Milk: Why a Production Cost Increase

Got Milk

Patrick M. McBride, Jr.

Renee Hafernick

Sam Koepp

June 13, 2007

Microeconomics

Dr. Spencer

Point Distribution for Paper

Turn on “track change” mode to see comments.

Criteria / Points Possible / Points Earned
Topic fulfilled the assignment:
How well the selected article illustrated the topic
Paper explained current economic issue
Paper used appropriate definitions/concepts/theory correctly / 24
8
8
8 / 8
8
8
Writing mechanics:
Relevant writing of appropriate length
Clarity and correct formatting of writing / 16
8
8 / 8
8
TOTAL / 40 / 40

This is the best written paper I’ve read this term! Might you consider allowing me to use it as an exemplar for students in later semesters?

M.K. Spencer

Got Milk

The purpose of this paper is to look at a production cost increase within an industry or product and tie that with the information obtained from this microeconomic class. At first glance the easiest product to look at is the price of gasoline, but we wanted to look at a product that’s increase of production cost is partially tied to the price of gasoline. The production that we chose as a group is the dairy industry, especially the increase in the production of milk.

Before we look at why there has been an increase in the production of milk, it may be important to review how we arrived at the total cost of production for a product. Hubbard’s text Microeconomics looks at the two types of cost that account for the total cost of production. He suggests that there are variable and fixed costs that equal the total cost of production. The equation for total cost is:

Total Cost (TC) = Fixed Cost (FC) +Variable Cost (VC)

Variable costs are considered costs that fluctuate as output fluctuates, while fixed costs are costs that remain consistent as the output fluctuates. The texts states that fixed cost consist of building costs, insurance, and advertisement, while variables cost are tied to labor and material needed for production. The cost that we will be looking at that contributes to the increased cost of milk production is considered variable.

The article entitled: Skyrocketing price of milk may top spikes in gasoline, states that milk has already seen an increase of about a dime per gallon this year. It suggests that milk can still see a further increase of 40 cents more in the next several months, including 60 cents per pound for cheese. Prices in the last survey, according to the article, have seen prices range from $2.76 a gallon to $4.09 a gallon in several cities across America with an overall average of $3.78 dollar per gallon.

The reason for the spike in the price of milk can be directly tied to the increase in the cost of production. The dairy industry has seen a substantial rise in the price of gasoline, but the push for alternative energy sources have also led to the up-tick in cost. The article states:

“Hutjens and others said higher gasoline prices have increased the costs of moving milk from farm to market, and corn—the primary feed for dairy cattle—is being gobbled up by producers of the fuel-additive ethanol. The USDA projects that 3.2 billion bushels of this year’s corn crop will be used to make ethanol, a 52 percent increase from 2006” (Mercer).

The demand for American milk by foreign buyers is also contributing to the increase in price. The economic boom that has been experienced in the Asian market, as well as, the inability of other developed countries to contribute to supplying milk has led to a decrease in the supply. Chris Galen, who is a spokesman for the National Milk Producers Federation, suggests that China is the biggest consumer on the international playing field. He suggested that China’s consumption of milk has increased, as well as, the use of more dairy ingredients. The problem with China’s consumption is the inability of other countries to contribute to the supply which has led to an increase consumption of milk from America.

The article further evaluated the cost of milk not only from the aspect of a consumer, but from a business standpoint. According to the article, it highlighted several different companies and industries that have been affected by the price of milk and dairy. Hershey Co., for example, has decreased their earning outlook for the remainder of the year due to the spike in the price of dairy, which is an essential ingredient in the production of chocolate. A second industry that relies on dairy is the pizza industry. The article suggested that Domino’s pizza is unable to increase their price of pizza because of the competitive nature of the industry. Therefore, the inability to pass the cost on to the consumer has led to a decrease in total revenue for the company.

Milk, as suggested by Mercer, is a necessity in the American economy. Therefore, we as the consumer will continue to buy milk as we see the price increase. However, with the increased political pressure on the federal government to find alternative forms of energy and the increased volatility of the oil market, just how much is the American consumer willing to pay for milk? Only time will tell, hopefully we won’t have to explore that possibility.

