expand production i n S t a t e s A ( the do t t ed a rea ) .

F i g u r e 13 : GAINS FROM INTERSTATE TRADEABILITY OF MARKET MILK QUOTA

G r o u p A: G r o u p B: E f f i c i e n t s t a t e s I L e s s e f f i c i e n t s t a k e s

Q;, QB Q u a n t i t y o f m i l k

Using n = 1 a s the e l a s t i c i t y o f the aggregate marginal c o s t schedule (Pandy e t a l . 1982), and assuming t h i s e l a s t i c i t y a l s o a p p l i e s t o reg iona l components of t o t a l supply and is constant over the re levan t range, it is poss ib le to c a l c u l a t e the n e t welfare gain i n re loca t ing production. (As estimated i n sec t ion 3.4, the d i f fe rence between marginal c o s t i n the quota-scarce S t a t e s and the average p r i c e is c u r r e n t l y about 3. ~ c / L . )

Resources re leased i n B a r e approximately:

and resources brought i n t o use i n S t a t e s A a r e valued roughly a t :

The n e t saving i n resources is the d i f fe rence between these , namely:

It is now poss ib le t o c a l c u l a t e the q u a n t i t y r e a l l o c a t i o n X between the two groups of S t a t e s f o r 1981-82 from the e l a s t i c i t y of t h e c o s t schedules, given t h a t t o t a l output QA + QB is equal t o 5199 ML an8 the constra ined S t a t e s produce about 65 per cen t of the t o t a l .

Quant i t i e s and c o s t changes a r e r e l a t e d by the formula:

AQ = nQ AC/C

where

n = 1 for both groups CA = 15.6c/L CB = 19.3c/L QA = 65 per cen t o f 5199 ML QB = 35 per cen t of 5199 ML.

The change, AQ, is equal t o X f o r both groups. Therefore:

and

Solving f o r X, it is found t h a t an e f f i c i e n t indus t ry would r e l o c a t e 243 ML of production from S t a t e s i n group B t o t h e more e f f i c i e n t S t a t e s i n group A. S u b s t i t u t i n g X = 243 ML i n the es t imate fo r the d i f fe rence i n resource c o s t s i n d i c a t e s t h a t t h i s r e loca t ion of production would reduce resource c o s t s by roughly $4.5m a year.

3.9 Losses Due t o Exports

Despite dec l in ing volumes i n recent years , the wholemilk equivalent of t o t a l Aus t ra l i an da i ry expor t s was s t i l l 1094 ML i n 1981-82. A s noted e a r l i e r , the average value of a l l milk produced during 1981-82 was 19.3c/L, or 3.7c/L above marginal c o s t s of e f f i c i e n t producers. Therefore, $40.5m (3.7c/L mult ip l ied by 1094 ML) is the cur ren t annual value of the deadweight l o s s t o t h e Aus t ra l i an economy of ' subs id i s ing ' expor t s of milk products. This is a deadweight l o s s ra the r than a t r a n s f e r t o fo re ign consumers s ince t h e volume of Austra l ian expor t s would presumably not a f f e c t world p r i c e s . Foreign consumers would have been a b l e t o purchase da i ry products a t those p r i c e s i n any case.

Deadweight l o s s e s a r e one of two types of d i s t o r t i o n s i n the a l l o c a t i o n of resources caused by t h e e q u a l i s a t i o n scheme which pays d a i r y farmers a p r i c e equal l ing the average value of a l l manufacturing m i l k produced during a year.

A f i n a n c i a l l o s s occurs on a11 m i l k which is so ld fo r l e s s than the c o s t of producing it. Such l o s s e s occur on some expor t s a l e s because producers expand production t o the po in t a t which marginal c o s t s equal average (equal ised) revenues r a t h e r than marginal revenues.

A deadweight l o s s occurs on a l l milk which is so ld fo r l e s s than the expected value of t h a t m i l k (valued a t t h e time of product ion) . Such l o s s e s occur on a l l export s a l e s because the expected (equal ised) value of a l l expor t s exceeds the marginal value of those goods. Deadweight l o s s e s a r e not incurred by the d a i r y indus t ry - farmers receive t h e expected value f o r t h e i r milk. Ins tead , the l o s s e s a r e incurred by t h e Aus t ra l i an economy because resources were a l l o c a t e d t o da i ry ing which

could have ma6e a l a rge r con t r ibu t ion t o na t iona l product had they been a l l o c a t e d t o some other industry . Producers a r e misled by the a r t i f i c i a l p r i c e s i g n a l they receive from the d a i r y equa l i sa t ion scheme: they bel ieve an a d d i t i o n a l u n i t of output (which is exported) w i l l con t r ibu te t h e equalised u n i t value t o the n a t i o n a l proauct ( the ind iv idua l farmers w i l l g e t t h a t p r i c e f o r another u n i t of ou tpu t ) . I n f a c t , t h a t a d d i t i o n a l u n i t of output w i l l only con t r ibu te the export (marginal) u n i t value t o t o t a l na t iona l product, meaning t h a t t h e r e was a lower r e t u r n on resources ' i nves ted ' than could have been the case.

