Economic and Marketing Report

COTTAGE CHEESE

Prepared for

THE MILK INDUSTRY FOUNDATION

by

The Economic and Marketing Committee on Cottage Cheese

July 1970

FOREWORD

This is one of three reports prepared for the Milk Industry Foundation by its Economic and Marketing Committee on Cottage Cheese, Cream, and Yogurt.

The Foundation and its members are deeply grateful to the Ex-Cel 1-0 Corporation and the suppl iers of Pure­Pak cartons for providing the necessary funds to conduct these studies. Their contribution to the industry through this channel is greatly appreciated.

The committee has carefully developed many facts re­garding the marketing of yogurt, cream,and cottage cheese. It has traced the competitive relationships of these products in the marketplace, identified substitutes and other products with which these compete, and calculated the potential effect on the market sales and dairy farmer income of various clas­sifications under Federal milk marketing orders.

The marketing information contained in each of the re­ports will be of great benefit to each company producing the products. Likewise, it will be of great benefit to regulatory officials in developing appropriate regulatory plans.

Committee members are prominent persons with extensive and varied backgrounds. Economists, marketing special ists, industry representatives,and food retailers have given their knowledge, talents,and broad experience to this study and its conclusions.

NEW YORK STATE COLLEGE OF AGRICULTURE A STATUTORY COLLEGE OF THE STATE UNIVERSITY

CORNELL UNIVERSITY

DEPARTMENT OF ACRICUL TURAL ECONOMICS

WARRBN HALL

ITHACA, NEW YORK 14850

Officers and Board of Directors Milk Industry Foundation Suite 1105, Barr Building 910 17th Street, N. W. Washington, D. C. 20006

Gentlemen:

We are pleased to transmit this report containing a considerable amount of marketing information on cottage cheese, and recommendations for the price classification of cottage cheese under Federal mi lk marketing orders.

We believe we have developed a number of facts which were heretofore not avai lable to the industry and regulatory officials. We have collectively analyzed these facts, reached conclusions, and offered recommendations. We hope the information presented in the report wi 11 be useful to all concerned.

Committee Members:

Dr. Robert E. Jacobson Co-chairman, Yogurt Report Ohio State University Columbus, Ohio

Dr. Ronald D. Knutson Co-chairman, Cream Report Purdue University Lafayette, Ind.

Dr. William Alexander Louisiana State University Baton Rouge, La.

C. N. Fistere Fistvre, Habberton & Durland Washington, D. C. (CounselfoT MIF)

Respectfully submitted on behalf of the M IF (:conomi ~ and ~1arket i ng Cammi ttee on Cottage Cheese, Cream, and Yogurt

" Dr. Richard Aplin, Co-chairman, Cottage Cheese Professor, Department of Agricultural Economics

Dr. Frank Groves University of Wisconsin Madison, Wis.

Dr. Richard C. Haidacher Purdue University Lafayette, Ind.

Mr. Dean Hicks The Kroger Company Cincinnati, Ohio

Mr. Joseph Kagan Dannon Milk Products Long Island City, N. Y.

Mr. Frank King Sealtest Foods New York, N. Y.

Dr. Don R. Nicholson Borden, Inc. New York, N. Y.

Dr. William G. Tomek Cornell University Ithaca, N. Y.

Dr. Francis E. Walker Ohio State University Columbus, Ohio

TABLE OF CONTENTS

FINDINGS AND CONCLUSIONS

PURPOSE

DESCRIPTION OF COTTAGE CHEESE INDUSTRY Production and Distribution Consumption Patterns for Cottage Cheese

ECONOMIC BASIS FOR CLASSIFICATION Application of Price Elasticities

1 1 2

5

FEDERAL ORDER POLICY ON COTTAGE CHEESE CLASSIFICATION 9

ELASTICITY ESTIMATES. . . . . 11 The Statistical Analysis 11 The Results 12 Elasticity for All Sales 12

PRICE ELASTICITY OF COTTAGE CHEESE AND CLASSIFICATION 13

CLASSIFICATION AND PRICING OF COTTAGE CHEESE. . . . 14 Cost of Alternative Sources of Cottage Cheese 15 Impact on Competitive Positions of Handlers 16

EFFECTS OF VARIOUS ALTERNATIVE PRICES OF MILK ON THE SALES OF COTTAGE CHEESE . . . . 17

Estimated Effect of Milk Price Changes on the Cost of Cottage Cheese. . . 18

Estimated Consumption Responses 19

EFFECT OF PRICING POLICIES ON DAIRY FARM INCOME 20

APPENDIX - STATISTICAL ANALYSIS 22 Pooled-Data Demand Relation 22 A Regional Demand Relation 26

Tables in Report

2

3

LIST OF TABLES

Total Production, and Production Per Capita of Cottage Cheese, Selected Years, 1950-1969, U.S .

Profi Ie of Users of Cottage Cheese and of United States Population ....

Comparison of Household Profiles of Cottage Cheese and Gelatin-Fruit Salad Users ..... . .

4 Federal Order Markets in which Cottage Cheese is Priced at an Intermediate Level Between Class and the Lowest Use Classification -- as of

2

4

6

Ap r i I I, .1970 . . . . . . . . 10

5 Cost of Mi lkfat per Pound and Cost of Skim Mi Ik per Hundredweight at Various Prices of Mj lk and with a Fixed Butterfat Differential of S.O Cents .. IS

6. Estimated Effects on Mi lk Ingredient Costs per Pound of Cottage Cheese of Changing to a Higher Priced Class for Cottage Cheese with a S.O Cent B.F. Differential. . . . . . . . . . . . .. . .. IS

7 Retail Price of Cottage Cheese per Pound with IO-Cent, 25-Cent and 50-Cent Differentials Added

Tab les in AppendiX

to $4.65 Class II Price (S.O-cent fat differential) .19

Price and Quantity of Cottage Cheese and Index of al I Grocery Sales for Selected Regional Groups of Supermarkets .............. ., 23

2 Estimated Demand Equations for Cottage Cheese at Retai I Level in the United States. . . . . . .. 25

STUDY OF MIF ECONOMIC AND MARKETING COMMITTEE ON COTTAGE CHEESE

Findings

1. Production per capita of cottage cheese in the United States increased steadi ly and significantly during the 1950 1 s, but it remained stable at around 4.6 pounds during the 1960 1 s.

2 Market research indicates that more than half the households in the United States use cottage cheese. Cottage cheese consumption increases as income and education increase.

3. Profiles of cottage cheese consumers and of gelatin and fruit salad con­sumers are nearly identical, indicating that these two categories may compete actively.

4. Production of cottage cheese has tended to become concentrated in fewer, but larger and more specialized plants. The product from many plants is dis­tributed over wide geographic areas. Some unregulated plants have regional distribution.

5. Milk used for cottage cheese is essentially priced in the surplus class in all federal order markets, but it is up-priced in some markets. As of April 1, 1970, milk used to manufacture cottage cheese was priced higher (5 to 25 cents per cwt. with 10-15 cents being most typical) than that used in other manufactured products in 18 federal order markets.

6. The retai 1 price elasticity of demand for cottage cheese was found to be -0.6. In other words, a 10% change in price will mean a 6% opposite change in the quantity demanded. This relationship is a measure of the net effect of price on quantity demanded, while simultaneously recognizing the impact of other significant factors.

