Competing eco-labels and product market competition

Journal Pre-proof Competing eco-labels and product market competition Yi Li

PII:

S0928-7655(18)30326-9

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https://doi.org/10.1016/j.reseneeco.2020.101149

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RESEN 101149

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Resource and Energy Economics

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Competing eco-labels and product market competition

Abstract

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I examine the impact of competition between eco-labeling programs in a market where eco-labels that communicate information about product’s environmental quality (a credence attribute) are also strategic variables for competing …rms. Speci…cally, I consider a dynamic setting where an industry-sponsored eco-labeling program and a program sponsored by environmental NGOs compete strategically in setting the labeling standards, before price-setting …rms make strategic choices of which eco-label (if any) to adopt; adopting …rms not presently meeting the labeling standards undertake costly quality improvement to comply with them. I …nd that the competition between eco-labeling programs may lead to the same high environmental bene…t as when there exists only the NGO program. I also …nd that the competition may yield higher social welfare. Key words: Eco-labels; Eco-label competition; Environmental quality; Duopoly JEL classi…cations: D43; L13; Q50

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Introduction

There is growing empirical evidence that consumers care about the environment and are willing to pay more for environmentally friendly products (Cason and Gangadharan, 2002; Teisl et al., 2002; Casadesus-Masanell et al., 2009; Ward et al., 2011; Michaud et al., 2013; Sexton and Sexton, 2014). Although this encourages pro…t-motivated …rms to improve the environmental quality1 of their products, they face a problem of asymmetric information. Environmental quality cannot be observed by individual consumers either from search or consumption, being a credence characteristic of the product. A …rm may make claims regarding the environmental quality of its product, but why should consumers believe it? In the absence of information disclosure mechanisms, …rms may …nd it

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di¢ cult to credibly communicate private quality information to consumers. One method to address this asymmetric information problem is the use of eco-labeling.2 Typically,

an eco-labeling program certi…es that the environmental quality of a product meets a voluntary quality standard determined by the program, and then allows the certi…ed product to display the program’s eco-label on its packaging or advertising materials.

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In recent years, there has been a proliferation of di¤erent eco-labels by di¤erent organizations, as multiple eco-labeling programs enter the labeling marketplace.3 Usually, these programs certify to their respective standards. I refer to this as eco-label

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competition. In many situations, the competition is between a program sponsored by a non-governmental organization (NGO) and a program sponsored by an industry as-

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sociation. A prominent example comes from the forest-products market. In 1993, a coalition of NGOs established the Forest Stewardship Council (FSC) program, with the goal to promote responsible management of the world’s forests. The industry Sustainable Forestry Initiative (SFI) program was created a year later, which introduced its 1

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Environmental quality of a product involves production process, product components and raw materials (Bottega and De Freitas, 2009). 2 There is market-based evidence that consumers respond to eco-labels by altering purchases toward eco-labeled products. For example, Teisl et al. (2002) …nd that the implementation of dolphin-safe labeling increases the market share of canned tuna and decreases the market share of luncheon meats (i.e., close substitutes for canned tuna). Bjørner et al. (2004) show that the Nordic Swan label leads to a signi…cant increase in sales of eco-labeled toilet paper and detergents. Furthermore, there is a rich empirical literature identifying factors that a¤ect consumer preferences toward eco-labeled products. It shows that consumer preferences are in‡uenced by socio-economic factors such as gender, education and age (e.g., Blend and van Ravenswaay, 1999; Johnston et al., 2001; Loureiro et al., 2002; Brécard et al., 2009; Schumacher, 2010). In addition to socio-economic characteristics, other factors may also impact consumer preferences. Consumer preferences are in‡uenced by their knowledge of environmental issues (Wessells et al., 1999; Brécard et al., 2009; Salladarré et al., 2010), level of environmental involvement (Teisl et al., 2008), moral and social norms (Ek and Söderholm, 2008) and trust in the certi…cation agency (Johnston et al., 2001). 3 See Harbaugh et al. (2011) and Heyes and Martin (2017, 2018) for a discussion of label proliferation.

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own label and established alternative quality standard as a response to the FSC label. Similar examples of label competition have also been observed in other markets including building (e.g., the NGO-sponsored LEED program vs. the industry Green Globes program) and ski-resort (e.g., the NGO-sponsored Ski Area Citizens’Coalition program vs. the industry Sustainable Slopes program). Despite the prevalence of industry and NGO eco-labels on the green markets, little is known about whether the competition between them is actually good for the environment. Even less is known about the e¤ect of eco-label competition on social welfare. On the corporate side, in order to extract consumers’ willingness to pay for environmental quality, …rms rely on eco-labeling programs to verify the ful…llments of their

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products to standards determined by the programs. Eco-labeling, besides being an information disclosure mechanism, is also commonly used by …rms as a strategic means

of vertical di¤erentiation (Deltas et al., 2004), which allows …rms to gain market power

and thus softens price competition.4 In particular, the positions of …rms on the quality scale are a¤ected by the labeling standards through …rms’label adoption choices. The labeling standards that are endogenously chosen by the eco-labeling programs will thus

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a¤ect the degree of product di¤erentiation, the intensity of price competition, as well as

consumer and producer surplus. Eco-labeling programs, in turn, must take into account

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how their choices of standards will in‡uence the strategic competition in the product market, since they rely on labels being adopted by …rms to achieve their objectives. Therefore, this paper examines competition between NGO and industry programs that

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act as standard setters to supply labels to strategically competing …rms; in particular, this paper analyzes the impact of this competition on the environment and social welfare. In particular, I consider a Bertrand duopoly where initially there is no eco-label available and the products of the two identical …rms are homogenous and have the same

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basic environmental quality. In the …rst stage, an NGO-sponsored labeling program develops a label and chooses the standard of the label, whose objective is to maximize the aggregate environmental quality on the market.5 In the second stage, an industry-

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sponsored program creates its own label and standard, whose objective is to maximize industry pro…ts.6 In the next stage, …rms simultaneously choose whether and which

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4 There is a large theoretical literature that considers strategic competition between …rms in the labeled products market (see Bonroy and Constantatos, 2015 for a comprehensive survey). Much of this literature assumes price competition à la Bertrand between a labeled …rm and an unlabeled one and adopts a vertical product di¤erentiation framework (e.g., Arora and Gangopadhyay, 1995; Amacher et al., 2004; Ben Youssef and Lahmandi-Ayed, 2008; Ibanez and Grolleau, 2008). 5 I use the terms aggregate environmental quality and environmental bene…t interchangeably throughout this paper. 6 Most of the literature on eco-labels (Heyes and Maxwell, 2004; Brécard, 2014; Fischer and Lyon, 2014;

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label to adopt. Finally, …rms engage in price competition. In order to meet the labeling requirements, …rms have to improve the environmental quality of their products, which involves a …xed quality-improvement cost.7 I show that when the NGO program is alone in the market it will end up setting a standard such that the …rm adopting the label earns zero pro…t. Surprisingly, the industry program whose objective is signi…cantly di¤erent from that of the NGO program, may …nd it optimal to set the same standard in the presence of label competition when …rms’ marginal cost increases quickly in environmental quality. The intuition is as follows. The optimal level of the industry standard depends on the relative sizes of two e¤ects: a “market segmentation e¤ect” and a “…xed cost e¤ect”. Increasing the

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standard increases the …xed improvement cost, which decreases industry pro…t. This is the …xed cost e¤ect. On the other hand, increasing the standard increases the extent

of vertical di¤erentiation which, in turn, softens price competition and allows higher industry pro…t. This is the market segmentation e¤ect. The market segmentation e¤ect

dominates when the marginal cost increases quickly in environmental quality as the cost of quality is borne largely by the marginal cost instead of the …xed cost; as a result,

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the industry program will keep increasing its standard until the adopting …rm earns zero

pro…t. The environmental bene…t, measured as the aggregate provision of environmental

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quality on the market, is thus the same under a single NGO label and label competition. I also show that the competition between industry and NGO labels can lead to higher social welfare relative to a single NGO label when the social planner places a su¢ ciently

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small weight on environmental bene…t relative to private bene…t (the sum of consumer surplus and industry pro…t). This suggests that eco-label competition might be desirable from a social standpoint.

The paper is organized as follows. In Section 2, I present an overview of the related

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literature. Section 3 describes the model. In Section 4, I present a benchmark model in which the NGO program is alone in the market. Section 5 extends the analysis to consider label competition and presents the major …ndings of this paper. Section 6 contains the

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welfare analysis. In Section 7, the robustness of the main results is addressed in several extensions. Section 8 concludes.

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Li and van ’t Veld, 2015; Fischer and Lyon, 2019) assumes that an NGO-sponsored labeling program maximizes the aggregate environmental quality, while an industry-sponsored program maximizes the aggregate pro…ts of the industry. 7 Poret (2019) uses a double duopoly model of vertical product di¤erentiation, which is similar to my model to study label competition between two NGOs.