3.10 Sunnnarl; o f Annual Costs ana I ' rznsfers

Estimates of costs and t r a n s f e r s f o r 1981-82 r e s u l t i n g from d a i r y p r ic ing p o l i c i e s a re presented i n Table 9. These f i g u r e s include a l l t h e es t imates described e a r l i e r i n t h i s s tudy p lus es t imates fo r the two remaining prescr ibed products, WMP and case in , which were ca lcu la ted i n the same manner a s those of SMP, b u t t e r and cheese.

Table 9: S U W Y OF ANNUAL COSTS AND TRANSFERS : 1981-82

Deadweight l o s s e s Transfer from Transfer from Welfare Loss from I n t e r s t a t e

Product consumers t o producers t o l o s s export ing resource producers importers misal locat ion

SM?? 2.6 o 0.02 ( a ) (b) Cheese 52.0 8.8 4.80 (a) (b) Butter 34.6 0 2.40 ( a ) (b) WMP 6.6 0 0.27 (a) (b) Casein 1.03 0 0.04 (a ) (b)

Manufacturing m i l k t o t a l 96.83 8.8 7.54 40.5 (b)

Market m i l k 189.53 0 6.27 0 4.5

T o t a l 286.36 8.8 13.81 40.5 4.5

(a) The amount f o r each product is included i n the f i n a l t o t a l - only t h e l o s s of cheese exports was ca lcu la ted s e p a r a t e l y , a s ou t l ined i n the t e x t . (b) This c o s t was ca lcu la ted using volumes of m i l k and the re fo re does not apply t o any p a r t i c u l a r processed product. A s ou t l ined i n the t e x t , it r e f l e c t s c o s t s a r i s i n g from market milk po l i c ies .

Note: Several of these es t imates were ca lcu la ted from averaged da ta , a s explained i n t h e t e x t .

The two l a r g e s t components i n the t a b l e a r e consumer t r a n s f e r s and l o s s e s £ran export ing . Domestic consumers pay domestic producers nea r ly $97m more fo r d a i r y products and about $190m more fo r market milk than would be required under competit ive market conditions. This t r a n s f e r

helps support the domestic d a i r y indus t ry by d i r e c t i n g resources i n t o those products. Losses due t o expor t s , a s described above, a r e a deadweight l o s s t o the e n t i r e Aus t ra l i an economy. A t h i r d f a c t o r , t r a n s f e r s t o importers, is both a consumer t r a n s f e r and - t o the e x t e n t t h a t resources leave A u s t r a l i a - a l o s s t o the Aus t ra l i an economy.

Welfare l o s s e s and i n t e r s t a t e resource misa l loca t ion c o s t s a re a l s o incurred due t o d a i r y p r i c i n g p c l i c i e s . These a r e c o s t s t o consumers but, unlike consumer t r a n s f e r s , the domestic indus t ry does not necesssar i l y b e n e f i t from them.

To pu t the t r a n s f e r s i n t o pe rspec t ive , note t h a t the $285m i n t r a n s f e r s from consumers t o producers represented 28 per cen t of the gross value o f m i l k production (GVP) during 1981-82. The t o t a l of $105.73111 f o r manufacturing milk was 1 8 per cen t of t h e GVP f o r t h a t sec to r , whi le market m i l k ' s t o t a l of $189.53m represented 44 per cen t of the GVP of t h a t por t ion of the industry .

4. Assessment o f Pol icy E f f e c t s

4.1 P o l i c y E f f e c t s

C r i t i c s of the d a i r y program a r e concerned about the ex ten t t o which the program has favoured producers and processors a t the expense of consumers. The ana lys i s undertaken i n t h i s paper thus f a r appears t o j u s t i f y t h i s concern. This sec t ion , then, a t tempts t o a s s e s s more p rec i se ly whether o r not m i l k producers and processors have been favoured by da i ry p r i c i n g p o l i c i e s .

