2. Risk Avoidance in Commodity Purchasing--The Benefits of Price
Stabilization
    Senator Patrick Leahy submitted extended comment referencing
studies in the economic literature of the adverse effects of commodity
price uncertainty and, conversely, the utility of price stability.\95\
One article described so-called ``risk avoidance'' pricing strategy in
the wheat industry. The analysis indicated that increased price
uncertainty and variability in the wheat industry led to significant
increases in retail wheat marketing margins.\96\ The article determined
both theoretically and empirically that increased price variability
results in higher margins. The authors theorized and then demonstrated
empirically that the uncertainty created by wholesale price volatility,
in essence, drives the retailer to retain a larger margin. The retailer
acts to retain such a larger margin to avoid the risk created by the
uncertainty in wholesale costs.\97\
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    \95\ Senator Patrick J. Leahy, WC 1/297.
    \96\ Brorsen, Chavas, Grant and Schnake, ``Marketing Margins and
Price Uncertainty: The Case of the U.S. Wheat Market,'' Amer. J.
Agr. Econ., (August, 1985) 521-527.
    \97\ The analysis is confirmed with regard to market conduct and
performance in the beef industry. Holt, ``Risk Response in the Beef
Marketing Channel: A Multivariate Generalized ARCH-M Approach'',
Amer.
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    The logical implication of this theory is that price stabilization
reduces or eliminates the retailers' need to act in such a risk-
avoiding manner, because the volatility and uncertainty that drove that
behavior is reduced or eliminated.
    The analysis of Hahn et al \98\ demonstrates convincingly that
price volatility within the meaning of the authors above cited defines
market conduct and performance of the fluid milk industry. The pattern
of pricing conduct described by these authors is consistent with the
risk-avoidance strategy described by Brosen et al and Holt.
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    \98\ See Hansen, Hahn, and Weimar, ``Determinants of the Farm-
to-Retail Milk Price Spread'', Agriculture Information Bulletin
Number 693 (March 1994). See also Kinnucan and Forker, ``Asymetry in
Farm-Retail Price Transmission for Major Dairy Products'', Amer. J.
Ag. Econ., 285-292 (May, 1987).
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    Based on this analysis, the Commission concludes that New England
retail prices likely will respond positively to the stabilization of
the wholesale price input which will result from imposition of Compact
Over-order Price Regulation. The price established by this rule will be
a certain one; Berthiaume suggests that the combined, federal Order and
Compact Over-order price will not vary for the six month term of its
duration. At least for the short-term duration of this price
regulation, the uncertainty of price variability in the region's Class
I market will have been significantly reduced if not eliminated.
According to the analysis described above, the Compact Commission
concludes that retail margins and, hence, prices, should positively
adjust, accordingly.\99\
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    \99\ The Commission recognizes that at least one comment
suggested that the ``impact'' of any price regulation would be a
straight dollar-for-dollar ``pass through'' from processors to
consumers, resulting higher retail prices. Alan Rosenfeld, December
19, 1996 at pages 183 et seq. The Commission is not persuaded by
Rosenfeld's predictions for several reasons. It is, in the
Commission's view, contrary to the weight of the comments submitted
and the prevailing economic literature and anecdotal evidence. More
fundamentally, however, it is not descriptive and provides no
reasoned explanation for the conclusion expressed therein. Nor does
it respond in any way to the comprehensive literature suggesting
precisely the opposite conclusion.
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