Modeling the U.S. Dairy Sector with Government Intervention

An econometric framework for estimating a two-regime dairy structural system is presented. Failure to account for switching between regimes due to government price intervention raises the problem of selectivity bias. Further, since a structural system of equations is involved, the problem is not limited to the associated with the intervention. Rather, bias from a single source can distort all equations in the system. The ramifications of not correcting for the bias in policy analyses are investigated. The federal dairy price support program was enacted in 1949 as a means of improving farm prices and incomes. Under this program, the government attempts to support raw milk prices by buying an unlimited quantity of manufactured dairy products at the wholesale level whenever the price falls below the announced government purchase price. The intervention of the government in this has broad-reaching effects not only on the farm level but also on the wholesale and retail levels. Our objectives are to: (a) investigate the implications of this type of intervention on the econometric specification of a structural model of the U.S. dairy industry and (b) examine the empirical ramifications of not using the appropriate specification in policy analyses. When considering how prices in the dairy sector are determined, the potential for government intervention introduces a special problem. Prices are determined by different forces depending upon whether the price established by competitive supply and demand conditions is above or below the government price floor. If the competitively determined price for wholesale manufactured dairy products is above the government purchase price, a market equilibrium regime holds.