Procedures used by Song (1981) and Song and Eal lberg (1982) a r e used here to spec i fy the nature of any b i a s i n Aus t ra l i an da i ry p r i c i n g po l i c ies . Estimates for each of 21 years a r e made, s u b j e c t t o the condi t ion t h a t the a c t u a l amount of milk t h a t was a v a i l a b l e f o r processing i n each year must be produced, fo r (1) a s e t of p r i c e s for market and manufacturing m i l k t h a t would have maximised consumers' welfare from consumption of these types c f m i l k , and ( 2 ) a s e t of p r i c e s fo r market and manufacturing m i l k t h a t would have maximised m i l k processors ' aggregate gross income. Actual farm-gate re tu rns a r e compared with the opt imal p r i c e s generated from these two s o l u t i o n s t o a s s e s s the ex ten t t o which p r i c i n g p o l i c i e s were biased toward e i t h e r producers or consumers i n each of the 21 years from 1962-63 t o 1982-83.

For the sake of comparison, two 'optimal ' s o l u t i o n s a r e generated. To determine which pr ice-quant i ty combinations w i l l maximise da i ry producer revenues, it is necessary t o spec i fy a demand function. The a n a l y s i s used here follows t h a t o f Song and Hallberg (1982). I f t h e r e a r e n products made from m i l k , the annual farm l e v e l demand funct ion can be wri t ten:

where i, j = 1,2,... ,n; Q i r ep resen t s consumer demand f o r m i l k used i n the i t h product; and Fj represen t s the p r i c e of milk used i n the j t h product. A maximum aggregate processor g ross income can be found by solving t h e quadra t i c programing problem:

(2 maximise R = C. P. Q. = C . P. (a i + C .b . .P .) , 1 1 1 1 1 3 13 3

s u b j e c t t o

( 3 ) a i + CjbijPj = Qi f o r a l l i,

( 4 ) CiQi = TQI

(5) P . , Qi > 0 f o r a l l i. 1

Maximum consumer we l fa re is def ined he re a s t he maximum u t i l i t y accruing to consumers from consumption of a l l milk. Therefore , us ing t h e demand func t ions de f ined by equat ion set (l), t h e p r i ce -quan t i ty combinations t h a t w i l l maximise consumer we l fa re can be found by so lv ing t h e problem:

(6) Maximise U = X i l (Ai + C BijQj)dQi,

s u b j e c t t o

(7) Ai + C B Q = P . f o r a l l i, j i j j 1

I t is e a s i l y shown t h a t marginal u t i l i t i e s i n a l l markets must be equal . I t is a l s o assumed t h a t t he na tu re o f demand is i d e n t i c a l f o r t h e two markets cons idered .

For t h i s s tudy , both market milk and manufacturing milk were cons idered . The two sec t o r s were assumed to c o n s t i t u t e s e p a r a t e markets, b u t the demand f o r each product was assumed t o b e a func t ion o f its own p r i c e a s w e l l a s t h e p r i c e o f t h e o t h e r product .

Own-price and c ross -p r i ce e l a s t i c i t i e s shown i n Table 10 were taken or de r ived from t h e demand s t u d i e s c i t e d e a r l i e r and from George and King (1971). These a r e used wi th a q u a d r a t i c programming a lgor i thm much l i k e t h a t o f Ladd and Updegraff (1969) t o o b t a i n s o l u t i o n s f o r each year .

Table 10: MATRIX OF FARM-WEL MILK PRICE ELASTICITIES

Marke t m i l k

M m u f a c t u r i n g m i l k

Market milk -0.25 0.01

Manufacturing milk 0.02

The r e s u l t s p re sen ted i n Tables 11 and 12 i n d i c a t e t h a t producers1 g r o s s income could have been inc reased i n each yea r by a r e a l l o c a t i o n o f

mi lk a c t u a l l y used among t h e two p r o d u c t s under a more d i s c r i m i n a t o r y p r i c i n g scheme. T h i s i n c r e a s e would have been p o s s i b l e had more mi lk been marke ted i n t h e form o f manu fac tu r i ng mi lk a t lower p r i c e s and less marke t mi lk s o l d a t h i g h e r p r i c e s (to t h e e x t e n t p o s s i b l e c o n s i d e r i n g t h e n a t u r e o f t h e p r i c i n g a r r angemen t s ) .

