Essays on industrial organization of U.S. dairy markets

Metin Cakir, Purdue University

Abstract

This dissertation is composed of three empirical essays that involve rigorous analyses of important economic questions with implications to welfare, public policy and marketing. In particular, these essays contribute to the existing literature by further illuminating our economic understanding of generic dairy promotion programs, dairy co-cooperatives’ conduct and food manufacturing firms’ marketing strategy of reducing product package size. In the first essay we estimate a dairy demand system to evaluate generic dairy advertising in the U.S. from 1990 to 2005. Previous empirical studies of generic dairy advertising focus only on the market of the advertised good, ignoring potential spillover and feedback effects. We specify an LA/AIDS model of dairy demand, which allows consistent estimation of cross-price and cross-advertising effects across dairy product markets, and is flexible and satisfies the axioms of consumer theory. We use the non-linear 3SLS estimator to address endogenous prices and serial correlation, and conduct bootstrapping to generate empirical distributions of elasticity estimates. Results suggest that cross-market effects are economically and statistically important. Thus, econometric dairy demand models that ignore cross-advertising and cross-price effects are misspecified. Previous work that ignores substitution between fluid milk and cheese overstates producers’ returns to generic advertising for either product. In the second essay we adopt a structural econometric model of the vertical relationship in U.S. dairy markets to identify pricing behavior in the supply chain for fluid milk. The model consists of a system of equations that allows estimation of oligopoly power of dairy co-operatives and downstream firms, exploiting Federal Milk Marketing Order regulations to identify co-operatives’ marginal cost. We take a Bayesian approach to estimate the model. The estimation framework incorporates inequality constraints on model parameters based on economic theory. A key finding is that co-operatives use their market power to raise the farm price of milk by almost 9% above marginal cost, resulting in an income transfer of more than $600 million per year in markets regulated by Federal Milk Marketing Orders. Market power by processors–retailers results in a mark–up of 0.5% and an income transfer of $86 million per year. In the third essay we estimate a random utility model of demand to measure consumer response to manufacturers’ package downsizing. We perform the analysis using Nielsen Homescan data on bulk ice cream purchases of a panel of households in Chicago, between 1998 and 2007. We adapt a Bayesian approach for estimation. The estimation framework involves modeling household heterogeneity, addressing price endogeneity and dealing with unbalanced choice alternatives. The main finding is that consumers are sensitive to package size changes, but on average the demand elasticity with respect to package size is approximately one-fourth of the demand elasticity with respect to price. This finding suggests that consumers are less sensitive to changes in package size than to changes in price. This result implies that manufacturers can use downsizing as a hidden price increase in order to pass through increases in production costs, i.e. cost of raw materials, and maintain, or increase, their profit margins.

Degree

Ph.D.

Advisors

Balagtas, Purdue University.

Subject Area

Marketing|Agricultural economics

COinS