[MUSIC] My name is Jim Dunn, I'm a Professor of Agricultural Economics at Penn State University and my specialization is Dairy Economics. Dairy markets are marked by time legs and perishability issues. For drinking milk in particular, and all dairy products to a lesser extent, people are not induced to buy more if the price is less. If drinking milk is on sale, the consumers are unlikely do buy twice as much since milk is not very storable as it must be refrigerated and takes up a lot of space in the refrigerator even refrigerated milk can spoil. Most dairy products are considered necessities, this is especially true of drinking milk, many parents will buy the milk for their children regardless of cost. This lack of price sensitivity is called inelastic demand. On the farm, milk has an inelastic supply, that is, the farmer cannot adjust milk production quickly if the milk price changes. Dairy cows stay in production for many years, in addition, it takes a long time for a cow to start producing milk. A calf is bred, once she's one year old and has her first calf a year later. So, you get no milk until the animal is two years old when her first calf is born. This lack of adjustment by both consumers and producers creates a lot of price volatility, we see in this slide the enormous amount of price volatility for the class three or the price of milk to make cheese, until 1985 we had a stabilization program where the government bought up all the surpluses, but the price was too high and we were buying up 15% of milk production and in the process of lowering the support price to a level where it no longer provides support, we have now very great price volatility for milk. The shelf life of milk depends on farm refrigeration. Generally, very small farms with one or two cows do not have a refrigerated milk tank, while some of the biggest farms quick chill the milk to just above freezing. Immediately, after it comes from the cow and pump it straight into the milk truck, that carries it to the factory that processes it. This reduction of temperature, reduces bacterial growth and spoilage. Other dairy products such as cheese, butter and powdered milk are much more storable and can last for several months or even years before it being consumed. Farm milk used to produce these products often receives a lower price. Since, there's no urgency for finding a customer for the product. The productivity in an average dairy cow grows by about 1 percent a year in the United States and other modern dairy countries, while in developed countries the population usually grows more slowly. This means the dairy industry depends, that if the dairy industry depends only on the domestic market, it will need fewer cows every year. Since, the number of cows per farm also grows, this means the number of dairy farms falls over time. Between 1990 and 2010, the number of dairy farms in the United States has dropped by 70%. The ability to export dairy products can partially offset this natural shrinkage, if the industry can effectively compete in world markets. To export dairy products, the nation must have prices and production costs below the world average and be able to produce products the rest of the world wants to buy. In the past decade, the United States exported much more dairy products, which has allowed the industry to grow and to benefit from increase in prosperity and other parts of the world. Especially, China and Latin America. The North American Free Trade Agreement provided market access to Mexico and Canada, that was not their previously and now Mexico is the biggest US dairy customer. What do different dairy customers want? For each customer the answer will vary. For example, Mexico imports American cheese for Resorts and exports Mexican cheese to South Mexican immigrants living in the United States. One challenge in an international trade is the issue of the regional appellations. Europe in particular has many limits on standards of identity according to origin. For example parmesan cheese must come from parma, in Italy. This is a continuing stumbling block in European Union, US trade talks since American Parmesan cheese is used to make pizza in the United States. American processors have developed this market over the years would not want to sacrifice it to Italian processors at this point. Historically, before trade in dairy products was widespread, many governments instituted polices to stabilize milk prices. Generally, these policies involved a system of production quotas and support prices, where the government would buy excess production and pre-established prices, and then dispose of these government inventories in various ways including selling them at a loss overseas or providing famine relief for distressed countries. Invariably, the political pressure led to raising government support prices faster than production cost grew and very large government stockpiles accumulated. The farmers didn't want the stocks distributed in their home country, and farmers in the receiving country didn't like having to compete with subsidized imports. These policies are now ending with New Zealand leading the way in the 1990s, now, the U.S. government has offered subsidized margin insurance to help farmers in a year of low prices, but is largely out of the commodity storage business. In April 2015, the European Union ended its dairy production quotas and farmers can expand or relocate as they see fit. And general, artificially high farm prices are not sustainable in the world of free trade. With the last 20 years,we've seen the growth of dairy exports in the United States grow from about 5% of milk production to up to 17% of milk production. As we've gotten rid of our dairy price supports and brought our prices in line with world markets, and now we are the third largest dairy exporter in the world after New Zealand and the European Union. A further complication in dairy markets is seasonal demand, when the students return to school in the autumn, milk consumption rises. During the winter holidays in Europe and America, more baking and entertaining increases butter consumption. These cycles do not coincide with the production cycles of the cows so storage is required to equalize seasonal supply and demand. Milk production is uneven throughout the year. Production depends on weather, quality feed, when the cow has a calf, and other factors. So, what we see in this slide is that milk production is most in May. In the spring, when you have good, new grass and it falls as the year goes on and is generally at it's lowest, just before Christmas. And at that point the cows are consuming stored feed and that feed isn't necessarily as good as the fresh stuff coming out of the field. The seasonality in the United States is much decreased because most of our cows are in confinement, but in some countries, like New Zealand, the seasonal high is 20 times the seasonal low, and so for example, in the middle of their winter they're basically producing just enough milk for the domestic milk drinking population. Historically, in temperate climates, the highest milk production is in the spring. As the temperatures rise,the quality of the grass decreases and milk production falls. In extremely hot climates such as south Australia. Dairy farmers often dry off their herd and take a break in the summer. In winter, places where there are mostly grass fed dairy herd suspend production and wait for spring. The examples are Ireland and New Zealand. These extreme fluctuations in milk production did not match well with the fluctuations in milk consumption. And create a lot of seasonal variation in prices and income. Farmers must plan ahead for the lean months, and consumers may find prices vary considerably throughout the year. All of this makes planning a challenge. It also means farmers must plan for periods of poor profitability. It occur but periodically. [MUSIC]