Why Does the Price of a Gallon of Milk Vary Across the U.S.?

This paper addresses a thought-provoking question, exploring why retail milk prices vary so widely across U.S. cities. The discussion highlights the intricate interplay between Federal Milk Marketing Orders, transportation costs, regional supply and demand, and local market dynamics.

Why do store milk prices vary widely across US cities?

Factors affecting fluid milk prices generally include:

Federal Milk Marketing Order (FMMO) Class I Price and Differentials: These establish minimum prices processors must pay producers for milk, which vary by region and are influenced by proximity to dairy production areas.

Transportation and Logistics Costs: Moving milk from farms to processing facilities and ultimately to retailers incurs costs that can vary significantly by location.

Regional Supply and Demand: Local milk production and consumer demand patterns affect how much retailers pay for milk and how they set retail prices.

That said, these factors above are often secondary to the pricing strategies of retailers, which aim to remain competitive in their local markets. Retailers frequently adjust milk prices to attract customers, as dairy products can be used as loss leaders. This was particularly pronounced during the first half of 2024 with significant retail butter discounting campaigns.

Income effects can also play a role in price variation. In higher-income areas, retailers may engage in less discounting, as the incentive to attract customers with bargain milk prices is less significant compared to lower-income areas. However, this trend is not consistent across all geographies or products. For example, in other grocery categories, high-attribute products such as organic or grass-fed options show more pronounced income effects than fluid milk.

It is worth noting that 1% milk is the lowest volume product sold in the fluid milk category. Retail prices might vary across other types of milk, such as 2% or whole milk, which have different sales volumes and price dynamics.

All of this to say, retail milk pricing is highly dependent on the competitive strategies and dynamics within each city’s grocery market. Geographic and competitive sensitivities, rather than production costs alone, heavily influence pricing.

Definitions

Federal Milk Marketing Order (FMMO)

A legal document which spells out the terms under which federal regulated handlers purchase milk from dairy farmers. The legal basis for federal orders is the Agricultural Marketing Agreement Act of 1937, as amended.

Class I Milk

The highest priced category in a classified pricing plan. Includes milk used in products intended for beverage usage. Generally, these are the most perishable dairy products. Milk products in this category are milk, skim milk, lowfat milk, milk drinks, cultured buttermilk, eggnog, filled milk, and milk shakes and ice milk mixes containing more than 6.5% nonfat solids and less than 9% butterfat.

Class I Price

Minimum price that handlers (dairy processors) must pay for milk used in class I products. Under federal orders it is calculated monthly and announced in advance from the higher of a two-week average of the average of class III or class IV prices plus the class I differential for the county in which the plant is located.

Class I Differential

Constant factor set within federal order regulation that is added to the higher of the class III or class IV price to determine the class I price in any given month. The differential is specified for each county in the country and varies generally being the lowest in the upper midwest and far west and higher in the east and south intended to reflect the location value of class I milk.