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between will represent the cost of transporting milk

between them.

Figure 3.3 depicts this alignment.

There is a second type of price alignment, blend price alignment, and the distinction is an important one. The Class I differential is the price set by the Department of Agriculture. These prices are aligned

in the sense that they increase with distance from the milkshed. However, the price that really affects the

flow of producer milk is the blend price, the price actually received by a farmer. This price is determined not only by the minimum prices set, but also by the utilization rate in the market. Blend prices will naturally align to reflect transportation costs between markets regardless of the actual level of Class I and Class II prices. This is because, although Class I differentials are set at fixed levels, the price mechanism operates to bring the system back into alignment when small supplydemand disequilibriums occur. If a "shortage" developed, Class I uses would have priority, thus forcing the utilization rate to increase. An increase in the utilization rate drives up the blend price. A higher blend price will attract increasingly distant suppliers into the market, which would than begin to drive the blend price back towards the level just high enough to compensate for transportation from one market to another. The term

88-934 0-77-pt. 1-49

Figure 3.3- Class I differentials in Federal Milk Order Markets, January 1, 1976. MILK MARKETING AREAS UNDER FEDERAL ORDERS AS OF JANUARY 1, 1976

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USDA, "Summary of Major Provisions in Federal Milk Marketing Orders January 1, 1976", p. 55.

Source:

-264

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"shortage" is used very loosely here.

Supply would be short only in the sense that there was not enough surplus to drive the blend price back down to the level which would make it unprofitable to ship raw grade A milk from farms which normally sell in other market orders. It is quite conceivable that distant sources will sometimes be attracted even though the fluid needs of a market are more than adequately covered.

The upper Midwest is the most efficient area of the country for milk production. For this reason, milk will ultimately come from this region if blend prices rise above Therefore, this area must be the basing

the alignment.

point. Figure 3.4 reveals how blend prices increase in a pattern radiating from the Minnesota-Wisconsin area. Given that blend prices will align anyway, the

question to be answered is at what level should the prices be set. This decision is implemented by setting the Class I differentials.

When the milk order program was first initiated, milk markets were correctly perceived as highly local in nature. The theory then was to have prices in the less efficient production areas set higher than they would be in the nation's milkshed in order to assure that an adequate supply of local milk for fluid needs would be produced. Now that the technology of transportation has improved

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Figure 3.4--Average Blend Prices in Federal Order Markets, 1975.

USDA, Federal Milk Order Market Statistics--Annual Summary for 1975, p. 68.

Source:

to the point where milk can move in bulk as far as 2,000 miles, a limit was effectively placed on the level to which prices in less productive areas could be raised. The upper bound is the price in surplus regions plus the cost of moving that surplus to deficit areas. If Class I differentials were set so as to result in blend prices higher than this, milk could be economically delivered to the distant markets from the surplus production regions in the upper Midwest. If prices went higher than this level, a market would become flooded with not only locally produced milk, but surplus milk from other regions as well. Thus, transportation alignment generates the greatest amount of local production without sacrificing the goal of insulating the local market from outside supplies. Instead of simply setting local prices to reflect local conditions as could be done when milk markets were local by necessity, pricing policy must now take into account transportation alignment. Keeping markets insulated from outside milk in the face of improved transportability has necessitated raising the overall price level for milk. To maintain local self-sufficiency, prices must first be set in the least efficient region at a level high enough to bring forth adequate supply, and then prices must be reduced consistent with transport costs as the base point, Eau Claire, Wisconsin, is approached.

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