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Related literature

There exists a large theoretical literature on eco-labels, which addresses several sets of issues. One strand of the literature focuses on …rm incentives to adopt an eco-label, using vertical product di¤erentiation models (e.g., Amacher et al., 2004; Ben Youssef and Lahmandi-Ayed, 2008). Other strands of the literature focus on the e¤ect of ecolabels on international trade (Tian, 2003; Basu et al., 2004; Greaker, 2006; Robertson, 2007), potential undesirable e¤ects of eco-labels (Swallow and Sedjo, 2000; Dosi and Moretto, 2001; Sedjo and Swallow, 2002), and implications of imperfect monitoring of labeling standards (Hamilton and Zilberman, 2006; Mason, 2011). All these analyses, as most of the theoretical literature on eco-labels, typically ignore the phenomenon of

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eco-label competition and con…ne attention to the case of a single label.

Studies that do consider multiple labels are rare, most of which abstracts from issues

of strategic interaction between labeling organizations and does not allow labeling stan-

dards to be set strategically. For example, Roe and Sheldon (2007) examine in a duopoly

model with vertical product di¤erentiation how quality is communicated through label-

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ing by assuming that the government standard is exogenous and the private labeling standard is always set at the …rm’s pro…t-maximizing level. Harbaugh et al. (2011) assume that …rms’qualities and the stringency of labels are exogenous; they …nd that if the informativeness of labels.

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consumers are unsure of labeling requirements then proliferation of eco-labels decreases

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To my knowledge, there are only three papers that explicitly allow labeling standards to be set strategically by competing organizations that have di¤ering objectives: Fischer and Lyon (2014, 2019) and Li and van ’t Veld (2015).8 In particular, all three papers study strategic competition between NGO-led and industry-led eco-labels. Fischer and

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Lyon (2019) examine competition between NGO- and industry-sponsored programs when two-tier standards are possible. Fischer and Lyon (2014) and Li and van ’t Veld (2015) are closest to this paper, in that they, too, focus on the case in which each labeling

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organization o¤ers exactly one standard when they compete in the label market. Fischer and Lyon (2014) consider a representative consumer model with a continuum of …rms who are heterogeneous in variable costs of green production. The authors …nd that

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competition drives the two programs’ standards apart and equilibria are possible in which the industry program sets a standard higher than that of the NGO program. In contrast, Li and van ’t Veld (2015) allow for consumer heterogeneity and assume that

8 Heyes and Martin (2017, 2018) and Poret (2019) also study competition between eco-labels. However, they model rivalry between labels created by competing NGOs, that is, by organizations that have the same objective.

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…rms are heterogeneous in …xed costs of green production instead of variable costs; they show that in the presence of both labels the unique equilibrium outcome is one where the NGO program sets a higher standard than the industry one. The main di¤erence between this paper and the papers cited above is that in my model …rms choose their prices strategically and have market power in the product market. In Fischer and Lyon (2014, 2019) and Li and van ’t Veld (2015), however, …rms are price-takers. Speci…cally, I consider a double duopoly model in which an NGO competes with an industry association in o¤ering labels to two …rms that are Bertrand competitors in the product market. In particular, the product market competition stage of the model in this paper is closely related to the vertical product di¤erentiation model.

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As in many papers in the theoretical literature on eco-labels, such as Amacher et al. (2004), Ben Youssef and Lahmandi-Ayed (2008), and Ibanez and Grolleau (2008), I

assume that …rms …rst make labeling decisions (quality competition) and then engage in

price competition. Arguably, the approach reported in this paper has particular relevance when only two or three major …rms compete in the market and display di¤erent labels.9

More importantly, the model I propose captures the empirical reality that the strategy

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of di¤erentiating products with eco-labels does help …rms to gain market power.10 To the best of my knowledge, this is the …rst paper to study strategic competition between

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NGO and industry eco-labels in a context where eco-labels create market power in the product market.

This connection between eco-labels and market power turns out to be an important

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force driving the results of this paper. In the present paper, …rms obtain market power when they are selling di¤erently labeled (vertically di¤erentiated) products. In particular, a higher degree of vertical di¤erentiation reduces price competition, increases …rms’ market power, and results in higher revenues for both …rms. At the same time, the

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degree of vertical di¤erentiation depends critically on the stringency of labels that are endogenously chosen by the industry and the NGO program. Since the industry program cares about industry pro…ts, it has incentives to di¤erentiate its label from the rival

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label; in particular, a low NGO standard will elicit a high standard from the industry program. Indeed, I show that equilibria are possible in which the industry program sets a higher standard than the NGO one. By contrast, in Li and van ’t Veld (2015) no such

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equilibria arise. 9

For instance, in many developed countries, only two or three major tea blenders, such as Typhoo, Lipton, or Tetley, compete on the tea market and display di¤erent labels. In particular, Typhoo displays no label at all, Lipton displays the Rainforest Alliance label that is an NGO-run label, and Tetley participates in the industry Ethical Tea Partnership program (Loconto, 2010). 10 See Deltas et al. (2004) for instance.

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Fischer and Lyon (2014) also …nd that equilibria with the industry standard higher than the NGO one are possible in their representative consumer model. I stress that the mechanisms that are at work in their analysis di¤er from the ones explored by this paper. In their model the pro…ts earned by a …rm that sells a labeled product as well as the price it charges depend only on the standard of that label; in other words, one …rm’s price and pro…ts are independent of the qualities of the other …rms. As a result, a change in the industry standard will only a¤ect the pro…ts of …rms that adopt the industry label, and will have no impact on the pro…ts of …rms that are already certi…ed to the NGO standard or …rms opting to be unlabeled. The primary motive for the industry program to o¤er a higher standard is to raise pro…t margins of …rms that are certi…ed to the

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industry standard. In my framework, however, each …rm’s price and pro…t depend on the quality of the …rm itself and of its rival. Hence, a change in the industry standard may a¤ect not only the pro…t of the …rm carrying the industry label but also the pro…t

of its rival who does not adopt the industry label. A …rm, whether it is certi…ed to the industry standard or not, can bene…t from less intense competition resulting from

greater di¤erentiation, which is the primary motive for the industry program to set a

The model

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higher standard.

I consider a market that consists of two …rms, indexed by i = 1; 2. The two …rms produce

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a product that can be vertically di¤erentiated in terms of environmental quality. I assume that consumers have unit demand, and the indirect utility of a consumer who purchases a product of environmental quality qi at price pi from …rm i is given by

where

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U = qi + u

pi ;

(1)

measures consumer’s marginal willingness to pay for the environmental quality,

which is uniformly distributed on [ , ] with probability density function f ( ) and cu-

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mulative distribution function F ( ). The parameter u > 0 is the baseline bene…t that consumers derive from buying the product. To focus on eco-labeling, products are sup-

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posed to di¤er only by their environmental qualities and, therefore, u is the same for the two products (and to all consumers). I assume that u is large enough that the market is covered, that is, all consumers buy in the equilibrium.11 11

The covered market assumption is an approximation, which …ts markets with low market elasticity: a small price change across all …rms does not change the number of consumers active in the market (Alexandrov, 2016). Examples of covered ecolabeled product market include the markets for toilet

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The marginal production cost for each …rm is given by ci (qi ) = qi ; where

(2)

> 0 is a constant. In other words, marginal cost is an increasing function of

environmental quality and it is increasing at a constant rate .12 In the absence of eco-labels, both …rms produce the lowest possible quality s.13 I assume that s is exogenously imposed as a minimum environmental quality standard (i.e., …rms face the constraint qi

s).14

Since environmental quality is a credence attribute of the product, consumers rely on eco-labels for information about it. In particular, the presence of an eco-label on the

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product means for consumers that the environmental quality of the product meets or

exceeds some given threshold, and I will refer to this threshold as ‘labeling standard’. In the present setup, …rms have two labeling options, one o¤ered by an NGO-sponsored

program and the other o¤ered by an industry-sponsored program. The labeling standard of the NGO label and the industry label is denoted by sN and sI respectively. sN and

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sI are known to all consumers.

Consumers understand that the NGO label is di¤erent from the industry label,15 and they also identify the presence of a label on a product as a sign of environmental

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superiority.16 Therefore, for consumers, a product stamped with the NGO label (respectively, the industry label) has a quality q product has a quality s

sN (respectively, q

sI ), and an unlabeled

q < minfsN ; sI g. Then, the simplest beliefs consumers may

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form about qualities are that an unlabeled product has the minimal environmental quality q =s, and a product carrying the NGO label (respectively, the industry label) has a

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paper, detergents and electricity. The assumption of covered market is common to the models of vertical product di¤erentiation; see Cremer and Thisse (1994), Crampes and Hollander (1995), or Bansal (2008). I will investigate in the last section the consequences on the main results if this assumption is modi…ed. 12 I thus assume that …rms’ marginal costs are independent of quantity but strictly increasing in quality. This assumption is standard in models of vertical product di¤erentiation since the seminal paper by Mussa and Rosen (1978), and I stick to this convention. To quote Mussa and Rosen (1978, p. 302) “This assumption is useful because it permits the analysis to focus clearly on the role of demand conditions and substitution among product varieties from self-selection, without complications arising from interactions among the costs of producing di¤erent varieties.” 13 Note that without labeling …rms have no incentives to produce a quality higher than s as higher quality is more costly to produce and cannot be discerned by consumers. 14 s can be normalized to zero without loss of generality, but for expositional clarity I will retain the notation s. 15 See Loureiro and Lotade (2005) and Brécard et al. (2012) for empirical evidence that consumers know labels are di¤erent. 16 There exists empirical evidence that most consumers view the eco-label as an indication of environmental quality of a product, and prefer an eco-labeled product to an unlabeled one (see Brécard et al., 2009).