T a b l e 11: ACTUAL AND 'OPTIVAL' MILK PRICES

Y e a r Market m i l k M a n u f a c t u r i n g W e i g h t e d m i l k a v e r a g e

$/kg b u t t e r £ a t $/kg b u t t e r f a t $/kg b u t t e r f a t

ACTUAL PRICES 0.96 0.95 1.23 1.53 3.62

'OPTIMAL ' PRODUCER PRICES 3.78 0.90 1.39 3.93 0.88 1.35 4.49 1.14 1.78 7.54 1.37 2.78

12.96 3.25 5.42

'OPTIMAL ' CONSUMER PRICES 1.09 1.09 1.09 1.06 1.06 1.06 1.32 1.32 1.32 1.73 1.73 1.73 3.88 3.88 3.88

Note: The a c t u a l and ' op t ima l ' p r i c e s were r eco rded o r c a l c u l a t e d f o r a l l 21 y e a r s , a s i n d i c a t e d i n F i g u r e 14.

T a b l e 12: MILK PRODUCER GROSS REVENUE UNDER 'OPTIMAL' CONDITIONS

1 U n d e r p r o d u c e r U n d e r c o n s u m e r

revenue m a x i m i s a t i on w e l f a r e m a x i m i s a t i o n Y e a r

D e v i a t i o n D e v i a t i o n E s t i m a t e f r o m a c t u a l E s t i m a t e f r o m a c t u a l

On the other hand, ha2 ilk been pr iced t o maximise consumer welfare, g ross producer income would have been lower. Consumers would have p re fe r red a decrease i n p r i c e and increase i n q u a n t i t y o f market milk marketed, and an increase i n p r i c e and decrease i n quan t i ty of manufacturing m i l k i n each year.

It is important t o note t h a t the a c t u a l weighted average p r ice has been c l o s e r t o t h a t p r i c e which would have maximised producer revenues, r a t h e r than t h a t which would have maximised consumer welfare. (The r e l a t i o n between a c t u a l and both 'optimal ' p r i c e s is shown i n Figure 14.)

F i g u r e 1 4 : 'OPTIMAL' PRICES AS A PERCENTAGE OF ACTUAL PRICE

P r o d u c e r o p t i m a l

1 1 0 -

Therefore, it can be concluded t h a t milk p r i c e s a r e not s e t t o maximise consumer welfare or producer revenue. Hence, producer and processor revenue is c u r r e n t l y higher than i f products were priced more i n l i n e with consumer i n t e r e s t s , but not a s high a s it would be i f producers were a b l e t o charge the optimal monopoly p r i c e . A s expected, d a i r y p r ic ing p o l i c i e s have r e s u l t e d in p r i c e l e v e l s f a l l i n g between those of the extremes of monopoly p r ic ing and p e r f e c t l y competitive p r ic ing systems. So, although t h e da i ry indus t ry has been receiving some monopoly p r o f i t s , the amounts a r e l e s s than those which an unregulated monopoly would have received.

1 0 0 -

90-

80-

70 -

%

The impl icat ion of the above r e s u l t s is t h a t the influence of consumers is f e l t through t h e i r impact on markets. I n the p r ice - se t t ing process, the nature of consumer demand a f f e c t s information pe r ta in ing t o t h e ten c r i t e r i a considered by t h e ADC. The n e t r e s u l t is t h a t consumer demand a c t s a s a l i m i t i n g f a c t o r on production decis ions - j u s t a s the theory of market equi l ibr ium s t a t e s .

Consumer o p t i m a l

1 " 1 1 ' 1 ~ 1 ~ ~ ' 1 ' 1 1 ' 1 1962-63 1965 -66 1968 -69 1971-72 1974-75 1977-78 1980 -81

4.2 Ef fec t s of Continuing Present P r i c i n g Trends

Since 1980, domestic wholesale p r i c e s of d a i r y products have experienced dramatic r i s e s ranging from 32 per cen t f o r b u t t e r t o up t o 63 per cent fo r WMP (see Table 13) . To a l a r g e ex ten t , these r i s e s have r e f l e c t e d equa l ly dramatic r i s e s i n export p a r i t y p r ices . During 1982, however, export p r i c e s fo r most d a i r y products were r e l a t i v e l y weak, and t h e BAE (1983) assessment is f o r continuing f l a t markets with a l ike l ihood of some easing i n r e a l p r i c e i n t o the medium term.

Table 13: DOMESTIC BULK WHOLESALE PRICES OF LEVIABLE PRODUCTS

Date But te r Cheese SMP WMP Casein

1 J u l y 1977 1 January 1978 1 Apr i l 1978 1 J u l y 1978 1 January 1979 1 J u l y 1979 1 January 1980 1 A p r i l 1980 1 J u l y 1980 1 November 1980 1 March 1981 1 J u l y 1981 1 November 1981 1 March 1982 1 May 1982 1 J u l y 1982 1 December 1982

Source: ADC (1982).