Citation:

Mercer, David. (2007, May 31). Skyrocketing price of milk may top spikes in gasoline. Columbus Dispatch. Retrieved June 13, 2007, from http://www.columbusdispatch.com/dispatch/content/local_news/stories/2007/05/31/dairy_prices.ART_ART_05-31-07_A1_BT6SHR7.html

Dairy dilemma

Skyrocketing price of milk may top spikes in gasoline

Thursday, May 31, 2007 3:51 AM

By David Mercer

ASSOCIATED PRESS

CHAMPAIGN, Ill. -- Liz Kooy loves sharp cheddar cheese and is willing to pay almost any price for it.

"Ten dollars a brick, I'd still buy it" and cut back on other purchases, the laughing 36-year-old social worker said as she browsed the dairy aisle in a grocery store near downtown Chicago yesterday.

She might want to start looking for places to cut back.

Dairy-market forecasters are warning that consumers can expect a sharp increase in dairy prices this summer. In a few weeks, the milk futures market predicts, the price paid to farmers will have increased 50 percent this year -- driven by higher costs of transporting milk to market and increased demand for corn to produce ethanol.

U.S. retail milk prices have increased about 3 percent, or roughly a dime a gallon, this year, according to the U.S. Department of Agriculture. But University of Illinois dairy specialist Michael Hutjens forecasts further increases of up to 40 cents a gallon for milk over the next few months, and up to 60 cents for a pound of cheese.

That would drive the cost of a gallon of whole milk across the country to an average of $3.78, based on the USDA's monthly survey of milk prices in 30 metro areas.

Prices in the last survey, earlier this month, ranged from $2.76 a gallon in Dallas to $3.86 in Chicago and $4.09 in New Orleans, where the dairy industry has struggled to bounce back from Hurricane Katrina.

Hutjens and others said higher gasoline prices have increased the costs of moving milk from farm to market, and corn -- the primary feed for dairy cattle -- is being gobbled up by producers of ethanol. The USDA projects that 3.2 billion bushels of this year's corn crop will be used to make ethanol, a 52 percent increase over 2006.

"There is no free lunch," Hutjens said. "That corn then has to come away from that dedicated resource."

Chris Galen, a spokesman for the National Milk Producers Federation, pointed to another factor: Global demand for milk, he said, has grown in the past few years, primarily in the new Asian economic powers.

"China, of course, is a big story," he said. "They're consuming more (milk protein); they're using more dairy ingredients in animal feed."

In years past, that demand might have been met by Australia and New Zealand, he said. But drought in Australia and the limits of New Zealand's dairy industry have pushed China and its neighbors to buy American.

Hutjens said the biggest dairy-price spikes are likely to come later this summer in the areas farthest from the Midwest corn and grain fields that feed most of the country's dairy cattle.

"Certainly, I think you're gonna see it worse in places like the Southeast -- in Georgia and Florida -- and California," he said.

The USDA doesn't survey prices in California because the state sets minimum farm-level prices, skewing retail dairy prices. But those retail prices are near $4 a gallon in many cities there, too.

Vons, one of the major chains operating in California, charged $3.99 for a gallon of whole milk at its Los Angeles-area stores yesterday, according to its Web site.

Like consumers, companies that use milk, cheese and other dairy products are expecting to spend more the rest of this year.

Hershey Co., the country's biggest candy-maker, recently scaled back its earnings expectations for this year, due in part to higher dairy costs. Kraft Foods raised prices earlier this year on some dairy-based products.

Similarly, Domino's Pizza recently said that it expects to pay more through the rest of this year for the cheese it melts on top of more than 1 million pizzas every day. But Domino's says it probably won't raise the price of a pizza because its industry is too competitive, spokesman Tim McIntyre said.

"Margins get squeezed when prices go up, but everything goes in cycles," he said in an e-mailed statement. "We plan for this and ride the wave."

Competition might be the best guard against rapid increases in retail dairy prices, too, said the Milk Producers Federation's Galen.

Mass-market retailers such as Wal-Mart, Target and Costco, he said, often sell milk at cost to pull in customers, then make their money elsewhere. That tends to limit how high grocers can raise their prices for milk.

The last dramatic dairy-price increases were in 2004, when -- following a period of low prices -- production fell and many farmers left the business, Galen said. The increase was sharp, he said.

This time, prices appear to be heading for a more sustained plateau, Galen said.

No matter, many consumers say. Similar to the way they continue to buy just as much gasoline now as they did before prices spiked this year, higher dairy prices won't change how much they buy.

Chicago interior designer Denise Olsen, 41, said as she shopped yesterday that she won't change how much milk, cheese and yogurt her family buys.

"Gas and food are necessities, where I don't need a new pair of shorts for the summer," she said.

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