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quality that exactly matches sN (respectively, sI ).17 It seems reasonable to assume that consumers form the beliefs speci…ed above in light of the nature of eco-labels considered in this paper. I focus here on Type I ecolabels, which communicate if a product meets a certain quality threshold instead of communicating the exact level of quality being produced.18 As such, eco-labels considered in this paper provide consumers with partial information as they merely allow consumers to know whether a product satis…es the labeling standard. For instance, when consumers observe a product stamped with the NGO label, they are, in fact, unsure of whether the environmental quality of this product is sN or strictly higher than sN . Therefore, the model assumes that consumers do not expect …rms adopting the NGO label (respectively,

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the industry label) to produce a quality level higher than sN (respectively, sI ).19 Given the perception by consumers, a …rm will never oversatisfy the labeling standard; indeed, it will always do the minimum required to qualify for the label to save production costs. That is, the …rm will produce quality q = sN (respectively, q = sI )

rather than a higher quality to obtain the NGO label (respectively, the industry label).

Similarly, the …rm will simply produce s if it opts to be unlabeled. Firms set the prod-

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ucts in “some category”(unlabeled, NGO labeled or industry labeled) at the least costs.

In other words, …rm i will simply choose its quality qi from the relevant qualities fs, sN ,

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sI g. Firm choices are therefore consistent with consumer beliefs.

If …rm i decides to adopt the NGO label (respectively, the industry label), it has to

move to quality sN (respectively, sI ). This entails a …xed quality-improvement cost Ii .

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I assume:

Ii = (sN 17

s)2 (or, Ii = (sI

s)2 );

(3)

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This assumption on consumer beliefs is made in several other papers including Ben Youssef and Lahmandi-Ayed (2008) and Ghazzai and and Lahmandi-Ayed (2018). 18 I focus on Type I eco-labels because of their prevalence. Type I eco-labels have also received considerable attention by the academic literature (Teisl and Roe, 1998; Greaker, 2006; Ben Youssef and Lahmandi-Ayed, 2008; Ibanez and Grolleau, 2008; Fischer and Lyon, 2014). Prominent examples of Type I eco-labels include the Blue Angel label, the EU Ecolabel, and the Nordic Swan label. The use of Type I eco-labels has been supported by organizations like the World Bank (see Teisl and Roe, 1998). Roe and Sheldon (2007) suggest that …rms prefer Type I labels to continuous labels (de…ned as labels that communicate the exact quality level) because Type I labels are less expensive. 19 To see this, suppose to the contrary that consumers are convinced the …rm adopting the NGO label is providing a quality higher than sN ; as a result their willingness to pay for this …rm’s product increases. Since the NGO label only delivers partial information about quality, the …rm has incentives to mitigate just to the quality level that is required to obtain the NGO label to save on costs, that is, the …rm has incentives to choose quality sN . In such a situation, consumers anticipate the …rm’s quality choice and rationally believe that the …rm adopting the NGO label will choose quality sN instead of o¤ering a quality above sN . A similar argument applies to the …rm adopting the industry label and the unlabeled …rm as well.

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where

> 0 is a constant.

I consider a multi-stage game. Initially, there is no eco-label available on the marketplace and the two …rms produce the same quality s. In the …rst stage, the NGO-sponsored program develops a label with labeling standard sN

s to maximize the aggregate envi-

ronmental quality on the market. In the second stage, the industry-sponsored program introduces an alternative label and chooses a standard sI

s to maximize industry

pro…ts. In the next stage, …rms simultaneously decide whether to adopt a label and which one to adopt. Finally, …rms engage in price competition. Note that in this model ci (qi ) is the marginal cost associated with a given level of environmental quality, which may correspond for instance to the use of raw materials

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more or less harmful to the environment; furthermore, Ii is the …xed cost of quality upgrading, which could be thought of as investment in green technologies.20 I use speci…c functional forms for ci (qi ) and Ii ; speci…cally, I choose, respectively, ci (qi ) = Ii =

(sN

s)2 (or,

Ii =

(sI

s)2 ).21

qi and

In fact, the analysis of stages 3 and 4 can be

done with very general cost functions. However, to be able to calculate endogenously the labeling standards I do need speci…c functional forms for cost functions.22 Assumption 1. 2 - <

<2

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In the remainder of this paper, the following parameter restriction is maintained: .

rate

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As the marginal production cost is increasing in environmental quality at the constant , Assumption 1 implies that it increases neither too quickly nor slowly, which

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ensures …rms will have strictly positive demand in price competition.

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Benchmark: a single NGO label

In this section I examine the benchmark case in which the NGO label is the only label

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available on the marketplace. This case is denoted by superscript SN. In this case, the NGO-sponsored program creates an eco-label with quality standard sSN N , whose objective I assume is to maximize the aggregate environmental quality E SN . 20

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In fact, investment in green technologies is quite prevalent among eco-labeling participants. Many eco-labeling programs encourage participating …rms to use only the “best available technologies” to achieve the required environmental quality standards (see OECD, 1997). A common assumption is that …rms must consider either modi…cations to existing technologies or adopting new technologies in order to satisfy a third-party auditor (see Amacher et al., 2004). 21 This speci…cation for ci (qi ) is also used by Conrad (2005), Kuhn (2007), and Ben Youssef and Lahmandi-Ayed (2008); furthermore, the speci…cation for Ii is also used by Ben Youssef and LahmandiAyed (2008). 22 The use of speci…c functional forms for cost functions is common practice in the vertical product di¤erentiation literature, as discussed in Lombardini-Riipinen (2005).

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First, I describe the equilibrium of the third stage pricing game after the …rms’label decisions are made. Speci…cally, when no …rm chooses the label, both …rms produce quality s, involve in competition “a la Bertrand”, and charge a price equal to the marginal cost

s. When both …rms adopt the NGO label and produce quality sSN N , they still sSN N . When only

engage in aggressive price competition and charge a common price

one …rm adopts the label, Appendix A shows that the unique equilibrium prices charged 1 SN by the labeled …rm and the unlabeled …rm are pSN N = 3 [ s + 2 sN + (2

and

pSN

=

1 3[

sSN N

+2 s+(

2

)(sSN N

s)]

)(sSN N

s)], respectively; furthermore, consumers with 2 [b; ] buy from the labeled …rm and those with 2 [ ,b) buy from the unlabeled …rm, where b = + + : 3

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In the second stage, the duopolists simultaneously determine whether to adopt the

label or not, taking into account the consequences of this decision for the third stage. Table 1 shows the normal form of the second stage of the game.23 < Insert Table 1 here >

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It is clear to see that this second stage game always possesses pure-strategy equilibria, as follows.

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Lemma 1 Suppose there exists only the NGO label. Then, the equilibrium outcome in label choices is:

(2 (1) No …rm adopts the NGO label, if sSN N >s+ 9

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(2) Only one …rm adopts the NGO label, if s Proof. See Appendix A.

( SN sN

)2 . ) s+ (29 (

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(2 Intuitively, if the NGO standard is stringent i.e., sSN N >s+ 9

cost associated with producing quality

sSN N

)2 . )

(

)2 )

then the …xed

will be high. It turns out that the …xed

cost will be even higher than the bene…t of selling the labeled product. That is, the …rm adopting the NGO label makes a negative pro…t (when its rival chooses to remain )2

(2

(sSN N

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unlabeled) i.e.,

is stringent i.e.,

9( SN sN

)

>s+ (29

(

s)

)2 , )

(sSN N

s)2 < 0. Indeed, when the NGO standard

if a …rm adopts the NGO label it will earn negative

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pro…t regardless of what its rival does; as a result, none of the …rms adopts the NGO label. On the other hand, if the NGO standard becomes lower i.e., s

sSN N

s+ (29

(

)2 )

then the bene…t of selling the labeled product will exceed the …xed quality-improvement cost i.e., 23

)2

(2

9(

)

(sSN N

s)

(sSN N

s)2

0. As adopting the NGO label by both

Calculations of payo¤s shown in Table1 can be found in Appendix A.