Domestic p r i c e r i s e s have not r e f l e c t e d t h i s f l a t t e n i n g i n world p r i c e s and, i f p resen t t rends continue, a marked divergence between domestic and i n t e r n a t i o n a l p r i c e s would quickly follow. Immediate consequences would be inc reases i n consumer p r i c e s and i n the l e v e l of

1 a s s i s t a n c e afforded the indus t ry by consumers. I n the long term, such t rends would encourage consumers to consider s u b s t i t u t e products (such a s margarine, imi ta t ion cheese, or f i l l e d milk) and would put increasing p ressure on t a r i f £ and informal import r e s t r i c t i o n s . Signs of t h i s happening have been evident s ince 1980 (BAE 1983).

Higher domestic r e t u r n s would, through equal ised p r i c e s , encourage increased production and exportable surpluses . Ind ica t ions a r e t h a t c u r r e n t r e tu rns a r e s u f f i c i e n t to s t a b i l i s e production. Evidence of t h i s is the l e v e l l i n g off of milk production seen i n 1981-82 and the small inc rease expected f o r 1982-83 (desp i t e a record drought) . Fur ther encouragement of exports i n the face of f l a t world p r i c e s would have a d e s t a b i l i s i n g inf luence i n the longer term and would inc rease the indus t ry ' s v u l n e r a b i l i t y t o sudden reduct ions i n world p r ices .

Appendix A

THE ELASTICITY OF DEMAND FOR MANUFAC'l'URING MILK

The b a s i s o f t he e s t i m a t e o f -0.82 f o r t h e e l a s t i c i t y o f demand f o r processed manufacturing milk is p resen ted i n t h i s Appendix. Th i s r e s u l t is de r ived from the e l a s t i c i t i e s o f demand f o r t h e j o i n t p roduc t s SW and b u t t e r , and f o r cheese.

The market f o r manufacturing milk has been c h a r a c t e r i s e d a s t he sum o f t h e demands f o r b u t t e r , SMP and cheese. While t h e s e do no t account f o r a l l uses o f f ianufac tur ing mi lk , t h e y a r e the major components o f t o t a l demand.

The e l a s t i c i t i e s o f demand used i n t h i s d e r i v a t i o n a r e taken from a range of e s t i m a t e s sugges ted by Skinner (1980) , t h e I n t e r n a t i o n a l Dairy Fede ra t ion (1982) and a 1978 EAE s tudy. These va lues a r e shown i n Table A.1.

Tab le A.l: ELASTICITIES OF DEMAND

B u t t e r Cheese Skim milk powder - domest ic - e x p o r t

T h i s s tudy has used these e l a s t i c i t i e s a s consumer responses t o changes i n wholesa le p r i c e s . S t r i c t l y , t h e y app ly t o r e t a i l p r i c e s , and t h e assumption h e r e is e q u i v a l e n t t o assuming a cons t an t p r o p o r t i o n a l markup by the r e t a i l e r on the wholesa le p r i c e . Yore c o n s i s t e n t wi th t h e assumption t h a t r e t a i l i n g is a compet i t ive i n d u s t r y would be a c o n s t a n t a b s o l u t e (not p r o p o r t i o n a l ) markup on the wholesa le p r i c e . U s e of wholesa le p r i c e s t h u s g ives a s l i g h t upward b i a s t o q u a n t i t y responses by t h e cons umer .

Haiever , t h i s s tudy has maintained cons i s t ency i n i ts t rea tment o f t h e wholesa le p r i c e i t s e l f . There is no c l e a r evidence of monopol is t ic p r a c t i c e s i n t h e p rocess ing s e c t o r and, t h e r e f o r e , it is p o s s i b l e t o assume t h a t a change i n t h e p r i c e of manufactur ing milk produces t h e same a b s o l u t e change i n the wholesa le p r i c e o f t he processed product . ( I m p l i c i t l y , t h i s assumes t h a t t h e p r i c e of milk does no t a f f e c t t h e q u a n t i t y o f milk used t o make b u t t e r , pa ide r and cheese - t h a t t h e processor cannot s u b s t i t u t e o the r i n g r e d i e n t s i n order to economise on t h e milk con ten t o f t h e f i n a l product .)