Conclusion

Although the responsiveness of quantity demanded to price for cottage cheese is in the general range of elasticities reported for most other manufactured products, con­sumer purchases of cottage cheese appear somewhat less sensitive to price than most other manufactured dairy products. The slightly lower sensitivity of cottage cheese consumption to changes in retail price suggests that milk used in manufacturing cottage cheese might be placed in an intermediate price class. However, several important factors place limits on the amount, if any, that the price of milk used in cottage cheese should be increased above prices of other manufacturing milk uses. These I imiting factors include the cost of alternative sources of cottage cheese (including product from unregulated plants), the cost of alternative sources of ingredients"and the need to avoid interference with competitive relationships among handlers. These factors argue strongly not only for a uniform price for milk used for cottage cheese in all federal milk orders but also raise serious ~uestions whether milk used in cottage cheese manufacture should be classified separately and up-priced even though the sales of cottage cheese at the consumer level are somewhat less responsive to price than are other manufactured dairy p roduc ts .

Purpose

The classification plans of federal milk marketing orders are based on use categories. These categories sometimes are justified by the differing sanitation requirements for alternate uses of milk. It is commonly assumed, however, that manufacturing uses have less price inelastic demands (to be defined) than fluid uses. Thus, one may justify price differences for milk going into different uses on the basis of the principles of price discrimination.

With renewed interest in the Ilappropriate" classification categories under federal orders, there is renewed interest in the economic basis for classification. This report on cottage cheese is one of a series that provides estimates of price elasticities of demand for dairy products. The principal objectives of this study, then, are to estimate the price elasticity of demand for cottage cheese in the United States and to use this estimate in an analysis of pricing pol icies.

The report is organized as follows: The cottage cheese segment of the dairy industry is brieflydescribe-d,--and then the economic rationale for classification by use under federal orders is discussed. We next turn -to empirical estimates of price elasticities, including supporting information and evaluation of the estimates. Finally, the elasticities are used to estimate the effects of price changes on sales and on total revenues.

Description of Cottage Cheese Industry

Production and Distribution

The cottage cheese industry generally follows the regional distribution of population and is concentrated in the larger population areas of the United States. Five states produced 47 percent of total United States production in 1968. The most important produc'ing states in descending order of importance were California, New York, Ohio, Illinois, and Michigan. The production of cottage cheese, like frozen desserts, is more widely dispersed geographically than is the production of butter, cheese, and nonfat dry mi lk.

Total production and production per capita of cottage cheese are shown in Table 1 for selected years from 1950 to 1969. Production per capita increased steadily and significantly during the 1950 1 s, but it has remained stable at around 4.6 pounds during the 1960 1 s.

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Table 1. Total Production and Production Per Capita of Cottage Cheese, Selected Years, 1950-1969, United States

Total eroduction Per caeita eroduction Year mi 1. 1 bs . 1 b.

1950 462 3. 1 1955 640 3.9 1960 858 4.8 1965 901 4.6 1966 894 4.6 1967 897 4.5 1968 931 4.7 1969,'· 951 4.6

,'<Est imated Source: Dai ry Situation, USDA. November 1969.

Lowfat, or partially creamed cottage cheese (i.e. 2% butterfat or less), which is not produced or sold in many states at the present time, represented about 4 percent of total cheese production in 1969. Although precise data are not avail­able, lowfat cottage cheese is apparently increasing in importance.

The production of cottage cheese has tended to become concentrated in fewer, larger, and more specialized plants. The product from many plants is distributed over wide geographic areas. To cite some examples, a plant in St. Louis manu­factures cottage cheese which is shipped to markets in seven states ranging from Iowa to Arkansas (in a North-South direction) and from Tennessee to Kansas (in an East-West direction). Plants commonly serve markets in four or five states. Distribution of cottage cheese over distances of 300 to 400 miles is common. In some cases, cottage cheese is distributed over distances of 1,000 miles or . more. For example, cottage cheese produced in New York and Massachusetts is regularly distributed as far as Florida. In short, the markets for cottage cheese are regional and much larger than the market for fluid ~ilk. Manufacturers of cottage cheese where plants are in widely separated areas are competitors in certain markets.

Consumetion Patterns for Cottage Cheese

Three studies of the characteristics of cottage cheese consumers and their attitudes are available. One study is based on a representative group of 4,000 households throughout the United States who supplied MRCA with detailed records of all foods they prepared, served, and ate during the period July 1967 to ~une 1968 . .!!

1/ National Household Menu Census of the Marketing Research Corporation of America.

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A second study is based on interviews of about 1,500 females who did shopping and cooking for the family in October 1967.~ The third study is based on personal interviews of more than 1,200 mothers, 1,200 children, and telephone interviews of 150 pediatricians during June - July 1965.11 Interviews were conducted in 34 states in the third study. The results and conclusions of these three studies are similar. The more significant results of the studies are summarized in the following par~­graphs.

Each of the three studies indicated that more than half of the households in the United States use cottage cheese.

The profile of users of cottage cheese as determined from the MRCA panel provides some interesting comparisions with the total United States population (Table 2).

The other two studies provide similar conclusions. The data in Table 2 permit the fol lowing conclusions:

1. The percentage of households using cottage cheese is highest in the West and North Central and lowest in the South.

2. Cottage cheese consumption has a positive relationship with income; usage of cottage cheese increases as income increases.

3, As the level of education increases, the use of cottage cheese increases.

4. Famil ies with one or two persons are more 1 ikely to buy cottage cheese than other fami lies. Large families, of five or more persons, were relatively small buyers.

5. On a racial basis, a much higher percentage of whites report using cottage cheese as compared with nonwhites.

2/ Cottage Cheese - Some Trends - Some Consumer Profiles, published by American Dairy Association, June 1968.

3/ Cottage Cheese Attitude Study; Executive Summary, prepared for Lily-Tulip Cup Corporation by Gilbert Marketing Group, Inc., & Hill & Knowlton, Inc., October 1965.

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Table 2. Profile of Households using Cottage Cheese and Households of the United States

Household Characteristic

Households using Cottage Cheese"<

U. S. House­holds+

-------------percent------~------------------

Census Region Northeast North Central South West

Household Income Under $4,000 $4,000-6,999 $7,000-9,999 $10,000-14,999 $15,000 & over

Education-Head of Household

Less than 9 years 9-12 years 13 yea rs & ove r

Household Size 1 person

. 2 persons 3-4 persons 5 or more

Race Wh i te Nonwhite

23 34 18 25

20 25 25 21

9

24 46 30

14 34 34 18

98 2

U.S. Census Total Families of Households in Menu Census

(1965) Sample

25 25 28 29 30 28 17 18

24 23 27 26 24 25 17 18 8 8

32 27 47 48 21 25

15 13 28 32 34 34 23 21

90 92 10 8

"~<I Source: National Household Menu Census of the Marketing Research Corporation of America.

+/ Source: U.S. Census, 1965

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The Market Research Corporation of America study of 4,000 households through­out the United States also indicates that cottage cheese is used nearly equally on different days of the week, with slightly lower usage on Sundays. In addition, it shows that 91 percent of the servings of cottage cheese are as a part of a meal, with the remaining 9 percent used at snack time.

A particularly significant conclusion of the MRCA study is that the profile of consumers using cottage cheese is nearly identical to users of gelatin and fruit salads. That is, few differences exist on a regional, income, education, occupation, size of household, age of housewife, or race basis in the proportion of households using cottage cheese and those using gelatin and fruit salads (Table 3). These findings suggest that these two categories may be substitutes.

The most common reasons given for eating cottage cheese are that "it tastes good," "it is nourishing,11 and Ilit is low in calories. 1I !!! ~

Economic Basis for Classification

A basic objective of classified pricing is the stabilization of dairy farmer returns. A further objective, and the one of direct concern in this report, is the use of classified pricing to enhance farmer incomes. Classified pricing as practiced in milk marketing orders is a form of price discrimination. That is, different prices are established for different classes of mi lk with the objective of increasing returns to producers beyond those that would prevail without the classification program. The primary prerequisites for successful price discrimina­tion are (1) division of the product market into two or more segments (classifications) with different demand elasticities and different prices, and (2) avoidance of sub­stitution of a product sold in the lower-priced classification for product sold in the higher-priced classification.