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…rms eliminates product di¤erentiation, it is in their mutual interest that only one …rm adopts the label. Now I turn to the …rst stage, where the NGO-sponsored program chooses sSN N that maximizes the aggregate environmental quality E SN . If the standard sSN N chosen by the NGO program is such that s

sSN N

s+ (29

(

)2 , )

then exactly one …rm will adopt the label and the NGO program solves the following optimization problem:

sSN N

Z

=

R

b

s+

Z

b

sSN N f ( )d )2

(2 9 (

)

:

(4)

sf ( )d is the environmental quality provision of the unlabeled …rm, sSN N f ( )d is the quality provision of the labeled …rm. I obtain the

following solution: (2 9 (

)2

)

sb:24

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sSN N =s+

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and the term

Rb

sf ( )d +

sSN N

s:t: s

The term

b

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maxE

SN

(5)

The aggregate environmental quality on the market is therefore =

Z

b

Z

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E

SN

sf ( )d +

b

sbf ( )d = s +

(2 27 (

)3 )2

b E:

(6)

On the other hand, if the standard sSN N chosen by the NGO program is such that (

)2 , )

then no …rm will adopt the NGO label. As a result, the market

na

(2 sSN N >s+ 9

provision of environmental quality is exactly the same as if there was no label at all, b which is equal to s (where s < E).

ur

Now, I can establish the main result of this benchmark case.

Proposition 1 When there exists only the NGO label, the optimal NGO quality standard is sSN b. Furthermore, one …rm adopts the NGO label and produces environN = s

Jo

mental quality sb whereas the other …rm remains unlabeled and produces environmental

quality s. 24

sb is a corner solution: it is the highest standard at which the NGO label will be adopted.

11

b the equilibrium indusThe equilibrium aggregate environmental quality is E SN = E; try pro…t is SN = b , where

Proof. See Appendix A.

b=( +

2 )2 (2 81 ( )2

)2

:

(7)

Proposition 1 indicates that the equilibrium features a vertical-di¤erentiation outcome with one …rm adopting the NGO label and the other …rm opting to be unlabeled. This is because the adoption of the NGO label by both …rms cancels out the di¤erentia-

ro of

tion between the two products, which will result in intense price competition and cause prices and pro…ts to fall for all …rms. Another interesting observation is that the optimal

NGO standard is set such that the bene…t of selling the labeled product and the …xed quality-improvement cost are equalized and the …rm adopting the NGO label makes zero

pro…t. The NGO-sponsored program will not increase the standard beyond sb, as otherwise the bene…t of selling the labeled product cannot cover the quality-improvement

-p

cost and consequently neither …rm improves environmental quality.

Combining NGO and industry labels

re

5

In this section, I turn my attention to the full model in which both NGO and industry

5.1

lP

labels are available.

Price competition

Using backward induction, I …rst turn to the last stage in which …rms choose prices given

na

their preceding choices of labels. In order to determine the Nash price equilibrium in the sub-game, I need to distinguish two possible cases: (a) …rms sell products that have the same quality, and (b) …rms sell vertically di¤erentiated products.

ur

No di¤ erentiation: When both …rms sell unlabeled products or when they choose the same label, so that q1 = q2 , the classic Bertrand game applies. As a result, both …rms charge a common price equal to the marginal cost of production.

Jo

Di¤ erentiation: When …rms sell di¤erently labeled products (i.e., when one …rm

adopts the NGO label while the other …rm adopts the industry label) or when only one …rm sticks a label on its product, so that q1 6= q2 (viz. q1 > q2 or q1 < q2 ) then both …rms

will have market power due to product di¤erentiation. For the moment, I abstract from which …rm is providing higher quality and simply assign the …rm that produces a higher 12

quality the index H and the remaining one the index L, so that qH > qL .25 Denote the price charged by …rm H as pH and that of …rm L as pL . Then, the equilibrium prices are given by the following formulas (computations can be found in Appendix A): 1 pH = [ qL + 2 qH + (2 3 1 pL = [2 qL + qH + ( 3

)(qH

qL )];

2 )(qH

qL )]:

Consumers with 2 [ ,b) buy from …rm L, and those with H, where b = +3 + :

2 [b; ] buy from …rm

can be found in Appendix A):

L

=

)2

(2 9(

(qH

qL )

(qH

2 )2 (qH )

qL )

(qL

)

( + 9(

Label choice

s)2 ;

s)2 :

-p

=

re

5.2

H

ro of

The corresponding pro…ts are then given by the following formulas (computations

In the third stage, each …rm now faces a choice between three options: to choose no label, to choose the NGO label or the industry label. Which label (or no label) a …rm

lP

signs up for will depend on the relative stringency of the di¤erent standards. To see this, …rst consider the case where the industry-sponsored program responds to the NGO standard by setting a lower standard (i.e., s

sI < sN ).26 The normal form of the

na

labeling sub-game is represented in Table 2.27

< Insert Table 2 here >

I am now ready to characterize the equilibria of the third stage game in the case (i.e., s

ur

where the industry program responds to the NGO standard by setting a lower standard sI < sN ). The results are summarized in the following lemma.

Jo

Lemma 2 Suppose that the industry-sponsored program responds to the NGO label by setting a lower standard (i.e., s

sI < sN ). Then,

25

For the moment, I also abstract from the issue of whether the NGO standard is higher or lower than the industry standard. 26 Note that I distinguish two possible cases, either s sI < sN or s sN < sI . 27 The derivation of Table 2 is analogous to that of Table 1 and is available upon request.

13

(i) One …rm adopts the industry label and the other …rm adopts the NGO label if: s+ (29

sI =s and sI < sN

)2 : )

(

(ii) One …rm adopts the NGO label and the other …rm remains unlabeled if: s< sI < sN < 2s+ (29

)2 )

(

sI :

(iii) One …rm adopts the industry label and the other …rm remains unlabeled if: maxfs,2s+ (29

(

Proof. See Appendix B.

)2 )

sN g

s+ (29

sI

(

)2 )

and sN > sI :

As before, pro…t maximization leads to incentives for …rms to o¤er di¤erentiated products. More interestingly, even though …rms have more options now the low-quality

ro of

…rm will still produce the lowest possible quality in equilibrium (i.e., the low-quality …rm exactly matches s). This could either be because the low-quality …rm elects to remain unlabeled (see (ii) and (iii) in Lemma 2) or because it decides to comply with

the industry standard (see (i) in Lemma 2). One may ask why the low-quality …rm sticks to the lowest quality level. This is because the pro…t of the low-quality …rm decreases with an increase in its own quality. Indeed, increasing quality has two negative e¤ects

-p

on the pro…t of the low-quality …rm. First, it increases the …xed quality-improvement cost. Indeed, the low-quality …rm can completely avoid this cost by choosing the lowest possible quality. Second, an increase in quality results in a reduction in the mark-up

re

(i.e., the di¤erence between price and marginal cost), thereby reducing the pro…t of the low-quality …rm.

lP

Another interesting observation is that when the industry program sets sI 6=s, one

…rm will opt to be unlabeled while the other …rm will choose between the NGO label and the industry label. Whether the latter …rm adopts the NGO label or the industry label will, naturally, depend on which label generates higher pro…t.

na

To determine which labeling option is more pro…table to the latter …rm, it is useful to imagine what will happen if the latter …rm is allowed to develop its own label. The …rm will then set a labeling standard equal to its pro…t-maximizing quality s+ (218

ur

that is, the …rm’s most preferred labeling standard equals

s+ (218 (

(

)2 , )

)2 28 . )

Now suppose in the third stage, for example, the following relationship between the

Jo

NGO standard and the industry standard is observed (see (ii) in Lemma 2): s < sI < sN < 2s +

(2 9 (

)2 )

sI ;

or equivalently, 28

Note that s+ (218

(

)2 )

is the unique and global maximum of this …rm’s pro…t function.

14

sN

(s +

)2 (2 ) < (s + ) 18 (

(2 18 (

)2 ) )

sI :

Then, the latter …rm will de…nitely choose the NGO label, as the NGO standard is closer to the …rm’s pro…t-maximizing standard and thus yields higher pro…t. By employing the same arguments used above, I have the following lemma in the situation where the industry program responds to the NGO label by setting a higher standard (i.e., s

sN < sI ).

Lemma 3 Suppose that the industry-sponsored program responds to the NGO label by setting a higher standard (i.e., s

sN < sI ). Then, s+ (29

sN =s and sN < sI

(

)2 : )

ro of

(i) One …rm adopts the industry label and the other …rm adopts the NGO label if: (ii) One …rm adopts the NGO label and the other …rm remains unlabeled if: maxfs,2s+ (29

(

)2 )

s+ (29

sI g < sN

(

)2 )

and sI > sN :

(iii) One …rm adopts the industry label and the other …rm remains unlabeled if: (2 9 (

Choices of labeling standards

)2 )

sN :

re

5.3

2s +

-p

s < sN < sI

Having described the equilibria of the third-stage game, I move back to earlier stages in which the NGO-sponsored program sets its standard sN in the …rst stage to maximize

lP

the aggregate environmental quality on the market and the industry-sponsored program chooses its standard sI in the second stage to maximize industry pro…t. I will have two scenarios. A …rst scenario arises when …rms’marginal cost increases slowly in environmental quality: 2

<

<

1 2(

+ ). I will refer to this as the low

na

marginal cost of quality scenario. The second scenario is one where …rms’marginal cost increases quickly in environmental quality:

1 2(

+ )

<2

. I will refer to this as

5.3.1

ur

the high marginal cost of quality scenario. Low marginal cost of quality

Here, I examine the strategic behaviors of the two programs when …rms’marginal cost

Jo

increases slowly in environmental quality i.e., 2

<

< 12 ( + ).

