Dairy product inventories and price movement relationships in the absence of effective price supports

Firms hold inventories for a variety of reasons, including the attempt to align availability with consumption, thus smoothing prices across time. Governments may hold inventories to support price levels when production is high relative to demand which also serves to smooth prices. Conventional wisdom suggests that the existence of such government stocks will affect the behavior of firms holding commercial inventories. In 1985, surplus accumulation prompted the United States government to lower support prices to the point that market prices moved free of the support. This change in dairy policy provides an opportunity for the empirical investigation of commercial inventory behavior under different policy regimes. The purpose of this research is to examine price movements in the dairy industry and the role of inventory behavior in price determination. The impact of storage behavior on price movements are examined through a structural model of the dairy industry incorporating a competitive storage industry. Optimal commercial storage rules are derived under different governmental policy regimes. These storage rules are examined in both a static and dynamic framework. Examination of optimal storage rules supports the proposition that agents providing storage adjust their behavior under different policy regimes. With an effective price floor, agents are more likely to hold inventories at low levels of availability but increase inventories at a decreasing rate. At higher availabilities, agents rely on the government to remove surplus from the market. When no support price is in effect, agents exhibit a constant marginal propensity to store. Comparing storage rules to actual market observations suggests that agents adjust their behavior rapidly when policies are changed. Simulations indicate that optimal storage behavior can result in highly variable prices when no support price is in effect