The appl ication of the price discrimination theory to the pricing of mi lk in­volves the classification of milk on the basis of product use. The highest price classification (Class 1) includes milk used for fluid bottl ing purposes with corres­pondingly lower prices for milk in other uses. Fluid milk has the most price inelastic demand; i.e., percentage sales respond relatively little to a given percent price change whereas the quantity demanded for other dairy products is more responsive.

The historical rationale cited by the USDA for use classification of milk and for the higher price for fluid milk is the higher cost of providing the higher quality of milk required for fluid bottling purposes. However, if sales of fluid milk were not less sensitive to price changes (less price elastic) than other uses, the higher price for fluid (Class I) milk would not result in larger total revenue for dairy farmers.

4/ Cottage Cheese - Some Trends - Some Consumer Profiles, publ ished by American Dairy Association, June 1968.

5/ Cottage Cheese Attitude Study; Executive Summary, prepared for Lily-Tul ip Cup Corporation by Gilbert Marketing Group, Inc., & Hill & Knov~lton, Inc., October 1965.

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Table 3. Comparison of Household Profi les of Cottage Cheese & Gelatin -Fruit Salad Users

Percent of Total User Households Cottage Cheese Gelatin/Fruit Salads

Census Region Northeast 23 20 North Central 34 33 South 18 22 West 25 25

Household Income ($) Under 4,000 20 21 4,000-6,999 25 24 7,000-9,999 25 24 10,000-14,999 21 20 15,000 & over 9 11

Education - Head of Household Less than 9 years 24 24 9-12 years 46 42 13 years & over 30 34

Occupation - Head White Collar 38 40 Blue Collar 33 29 Farmer 4 6 Not a Worker 25 25

Household Size 1 Person 14 14 2 Persons 34 36 3-4 Persons 34 33 5 or more 18 17

Presence of Children None 56 58 Under 6 years 8 8 6-12 7 7 13-17 11 9 Under 6 & 6 - 12 9 8 Under 6 & 13 - 17 1 1 6 - 12 & 13 - 17 6 7 All 3 Ages 2 2

Age of Housewife Under 25 6 5 25 - 34 16 15 35 - 44 17 17 45 - 54 21 20 55 - 64 22 22 65 & over 18 21

Race --White 98 96

Nonwh i te 2 4

Source: National Household Menu Census by Market Research Corporation of America.

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The effect that price has on the volume of sales of different dairy products, therefore, should be a primary consideration in the classifying and pricing of milk used in various products. Unless price has a different effect on the sales of one milk product as compared with others, the price of milk used for all products inclusing fluid milk should be the same. If sales of one manufactured dairy product (e.g., cottage cheese) are less sensitive to price (less price eiastic) than other manufactured products, a higher price may be justified for the milk used in cottage cheese than for milk used in other manufactured dairy products. However, several important factors (discussed below) limit the amount, if any, that the price of milk used in such a product should be increased above prices of other manufacturing milk uses even if its demand is less price elastic.

If a higher price for milk used for cottage cheese appears to be justified on the basis of price elasticities, then the size of such a price differential, if any, depends primarily on the cost of alternative sources of cottage cheese and of ingredients and the need to avoid interfering with competitive relationships among handlers. These costs of alternative supplies include not only the cost of alter­native sources of the finished product but also the cost of alternative sources of ingredients needed to make the finished product. Both fluid skim milk and nonfat dry milk can be used to make cottage cheese, and thus the cost of alternative sources of fluid skim mi lk as weI I as the cost of nonfat dry mi lk must be considered. Even if a higher price could be justified for milk used for cottage cheese than for other manufactured products on the basis of differences in retail-level demand elasticities, this higher price may not be justified if handlers have lower cost sources of finished product (e.g., from unregulated plants) or of product ingredients.

If handlers in a market with a separate, higher-priced class for milk used in cottage cheese can buy cottage cheese from out-of-market sources at lower cost, they are likely to do so. In this case, producers would not benefit from the high price for milk used in cottage cheese. If the price of skim milk in outside markets is lower than within the market by more than the cost of transporting the finished product, cottage cheese is likely to be available from outside sources at lower cost than it can be made within the market. In addition, if skim milk in outside markets is available at lower cost than from within the market, this would defeat the purpose of a higher price for milk used in cottage cheese within the market. However, the advantage in the use of Iioutside" fluid skim milk would be less than for the finished product because of the greater bulk and higher transport cost.

The impact of a higher price for milk used in cottage cheese on the competiti ve position of handlers within the market also must be carefully considered in establ ish­ing such a price. Cottage cheese is distributed from some markets over very broad geographic areas, and the impact of a price change may occur at considerable distances from the market where the price change is made. A higher price for milk used in cottage cheese may cause handlers to lose cottage cheese outlets in distant markets. It is very important, when considering a separate classification, to make comparable changes over the entire area in which handlers compete for outlets. Otherwise the change in classifications and price may adversely affect the competitive position of some handlers and improve the competitive position of others. The theoretical improvement in producer incomes can be lost in the practical real ities of the market place .

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Application of Price Elasticities

Measures of price elasticities of demand for different dairy products are necessary in identifying potential changes in product classifications even though by themselves they do not indicate the feasibility of classification and pricing changes. This and companion studies are designed to provide information on the price elasticities for dairy products at the retail (consumer) level and as such to indicate the economic justification for classification changes in federal milk orders.

The price elasticity of demand is measured at the retail level. It is only at the retail level that the price responsiveness of the final purchaser, the consumer, can be measured. Price elasticities at the farm level can be derived from retail elasticities, and at that level the coefficient is generally more inelastic than at retail. But, unless the size and behavior of marketing margins differ for different products or in different markets, thereby changing the relative magnitudes of the elasticities, those estimated at the retail level are appl icable to a price discrimi­nation scheme to benefit farmers; that is, the commodity with the most price-inelastic demand at retai 1 will typically have the most price-inelastic demand at the farm level.

The demand for producer milk used in Class I depends on the retail-level demand for Class I milk and for butterfat and skim milk used in Class I products. Two facts are relevant in this determination. One is the demand elasticity for the product at the retail level. Obviously, the effect of the producer price on the retail price and, in turn, on the consumption of the product i~ a major determi­nant. If retail price has little effect on the sales of a product, then it is more logical to increase the cost of ingredients for that product than it is for a product with greater price responsiveness.

The second fact relates to the question of alternate sources of ingredients. If an alternate source of milk is available at lower cost, then the demand by hand­lers for local suppl ies would be highly elastic, or if no such alternate source is available, then the demand for local supplies would be highly inelastic. In most cases, this is not a very important consideration in determining which products should be in Class I under federal milk marketing orders. If Class I prices are properly al igned, such a lower cost alternate supply would not be available from another federal tirder area. Suppl ies from unregulated sources would not provide a lower cost alternate supply when down-allocation or compensatory payment provisions of orders are appl icable. Likewise, the use of milk components in Class I products which were previously priced at lower levels does not provide a lower cost source of milk ingredients when the cost of compensatory payments is added. The retail elasticity is the relevant elasticity assuming (1) proper Class I price al ignment among markets, (2) the use of compensatory payments or down-allocation procedures, and (3) increases in prices at the farm level are passed on to consumers. The last assumption is certainly appropriate in the case of fluid milk, at least over any period of time.

Thus, in determining whether certain products should be in Class I or some other classification, the elasticity of demand at the retail level is of utmost importance and should be the primary determinant.