First, I obtain the best-response of the industry-sponsored program. Interestingly,

I …nd that a low standard by the NGO program may elicit a high standard from the industry program, whereas a high NGO standard may elicit a low industry one.

15

To see this, suppose that the industry program observes a very low NGO standard )2 ( + 18 ( )

such that s< sN < se, where se =s+ (2

2 )2

. Then, the industry program

knows that if it responds with a higher standard such that sN < sI

2s+ (29

(

)2 )

sN ,

one …rm will opt to be unlabeled and the other …rm will choose the industry label (see Lemma 3). Therefore, in this case, the industry program sets sI to maximize industry pro…ts: =

( + 9(

2 )2 (sI )

s) +

)2

(2 9(

)

(sI

s)

(sI

s)2 ; 29

(8)

which gives )2 + ( + 18 ( )

(2

2 )2

and industry pro…t is then 2 )2 + (2 324 ( )2

[( +

)2 ]2

s ;

(9)

:

(10)

-p

=

ro of

sI = s +

If the industry program instead responds with a lower standard such that sI < sN or a very high one (above 2s+ (29

)2 )

(

sN ), then one …rm will opt to be unlabeled

( + 9(

re

and the other …rm will choose the NGO label (see Lemma 2 and Lemma 3). As a result, 2 )2 (sN )

)2

(2

(sN

s)2 ,

and it is straightforward to verify that this industry pro…t is strictly lower than

for

=

s) +

9(

)

(sN

s)

lP

the industry pro…t becomes any sN 2 (s; se).

Thus, when faced with a sN standard between s and se, the industry program’s

optimal response is to set sI = s .

na

Similarly, I can characterize the industry program’s best response when faced with a sN standard in the remaining range, which is described in the following lemma.30 Lemma 4 When 2

ur

program writes:

<

<

1 2(

+ ), the best response of the industry-sponsored

(1) sI = s , if sN =s or s< sN < se

Jo

(2) sI = 2s+ (29

(

)2 )

sN , if se 0

(3) sI =s or sI > sN , if s

29

Note that

sN

0

sN < s s

is determined by the formula given by (18) after replacing qL by s and replacing qH by

sI .

30

A similar analysis is developed to analyze when sN is in the remaining range and the complete proof of this lemma can be obtained from the author upon request.

16

(4) sI = s , if sN > s , )2 ( + 18 ( )

where se =s+ (2

2 )2

)2 . )

0

and s =s+ (218

(

I now turn to the …rst stage, where the NGO-sponsored program chooses sN to

maximize the aggregate environmental quality on the market, anticipating the reaction of the industry program. If the NGO program chooses either a very high standard (i.e., sN > s ) or a very low one (i.e., sN =s or s< sN < se), the industry program will set sI = s in the next

stage (see Lemma 4); one …rm will produce quality s, while the other …rm will adopt

the industry label and produce quality s . Then, the aggregate environmental quality

Z

b

sf ( )d +

Z

b

s f ( )d = s+

ro of

on the market is:

)[( + 2 )2 + (2 54 ( )2

(2

)2 ]

E (11)

I now argue in this low marginal cost of quality scenario, the maximum of the aggre-

-p

gate environmental quality that can be reached is exactly E no matter what standard the NGO program chooses in the …rst stage. To see this, consider the case where the NGO program instead sets an intermediate standard (i.e., se

re

industry program’s best response becomes sI = 2s+ (29

(

)2 )

0

sN < s ), then the

sN ; one …rm will pro-

duce quality s, while the other …rm will adopt the industry label and produce quality (

)2 )

sN . In this case, the aggregate environmental quality on the market is: E=

Z

b

lP

2s+ (29

sf ( )d +

Z

b

(2s +

(2 9 (

)2 )

sN )f ( )d :

na

It is straightforward to check that the above expression is strictly decreasing in sN . This implies that the NGO program should choose a standard as low as possible in the …rst stage, which is se in this case. This, in turn, implies that the industry program (

)2 )

ur

will set sI = 2s+ (29

se = s in the following stage; as a result, the aggregate

environmental quality on the market is equal to E .

Jo

I summarize the above discussion in the following proposition: Proposition 2 Suppose that 2

<

< 12 ( + ), i.e., …rms’ marginal cost increases

slowly in environmental quality. Then, the industry-sponsored program is indi¤ erent between setting sI =s and setting a standard sI > s (where s is as de…ned in (9)),

provided the NGO-sponsored program chooses sN = s in the …rst stage. Another possible

17

equilibrium outcome is that the industry-sponsored program chooses sI = s , while the NGO-sponsored program chooses a standard sN 2 [s,e s] or a standard sN > s .

Further, one …rm will produce environmental quality s whereas the other …rm will

produce s . The equilibrium aggregate environmental quality and industry pro…t are equal to E and

, which are given by (11) and (10), respectively.

Proof. See Appendix B. Proposition 2 shows that when the NGO program sets sN = s in the …rst stage then the industry program may choose to cede the market to the rival by o¤ering a su¢ ciently high standard i.e., sI > s ; indeed, the industry program may even choose not to enter the market. The intuition is as follows. Recall that the formula for the industry pro…t =

( + 9(

2 )2 (s )

s) +

)2

(2 9(

)

(s

(s

s)

s)2 ,31 and exactly at standard s = s

ro of

is

the industry pro…t is maximized. Therefore, as long as the NGO standard is at level s , the industry program whose objective is to maximize the industry pro…t is indi¤erent

between choosing a standard above s and staying out. However, if, for instance, the NGO program chooses a very low standard in the …rst stage (i.e., s

sN

se), then

-p

there is room for the industry program to enter and choose an alternative strategy. In

particular, the industry program will introduce its own label and respond with a quality standard that is much more stringent than the NGO one, that is, sI = s > sN .

re

Consistent with my analysis, in some markets the entry of a new industry label is indeed induced by a lenient incumbent NGO label. On the labeling market for …sheries,

lP

for example, the Alaska’s salmon industry used to adopt the label created by the Marine Stewardship Council (MSC) which was formally established as an NGO in 1997 and also the incumbent certi…er for wild catch …sheries; however, in 2012, the whole industry turned away from the MSC and created its own label due to the MSC weakening its

na

quality standard.32

These results have some implications for the debate over the role of industry ecolabels aimed at environmental aspect of product quality. Opponents of industry eco-

ur

label (who are mostly to be environmental groups) often claim that if there is already an NGO label in existence then the entry of industry eco-label is useless.33 However, if for some reason the NGO program sets a very weak standard, and if the industry 31

Jo

See Appendix A. See Jolly (2013). 33 For example, on May 20, 2005, a group of NGOs run an advertisement in the New York Times which said: ‘How can you trust the timber industry to measure its own environmental sustainability? Isn’t that like the fox guarding the henhouse? Simply stated, the Sustainable Forestry Initiative program is a historic greenwashing e¤ort to blur the public’s trust in ecolabeling, helping loggers appear “sustainable” when it’s really just the Same-old Forest Industry.’ 32

18

program enters and succeeds in creating a more stringent label, then there can be a gain to the environment. The introduction of the industry label as a potential alternative guarantees the high environmental quality of the labeled product, which has a positive e¤ect on the environment. 5.3.2

High marginal cost of quality

Here, I examine the strategic behaviors of the two programs when …rms’marginal cost increases quickly in environmental quality i.e., 12 ( + )

<2

. Replicating argu-

ments along previous lines, I have the following result. 1 2(

+ )

<2

, i.e., …rms’ marginal cost increases

ro of

Proposition 3 Suppose that

quickly in environmental quality. Then, the industry-sponsored program is indi¤ erent

between setting sI =s and setting a standard sI > sb (where sb is as de…ned in (5)),

provided the NGO-sponsored program chooses sN = sb in the …rst stage. Another possible

equilibrium outcome is that the industry-sponsored program chooses sI = sb, while the

-p

NGO-sponsored program chooses sN = s or a standard sN > sb.