F igu re A.l shows t h e v e r t i c a l summation of t h e demands f o r t h e j o i n t p roduc t s b u t t e r and SMP. A t c u r r e n t l e v e l s o f ou tpu t , t h e demand a t t he margin is t h e domestic demand f o r b u t t e r combined wi th t h e world demand f o r SMP. T h i s s tudy has assumed t h a t A u s t r a l i a n expor t s of SMP a r e n o t l a r g e enough t o a f f e c t t h e world p r i c e , and s o t h i s component of demand is i n f i n i t e l y e l a s t i c . Therefore , added v e r t i c a l l y is t h e demand f o r b u t t e r , wi th an e l a s t i c i t y of -0.7, t o a h o r i z o n t a l demand schedule f o r SMP a t t he world p r i c e . The aggrega te demand f o r t h e j o i n t products ,

Figure A.l: DEMAND FOR BUTTER AND SKIM M I L K POWDER ( I N MILK EQUIVALENT)

D D e m a n d f o r milk processed M i n t o b u t t e r and s k i m m i l k

DB-Demand f o r b u t t e r

~~-Dernand f o r skim milk powder

powder

Q j Q u a n t i t y of m i l k e q u i v a l e n t

t h e r e f o r e , has the same s l o p e ( a t c u r r e n t l e v e l s o f ou tpu t ) a s t h e demand f o r b u t t e r and is d i s p l a c e d upwards from t h e b u t t e r schedule by t h e expor t p r i c e o f powder.

S ince t h e e l a s t i c i t y o f demand f o r b u t t e r nb is:

and t h e e l a s t i c i t y o f demand f o r t h e j o i n t products n,

n = dQ/dP Q/Pj j j

then , s i n c e t h e s l o p e s dQ/dP and dQ/dP. a r e equa l b 3

where

P = p r i c e of bu t t e r ($2100/t) b

PS = export p r i ce of s k i m m i l k powder ($950/t)

rj, = e l a s t i c i t y o f demand for b u t t e r (-0.7)

Data a r e annual averages for 1980-81 and 1981-82, am? values a r e i n cons tan t 1981-82 do l l a r s .

The e l a s t i c i t y o f demand fo r milk derived from the j o i n t l y produced products is thus:

For cheese, the other major component of the demand for manufacturing m i l k , t h e f i r s t t a sk is t o reduce the e l a s t i c i t y of demand fo r domestic cheese from the t o t a l demand which is p a r t l y suppl ied by imports. For the sake of s impl ic i ty , t h i s s tudy assumes a l l cheese may be aggregated by weight a s i f it were a l l cheddar. There is some d i f f i c u l t y i n i n t e r p r e t i n g a s ing le demand schedule and its e l a s t i c i t y f o r a heterogeneous product. Nevertheless, t h i s assumption allows the de r iva t ion of a r e a l i s t i c adjustment t o allow fo r the g r e a t e r e l a s t i c i t y o f demand faced by domes t i c producers.

Allowing imports i n t o the cheese market inc reases the e l a s t i c i t y of demand for domestic cheese by reducing i ts share of the t o t a l market.

Referr ing t o Figure 12 where the demand fo r domestic cheese is t h e t o t a l demand l e s s the constant amount allowed t o be imported, the e l a s t i c i t y f o r a given l e v e l of consumption is r e l a t e d t o the d m e s t i c sha re of the market.

The e l a s t i c i t y o f demand is given by the formula:

Thus, the e l a s t i c i t y of demand nd fo r domestic cheese can be ca lcu la ted from the o v e r a l l e l a s t i c i t y n t by the express ion

Where Q t is t o t a l consumption of cheese, and Qd (equal t o Qt l e s s imports) is the consumption of d m e s t i c cheese.

Using n t = -0.5 and average annual values fo r consumption (101.3 k t ) and imports (14.6 k t ) f o r the years 1980-81 and 1981-82, g i v e s

= -0.58

The two markets fo r whole m i l k a r e summed t o de r ive the e l a s t i c i t y of t o t a l demand fo r processed manufacturing milk. By summing the two demand

schedules h o r i z o n t a l l y , it can be shown t h a t t he e l a s t i c i t y o f t he aggregate demand is t h e weighted sum of t h e e l a s t i c i t i e s of t h e components, t he weight being r e l a t i v e q u a n t i t i e s consumed.