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What is the potential for practicing price discrimination in classifying milk used in various manufactured prOducts where the consumption of some product(s), although more price sensitive than fluid milk, is less sensitive to retail prices than other manufactured dairy products? In such products, when compensatory pay­ments or down-allocation procedures are not imposed, demand at the farm level could be highly elastic as compared to the retail level. If unregulated products can enter the market at lower prices, then the demand by handlers for local milk would be highly elastic. Likewise, without compensatory payments, if milk com­ponents in concentrated form may be substituted for fresh milk suppl ies (e.g., making cottage cheese from nonfat powder) and if fresh suppl ies are priced higher than the cost of using the alternative source of ingredients, then the demand for fresh suppl ies would be highly elastic. Thus, the cost of "alternative suppl ies " place a I imit on the up-pricing of milk going into a manufactured dairy product even if the retail elasticity suggests that discrimination can be practiced.

On the other hand, the farm-level demand for milk used in one product in a particular market may be more inelastic than measurements at the retail level would infer . Institutional factors (e.g., control of supply by a cooperative or restrictive local health regulations) may severely I imit the availabil ity of alternative sources of supply (at least in the short run), and thus seemingly could make the demand for local milk suppl ies highly inelastic. However, under these conditions, it is the elasticity at the retail level that is controlling unless handlers absorb the price premiums resulting from a local monopolistic supply position. Thas is, assuming that higher milk prices are passed on to consumers as higher product prices, it is the retail elasticity that indicates the response of consumers to the higher price at the farm level. While suppliers might extract a premium for milk . used in a particular manufactured product, they cannot control the quantity demanded by consumers of the final product. And the quantity of milk purchased by the processor wil I be determined by retai I sales of the product. Consequently, assuming the handler passes higher milk prices on to the consumers, the retail-level elastici­ties are the relevant coefficients for determining the appropriate classification of milk.

Federal Order Policy on Cottage Cheese Classification

Milk used for cottage cheese is priced in the surplus class in virtually all federal order markets, but it is up-priced in some markets. As of April 1, 1970, milk used to manufacture cottage cheese was priced higher (5 to 25 cents per cwt. with 10-15 cents being most typical) than other manufactured products in 18 federal order markets (Table 4).

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Table 4 Federal Order Markets in Which Cottage Cheese is Priced at an Intermediate Level

Between Class I and the Lowest Use Classification as of April 1, 1970

(In all other Federal Orders, cottage cheese is in the lowest use classification.)

Market

Central Arizona Corpus Christi

Eastern Colorado Great Basin Inland Empire Kansas City Miami Valley Nebraska-Western Iowa Oklahoma Metropolitan

Oregon-Washington Puget Sound Red River Valley

Southern Michigan Tri-State Upstate Michigan Western Colorado Wichita

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Amount of Differential above lowest use classification price

+ .25 + .25 July-February + .13 March-June + .15 + .15 + .25 + .15 + . 20 + .15 + .10 above the price of butter,

powder,and cheese during March through August

+ .25 + .25 + .10 above the price of butter,

powder,and cheese during March through August

+ .15 + .15 + .15 + .05 + .15

A review of the decisions of the USDA in which milk for cottage cheese has been up-priced indicates that the primary factor considered.in rational izing the higher price was the fact that cottage cheese in each particular market was made in Grade A plants. In addition the "substantially" higher cost of deriving nonfat sol ids from powder than from producer milk has been estimated and reported in the decisions as an indication of the 1 imit to which milk for cottage cheese can be up-priced. Thus, the decisions indicate that the justification for increasing the price of milk used for cottage cheese has been (1) higher production costs asso­ciated with the Grade A milk used in cottage cheese and (2) the cost of acquiring cottage cheese ingredients from alternative supply sources. In fact, the USDA has not expl icitly considered the responsiveness of cottage cheese sales to price changes in its decisions.

Elasticity Estimates

The Statistical Analysis

An objective of this study, as indicated in the introduction, is to estimate the price elasticity of demand for cottage cheese in the United States. Cottage cheese is defined to include "regular" creamed cottage cheese, lowfat cottage cheese, and flavored cottage cheese. No attempt is made to measure elasticities for the different types. The prices of the various cottage cheeses are highly correlated, precluding separate analyses, and, in any case, we are interested in the demand for the aggregate category of cottage cheese.

Price elasticity of demand is defined as the percentage change in quantity demanded in response to a one percent change in price, net of the influence of other factors that cause quantity to vary. This does not mean-that other factors are assumed constant in the statistical analysis, an~ndeed we know that many factors cause variation in quantity. For instance, the consumption of cottage cheese is 1 ikely to increase with growth in population.

The classification plan under federal orders, as we argue elsewhere, does assume that price changes have differing effects on quantities demanded for different mi lk product, i.e., that price elasticities differ among products. Thus, an interest exists in measuring the net influence of price on quantity. Statistical methods are available to estimate such a net relationship. The statistical analysis, using observations on prices and on other factors influencing quantity, provides an esti­mate of the net relationship between price (as well as other factors) and quantity. In sum, whi le this report emphasizes the price-quantity relationship, the analysis recognizes that other factors influence quantity, and these other factors are incor­porated in the analysis (see appendix for technical details).

The analysis is based on data from supermarkets in the Northeast, Midwest, Texas, and California.Y Thus, the estimated elasticities are based on retaif-level data. The observations for each supermarket group cover the 5 years 1965-69, and these data are "pooled" to provide an estimate for the United States.

6/ Data on per capita consumption for the United States are available from the USDA; however, appropriate retail price data are not available. As a consequence,the analysis is based on data from selected supermarkets to represent a cross section of the United States.

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In addition, the group of Midwestern supermarkets provided data for the 10-year period 1960-1969. These data are also analyzed as an alternative to, and check of, the cross section analysis.

The heart of a demand relationship is, of course, price quantity is made a function of price in this analysis. The cheese is deflated by the index of all retail food prices. states that it is not just the absolute price but the price relative to all alternatives that is important. "All" food as a substitute.1!

and quantity, and retail price of cottage This specification of cottage cheese is implicitly treated

In the pooled-data equations, several variables are used to adjust for possible differences in regional demands. We, of course, also include nonprice variables to allow for other factors influencing the quantity of cottage cheese purchased each year.~ These technical details are explained in the appendix.

The Resu 1 ts

Price is a statistically significant variable in explaining variation in the quantity of cottage cheese. Other variables also are important in explaining varia­tion in quantity. Depending on the particular regression equation used, we found that 91 to 99 percent of the variation in the quantity of cottage cheese (through time and among regions) was associated with the explanatory variables used.

The price elasticity of demand for cottage cheese at retail, based on the pooled regional data, is Estimated to be -0.6. That is, a one percent change im retail price is estimated as resulting in a 0.6 percent change in quantity demanded net of the influence of other factors.2/

Elasticity for All Sales

Sales of cottage cheese by retail stores apparently account for about 80 percent of total sales of cottage cheese in the United States. The remainder is sold on home delivery routes and to institutional outlets, such as restaurants and hospitals, but data are not available for estimating elasticities for these other outlets. We did ask a number of cottage cheese manufacturers whether sales through nonretail store channels are more or less responsive to price changes than sales through retail stores.

11 Analyses were also conducted in which the observed (undeflated) price was used. In our judgment, the deflatp.d price gave the best statistical results as well as being consistent with econ')lTlic logic.

8/ It is perhaps worth emphasizing that the data cover just 5 years. Thus while changes in demand occur in response to change in population, income, preferences, and so forth, these changes will not be extremely large in 5 years.

9/ An increase in price would result in a decrease in quantity, assuming no other variables changed. Naturally, the effects of such a price increase might be "offset!! by population growth (or by other factors) so that observed quantity increases or does not change. But these other factors do not negate the effect of price. The price increase kept quantity from increasing by as much as it otherwise would have increased.

