Certification and minimum quality standards when some consumers are uninformed

Abstract

We compare certification to a minimum quality standard (MQS) policy in a duopolistic industry where firms incur quality-dependent fixed costs and only a fraction of consumers observes the quality of the offered goods. Compared to the unregulated outcome, both profits and social welfare would increase if firms could commit to producing a higher quality. An MQS restricts the firms' quality choice and leads to less differentiated goods. This fuels competition and may therefore deter entry. A certification policy, which awards firms with a certificate if the quality of their products exceeds some threshold, does not restrict the firms' quality choice. In contrast to an MQS, certification may lead to more differentiated goods and higher profits. We find that firms are willing to comply with an ambitious certification standard if the share of informed consumers is small. In that case, certification is more effective from a welfare perspective than a minimum quality standard because it is less detrimental to entry.

Optimal eco-labeling strategy with imperfectly informed consumers

“…Previous modeling of consumer confusion assumes a homogeneous misperception eco-label among consumers, while we allow the consumers' imperfect knowledge about the quality level to be heterogeneous. This is partially in line with the convention adopted by Buehler and Schuett (2014), who divided consumers into two parts: informed and uninformed. Moreover, we compared three goals of labeling authorities and discussed the impacts on labeling strategies, profit of firms and social welfare in each case.…”

Potential competition and quality disclosure

“…Moreover, even when the quality space is continuous itself, limited disclosure technology may create a discrete quality choice. For example, suppose that a certification agency exists and awards a certificate if and only if the firm's quality is above a certain threshold (Buehler & Schuett, ). In this case, only two quality levels dominate all possible qualities (i.e., the threshold for a certificate and the minimum level).…”

“…However, this is not the case in our model. As Buehler and Schuett () note, we can justify this choice on the grounds that we focus on the markets in which signaling cannot alleviate the distortions caused by asymmetric information.…”

“…Prior studies indicate that the differences in the marginal production costs according to the product quality leads to a separating equilibrium in which price has a positive association with quality (Bagwell & Riordan, ; Daughety & Reinganum, ). However, our model abstracts from this issue with the assumption that variable production costs do not depend on quality, as in many prior studies in the literature (Board, ; Buehler & Schuett, ; Hotz & Xiao, ). Indeed, price signaling could be credible only when variable costs depend on quality, thereby causing the difference in the price‐setting incentive between the high‐ and low‐quality product incumbents.…”

Information acquisition, referral, and organization

“…“Passive belief” is a common assumption in models of foreclosure, delegation, and integrations; see Dequiedt and Martimort (), de Fontenay and Gans (), Hart and Tirole (), Laffont and Martimort (), O'Brien and Shaffer (), Reisinger and Tarantino (), and Rey and Tirole (). More recently, it has also been used in the consumer‐search literature; see Bar‐Isaac, Caruana, and Cunat (), Buehler and Schuett (), and Inderst and Ottaviani ().…”