Academic journal article Economic Inquiry

Information and the Provision of Quality Differentiated Products

Academic journal article Economic Inquiry

Information and the Provision of Quality Differentiated Products

Article excerpt

I. INTRODUCTION

In the past 20 years, consumers have become increasingly conscious of the undesirable health and safety attributes of the products they consume, and surveys suggest that a growing percentage of consumers are willing to pay more for higher quality products, such as organic foods and household cleaners and detergents that contain less toxic ingredients (Guber 2003). Other high-quality products facing higher demand include energy-efficient products like extended-life lightbulbs and improved home insulation. Often, these high-quality products provide private benefits that are excludable to buyers as well as public benefits that are nonrival and nonexcludable. For example, reduced pesticide and chemical residue on food may lower the risk of cancer while also reducing contaminated run-off that degrades ground and surface water quality. Extended-life lightbulbs and improved home insulation may reduce an individual's utility bill while also reducing greenhouse gas emissions from lower energy consumption. Although interest in these types of high-quality products is growing, demand is often relatively small. Market shares of organic produce, for example, account for only 1%-2% of total sales (Baker et al. 2002).

One factor that may limit consumer demand for such products is uncertainty about the extent to which these products are indeed of higher quality (i.e., healthier and safer) compared to conventional products. For example, consumers are often unable to determine the amount of pesticide residue on a given piece of produce or the risks associated with its consumption. They may also be uncertain about the true benefits of switching to organic produce. Products whose quality characteristics cannot be determined before, during, or after use are known as credence goods (Darby and Karni 1973). While firms are increasingly advertising the health, safety, and environmental attributes of their products (Scientific Certification Systems 2002), private marketing claims are often vague (e.g., the term organic can refer to different things) or misleading (e.g., nontoxic cleaners may still be toxic when used in excess quantities). Surveys show that consumers are often uncertain about such marketing claims (Mater 1995; Morris et al. 1995), and this uncertainty may reduce consumer willingness to pay for such products (Ottman 1998).

The inability of the market to provide credible information has encouraged government agencies to enact several types of information provision programs. These include direct labeling programs such as the Environmental Protection Agency (EPA) EnergyStar eco-label or the recently approved U.S. Department of Agriculture organic food label. Government information provision may also include more indirect programs such as education and information campaigns as well as the development of guidelines for environmental marketing and labeling policies to improve the standardization and credibility of firms' advertising. (1)

Information provision programs enable consumers to differentiate among products and to express their preferences for product attributes in the market through their consumption choices. Firms may respond to these market signals by producing goods with higher levels of product quality. In an oligopolistic setting and when increasing quality is costly, a firm, however, must consider its rival's response when choosing the quality of its product. A firm producing a low-quality product, for example, must balance the incentive to increase product quality to capture higher consumer willingness to pay against the increase in competition that will result when the firm's product quality becomes closer to its rival. Our first objective in this article, then, is to examine the role that consumer beliefs and provision of information about the quality attributes of products play on the incentives for duopolistic firms to produce higher quality goods. Because information allows firms to more clearly transmit quality differences to consumers, information may allow firms to segment the market and exercise market power, which would allow them to charge higher prices. …

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