Economics and the 2008 crisis: a Keynesian view
Economics and the 2008 crisis: a Keynesian view

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Economics and the 2008 crisis: a Keynesian view

Cost of producing a pint

Producing a pint of milk is a costly business. Firms producing milk, usually referred to as dairy farms, take inputs in the form of land, capital (the herd, milking parlours and storage) and raw materials (such as feed and seed). They then use these inputs to make milk, which can also be used to produce cheese and yogurt.

Activity 26

Some farms may receive income from the government, but like all firms, if their income doesn’t cover the cost of milk production, they risk going out of business. Watch this short video on the challenges facing milk producers, which introduces one of the main ideas covered in Section 7: reducing cost. Notice how the video uses ideas from short run and long run cost curves.

Whilst watching the video, think about the key challenges milk producers face and what they can do to reduce these challenges. Make some notes on your thoughts here – you will need to refer back to them later on.

Download this video clip.Video player: Costs of milk production
Skip transcript: Costs of milk production

Transcript: Costs of milk production

JOHN CRAVEN
The auction's going well, with strong interest in Ken's herd. The price farmers get for their milk is the highest for 15 years, but the average dairy farmer's profit margin is being squeezed by spiralling costs.
A pint of milk costs us consumers about 48 pence. Now, of that, 15 pence goes to the farmers. The rest of it goes to the processors and to the retailers.
Now, what about the farmers' costs? Well, of that 15 pence, 9 pence goes on to variable costs - things like feed and vet's bills, bedding, fertilisers and those sort of things. Then there's another 6 pence going to overhead costs, such as fuel, electricity and, of course, wages.
And that's it. The bottle's empty. The farmer has broken even. But that doesn't take into account his extra costs, such as depreciation, and vital investment in the future. When you add that on, the farmer is losing at least one penny for every pint.
Dairy farmers like Ken say they aren't asking for the earth. Just a little more a litre would make all the difference.
Vicky, you were Ken's milk buyer. A lot of people will say, well, look. We pay 48 pence a pint for our milk, and the farmer's only getting 15 pence. People like yourself are getting an unfair share.
VICKY HICKS
Well, I mean, I think figures recently published by Dairyco themselves actually show that the biggest proportion in the supply chain has actually gone to the supermarkets. They do relatively little, and actually get relatively a lot for what they do. All they do is put the milk on the shelves. We have to process it and pack it, and that itself is a very small margin to what we have to work to to sell it to the supermarkets, or whoever our customers may be. And they dictate what we can pay.
JOHN CRAVEN
There are around 11,000 dairy farms in England and Wales. That's half what there were 20 years ago. But every day for the past 12 months, two dairy farms have closed. That keeps auctioneers like Gwilym Richards busy.
Dairy farmers are facing a crisis. Rising costs mean many are losing money on every pint of milk they produce. Rather than give up on dairy, others see a supersized future. In America, the mega-dairy is already a reality. This is just a small part of a 30,000 cow farm in Indiana.
In Gloucestershire, David Ball has 750 cows. Only by getting bigger has he been able to turn the white stuff into a profit.
Well, you've put a huge investment into things like the milking machines here.
DAVID BALL
That's right. I mean, this equipment represents a huge capital investment.
JOHN CRAVEN
How much, roughly?
DAVID BALL
So this would be in excess of 200,000 pounds for this milking equipment. And so, therefore, we need to use it as efficiently as we possibly can. And if that means putting more cows through it in order to utilise it more efficiently, then it represents a better return on that investment.
JOHN CRAVEN
So how many times do your cows get milked every day?
DAVID BALL
The cows come through here three times a day, and the equipment will be running for 15 to 18 hours a day.
JOHN CRAVEN
So it's really earning its keep
DAVID BALL
Indeed, yes.
JOHN CRAVEN
David's herd is one of Britain's biggest. But could mega-dairies be the ultimate answer?
PRESENTER
The scale of this farming operation is absolutely enormous. I've never seen anything like it in my life. Each of these sheds has got about 3000 cows in it, and there's ten units spread out across this farm.
And you can't see any of the cows because they're all indoors. They never go outside. It makes my farm look like an allotment.
JOHN CRAVEN
Adam, obviously taken aback by the size of that farm, David. And you've been to that very same place. Is it the way that UK dairy farming will go eventually?
DAVID BALL
I think that the scale that we've seen there represents a huge step forward from where we are here, and so that will be a long time before we see anything of that nature here. But generally speaking, over time, sizes of businesses grow.
JOHN CRAVEN
But not to thirty-odd thousand cows, you don't think?
DAVID BALL
I don't think that's going to happen here, because we haven't got the space.
JOHN CRAVEN
We might never see the scale of the American mega-dairy in the UK. But while some smaller dairy farms decide to call it a day, those that want to carry on are finding that getting bigger is the only way to survive. Bigger may be better for business, but will we, the consumer, be happy with the idea of huge herds living 24 hours a day indoors rather than in fields?
End transcript: Costs of milk production
Costs of milk production
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Discussion

Here are some notes about the video – you may have some similar points in your notes.

  • Costs of production are high, sometimes higher than the price dairy farmers are paid, and rising.
  • Milk prices are falling.
  • Farmers have difficulty investing in new equipment to replace worn or old equipment – this wear and tear cost is what the presenter, John Craven, refers to as ‘depreciation cost’.
  • Some producers are considering stopping milk production.

Possible responses to reduce cost:

  • Invest in new technology to shift the farm’s long run cost curve downwards, for example, by buying more equipment that is more efficient to run, or updating their production process (production function) to reduce labour input. However, this is difficult if the farmer cannot afford to increase their fixed cost in the short run to purchase new equipment.
  • Gain from economies of scale by increasing their scale of output, like in the mega dairy example. If firms invest in new technology, not only may they experience a downward shift in the LRAC, they may also benefit from decreasing unit cost as output increases. This may be as a result of economies of scale arising from indivisibility – that costs per unit of output from running and maintaining new technology or machinery will decrease as output increases. Other indivisibilities may arise from the running of the farm office and administration, which have a fixed cost whether the farm has a high or low output, but if spread over higher output, will help to decrease average cost.
  • Stop producing milk.

Challenges:

  • Most farms are small in the UK, and land is scarce and expensive. It may not be easy to increase the scale of the business, like in the mega dairy example.
  • Some overseas producers already produce at a lower cost per pint.
  • Economies of scale require investment in production, which is difficult when making a loss.
  • Issues of animal welfare related to the mega dairy.
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