I n 1980-81 and 1981-82, average annual consumption o f domestic cheese was about 86.7 k t . Bu t t e r consumption, n e t of e x p o r t s , was 62.9 k t , r e s u l t i n g i n a demand f o r 102.2 k t t o be processed i n t h e butter/pawder s e c t o r . Thus t h e weighted average of t h e e l a s t i c i t i e s is:

I t is noted aga in t h a t e l a s t i c i t i e s o f demand apply t o consumer p r i c e s . The diagrams have shown de r ived demand n e t of p rocess ing c o s t s . For t r a n s f e r s , which depend on p r i c e d i f f e r e n t i a l s , t h e use of t h e p r i c e of manufacturing milk i n s t e a d of processed p roduc t s causes rx, problem. When c a l c u l a t i n g we l fa re costs, which depend on q u a n t i t y responses t o p r o p o r t i o n a l changes i n consumer p r i c e s , t h e p r i c e o f processed milk is used ( i n f a c t , t h e wholesa le p r i c e o f cheddar) f o r consumer responses , and t h e p r i c e of manufacturing milk f o r supp ly responses . These two l e v e l s o f p r i c e s a r e n o t shown on t h e same diagram b u t a r e e x p l i c i t i n t h e c a l c u l a t i o n s .

Appendix E

RISK OF GOVERNMENT UNDERWRITING PAYOUT

E f f e c t s of a change i n domestic p r i c e on pool p r i c e and, hence, on t h e r i s k of government payout t o underwrite da i ry p r ices :

tT = pD + e (T-D)

D D t = q + e - e ; ; ;

dD D e d t = r , + , dp - - T dD

1 e = F [ Q - p r i + 1 1 Ddp

D - - e - ( l - - )Q + l 1 dp T P

NOW fo r d t < 0 (given dp > 0)

e (l - p ) q + 1 < 0

i .e. n < - ( fo r a l l p > e ) P-e

where t = pool p r i ce

p = domestic price e = export price D = domestic quantity E = quantity exported (surplus) T = t o t a l production

= e l a s t i c i t y of demand

Hence, for increased r isk of government underwriting payout, the e las t i c i ty of demand must be greater than A. This r a t i o i s always

P-e greater than one for p > e, and only approaches one as the domestic price becomes considerably greater than the export price.

REFERENCES

ADC (Aus t ra l i an Dairy Corporation) (1977), Manual o f Administrative and F inanc ia l Procedures, Melbourne.

- (1982), Revenue D i s t r i b u t i o n Arrangements - 1982-83, l e t t e r t o Minister of Primary Industry , 7 May.

- (1983) , Annual Report: 1981-82, Melbourne.

BAE (1981a), Aus t ra l i an Dairy I n d u s t r y Survey 1976-77 and 1977-78, S t a t i s t i c a l Bu l le t in , AGPS, Canberra.

- (1981b), Comparative Ef f i c iency Between Aus t ra l i an and New Zealand Dairy I n d u s t r i e s and Impl icat ions f o r Trans-Tasnan Trade, Occasional Paper No. 60, AGPS, Canberra.

- (1982), Trends i n the Aus t ra l i an r u r a l s e c t o r , No. 103, Canberra, September . - (1983), Dairy Products: S i t u a t i o n and Outlook 1983, AGPS, Canberra.

Blank, S. and Campbell, D. (1982), Recent Developments i n t h e Aus t ra l i an Cheese Market: Impl icat ions f o r P ro tec t ion , BA33 Occasional Paper No. 69, AGPS, Canberra.

Campbell, D. and Blank, S. (1983), Factors Inf luencing Future Trans-Tasman Dairy Competitiveness, BAE Occasional Paper No. 85, AGPS, Canberra.

Co l l ins , D. (1981), An a n a l y s i s o f demand for f l u i d milk i n Aus t ra l i a . B.Ag.Ec. t h e s i s , Univers i ty o f New England, Armidale.

George, P. and King, G. (1971), Consumer Demand fo r Food Commodities i n t h e United S t a t e s with Pro jec t ions f o r 1980, Giannini Foundation Monograph No. 26, Univers i ty o f Ca l i fo rn ia , Berkeley.

Godden, D. (1978) , 'The resource misa l loca t ion c o s t s of equa l i sa t ion - again ' , Review of Marketing and A g r i c u l t u r a l Economics 46 (2) , 141-9.

Harr is , S., Crawford, J., Gruen, F. and Honan, N. (19741, The P r i n c i p l e s of Rural Po l i cy i n Aus t ra l i a , AGPS, Canberra.

Hunter, R., Bennett , C. (1983), 'Dairy industry: pre l iminary survey r e s u l t s fo r 1981-82 and p ro jec t ions fo r 1982-83 l, Q u a r t e r l y Review of t h e Rural Economy 5 ( 1 ) , 28-31.

IAC ( I n d u s t r i e s Assis tance Commission) (1976), Dairy Indus t ry Marketing Arrangements, AGPS, Canberra, 9 September.