Further, one …rm will produce environmental quality s whereas the other …rm will

re

produce sb. The equilibrium aggregate environmental quality and industry pro…t are equal b and b , which are given by (6) and (7), respectively. to E Proof. See Appendix B.

lP

Proposition 3 challenges the view that eco-label competition is detrimental for the environment. Instead, by comparing Propositions 1 and 3, I …nd that eco-label competition may yield the same high environmental bene…t as when there exists only the NGO b in both cases. Intuitively, when label. More precisely, environmental bene…t is equal to E

na

the marginal cost increases quickly in environmental quality i.e., 12 ( + )

<2

,

the equilibrium qualities o¤ered by the two …rms are the same under label competition

and a single NGO label; in particular, the low-quality …rm always produces a product of

ur

quality s while the high-quality …rm always produces a product of quality sb. Moreover, each …rm’s market share remains unchanged. As a result, the quality provision of each

…rm (the quality of its product times the market share) as well as the environmental

Jo

bene…t (which is the sum of the quality provision of the two …rms) is exactly the same under label competition and a single NGO label. Note also that when the marginal cost increases quickly in environmental quality i.e.,

1 2(

+ )

<2

, the industry program may …nd it optimal to choose sI = sb, where sb

is high enough that the …rm adopting the industry label earns zero pro…t in equilibrium. 19

Things are di¤erent, however, when the marginal cost increases slowly in environmental quality i.e., 2

<

< 12 ( + ). In that case, recall, the quality standard preferred by

the industry program becomes s , where s will leave the …rm adopting the industry label with strictly positive pro…t. In other words, the industry program’s choice of standard is a¤ected by whether the marginal cost increases quickly or slowly in environmental quality. The question is then, why does this come about? The answer to this question appears to hinge on the fact that the industry program has to trade o¤ two countervailing e¤ects when choosing its optimal standard. Firstly, increasing the standard increases the …xed improvement cost borne by the …rm that chooses to adopt the industry label, which decreases industry pro…t. This is the …xed

ro of

cost e¤ect. Secondly, increasing the standard increases the extent of vertical di¤erentiation which, in turn, softens price competition and allows higher industry pro…t. This

is the market segmentation e¤ect. The market segmentation e¤ect dominates when the

marginal cost increases quickly in environmental quality. This is because, in my frame-

work, increases in environmental quality involve increases in both …xed cost and marginal

cost; if the marginal cost increases quickly in environmental quality, meaning that the

-p

cost of quality is borne primarily by the marginal cost instead of the …xed cost, then the pro…t loss resulting from the higher …xed cost will be rather small and, consequently, of quality scenario (where 12 ( + )

re

the …xed cost e¤ect becomes insigni…cant.34 As a result, under the high marginal cost <2

holds), the industry program will keep

increasing its standard until the point sI = sb is reached.

Jo

ur

na

lP

34 Note that the market segmentation e¤ect dominates when the marginal cost increases quickly in environmental quality, that is, when the improvement of quality is mainly related to …rms’ marginal production costs. There is empirical evidence that in some industries the cost of quality is borne largely by marginal cost instead of …xed cost when marginal cost increases quickly in quality (see Berry and Waldfogel, 2010). This happens when the main burden of quality improvement falls, for instance, on the use of more environmentally friendly raw materials that are usually more expensive. For example, in the textiles industry, OEKO-TEX is the most widespread and best-known eco-label, which requires participating …rms to use environmentally friendly materials and replace toxic chemicals by safer alternatives in the production process. However, there are also circumstances under which quality is produced largely with …xed costs. This is likely to occur when …rms have to invest heavily in new technologies to improve quality. For example, in the electricity sector, electricity generating …rms that seek Green-e certi…cation need to reduce emissions to certain levels, and …rms can invest in scrubbing to lower emissions. Note that scrubbing is a typical example of end-of-pipe technology. In the case of end-of-pipe technology, some fraction of the pollutant is reduced while the production process remains unchanged; as a result with end-of-pipe technology the cost is typically assumed to be …xed (see Clemenz, 2010).

20

6

Welfare analysis

In this section, I analyze the e¤ects of eco-label competition on social welfare. To do this, I compare welfare under a single NGO label and label competition. Welfare is de…ned as the sum of consumer surplus, industry pro…t and the aggregate environmental quality weighted by , where the parameter

0 measures the weight

the social planner places on the aggregate environmental quality: + E:35

W = CS +

(12)

In the rest of this section, I will refer to the sum of consumer surplus and industry

ro of

pro…t (CS + ) as private bene…t. Let the superscript LC indicate the presence of label competition and the superscript SN indicate a single NGO label.

The following proposition shows that social welfare may be higher under label competition than under a single NGO label. <2

result in the same welfare level (i.e.,

W LC

(ii) For 2

<

, label competition and a single NGO label = W SN ).

-p

Proposition 4 (i) For 12 ( + )

< 12 ( + ), label competition leads to higher welfare than a sin-

su¢ ciently small, i.e., 0

< , where

Proof. See Appendix C.

( +

2 )(5 6(2

lP

=

re

gle NGO label (i.e., W LC > W SN ) if the welfare weight on environmental bene…t is

4 )

)

:

(13)

na

Proposition 4 implies that the welfare comparison depends crucially on whether the marginal cost increases quickly or slowly in environmental quality. Speci…cally, if the

Jo

ur

35 Note that can be also interpreted as the marginal bene…t of the externality associated to the aggregate environmental quality. I thus assume that the marginal bene…t of improving the quality of the environment ( ) is constant. The assumption of constant marginal environmental bene…t seems plausible for air pollutants like sulfur dioxide and particulates. For instance, harm to human health is the major damage component from air pollution, and the health e¤ect is roughly linear with respect to pollution concentrations; that is, the marginal bene…t of pollution reductions is (almost) constant (Burtraw et al., 1998). The assumption of constant marginal environmental bene…t is also reasonable when emission reductions in a single period have only a small e¤ect on the total stock of the pollutant, as in the case of greenhouse gases; as a result, stock pollutants will have relatively ‡at bene…t curves associated with emission reductions (Pizer, 1998). Admittedly, when there are thresholds in the assimilative capacity of the environment, the assumption of declining marginal environmental bene…ts can be reasonable. Incorporating this additional feature adds considerably to the complexity of my model. I leave this extension for future work.

21

marginal cost increases quickly in environmental quality (i.e.,

1 2(

+ )

< 2

)

then it is clear from Propositions 1 and 3 that every component of welfare is exactly the same under a single NGO label and label competition so that W LC = W SN results unambiguously. However, if the marginal cost increases slowly in environmental quality (i.e., 2 <

1 2(

<

+ )), things become quite di¤erent. Here, the two welfare components, namely

the environmental bene…t and the private bene…t, are sharply di¤erent under a single NGO label and label competition. In particular, the environmental bene…t is higher under a single NGO label than under label competition, that is, E SN > E LC . This is because, although the quality provision of the low-quality …rm is the same in both

ro of

cases, the quality provision of the high-quality …rm is strictly higher under a single NGO label. As the environmental bene…t is the sum of the quality provision of the two …rms, it is strictly higher under a single NGO label. On the other hand, the private bene…t is strictly lower under a single NGO label than under label competition, that is, (CS SN +

SN )

< (CS LC +

LC ).

Intuitively, label competition leads to greater private

bene…t for two reasons. First, label competition generates a higher industry pro…t than

-p

a single NGO label. Second, label competition may improve consumer welfare. In

particular, it improves the welfare of consumers who purchase from the low-quality …rm

re

(i.e., the …rm that produces quality s) as the quality remains unchanged but the price they pay is strictly lower under label competition. As label competition leads to higher private bene…t but lower environmental bene…t, whether it increases or decreases social

lP

welfare depends on the welfare weight on environmental bene…t. Based on the previous …ndings, it is relatively straightforward to establish that label competition improves

7

< .

na

welfare if the weight on environmental bene…t is small enough i.e., 0

Extensions

In the main model, I have assumed that (i) there are only two …rms competing in the

ur

product market; and (ii) the NGO program moves …rst, followed by the industry program. Under these assumptions, I have established the main result that label competition and a single NGO label may lead to the same environmental bene…t and, furthermore,

Jo

social welfare under label competition may be greater (or the same) than that under a single NGO label. In this section, I relax these assumptions in turn and examine whether the main result would still hold.

22

7.1

Extension to N Firms

So far I have considered a duopoly model. A natural question that arises then is how this model would be generalized to an N -…rm case (N

3). In this subsection, I explore

whether the degree of competition in the product market would a¤ect the main result. 7.1.1

Benchmark: a single NGO label

As before, I start with the benchmark case where only the NGO label is available. It is clear that in equilibrium at most one …rm will adopt the NGO label and produce quality 36 sSN N .

ro of

If none of the …rms adopt the NGO label then all …rms must charge a common price s and their pro…ts are equal to zero in equilibrium. If a …rm, say …rm 1, adopts the

label then imperfect price competition arises. Denote by pSN the price charged by …rm 1 SN s) s+ sSN N + (sN and at 2 2 s) (see Appendix D).