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Opinion was divided; some manufacturers thought sales to "other" outlets were less responsive to price than retail sales while other manufacturers thought the opposite was true. We conclude that the elasticity of -0.6 may be taken as representative of the one for all sales.

Price Elasticity of Cottage Cheese and Classification

The retail price elasticities for most manufactured dairy products have been estimated as being similar~ i.e., in the range -0.5 to -1.0_10_/ At the same time, the elasticity for fluid milk has been estimated as more price inelastic, i .e.~ in the range -0.2 to -0.4.~ Our analysis suggests that the price elasticity for cottage cheese is similar to those for other manufactured dairy products but perhaps slightly more inelastic than most other manufactured products.

The -0.6 coefficient for cottage cheese is somewhat different from the elasti­city of -1 . 0 for yogurt and for heavy cream reported in companion studies.~ ll! The elasticity for cottage cheese, however, is 1 ittle diffe47nt from those reported for ice cream and light cream in other recent studies.ll! _1_ Thus, the responsive­ness of quantity demanded to price for cottage cheese is in the general range of elas­ticities reported for most other manufactured dairy products. It fol lows that a different price for milk used in cottage cheese as compared with milk used in most other manufactured dairy products would be difficult to justify. Of course, since the demand for cottage cheese is slightly more price inelastic than for most other manufactured dairy products, one can argue that a higher price is technically justified for milk going into cottage cheese. But the differences in elasticities are small and the corresponding gains from separate classification will be small.

10/ George Brandow provides the following estimates: butter, -0.85i cheese, -0.70; icr cream, -0.55 (Interrelationships Among Demands for Farm Products and Impl ica­tions for Control of Market Supply, Penn State U. Bul. 680, Aug. 1961, p. 17).

11/ Brandow estimates the elasticity of fluid milk and cream as ~0.285 (ibid). Stewart Johnson estimates the price elasticity for milk to be -0.3 in the 1950's and -0.2 in the 1960 l s (liThe Effect of Price on Consumption,")Proceedings of the Sixth National Symposium on Dairy Market Development~ ADA, 1966, pp. 7-18). At least three other studies of either fluid milk alone or fluid milk and cream combined have obtained estimates of about -0.3 for the period from the late 1940's to the mid-1960's (Marguerite Burk, Consum tion of Dairy Products, an Anal sis of Trends, Variability and Prospects, Univ. of Minn. Tech. Bul. 2 ,19 9 .

12/ Economic & Marketing Report on Yogurt, MI~ July 1970

13/ Economic & Marketing Report on Cream, MI~ July 1970

14/ Ice cream study. The difference between the IAICM study and Brandow estimates of the price elasticity of ice cream are discussed in the IAICM study.

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Moreover, while it is difficult to test statistical hypotheses about parameters estimated in different studies, it seems unl ikely that coefficients such as -0.6 (cottage cheese) and -0.8 (ice cream and light cream) are "significantly" different.

Classification and Pricing of Cottage Cheese

Since consumer purchases of cottage cheese are somewhat less sensitive to price than purchases of most other manufactured dairy products, we turn to a more detailed discussion of the possible separate classification and pricing of milk used in cottage cheese. In estimating the amount that the price of milk used in cottage cheese might be increased if placed in a separate classification, several factors relating to the manufacturing and distribution of cottage cheese must be reviewed.

The production of cottage cheese over time has become concentrated in fewer, but larger,more specialized plants. As previously discussed, the cheese produced in these plants frequently is distribute~ over wide geographic areas. Because of the wide areas of distribution, the market for cottage cheese is regional or inter-regional in nature. Cottage cheese processed in one market frequently is distributed in several markets.

Another dimension of the problem of classification of cottage cheese under federal orders is that a number of specialized cottage cheese plants and the milk used are not subject to any market order regulation. To cite a few specific examples, a large cooperative plant located in Missouri and utilizing almost 100 percent unr~gu­lated milk, distributes cottage cheese throughout the south and southwest. A national dairy company operates a plant in Illinois which uses primarily unregulated milk to produce cottage cheese that is distributed in Iowa, Missouri, and, at times, in Florida. These are but two examples of the fact that a number of plants making cottage cheese from milk regulated under 'federal milk marketing orders are indi rect competition with unregulated plants. The relative costs of milk at such plants influence the nature of competition between regulated and unregulated plants.

Another complication in classifying and up-pricing milk used in cottage cheese arises because manufacturers can use nonfat dry milk rather than fresh skim milk in making cottage cheese.

Another very important market reality that bears on the feasibil ity of the up­pricing of milk used in cottage cheese, is the wide variation in the actual skim milk and whole milk prices in various markets. In September 1969, the prices of Class II skim milk among federal orders varied over a range of more than $.40 per hundredweight. Moreover, premiums, the level of hauling charges, and charges made by cooperatives for services performed mean that Class I I prices do not necessari l y reflect the actual cost of skim milk for cottage cheese processors. Such rea l ities of the market­place must be considered in making decisions on classification and pricing.

Consequently it is important to recognize that there are limits on the amount that the price of milk used in cottage cheese should be increased above prices of other manufacturing milk uses. The premium, if any, on milk used in cottage cheese is limited by two factors: (1) the cost of alternative supplies and (2) the need to avoid interfering with competitive relationships among handlers. These considerations were discussed in an earlier section of this report. In this section the 1 imitations are quantified to the extent that they limit the price differential that can be justi­fied for milk used in cottage cheese.

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Cost of Alternative Sources of Cottage Cheese

Not only must the cost of alternative sources of the finished product be taken into account in determining the feasibility of up-pricing mi lk used in cottage cheese but the cost of alternative sources of ingredients needed to make the finished product should be considered. Both fluid skim milk and nonfat dry mi lk can be used to make cottage cheese and, therefore, the cost of alternative sources of fluid skim milk as well as the cost of nonfat dry milk must be taken into consideration in deter­mining the price differential that can be justified for milk used to make cottage cheese. For instance, if handlers in a market with a separate,higher-priced class for milk used in cottage cheese can buy cottage cheese from out-of-market sources at lower cost, they are likely to do so. If this occurs, local producers would not receive any benefit from the higher price for milk used in cottage cheese.

The cost of transporting packaged cottage cheese in refrigerated trucks with 40,000 pound capacity, as reported by several industry sources, ranges from 26 to about 60 cents per hundred pounds per 100 mi les on hauls of 200 to 350 miles. Since approximately 15 pounds of cottage cheese are manufactured from 100 pounds of milk, it costs from between 4 and 9 cents to move 100 pounds of mi lk equivalent in the form of cottage cheese. The variation, in part, reflects the degree of back-haul involved. Furthermore, costs per mile are lower for longer-distance hauls than for short distances. The cost of transporting cottage cheese is no more than 20 cents per 100 pounds of product per 100 miles for hauls of more than 1,000 mi les. This is equivalent to about 3 cents per 100 pounds of milk equivalent. Thus, handlers in a market with a 30-cent per hundredweight higher price for milk used in cottage cheese could afford to transport finished product from a market location well over 1,000 miles away. As noted earlier, differences in order prices vary by more than 30 cents. Super pool premiums and handl ing charges by cooperatives may add to these differences.

If skim mi lk in outside markets is available at lower cost than within the market, this would offset any advantage to producers of a higher price for milk used in cottage cheese within the market. The advantage of the use of fluid skim milk would be less than for the finished product because of the greater bulk and higher transport cost.

