	Introduction

A dramatic collapse in farm milk prices late in 2008, which resulted in severe financial stress for many dairy farmers, led to efforts in 2009 by both Congress and the Administration to provide assistance for milk producers. Market dynamics in 2009 have also generated concerns about "dairy pricing" and the adverse effects of milk price volatility on farmers. Dairy pricing is shorthand for the process of establishing the farm value of milk. The federal government plays a prominent role in that process. Among the related issues are (1) how milk producers receive price signals under existing policy and how that affects production decisions, (2) farm milk price variability and managing price risks, and (3) the farm share of retail prices for dairy products and whether retail prices track changes in the farm milk price. Dairy Pricing Mechanics

Dairy pricing in the United States is a unique combination of both market-based and administered (through public dairy policies or programs) prices. Each influences the other to determine the overall level of farm milk prices as well as price movements to some extent. Two characteristics—perishability and production on a daily basis—create challenges for pricing and marketing milk (and the products made from it). Market-Based Pricing

Market-based pricing for milk and dairy products is similar to that for many other agricultural commodities, in that primary mechanisms for price discovery like cash and futures markets, such as those located at the Chicago Mercantile Exchange (CME), play key roles. Wholesale cash prices for dairy products (cheese, butter, and nonfat dry milk) are determined daily at the CME. The prices written into contracts nationwide between dairy manufacturers and wholesale or retail buyers of basic dairy products often reflect CME prices. Some dairy producers say that cash market pricing on the CME works to the detriment of producers (see " Potential for Price Manipulation ," below). Administered Pricing

Administered farm milk prices are derived from two government policies: the dairy product price support program (DPPSP) and federal milk marketing orders (FMMOs). The two policies originated at least 60 years ago and operate independently until market prices decline to support levels. The DPPSP simply provides price support for dairy farmers through government purchases of dairy products at legislated minimum prices. In contrast, the FMMO system generally does not support prices but is designed to stabilize market conditions, which had been chaotic in the 1920s and early 1930s, through monthly, market-based minimum prices that processors must pay for farm milk. FMMOs also provide a pricing system for sharing farm revenue across producers in certain geographic areas and for balancing marketing power between milk handlers, who reportedly held an advantage prior to FMMO development, and farmers. Under the DPPSP, the federal government stands ready to purchase unlimited amounts of butter, American cheese, and nonfat dry milk from dairy processors at specified minimum prices. As Congress, the Administration, and the dairy industry consider how possibly to revise the dairy pricing system, two schools of thought appear to be emerging. One is to reduce price volatility through some means of supply control while raising farm prices. The other is to allow the market to fluctuate and help farmers manage the resulting price risk through hedging strategies used by farmers in other parts of the agriculture sector. Outlook

Current policy is set for the dairy product price support program until 2012 under the 2008 farm bill, and federal milk marketing orders are permanently authorized.
A dramatic collapse in farm milk prices late in 2008, which resulted in severe financial stress for many dairy farmers, has generated congressional concerns about "dairy pricing" and the adverse effects of milk price volatility on farmers. Dairy pricing refers to the process of establishing the farm value of milk. The federal government plays a prominent role in that process.
Among the dairy pricing issues are how milk producers receive price signals under existing policy and how that affects their production decisions. Some market participants say that the system does not transmit price signals to milk producers quickly enough, which can delay the response of producers needed to correct market imbalances. Another issue is farm milk price variability and managing price risks, given declines in dairy price supports and increased dependence on exports over the years, which have contributed to greater price volatility. Finally, some observers are concerned about the farm share of retail prices for dairy products and whether retail prices track changes in the farm milk price. The difference between farm and retail prices has declined in recent months after increasing in late 2008.
Dairy pricing in the United States is a unique combination of market-based and administered (through public dairy programs) prices. Each influences the other to determine the overall price level and price movements to some extent. Two characteristics—perishability and production on a daily basis—create challenges for pricing and marketing milk (and the products made from it).
Market-based pricing for milk and dairy products is similar to many other agricultural commodities, in that primary mechanisms for price discovery like cash and futures markets, such as those located at the Chicago Mercantile Exchange (CME), play key roles. Wholesale cash prices for dairy products (cheese, butter, and nonfat dry milk) are determined daily at the CME. The prices written into contracts nationwide between dairy manufacturers and wholesale or retail buyers of basic dairy products often reflect CME prices. Some producers have raised concerns about limited trading volumes and the potential for price manipulation at the CME.
Administered farm milk prices are derived from two government policies that originated more than 50 years ago: the dairy product price support program (DPPSP) and federal milk marketing orders (FMMOs). The two policies operate independently until market prices decline to support levels. The DPPSP simply provides price support for dairy farmers through government purchases of butter, American cheese, and nonfat dry milk from dairy processors at legislated prices. In contrast, the FMMO system generally does not support prices but is designed to stabilize market conditions, which had been chaotic in the 1920s and early 1930s, through monthly, market-based minimum prices that processors must pay for farm milk. FMMO prices are based on current wholesale product prices, which are determined largely by prices established on the CME. FMMOs also provide for sharing farm revenue across producers in certain geographic areas and for balancing marketing power between milk handlers, who reportedly held an advantage prior to FMMO development, and farmers.
Current policy is set for DPPSP until 2012 under the 2008 farm bill, and FMMOs are permanently authorized. As Congress, the Administration, and the dairy industry consider how to revise the dairy pricing system, two schools of thought appear to be emerging. One is to reduce price volatility through some means of supply control while raising farm prices. The other is to allow the market to fluctuate and help farmers manage the resulting price risk through hedging strategies used by farmers in other parts of the agriculture sector.