Economies of Scale in Production versus Diseconomies in Transportation: On Structural Change in the German Dairy Industry

This paper analyzes the structural change in the German dairy sector using a sector-wide optimization model. In particular, the model includes a spatially explicit representation of dairy processing farms and dairy farming regions to account for the trade-off between economies of scale in dairy production and diseconomies of scale in transportation. We simulate cost-optimal sectoral structures for different time horizons and various transport cost levels. The results demonstrate that the model is able to explain the trend towards fewer but larger dairies as currently observed in reality and indicate, ceteris paribus, a continuation of this trend. However, if the importance of transport costs increases relative to other costs in dairy production this trend might level off. The structural impacts found differ markedly by region.