Another factor that limits the size of the price differential for milk used in cottage cheese is the added cost, if any, of using nonfat powder instead of fresh skim. If the price of milk under an order were "too high" relative to the price of powder, then cottage cheese manufacturers would have an incentive to substitute powder for fresh skim milk. Currently, some manufacturers do not use powder in making cottage cheese "regardless of the circumstances;!! others use powder only as a supplement to fresh skim milk. Still other manufacturers report that in some operations (especially in the South), at least some times of the year, they use nonfat dry milk exclusively in making cottage cheese. Although the majority of the manufacturers surveyed indicated that they can make a better qual ity product from fresh skim, some indicated that a good product of consistent quality can be made from 100 percent powder.

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It is difficult, if not impossible, to calculate precisely the difference in cost of making cottage cheese from powder and from fresh skim milk. The CCC price per pound of spray process nonfat dry milk as of April 1,1970 was 27.2 centa a pound. Using a yield of 8.6 pounds of nonfat solids per hundredweight of skim milk, the cost of nonfat milk sol ids from powder was equivalent to $2.34 per hundred­weight of skim equivalent. Although the manufacturers queried agreed that it was more expensive to use powder than skim in their cheese operations (because of the cost - especially labor - of reconstituting powder), they were unable to give a very precise estimate of the added costs. The majority seem to think that the added cost of reconstituting and using powd~r for cottage cheese would be approximately 3 to 5 cents a hundredweight. It is also difficult to compute an accurate, representative cos-t of nonfat solids derived from producer milk. If we assume a manufactured milk price of $4.65 per hundredweight and an 8-cent butterfat differential, a cost of $1.85 per hundredwe~ght of skim appears reasonable.l2/ These calculations would suggest that the cost of nonfat milk sol ids derived from powder is about $.53 ($2.34 + .04 - 1.85) per hundredweight of skim equivalent more than the cost of nonfat sol ids derived from producer milk. However, the answer is not quite that simple. A number of factors (some favoring powder,others the use of skim) could be as significant as the calculated $.53 per hundredweight difference. These factors include differences in yield; diff­erencesin the effect on manufacturing plant scale economies (i .e., in many areas the use of powder instead of fresh skim would seem to facil itate the achievement of plant-scale economies); differences in the cost of hauling skim from country points to city plants vs. the cost of hauling powder (which would favor the use of powder to the extent cheese is made in city locations); qual ity differences (which would appear to favor use of fresh skim); differencesin the effective cost of skim milk to handlers (which varied as much as $.50 per hundredweight in September 1969); and the problem of disposing of fat from fresh whole milk.

Impact on Competitive Positions of Handlers

The impact of a higher price for milk used in cottage cheese on the com­petitive position of handlers within the market must be carefully considered in establishing such a price. Cottage cheese is distributed from some markets over very broad geographic areas and, as previously discussed, the impact of such a price change may occur at great distance from the market where the price change is made. A higher price for milk in one region may cause handlers to lose cottage cheese outlets in distant markets. It is very important, when considering a separate classification and higher prices for milk used in cottage cheese to make comparable changes over the entire area in which handlers compete for outlets.

15/ See Table 5.

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As noted earlier, reported class prices do not necessarily indicate the actual cost of milk to a handler. The lack of firm prices across the nation, because of various institutional factors, makes it impossible to determine the precise impact of a premium on milk used in cottage cheese. Consequently, the possibility of administrative interference with the competitive position of processors suggests caution in up-pricing milk used to make cottage cheese. Placing milk used in cottage cheese in a separate class could upset competitive relationships and still not improve returns to farmers.

These factors argue strongly not only for a uniform price for milk used for cottage cheese in all federal milk orders but also raise serious questions whether milk used in cottage cheese manufacture should be classified separately and up~priced even though the sales of cottage cheese at the consumer level are somewhat less responsive to price than are other manufactured dairy products.

Effects of Various Alternative Prices of Milk on the Sales of Cottage Cheese

This section analyzes the likely effect of price increases on the use of dairy ingredients in cottage cheese and the likely effect on consumer purchases as these cost increases are reflected in the retail price.

Federal regulations on creamed cottage cheese call for a minimum of 20 percent total sol ids and at least 4 percent milk fat. Trade sources indicate that manufacturers aim for 4 percent milkfat and 16 percent solids-not-fat in creamed cottage cheese.

The following analysis of cost changes is based on four assumptions:

1. In many federal order markets, the butterfat differential for Class I I or I I I milk has been standardized at approximately 11.5 percent of the Chicago butter price. The Chicago butter price used in these calculations was 69.85 cents per pound, the CCC purchase price. The price for spray process powder was 27.2 cents per pound, also the CCC purchase price. Based on this butterfat price, the butterfat cost per pound paid by processors would be 81.85 cents (Mfg. milk price $4.65, butterfat differential 8.0 cents, and skim cost per hundred weight $1.85). Holding the butterfat differential at this level also dictates that any increase in milk ingredient cost would be reflected largely in the price charged handlers for the skim milk or solids-not-fat portion.

2. The cost changes are based on increased prices for milk used to make cottage cheese of $0.10, $0.25 or $0.50 per hundredweight.

Starting with a manufacturing milk price of $4.65 per hundredweight, the cost of butterfat, and costs of skim milk and soldis-not-fat to processors would be as indicated in Table 5.

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Table 5. Cost of Mi lkfat Per Pound and Cost of Skim Milk Per Hundredweight at Various Prices of Milk and With a Fixed Butterfat Differential

of 8.0 Cents

Fat Cost Skim Cost Pri ce of Milk Per Pound Per Cwt.

$4.65 81. 85¢ $1.85 4.75 81.95 1. 95 4.90 82.10 2.10 5. 15 82.35 2.35

3. It is assumed that any increase in ingredient costs for cottage cheese is passed along to the consumer.

4. It is assumed that all of the cottage cheese at all four price levels will be made from fresh skim milk rather than powder.

Estimated Effect of Milk Price Changes on the Cost of Cottage Cheese

The effect of price changes of $0.10, $0.25, and $0.50 per hundredweight with a fixed butterfat differential of 8.0 cents is shown in Table 6. Prices used in this analysis begin with the previously mentioned $4.65 price for manufactured milk plus the incremental increases. These hundredweight prices were then converted to a fat and skim cost as shown in Table 5.

Table 6. Estimated Effects on Milk Ingredients Costs Per Pound of Cottage Cheese of Changing to a Higher Priced Class for Cottage Cheese

with a 8. O¢ B. F. D i ffe ren t i a 1

Cost Pe r Pound of Cheese'"

Wi th the Pri ce of Mi 1 k at Item $4.65 $4.75 $4.90 $5.15

----Cents Per Pound----

Cost of Uncreamed Curd 8.63 9.10 9.130 10.97 Cost of Dress i ng 3.93 3.95 4.00 4.07

Total Cost per 12.56 13.05 11.80 1S.04 Pound of Cheese

Increase in Cost .49 1. 24 2.48 from $4.65 Price Level

* Based on a recipe of 30 pounds of 14% butterfat dressina to 70 Dounds of curd. Based on a yield of 15 pounds of curd from 100 pounds of fluid skim. Source of yield: Frank V. Kosikowski, Cheese & Fermented Milk Foods, 1966. Does not reflect the addition of other ingredients such as stabilizers which can be ignored in this analysis.

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The results of this analysis show that a 10-cent premium per hundredweight of milk would increase the cost of cottage cheese by 0.49 cent a pound. A 25-cent and a 50-cent premium per hundredweight would increase the cost of cottage cheese 1.24 and 2.48 cents a pound, respectivel~.

