and ungraded milk zones, is 100 miles from the market. The price of Grade A milk is just 50 cents higher than ungraded milk at this point. We have already pointed out that the higher cost of producing Grade A milk is incorporated in the chart. This results in the division of the zones where the Grade A price is 50 cents higher, rather than where it is the same as the price of ungraded milk. Beyond this distance, it tends to be most profitable to produce manufacturing grade milk. Within the 100-mile radius, the Grade A milk price is more than 50 cents higher than ungraded milk, and most farmers will sell Grade A milk rather than ungraded. Of course, this line between zones of production of graded and ungraded milk is defined much less clearly in practice.

This figure illustrates how a milk production area tends to become divided into zones. It is most practical to use whole milk for bottling and most other Grade A products. It is costly to move whole milk, so the farm price is much lower 100 or 200 miles out than at the market. The price of ungraded milk is lower than Grade A near the market, but the transportation cost is lower for manufactured products. That is, the transportation cost is lower on a milk-equivalent basis, since much of the bulk is left in the country. Therefore, the price of ungraded milk falls less rapidly, and it is more profitable to produce ungraded milk far away from the market.

How, then, does transportation cost affect class pricing? First we will show how the price of ungraded and Grade A milk at the market was determined. The price of ungraded milk, $4.275, represents about the national price of milk for manufacturing. It is necessary, however, to pay a premium to get the Grade A milk. This premium must include transportation cost.

Therefore, the price necessary to get enough Grade A milk for bottling is increased by the high cost of hauling this milk. The high cost of hauling whole milk is simply another reason, along with quality requirements and seasonality, for separate pricing of milk used for bottling and similar products.

The illustration could be expanded to include 3 or 4 forms of milk, hauling costs, zones of production and prices. For example, some milk is separated at country receiving stations in a few of the largest market areas and Grade A cream is shipped to the market. The transportation cost for this cream, on a milk-equivalent basis, is between that for whole milk and for butter and cheese. Therefore, a zone tends to develop where Grade A milk is produced, separated, and shipped as cream. This zone tends to lie beyond the "milk zone" and before the zone where milk is used for manufacturing.

Thus, it is practical in the largest milk markets to use cream separated in the country receiving stations for bottled cream and a few other products. This should be considered in grouping products for class pricing. Milk used for fluid cream and similar products sometimes should be priced slightly below milk for whole bottling.

Most markets, however, find it impractical to separate milk for cream in the production area. They can use much or all the skim milk in fluid products, and the cost of the equipment necessary to separate milk for Grade A use in the country would be prohibitive. Therefore, only two transportation rates usually need to be considered in most cases, one for whole milk and one for manufactured products like butter and cheese.

Demand Bases

The most complex problems of class pricing involve demand. Ac

curate information seldom is available about the effect on sales of changes in the price of a product. Neither is information available on the substitutability of productsthe effect on sales of a particular product when the prices of other products change. Producers, dealers, and consumers also disagree as to the importance and relevance of demand conditions in pricing milk for individual products.

It is necessary to indicate how demand fits into the general picture before exploring the detailed problems. The markets for bottled milk and related products are different and separate from the market for butter and cheese. A glass of milk satisfies a different desire than a pat of butter; they do not substitute freely for each other. On the supply side, manufacturing-grade milk cannot be used in Grade A products. Thus, the markets are separate in most ways. This situation is significant since a higher price could not be obtained for fluid-use milk than ungraded milk if each group of product-uses did not essentially amount to a separate market, as is the case.

We have mentioned previously that sales of fluid milk respond only slightly to minor changes in the retail price. The price obtainable for milk used for manufacturing, on the other hand, is largely dependent on national markets. All the products from the reserve milk of one market can be sold at the prevailing price for manufactured items; little (almost none, in theory) could be sold at a higher price. Sales responses to price changes for cream and other products lie between the extremes of the milk and butter markets.

Difficult problems arise from competition among dairy products for the consumer's food dollar. There is some competition between evaporated and bottled whole milk. Whole milk is preferred to evaporated milk for most uses and by most persons, however, unless there

are substantial price differentials. The different characteristics of storability, lower transportation costs, and lower raw product quality requirements also distinguish whole and evaporated milk. Milk for evaporating usually is priced with other manufacturing uses as a result. Though the products conpete to a degree-the flexible demand and the supply conditions affecting evaporated milk inevitably result in widely different milk prices for whole and evaporated

uses.

