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Abstract

Using the fact that separate markets exist for used and unused quota, this paper derives a formula to compute the marginal cost of the milk production using a competitive dynamic optimization model. It is showed that, under a perfect competitive quota market, the difference between unused quota and used quota prices gives an exact measure of rental value of quota and thus marginal cost. Policy risk is showed to have no effect on the calculation of equilibrium rental value of quota. The formula is modified to allow for the presence of a transfer assessment. It is showed that the effect of transfer assessment on the calculation of equilibrium rental value of quota depends on the elasticities of demand and supply for quota as well as the level of the transfer assessment. Using empirically estimated elasticities of demand and supply for quota, above modified formula is applied to compute the marginal costs of Ontario milk production over the period 1980/81 to 1994/95. While it represents an improvement over Barichello's approach, the measured marginal costs are not totally satisfactory. The problem lies in the fact that the monthly rental rates are unstable both within the dairy year and across the time series. The results here suggest that one must be cautious in the use of the difference between unused and used quota prices as a measure of rental rate.

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