Estimated Consumption Responses

With the cost effects of various price differentials having been estimated in Table 6, the price elasticity coefficient is appl ied to the adjusted price (based on higher milk costs) in order to estimate consumption responses. The first step in making such estimates is to compute retail prices of cottage cheese. The weighted average pri~e for a number of selected cities in the U.S. in 1969 is about 37 cents a pound,_I_1 and this is also the average 1969 price in the stores of the four groups reporting the data on which elasticities are estimated. For this analysis, we use 37 cents as the retail price of a pound package of cottage cheese. With this price and assuming a constant dollar marketing margin, the cost increases associated with 10-cent, 25-cent, and 50-cent class price differentials can be added to indicate the new retail price. These cost increases are taken from Table 6 and the new retail prices are indicated in Table 7. Increasing the price of milk used in cottage cheese by 10 cents results in increasing the retail price by 1.3%. Up-pricing milk used in cottaqe cheese 25 cents per hundredweight will increase the price of cottage cheese 3.4%, and a 50-cent premium results in a 6.7% price increase.

Table 7. Retail Price of Cottage Cheese Per Pound With 10-Cent, 25-Cent, and 50-Cent Differentials Added to $4.65 Class I I Price

(8.0-cent fat differential)

Product

Price per pound of creamed cottage cheese

Percent increase in reta i I pri ce

Retai I Price at $4.65

C I as s I I P rice

$.3700

Retail Price at $4.75

Class I I Price

S.3749

1. 32

Re t ail Prj ce at $4.90

Class I I Price

$.3824

i.it;

Re t ail P rice at $5. IS

C I a ss I I P rice

$.3948

6.70

To estimate consumption responses to these price increases, the -0.6 price elasticity derived in the earlier analysis is utilized. We relate this elasticity to the percentage increas~ in prices for the products taken in Table 7 as follows:

I. A 10-cent per hundredweight increase: 1.32 % price increase times -0.6 = 0.79% decrease in consumption ,

16/ Fluid Milk and Cream Report, Crop Reporting Board, Feb., May, Aug. & Nov, 1969, USDA.

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2. A 25-cent per hundredweight increase: 3.35% price increase times -0.6 = 2.01 % decrease in consumption~

3. A 50-cent per hundredweight increase: 6.70% price increase times -0.6 = 4.02% decrease in consumption ,

By relating these estimated consumption responses to the total U. S. pro­duction of cottage cheese, some idea of the impact of the 10-cent, 25-cent and 50-cent differentials can be visualized. The estimated total U. S. production was 950,742,000 pounds.lZ! The effects on cottage cheese consumption of the three premiums being considered can be determined as follows:

1. A 10-cent per hundredweight increase 950,742,000 pounds x -0.79% = 7,511 ,000 pounds decrease in consumption.

2. A 25-cent per hundredweight increase 950,742,000 pounds x -2.01 % = 19,110,000 pounds decrease in consumption.

3, A 50-cent per hundredweight increase 950,742,000 pounds x -4.02% = 38,220,000 pounds decrease in consumption.

This analysis suggests that total cottage cheese consumption in the United States would be about 7.5 mil lion pounds a year less if milk used in cottage cheese carried a 10-cent per hundredweight premium over the assumed manufacturing price of $4.65; approximately 19 mil lion pounds less if a 25-cent per hundredweight premium were placed on it; and 38 million pounds less if the premium were 50 cents a hundredweight.

Effect of Pricing Policies on Dairy Farm Income

In this section, we discuss the net effect on farm income of changes in the price of milk going into cottage cheese. Higher prices for cottage cheese result in a smaller quantity damand, but since demand is price inelastic , total revenue increases. Specifically, a 25-cent increase in Class I I price would increase farm revenue about 9.6 million dollars.~ This, however, is not the final net effect on total revenue. The smaller quantity of milk used in cottage cheese implies a diversion of milk to other manufacturing uses with a possible price depressing effect. Also, if pricing policies lead to higher revenues nut of current production, we may expect a supply response; the net effect of the longer-term supply response may offset some of the initial consequences of the new price policy.

17/ Based on preliminary estimates released by the Chicago Office of the Crop Reporting Board, SRS, USDA

18/ The increased price is estimated to decrease cottage cheese consumption 19.11 million pounds; i.e., milk used in cottage cheese would decrease about 127 million pounds to 6.21 billion pounds. With the higher price, revenue increases 9.6 million dollars.

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A 25-cent increase in the Class II price is estimated as causing a 19.11 mi 11 ion pound dec1 ine in consumption of cottage cheese (previous section). Assuming approximately 15 pounds of cottage cheese are manufactured from 100 pounds of milk, the price increase results in a decrease of 127 mi 11 ion pounds in usage of mi 1k.

The effect on manufacturing price of this diversion may be estimated from the elasticity formula.

E =~ Q P _____ x_

AP Q

In this equation,AQ equals 127 million pounds; price (p) is taken to be the present support price of 4.65 cents per pound ($4.65 per cwt); quantity (Q) is assumed to be 58.9 bill ion pounds--the amount of milk used for manufacturing purposes in 1969; the average elasticity for manufactured products is assumed to be -0.8. Thus, -.8 = 127 mi 1. lb. x 4.65 cents per lb.

X 58.9 bil. lb.

Solving for X, the price change in cents per pound, we obtain

X = ~ 012 cen t (1. 2 ¢ cwt)

If the price decl ine is appl ied to total milk sales of 112 bill ion pounds, then dairy farm revenue would decl ine about 1.3 mi Ilion dollars, and to obtain the "net ll effect of a 25-cent hi~her price for milk going to cottage cheese, the higher revenue from this source (9.6 million) must be reduced by 1.3 million.

Thus, farm income is estimated to increase 8.3 mill ion dollars. The comparable net increase for a 10-cent higher milk price is 3.5 million dollars.

This result is subject to several qualifications. If the manufacturing milk price is resting on the support floor, it is not clear that price will decline by the computed amount. But with decl ining milk production and with the possibil ity of prices rising above the floor level, the type of real location outl ine above may prevent a price increase. It is also true, however, that the supply effects of an up-pricing of milk for cottage cheese are not considered. Higher prices may result in larger quantities supplied, with corresponding impacts on milk price and costs. Finally, the impact estimated above would take time to work itself out. We assume, in effect, an instantaneous decline in the price of all milk in the United States of 1.2 cents per cwt. as the result of a 25-cent per hundred increase in the price of milk going into cottage cheese.

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APPENDIX: STATISTICAL ANALYSIS

The objective of this appendix is to provide additional detail about the estimation of the demand relations for cottage cheese. In the fi r st section we discussed equations combining regional data to obtain estimates for the United States. A second section describes an analysis of data for one region -- the Midwest.

The general objective of this analysis is to estimate a market demand re­lationship for cottage cheese in the United States; in particular we are inter­ested in the net price-quantity relationship. To directly accomplish this objective, it would be preferable to have observations on total sales of cottage cheese and the corresponding prices for the whole United States. Relevant price data, however, are not available. We do have access to data from supermarkets in different regions; thus, it is necessary to describe how these data are used to obtain an "average" demand relation.

Pooled-Data Demand Relation

Available data. Four groupsl! of supermarkets agreed to provide observations on their annual sales of cottage cheese and the corresponding annual average price for the years 1965-1969. In each case, the group represented more than 100 stores; they are located in the Northeast, Midwest, Texas, and California.

Data are also available to construct an index of total sales for each group (see Table 1). This may be used in co~junction with an index of all grocery sales in the United States to measure special characteristics of each group. For instance, if the supermarkets under analysis are located in a high income growth area, then this rapid growth in regional income could be an important factor in explaining growth in sales. We also obtained approximate regional population estimates. Thus, another method of adjusting for regional differences is computing the approximate per capita sales of cottage cheese for e~ch group of stores. These adjustments permit us to view the estimated relationships as "representativell market demand functions even though each supermarket group is serving a subset of consumers in each region.