P (1975), Dairy Industry , AGPS, Canberra, 23 October.

I n t e r n a t i o n a l Dairy Federation (1982), The World Market f o r Cheese, I n t e r n a t i o n a l Dairy Federation Document 146, Brussels.

J u s t , R. (1977), 'Theoret ical and empi r i ca l p o s s i b i l i t i e s fo r determining the d i s t r i b u t i o n of welfare ga ins £ram s t a b i l i s a t i o n ' , American Journa l of A g r i c u l t u r a l Economics 59 (S) , 912-7.

- , Lutz, E., Schmitz, A. and Turnovsky, S. (1977), 'The d i s t r i b u t i o n of welfare ga ins from i n t e r n a t i o n a l p r i c e s t a b i l i s a t i o n under d i s t o r t i o n s ' , American Journal of A g r i c u l t u r a l Economics 59(4) , 652-61.

Ladd, G. and Updegraff, G. (1969), Al locat ion o f Milk Among Products t o Maximise Gross Income of t h e Nat ion 's Dairy Farmers Under 1964 Demand Functions, Iowa A g r i c u l t u r a l and Home Economics Experiment S t a t i o n Research B u l l e t i n 567, Iowa S t a t e University.

Layard, P. and Walters, A. (19781, Microeconomic Theory, New York: McGraw-Hill Book Company, ch. 1.

Lipsey , R. and Lancaster, K. (1957) , 'The genera l theory of the second Best ' , Review o f Economic S tud ies 24(1) , 11-32.

Lu, W. and Marshall , R. (1973), A Demand Analysis f o r F lu id Milk i n Ontario, Univers i ty of Guelph, Guelph, Ontario.

Nelson, P. (1977) , 'Demand model f o r f l u i d milk' , g u a r t e r l y Review o f A g r i c u l t u r a l Economics 30 (4 ) , 341-52.

Pandey, S., P iggo t t , R., and MacAulay, T. (1982), 'The e l a s t i c i t y of aggregate Aus t ra l i an a g r i c u l t u r a l supply: e s t imates and p o l i c y impl icat ions ' , Austra l ian Journa l of A g r i c u l t u r a l Economics 26(3) ; 202-19.

Par i sh , R. (1962), 'The c o s t s of p r o t e c t i n g the d a i r y indus t ry ' , Economic Record 38 (85) , 167-82.

Samuel, S.N., Shaw, I.H. (1983), Cost-Size Relat ionships and S t r u c t u r a l Considerations i n Aus t ra l i an Dairy F a r m i n ~ , BAE Occasional Paper No. 75, AGPS, Canberra.

Skinner, S. (1980), An a n a l y s i s of the demand f o r b u t t e r i n Aus t ra l i a . B.Ag.Ec. t h e s i s , Univers i ty of New England, Armidale.

Song, D. (1981), 'An economic a n a l y s i s o f a g r i c u l t u r a l p r i c e pol icy b i a s toward producers or consumers: a case s tudy of US d a i r y p r i c i n g p o l i c i e s ' , Journa l of Rural Deve lopen t 4 ( 2 ) , 133-47.

- and Hallberg, M. (1982), 'Measuring producers ' advantage from c l a s s i f i e d p r i c i n g o f m i l k ' , American Journa l of A g r i c u l t u r a l Economics 64(1) , 1-7.

S t r e e t , J. (1974), 'Demand f o r milk', Review of Narketing and A g r i c u l t u r a l Economics 42 ( 2 ) , 100-12.

Tedesco, R. (1980), The Factors Inf luencing Demand fo r Wholemilk i n New South Wales, Masters t h e s i s , Univers i ty o f Sydney.

Turnovsky , S. (1978), 'The d i s t r i b u t i o n o f welfare ga ins from p r i c e s t a b i l i s a t i o n : a survey of some t h e o r e t i c a l i s sues ' i n F. Adams and S. Klein (eds.) , S t a b i l i s i n g World Commodity Markets, L,exington Books, Lexington, Mass, pp. 119-48.

- (1976), 'The d i s t r i b u t i o n of welfare gains f rom p r i c e s t a b i l i s t i o n : the case of m u l t i p l i c a t i v e d i s tu rbances ' , I n t e r n a t i o n a l Economic Review 17 (l), 133-48.

Veeman, M. (19821, 'Socia l costs of supp ly- res t r i c t ing marketing boards ' , Canadian Journa l of A g r i c u l t u r a l Economics 30(1) , 21-36.

I R831275 Cat. No. 83 1550 1