1.37 In this case …rm 1’s optimal price is pSN = 1 makes a pro…t of

SN 1

=

( 4(

)2 SN (s ) N

(sSN N

s)

this price it

I next turn to the labeling-choice stage of the game. Clearly, …rm 1 will adopt the sSN N

s+ 4(

(

)2 , )

and remains unlabeled otherwise.

-p

NGO label if s

I am now ready to characterize the equilibrium value of the NGO standard in the

Proposition 5 Suppose that N

re

N -…rm case when there exists only the NGO label.

3, and only the NGO label is available on the market.

Proof. See Appendix D.

)2 . )

Combining NGO and industry labels with N = 3

na

7.1.2

(

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( Then, the NGO program sets a labeling standard sSN N =s+ 4

Now I turn my attention to the full model where the NGO and industry programs coexist. I start with N = 3, so three …rms are competing in the product market.

ur

For the moment, let us abstract from the issue of whether the NGO standard is higher than the industry standard and simply refer to a “High”and a “Low”standard, so that sH > sL >s.38 Then, …rm i will choose its quality qi from fsH ; sL ;sg, with i =1,2,3.

Jo

36 Since moving to quality sSN N involves a …xed cost and …rms producing the same quality are compelled to price at marginal costs, there may not be more than a single labeled …rm. 37 Note that all the other N 1 …rms charge a common price s and therefore earn zero pro…t in equilibrium. 38 Note that if, for instance, the industry standard is stricter than the NGO standard, then sH represents the industry standard while sL represents the NGO standard. Similarly, sH represents the NGO standard while sL represents the industry standard, if the NGO standard is stricter.

23

Clearly, …rms have strategic incentives to di¤erentiate their products by the quality level in order to alleviate price competition. As a result, …rms respectively produce s, sL , and sH . Without loss of generality, assume that …rm 1 produces quality sH , …rm 2 produces sL , and …rm 3 produces s. For simplicity and without loss of generality, I normalize by setting s= 0. When …rms o¤ering products of unequal quality engage in price competition, imperfect price competition arises. Lemma 5 Suppose that N = 3 i.e., there are three …rms competing in the product market. In the unique price equilibrium, the prices of …rm 1, 2, and 3 are p1 = 16 [3( + )sH + 2

)sL

(

)s2L ], sH

p2 =

sL [(3 +

)sH ( 3sH

)sL ]

, and p3 =

sL [(3 +

4 )sH ( 6sH

)sL ]

,

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(3

respectively. Proof. See Appendix D.

I turn now to the second stage of the game in which the industry program chooses

its standard to maximize industry pro…ts. The NGO has already selected its standard

-p

in the …rst stage, and the industry program must choose a best response. In particular,

the industry program may respond to the NGO standard by either setting a standard higher than that of the NGO or setting a lower one.

re

I then conduct the analysis by considering both the case where the industry response is below the NGO standard, and the opposite. Clearly, the complexity of the expressions

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I have arrived at precludes the analytical derivation of best-response functions as well as the equilibrium levels of the standards. I therefore turn to numerical analysis. I start with a central scenario, where parameters are set as follows:

= 0;

= 1;

= 13 , and

= 21 . It turns out that the industry’s best-response function sI (sN ) is discontinuous at

na

1 4 sN = 0:0748, with sI (sN ) = 54 [2 ( 8 24057s2N + p p 1 ( 8 24057s2N +27 33 s2N (16+24057s2N )) 3 p q 1 4sN 27 33 s2N (16 + 24057s2N )) 3 ] > sN for 0 < sN 0:0748 and sI (sN ) = 11+18s < sN N

for sN > 0:0748.39

ur

Now, at the …rst stage of the game, the NGO program anticipates the industry program’s strategic behavior in the subsequent stage and designs the stringency of its label accordingly. Speci…cally, if the NGO program selects a standard sN such that sN >

Jo

0:0748, then the industry program will respond with a standard of sI (sN ) =

4sN 11+18sN ;

it

can be shown that in this case the NGO program will set sN = 0:2089, which leads to an

aggregate environmental bene…t of E = 0:0979.40 Similarly, the NGO program will set 39

40

Computations are available from the author upon request. Details are available from the author upon request.

24

sN = 0:0748 if it is planning to select a standard sN such that 0 < sN

0:0748, which

leads to an aggregate environmental bene…t of E = 0:0941. Clearly, then, the unique equilibrium outcome is one where the NGO program sets sN = 0:2089 and the industry program responds with a standard of sI (0:2089) = 0:0566. I now examine whether welfare and environmental bene…ts are higher under a single NGO label or label competition. Table 3 displays equilibrium welfare and environmental bene…ts under a single NGO label and label competition. < Insert Table 3 here > Based on the numerical analysis, I report the following observation:

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Observation 1. When there are three …rms competing in the product market, label

competition can lead to strictly higher environmental bene…t and social welfare than a single NGO label.41 7.1.3

Combining NGO and industry labels with N

4

4 …rms. As before, I

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I now study the case where the product market consists of N

…rstly abstract from the issue of whether the NGO standard is higher than the industry

re

standard and simply refer to a “High” and a “Low” standard, so that sH > sL >s= 0. When the product market consists of N

4 …rms then exactly two …rms will pro-

vide labeled products, with one …rm providing a labeled product of quality sH and the

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other …rm providing a labeled product of quality sL , while the remaining …rms will sell unlabeled products. The following lemma describes the price equilibrium. Lemma 6 Suppose that N

4 i.e., there are four or more …rms competing in the

na

product market. In the unique price equilibrium, the prices of the …rm o¤ ering quality sH , sL , and s are pH = respectively.

sH (2 sH +2 sH + sL 2 sL ) , 4sH sL

pL =

sL (3 sH + sH 4sH sL

sL )

, and p=

s,

ur

Proof. See Appendix F.

Next I move back to earlier stages where the two labeling organizations sequentially choose their standards. In general, it becomes more di¢ cult to solve the model ana-

Jo

lytically when the number of …rms is more than three. I therefore revert to numerical simulations. I conduct simulations with various suitable values of ; ; and . In terms 41

I have also run additional numerical simulations. Further numerical simulations con…rm the result that label competition can be both environmentally bene…cial and socially bene…cial. For further details, see Appendix E.

25

of equilibrium outcomes, environmental bene…ts, and social welfare, the results are summarized in Table 4. In all cases, the NGO program will set the same standard it o¤ers when it is alone in the label market and the industry program will respond by setting sI =s= 0.42 Therefore, environmental bene…ts and social welfare are the same as in the benchmark case. < Insert Table 4 here > Based on the numerical analysis, I report the following observation: Observation 2. When there are N

4 …rms in the product market, label competi-

tion can lead to the same environmental bene…ts and social welfare as when there exists

7.2

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only the NGO label.

A simultaneous game between NGO and industry programs

In the main model, competition between labelers takes the form of a sequential game in

which the NGO program moves …rst, followed by the industry program. Exploring the

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possibility of a simultaneous game, where the NGO program and the industry program simultaneously set their standards, will also be interesting.

In this subsection, I examine whether the main result will hold when competition

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between labels is formalized as a simultaneous game. Speci…cally, in the …rst stage, the two labeling organizations choose their standards simultaneously. In the next stage, compete in prices.

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…rms simultaneously choose whether and which label to adopt. In the last stage …rms I claim that all the …ndings reported in the main model carry over to this modi…ed model. The key point here is that any outcome that is sustained in the sequential

na

standard-setting game between the NGO program and the industry program can also be sustained in the simultaneous-move game. To understand this result, …rst consider the case where …rms’marginal cost increases 1 2(

+ )

< 2

. Then, in the …rst stage

ur

quickly in environmental quality i.e.,

game there are four Nash equilibria: (1) the NGO program chooses sN = sb while the industry program chooses sI =s,43 (2) the NGO program chooses sN = sb while the

Jo

industry program chooses a standard sI > sb, (3) the NGO program chooses sN =s while

the industry program chooses sI = sb, and (4) the NGO program chooses a standard

sN > sb while the industry program chooses sI = sb. Thus, the simultaneous-move 42 In other words, the N 2 …rms who have previously opted to be unlabeled may now adopt the industry label as the industry program sets sI =s= 0. 43 sb is de…ned in (5).

26

Nash equilibrium outcome features the same combination of standards as the sequential equilibrium outcome does. The resulting equilibrium industry pro…t is equal to = b ,

b 44 and the environmental bene…t is equal to E = E.

I now argue that neither labeling organization has any incentive to deviate from the

proposed equilibrium at the standard-setting stage. For example, under the …rst Nash equilibrium (sN = sb; sI =s), if the NGO program deviates to a standard above sb, then

both …rms will o¤er quality s and the resulting environmental bene…t equals s which is b Therefore, the NGO strictly lower than the equilibrium environmental bene…t i.e., s< E. program has no incentive to deviate to a standard above sb. On the other hand, if the

NGO program deviates to a standard below sb, say, to sb ",45 then one …rm o¤ers quality

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s and the other …rm o¤ers quality sb ", which will lead to an environmental bene…t that is still lower than the equilibrium environmental bene…t. Thus, one can conclude that deviation by the NGO program from the proposed equilibrium is not gainful. Similarly,

the industry program has no incentive to deviate from the proposed equilibrium. Since neither labeling organization has an incentive to deviate from (sN = sb; sI =s), it is indeed an equilibrium. The same reasoning applies to the other three Nash equilibria.

