British dairy farmers are having a tough year. The global oversupply of milk has pushed down prices to the point where many farmers, their representatives and their political champions are coming out with this statement:
Supermarkets are paying farmers less for a pint of milk than it costs to produce
While not wishing to downplay the commercial difficulties many farmers face, we have to challenge such oversimplification. Every farm has different costs of production, depending on their size, level of automation, location, staffing, debt etc. For each farm, a dedicated accountant might be able to work out the full cost of that pint of milk (factoring in a percentage of all fixed costs and interest payments), but they would also be interested in the marginal cost (the cost to produce one extra pint) which would be much lower.
For some large, automated farms, milk production will still be fully profitable, even with the low prices currently on offer. For others, it may be loss-making if one factors in all sunk costs, yet it is still worth producing milk and selling it to stingy supermarkets because the marginal cost of production is low. Meanwhile a few unfortunate farmers may actually be losing money with every pint they sell, if their marginal cost is above the offered price.
The idea that different producers have different costs of production (just as different purchasers are willing to pay different prices for their product) is fundamental to microeconomics. These different producers with their different costs form the supply curve which, where it intersects with the purchasers’ demand curve, determines the price a product ought to command. The reason milk is cheap is that enough producers, globally, have achieved a sufficiently low cost of production to shift the supply curve down relative to the demand curve. If that is hard to understand, look at it this way: the price of milk is what it is because enough farmers are able to produce it for less than that price. In other words, the quote at the top is nonsense.
One of the consequences of the supply curve in free markets is that those producers who are consistently lodged at the upper end — above the point of intersection with the demand curve — go out of business. It happens in all other industries, so it would be surprising if it did not happen in farming. It is this process which is playing itself out in protests at supermarkets and in the headlines of our newspapers. It’s not pleasant, but it’s the essence of capitalism and it has useful outcomes such as greater efficiency and lower prices for consumers.
Of course, we may not like the way in which farmers achieve lower costs and stay at the profitable end of the supply curve: factory farming, poor treatment of animals, growth hormones and so on. In which case we should be willing to pay extra for premium brands or categories of milk that avoid these practices. Equally, if we want to keep cows on the pastures of British farms, we will need to buy British milk, even if it costs more. In other words, we need to buy from a different supply curve, representing a different product.
But we shouldn’t fall into the trap of believing that there is a single cost of production for milk.