Cottage cheese perhaps has numerous substitutes; e.g., the potential alter­nate ingredients of salads. But such products are not close substitutes in the sense of margarine substituting for butter. We take the view that Ilall ll food may be a reasonable measure of substitutes for cottage cheese, and the observed prices of cottage cheese are deflated by the Index of Retail Food Prices.

1/ ~hese groups are either regional divisions of larger chains or regional-sized chains.

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Ta ble 1.

Year af'ld Region Quantity

(1000 1 b)

Northeast

1965 2299

1966 2926

1967 3075

1968 3286

1969 3686

Midwest

1965 1960

1966 1861

1967 1942

1968 1924

1969 2048

Price and Quantity of Cottage Cheese and Index of All Grocery Sales for

Selected Regional Groups of Supermarkets

Index of Year grocery and

Pri.ce sales Region Quantity (cents/l b) (1965=100) (1000 lb)

Texas

31. 7 100.0 1965 1693

31.5 116.6 1966 1695

33.9 112 . 2 1967 1707

35.8 125.8 1968 1964

37.0 133.4 1969 2437

California

28.7 100.0 1965 6182

33. 1 100.7 1966 7140

37.5 108.0 1967 6844

41.0 121.3 1968 6558

42.4 128 . 6 1969 6670

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Index of grocery

Pri ce sales (cents/lb) (1965=100)

29.5 100.0

34.0 95.3

33 . 0 95 . 1

34.0 110.3

37 . 0 134.0

29.0 100.0

25.0 110 .8

31.0 107 · 3

31.0 107.8

31.0 105.1

Equation specification. Each estimated equation is based on 20 obser~a­tions -- 5 years and 4 regional supermarket groups. Each equation makes quantity a function of price. Two alternative measures of price were considered: observed pric~ and deflated price. Deflated price is apparently the best alternative both from a statistical and an economic theory viewpoint.

Adjustments for regional differences are made in several ways. Each equation contains regional zero-one variables; these permit the pooled-data demand function to take different "levels" by region. In addition, two alternative measures of the possible special nature of the regional data are considered. One is the ratio of the index of grocery sales of the group to the index of all grocery sales in the United States. A second method was to use per capita, rather than total, sales as the dependent variable. .

The possibility of systematic changes in demand with the passage of time within each region is taken into account by using trend variables in the equation. These variables do not tell us why demand is systematically changing (if it is), but they do adjust for such changes. Thus, the resulting price coefficient is a better measure of ' the net influence of price. Selected regressions are reported in Table 2; they represent equations that are "best" in the judgment of the authors and are illustrative of the range of experience of the alternate equation specifications. The variables are defined as follows:

Yl

quantity cottage cheese, 1000 lb.

Y2

: quantity in pounds per capita (regional population)

°1 1 for observations on Northeastern supermarkets 0 for others

°2 1 for observations on Midwestern supermarkets 0 for others

°3 for observations on California supermarkets~

0 for others

Xl : re t ail price of cottage cheese deflated by Index of Retai 1 Food Prices (1957-59= 100) , cents per 1 b .

X2 index

X3 1 i nea r trend for Northea s te rn group of supermarkets

X4 = 1 i nea r trend for Midwestern group of supermarkets

X5 1 i nea r trend for Texas group of supermarkets

X6 : linear trend for California group of supermarkets (trend in each case is 1965 : 1, 1966: 2, etc.)

2/ With 4 regions, only 3 zero-one variables are necessary. The in tercept coefficient measures the "Texas" effect. The coefficients of t he zero-one variables measure the difference between the intercepts for the respective regions and the base (Texas) intercept.

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Table 2. Estimated Demand Equations for Cottage Cheese at Retail Level in the United States

Equation Independent Variables~ Number and Pri ce

-i Elast.£! Dependen t lJ 1 D2 lJ3 xl x2 x3 "4 "5 "6 R Variable Intercept

( 1 ) Yl 4027.7 791.2 261.4 4953.5 -96.3 348. 1 224.3 213.3 44.2 .991 -0.80

1035.5£1 286.4 300.4 299.6 36.8 62.4 97.9 62.6 61. 0

(2 ) Y1 1176.8 514.6 221. 8 4628.8 -63.4 2140.4 322. 1 133.8 168.8 144.9 .994 -0.53

1400. 1 257.6 245.6 275.6 32.7 838.2 51.9 87.4 54.0 63.5

(3) Y 0.563 0.215 1.767 0.469 2

-0.016 0.053 0.009 0.020 -0.003 .997 -0.58

0.204 0.056 0.059 0.059 0.007 0.01-2 0.019 0.012 0.012

a/ See text for definition of variables.

b/ Price elasticity computed at arithmetic mean of price and quantity.

c/ The first 1 ine for each equation contains the estimated regression coefficients; the estimated standard errors are immediately below the coefficients.

Interpreting results. In equation (I), regional differences in demand are adjusted only by including zero-one variables (the Dis). In equation (2), the ratio variable (x2) , which measures the growth of regional grocery sales relative to the national total, is added. In equation (3), as an alternative to the ratio, total cottage cheese sales by the particular group of stores is divided by a measure of regional population.

The price elasticities for each equation are computed at the arithmetic means of the data; in statistical terms, each elasticity is a point estimate. The computed elasticity for equation (3), which is representative, is -0.58. An interval estimate for equation (3); i.e., a range which has a reasonable probability of containing the "true" elasticity, is -0.33 to -0.83.

Two considerations, however suggest that the retail-level elasticity is about -0.6 or sl ightly less inelastic. First, varying the specifications of the equa­tion provided elasticity estimates ranging from -0.5 to -0.8. Th us, this range of "experience" implies, if anything, a less inelastic demand (up to -0.8) than -0.6. Second, a rather complete analysis of data from one region (see next section) also provides elasticity estimates of about -0.6.

The estimated slope coefficients receive the usual interpretation. For instance, In equation (2) the estimated price coefficient is -63.4. A one-cent per pound change in the price of cottage cheese is estimated as resulting in a 63,400-pound change in total sales quantity moving in the opposite direction from price -- net of the influence of other factors .

The~4 are estim.ated coefficients of determination adjusted for degrees of freedom. They suggest that over 99 percent of the temporal and spatial variation in quantity is associated with the independent variables.

A Regional Demand Relation

The Midwest supermarket group provided data for the 10 years 1960-69, and this permitted a reasonably thorough analysis of the demand for cottage cheese in one region. Using data only from one region has the advantage of not having to pool data and adjust for regional differences. Alternative model specifications were considered. These included different variables to measure changes in demand over the 10-year period and alternative functional forms for the demand relation.

The three "best" equations in terms of the coefficient of determination provided elasticity estimates of -0.60, -0.65, and -0.7731 These elasticities clearly are similar to those estimated for the United States. A representative

31 The elasticity of -0.77 is from an equation in logarithmic form. The other elasticities are computed at the arithmetic means of linear demand equations.

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equation for the Midwest is

y = 487.1 - 36.56 Xl + 1841.79 X2 + 63.53 X3. (15 . 28) (782.95) (25.32)

_2 R = .91 elasticity 0.60.

where Y = quantity, 1000 pounds

Xl= retail price, cents per of retail food prices

Index Xt= ratio of indexes =

lb., deflated by index

of grocery sales by Midwestern Grou 1960=100)

Index all grocery sales u.s.

X3= linear trend (1960=l, 1961=2, etc.)

The parenthetical coefficients are standard errors and each estimated regression coefficient is Iistatistically significant. 11 A one-cent change in retail price is estimated as resulting in a 36,560-pound change in the opposite direction in annual cottage cheese sales, net of other changes. The quantity of cottage cheese is estimated as increasing 63,530 pounds per year (the trend coefficient), net of other factors. In sum, price has a significant effect on quantity demanded, and the demand relation also has shifted to the right (increased) foj any given level of price.

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