Concentrated fresh milk may also compete with numerous products. Most of it probably replaces whole milk, but it also competes with cream and evaporated milk. No detailed study of the market for concentrated fresh milk has been made, to the writer's knowledge. Its ease of substitution for whole milk, alone, suggests pricing milk for concentrating with that for whole milk. Supply conditions, except the cost of transportation in large milksheds, also are similar to those for whole milk. Concentrated fresh milk, unlike evaporated milk, is not sterilized. Therefore, local health officials require it to be made of Grade A milk. Like milk for other Grade A uses, it may be obtained from the nearby milkshed or from greater distances. Since milk for use in concentrated fresh milk must be Grade A, it usually has been priced with or near the same level as milk for sale as fresh whole milk.16 Milk for concentrating probably is properly priced with that for whole bottling,

in most markets.

Details of competition between

16 Sales of concentrated fresh milk in Federal order markets were negligible in early 1953. However, pricing problems relating to concentrated milk provide useful illustrations in several parts of this report. PARKER, ELEANORE J., and HARRIS, EDMOND S., WHAT HAS HAPPENED TO CONCENTRATED MILK? U. S. Prod. and Mar. Adm., Marketing Activities, July 1953, pp. 7-9.

products and response of sales to price changes are important only in choices between narrowly separated prices for milk. Milk for evaporating cannot be priced with bottling milk since sufficient ungraded milk is available. Almost no Grade A milk would be sold for evaporating at Class I prices. An attractive market for surplus Grade A milk would be lost and nothing gained.

Milk for sale as concentrated fresh milk, on the other hand, could not be sold for the condensery price. The condensery price would not repay farmers for meeting the strict production conditions required for this use. Sale at the condensery price would be unwise even if com

petition of concentrated fresh milk were largely with evaporated and (ungraded) condensed milk.

Note again that the effect of restrictions on the use of ungraded milk for some purposes provides one basis for classification. This is the demand situation which provides one entire side of the foundation for class pricing, the other side being supply. This makes possible a substantially higher price for these uses. The broad outline of this situation gives no trouble in classifying milk, being well understood from the viewpoint of the cost of producing Grade A milk. The details of product competition lead to troublesome problems, as the discussion has indicated.

THE number of classes which it is

necessary to use in a market is determined by the economic condition of the market-including both specific cost and demand factors and institutional arrangements. Institutional arrangements which may enter into decisions affecting the number of classes include the number of dealers, the degree of their specialization, the plant facilities in the market, who operates them, and many other factors. A specific number of classes certainly is not a goal in itself.

However, setting the final number of classes is a distinct problem. In particular, an eye should be kept on simplicity and holding the number of classes to a minimum. On the other hand, each group of milk products actually affected by distinctly different cost and demand conditions usually must be priced separately from other groups. Balancing these two considerations, the need for simplicity and the need to recognize distinct economic conditions, leads to some difficult

decisions. Deciding whether a minor class can be eliminated is difficult but often necessary.

Basic Grouping of Products

The proper objective in classifying products is to group together products affected similarly by economic conditions.

Grade A milk can simply be divided for pricing into that used in fluid products and that manufactured. This is a very acceptable classification in some markets, but would be very crude in others. A more thorough approach requires. consideration of the four principal economic factors which distinguish some products from others as markets for milk. The four factors which have been discussed are quality requirements, seasonality, transportation cost, and demand conditions.

The idea of grouping on each of several bases may suggest that a large number of classes are necessary. However, since milk for most Grade A products usually is shipped

in whole form, and these uses require about the same amount of milk throughout the year and are subject to similar demand conditions, the result usually is simple. That is, the groupings of products are similar on each of the several bases. Two or three classes usually are enough.

Several Classes Sometimes Necessary

In some markets, however, a few products do not fall in the same groups on all bases. These markets do not find it satisfactory simply to divide product-uses into fluid and manufacturing products for class pricing. They need additional classes.

