> the only possible reason that a farmer can't charge more than $1.35 for a gallon of milk is that some other farmer is able to produce a gallon of milk for less than $1.35

Not necessarily - if you have demand for 300 units of milk and there are enough producers to match, then when demand halves, the producers are still producing 300 units of milk and paying for the costs to produce that amount of milk. To offset those costs as much as possible, they'll willingly momentarily sell under marginal cost - the production costs have already been spent anyways