Thoughts on the price of milk

This is from an email exchange between Agnitio and myself on why dairy prices rose, following his post on Fonterra’s auctions:

A few reasons:

  1. Sharp increase in demand in Asia and the Middle east as a result of rising incomes (and dairy products are a normal good),
  2. Drought in Australia and a drop in production over the Americas,
  3. Increase in the price of feed stemming from biofuel’s sucking up grain (good for NZ as we grass feed cattle – increasing our comparative advantage),
  4. Sharp rise in the price of other inputs (fertilizer and fuel),
  5. Sharp increase in shipping costs.

All these things combined to see dairy prices increase 200% odd in a couple of years 🙂

Note, all these factors have decreased somewhat, which is why spot prices have fallen like 50% over the past year. To figure out where prices will settle we need to ask two questions:

  1. What shifts are permanent?
  2. What does the long-run supply curve (and long-run demand curve) look like?