Wednesday, 25 July 2018

Are the days of the A2 milk price premium numbered?

In Dairy News this week, Federated Farmers national dairy chair Chris Lewis is quoted:
“If we are all going to start supplying A2 milk, will there still be a premium when the world is awash with it in five or 10 years time?” he queries.
“That is the question mark I have on it. I am looking at doing it… but knowing full well that if lots of other farmers in New Zealand, Australia and worldwide are doing it, will there be a premium for it if it is a common thing?”.
Plenty of farmers are talking about it and have seen the rise of The a2 Milk Company on the stock exchange, he says. Some worldwide companies are looking at it.
 “The only word of caution: is there going to be a flood of A2 milk and will there be a premium after that?”...
Lewis’s supply company Open Country Dairy is also looking at A2 milk.  “But so is everyone else around the world. With everyone looking at it and looking to breed A2 milk, what is going to happen to the supply and demand graph?” he cites as his main reservation.
Having just covered supply and demand in ECONS102 last week, we can answer that last question. What will happen to the supply and demand graph?

Consider the market diagrams below. On the left is the market for standard milk, and on the right is the market for A2 milk. Assuming the scales on the price axes are the same, you can see that there is a price premium for A2 milk (the farm-gate price of A2 milk, PA, is greater than the farm-gate price of standard milk, P0). If the costs of having a herd of A2 cows probably aren't too much different from having standard cows, then the price premium for A2 milk translates into higher profits for farmers with A2 cows.


Consider what happens next, as shown in the second diagram below. Higher profits for A2 milk attract some farmers to switch from standard cows to A2 cows, as Lewis noted above. The supply of A2 milk increases, from SA to SB. This decreases the price of A2 milk from PA to PB. At the same time, the supply of standard milk decreases, from S0 to S1, which pushes the price of standard milk up from P0 to P1. Notice that the price premium has shrunk, which is obviously what Lewis is worried about.


Of course, the price decrease in A2 milk is based on the assumption that demand remains constant. Demand for A2 milk is increasing. The price will fall in absolute terms if the increase in supply is greater than the increase in demand. Otherwise (if the increase in demand is greater than the increase in supply), the price will rise. However, regardless of what happens to the price of A2 milk in absolute terms, the price of standard milk will increase as farmers exit that sub-market and move into A2 milk production. So, relative to the price of standard milk, it does seem likely that the price premium for A2 milk will eventually fall.

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