Modeling the Price of Dairy Quotas under Price Ceiling Legislation
Alex Chernoff - PhD Student, Queen’s University | [email protected]
Research affiliation: Canadian Agricultural Trade Policy and Competitiveness Research Network
Rising Dairy Quota Prices
Dairy quota prices in Québec tripled in value between the early 1990s and
2006. How can we explain this rapid ascent in the price of quotas? I
develop a dynamic economic model of dairy farmers demand for production
quotas. Working from this economic model I develop an econometric model
that is used to estimate producers' discount factor. The model is estimated
using farm-level data from the Québec Federation of Management Clubs'
Agritel database. The estimation results are presented in Table 1. My
results suggest that the rapid escalation in dairy quota prices during the late
1990s was driven by a decline in dairy farmers’ perception of the risk of
major policy reform following the conclusion of the Uruguay Round of
multilateral trade negotiations in 1994. Working with my estimation results,
I calculate that Québec dairy farmers’ perception of this risk decreased from
11.15% in the early 1990s to 5.89% in the late 1990s and early 2000s.
In this paper I determine the magnitude of the decrease in the price of farm
milk that would be required to reduce the valuation of Québec dairy quotas
to the current price ceiling level of $25,000 per unit. Accomplishing this task
requires modeling the implicit valuation of quotas during the price ceiling
era. The modeled price, exchange price, and price ceiling are presented in
Figure 1 for the years 2000-2010.
Table 1: Discount Factor Estimates
Figure 1: Québec Dairy Quota Prices
Measuring the Impact on Dairy Farmers
In 2010, I estimate that dairy quotas in Québec would have traded at a
price of $31,955 in the absence of the price ceiling. My results indicate
that lowering the valuation of quotas to $25,000 per unit would have
required an 11.83% reduction in the price of farm milk.
How would an 11.83% reduction in the price of farm milk affect the
profitability of dairy farming in Québec? I answer this question by using
Statistics Canada data to compare the profit margin of Québec dairy farmers
with dairy farmers in the rest of Canada, and other Canadian animal product
producers. Figure 2 illustrates that dairy farming in Québec is more
profitable than in other parts of Canada. In 2010, an 11.83% reduction in
operating revenue would have reduced Québec dairy farmers' profit
margin to 4.46%. While this is the lowest level in recent history, the margin
would remain higher than the profit margin in other Canadian animal
product production industries.
Figure 2: Profit Margins in Animal Product Production
Price Ceilings on Dairy Quotas
Concern over escalating dairy quota prices prompted the provincial
marketing boards in Canada's two largest dairy producing provinces, Québec
and Ontario, to introduce ceilings on the price of quotas in 2007 and 2009
respectively. In Québec, dairy quotas have been traded at the price cap
(currently at $25,000 per unit) for over three years. Cairns and Meilke (2012)
note that the introduction of a cap on the price of quotas has created a new
source of inefficiency in the Canadian dairy sector. The authors argue that
the best mechanism to lower the price of quotas is to reduce the
administered price of farm milk. In theory, lowering the price of farm milk
could effectively reduce the price of quotas to any targeted level. The
advantage of this policy over the price cap is that the quota markets can
continue to allocate quotas to the most efficient producers.
Source: Statistics Canada CANSIM table 20048
Profit margins are defined as the ratio of net operating income adjusted for capital cost allowance to total
operating revenue
References
Cairns, A. & Meilke, K. (2012). Price ceilings on milk production quota values: future or folly? Canadian Journal of Agricultural Economics, 60, 93-112.