Keywords:micro-economic models, panel data, GMM, CAP reform, dairy farmingIn The Netherlands, thedairy sector is the largest agricultural sub-sector based on both gross production value and number of farms.It is characterised by family farms in which large part of labour, management and risk bearing capital are supplied by the owner and his or her household. The dairy sector is highly regulated by the Common Agricultural Policy (CAP) of the EU. Within the CAP, milk production is limited since 1984 by farm specific quotas. The 2003 CAP reform, by introducing direct income payments, makes policies even more farm specific. To understand how individual family farms react to policy changes it is necessary to develop farm specific models. This is done using panel data and generalised method of moments (GMM) econometric estimation, keeping account of endogeneity, sample selection and unobserved farm specific effects. The estimated models describe milk production, on- and off-farm labour supply, investment in machinery, exit from, and growth in milk production. The models are used to understand how Dutch dairy farms react on the 2003 CAP reform.Results show a strong decrease of income on Dutch dairy farms due to the milk price decrease resulting from the 2003 CAP reform. Results are calculated without taking structural changes in Dutch dairy farming into account. However, results show that due to the milk price decrease the number of milk producing farms decreases and that it will be mainly small farms that exit. This leaves possibilities for remaining farms to grow and take advantage of the better earning capabilities of larger farms. In total the effect on income for the remaining farms is therefore less strong than calculated in a situation without structural change.Decoupled payments are advocated by the World Trade Organization (WTO) as a way to transfer income to farmers with minimal potential to distort production and trade. However, theoretically decoupled payments can impact production through an income effect ...