Groupings on the basis of seasonal needs for milk sometimes are different from the quality grouping. Ice cream is an example when it is required to be made of Grade A milk. This example does not apply where ice cream may be made of ungraded milk. On the basis of sanitary requirements, milk for bottling and for ice cream would be grouped together. On the basis of seasonal requirements for milk, they would be grouped separately. Bottled milk use remains about the same all year, but much

for

more

fresh milk can be used in ice cream during the summer than during the fall and winter. Further, stored milk products can be used during the fall and winter for much of the production, thus absorbing even more spring-summer production. Thus, groupings on these two bases are not the same; an additional class of milk may be required.

As another example, let us consider a market where cream may be made of Grade B milk, a quality standard slightly below Grade A. The quality requirements may be substantially the same as for milk which is bottled, but yet enough different to merit separate pricing. Markets with three sets of quality standards for milk, cream, and

manufactured products-usually need three classes for pricing be cause of quality alone.

These are the types of situations which sometimes result in need for more than two classes. Many more illustrations could be discussed. The procedure used on pages 24-29 in classifying milk in an hypothetical model market will show how such situations may be considered in practice.

Classifying Surplus Milk

A single price for all reserve milk usually is appropriate. Manufac turing plants usually pay similar prices for milk for butter and pow der, cheese, or condensed milk. Competitive field prices for manufacturing-grade milk for these uses tend to be about the same.

The procedures used in many Federal order markets obtain for producers the benefits of small variations in price trends of individual manufactured products. The highest of the prices resulting from two or more formulas determine surplus prices in over ten of the markets. That is, the price for the surplus class may be the higher of two prices resulting from, say, a "butter-powder" formula or a formula based on the "14 Midwest Condensery Price Series" (an aver age price used under a number of Federal orders). There are several combinations of formulas.

The price of surplus milk in ten or so other Federal order markets is the average of the prices paid by the local manufacturing plants. This practice also should tend to gain the benefits of small variations in price trends for producers. The plants must compete with each other and with neighboring plants for milk.

A single price for all surplus milk is not satisfactory in all cases. The following situations

will illustrate:

1. A large proportion of surplus

milk is used in products for which Grade A milk is preferred but not required. This situation exists in many markets permitting ice cream to be made of ungraded milk.

The price of reserve or surplus milk is the average of prices paid by _local_manufacturing plants in several Federal order markets. Here plant worker uses a special sterilized fork to loosen curd for cheese made from surplus milk.

2. Pricing milk for condenseries in the Chicago market illustrates another situation. Condensery-pay prices sometimes do not follow butter and cheese price series closely. (See details of the Chicago situation discussed under "Eliminating Minor Classes.") The general situation is as follows: There are two or more major uses for surplus milk. The typical prices paid farmers by plants in the area which specialize in only one of these uses sometimes diverge from the other prices. There is not enough plant capacity to use all surplus Grade A milk in each of these single uses. Therefore it sometimes is impossible to sell all the surplus Grade A milk to the types of specialized plants which currently are paying the highest price.

In such a case, producers would fail to receive the highest price obtainable if all surplus milk were

priced together. Also, where hanIdlers have at hand a high-return surplus use such as ice cream, it may be difficult for producers to insure that their milk will be used in fluid classes. If fluid milk for ice cream is priced low, handlers may be able to obtain higher profits from this use than from bottling.

Simplifying Class Pricing

The ultimate in classification would be to price milk for each product separately. But it would be exceedingly difficult to keep milk for each product priced in line with the supply and demand conditions facing that product. Pricing according to the general nature of economic conditions, not by precise price estimates for each product, is the appropriate goal in classifying milk for pricing.

Classified pricing plans, as well as other pricing procedures, should be as simple to administer and as easy for producers to understand as is consistent with other objectives. Simple plans usually are understandable. Bargaining to set prices for many separate classes is costly and time consuming. Also slightly less effort is required in accounting for milk use when there are few classes.

Eliminating Minor Classes

Cooperative marketing agents and handlers can benefit from an occasional review of pricing plans where several classes are involved. Let us review two situations which illustrate the appropriate reasoning for deciding whether a class is necessary or could be combined with others.

Class III in the Chicago marketing area might be termed a minor class. Only 5 to 7 percent of the producer milk went into the Class III products during the years 194952.17 The class largely includes

17 COLEBANK, A. W., REPORTER, Office of Chicago Federal Milk Market Administrator. Jan. 1953, p. 7.