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Replicating arguments along previous lines, I can show that when …rms’ marginal

cost increases slowly in environmental quality i.e., 2

<

< 12 ( + ) the simultaneous-

sequential equilibrium outcome does.

re

move Nash equilibrium outcome still features the same combination of standards as the After the …rst stage the ensuing game is identical to the one analyzed in the main

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model and, therefore, all the …ndings reported in the main model carry through. I summarize the above discussion in the following observation: Observation 3. Results are the same whether the labeling standards are set sequen-

na

tially or simultaneously.

8

Conclusion

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I have developed a double duopoly model in which an NGO competes with an industry association in o¤ering labels to two …rms that are Bertrand competitors in the product market, and I examine the e¤ects of this competition on environmental bene…t and social

Jo

welfare. Although the analysis in this paper rests on a stylized model, I believe it o¤ers some insight into the e¤ects of eco-label competition. Speci…cally, eco-label competition and a single NGO label may lead to the same environmental bene…t and, furthermore, 44

45

b and E b are as de…ned by (7) and (6). Note that I assume that 0 < " < sb s.

27

social welfare under eco-label competition may be greater (or the same) than that under a single NGO label. These results have some implications for the debate over the role of industry-sponsored eco-labels. The introduction of industry eco-labels has long been criticized by NGOs who often cite industry labels as embodying low quality standards. This paper shows that this is not necessarily the case. In fact, if the NGO-sponsored program chooses a low standard in the …rst place, then there is room for the industry-sponsored program to enter and respond with a higher standard. The public policy implication is that when both NGO and industry labels are reliable and perfectly understood by consumers, the social planner may want to promote eco-label competition particularly when the welfare

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weight on environmental bene…t is relatively small. These results must be considered while taking into account some limitations of my model. The analysis proposed here has focused on the case in which the market is fully

covered. In other words, I assume that the global demand is …xed. Such an assumption is admissible in markets where the overall demand is inelastic. However, this assumption

may be restrictive for other markets and, therefore, my model would undoubtedly gain

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from being generalized to the case of a partially covered market. In fact, it is possible to show that when the …xed quality-improvement cost is either absent or una¤ected by

re

quality, the main result (label competition can lead to the same environmental bene…ts and social welfare as when there exists only the NGO label) continues to hold even if the market is partially covered.

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Next, my model implicitly assumes that consumers have identical trust in NGO and industry labels, while empirical evidence in several developed countries suggests that consumers may indicate di¤erent levels of trust in labeling agencies (Johnston et al., 2001). A richer, more realistic model might assume that consumers’ trust in labels

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varies depending on the type of labeling agencies; consumers, besides considering the environmental quality communicated by the labels, may make their purchase decisions based on the labels they trust. How do the results of this study change when consumers’

ur

trust in the NGO label di¤ers from that in the industry label? I would expect that if consumers’ trust varies from one label to another then label competition might have ambiguous e¤ects on the environment and social welfare.

Jo

Another limitation of the model is related to the assumption that environmental

quality is the only di¤erentiating factor between products. This assumption might be applicable to situations where environmental quality emerges as the main distinguishing characteristic across variants of the same product.46 However, in some circumstances, 46

In fact, this is the case of the Nordic electricity market where consumers can choose between green

28

this may not be the most plausible assumption. This is particularly the case if products are di¤erentiated vertically as well as horizontally. In this case, it would be useful to allow for several quality dimensions. Results from the earlier theoretical literature (see, for instance, Irmen and Thisse (1998)) suggest that …rms often seek to di¤erentiate their products only in the quality dimension that is most valued by consumers and choose identical quality in other dimensions. Therefore, as long as consumers view environmental quality as the dimension of great importance, the results presented above should retain relevance. In this paper, I have also assumed speci…c functional forms for cost functions. I make several remarks regarding the use of speci…c functional forms. Admittedly, assumptions

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about functional forms entail some loss of generality. However, one cannot hope to obtain any results whatsoever in a very general model where properties of costs are speci…ed only qualitatively. This is because one needs to compare equilibria and in order to do

so one needs to be able to compute them. Indeed, I adopt the common assumptions in models of vertical product di¤erentiation: a marginal cost linearly increasing with

quality and a quadratic …xed cost. Finally, although the results arise from a speci…c set

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of functional forms, the underlying intuition is quite general. Yet, in future research, it

should be interesting to test the robustness of this study’s results under more general

re

cost functions.

Finally, I have restricted my analysis to the case where …rms have identical cost structures. If I assume heterogeneity of …rms’marginal costs (or, …xed costs), the results

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of this study could be a¤ected. One may suggest that if …rms are heterogeneous, then it is possible that the eco-labeling programs’choices of standards will depend on whether the more e¢ cient …rm or the less e¢ cient one chooses to adopt a label. Addressing this issue requires the introduction of considerable complexity into the present model. I leave

na

this extension for future research.

Jo

ur

and conventional electricity (Lombardini-Riipinen, 2005).

29

A

Appendix A

SN . Before deriving pSN and pSN , I establish two results which Derivation of pSN N and p N

I will use repeatedly throughout the paper. The …rst one deals with the formula of equilibrium prices when two …rms supply di¤erentiated products, and the second one deals with the formula of equilibrium pro…ts. When …rms supply di¤erentiated products so that q1 6= q2 then both …rms will have market

power. For the moment, I abstract from which …rm is providing higher quality and simply assign the …rm that produces a higher quality the index H and the remaining one the index L, so that

qH > qL . Denote the price charged by …rm H as pH and that of …rm L as pL . A consumer is indi¤erent between purchasing from …rm L and …rm H if:

qL + u

pL = qH + u

pH

b. It follows that all b consumers will buy the product from …rm H. Using the de…nition of b and the assumption that the market is fully covered, the demand for Rb R b). each …rm is given by DL = f ( )d = 1 (b ); DH = b f ( )d = 1 ( =

ro of

)

pH pL qH qL

L=

q L )DL

(pH

q H )DH

(q L s)2 ;

(q H s)2 :

re

H=

(pL

-p

Let L denote the pro…t of …rm L and H denote the pro…t of …rm H. At the last stage, …rm L and …rm H choose prices so as to maximize, respectively,

First-order conditions give the equilibrium prices.

Thus, the general formula for the price charged by the …rm who produces a lower quality is:

lP

1 pL = [2 qL + qH + ( 3

2 )(qH

qL )]:

(14)

na

The general formula for the price charged by the …rm who produces a higher quality is:

ur

1 pH = [ q L +2 q H +(2 3

)(q H q L )]: +

2

(15) 2

Jo

; DH = 3( ) . The expressions for demand can be obtained as DL = 3( ) Thus, the general formula for the pro…t of the …rm who produces a lower quality is: L=

( + 9(

2 )2 (q H q L ) )

(q L s)2 :

The general formula for the pro…t of the …rm who complies with the high standard is:

30

(16)

H=

)2

(2 9(

)

(q H s)2 :

(q H q L )

(17)

When …rms supply di¤erentiated products, the general formula for industry pro…ts is:

=

( + 9(

2 )2 (2 (q H q L )+ ) 9(

)2 )

(q H q L )

(q H s)2

(q L s)2

(18)

pSN is determined by the formula given by (14) after replacing qL by s and replacing qH SN by sSN N . pN is determined by the formula given by (15) after replacing qL by s and replacing

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qH by sSN N . Calculations of payo¤s shown in Table 1. If both …rms choose to remain unlabeled,

then Bertrand–Nash competition will drive prices down to the marginal cost, that is, p1 = p2 =

s; as a result, each …rm earns zero pro…t. If both …rms adopt the NGO label, Bertrand–Nash

competition will again drive prices down to the marginal cost, that is, p1 = p2 = sSN N . But, SN 2 since …rms now incur the …xed quality-improvement costs (sN s) which are sunk during

-p

the price competition stage, each …rm makes a negative pro…t equal to

(sSN N

s)2 . Finally,

consider the case where one …rm adopts the NGO label and the other …rm remains unlabeled. In this case, …rms’pro…ts are determined by the formulas given by (16) and (17). )2

(2

9(

)

(sSN N

s)

(sSN N

2

s+ (29 ( )) . Proof of Proposition 1. I will show how to derive b :Since in equilibrium, one …rm 0. It is clear that this inequality holds if s

sSN N

lP

s)2

re

Proof of Lemma 1. The NGO label will be adopted if

produces quality s and the other …rm produces sb. The equilibrium industry pro…t is determined

na

by the formula given by (18) after replacing qL by s and replacing qH by sb.

B

Appendix B

Proof of Lemma 2. I will write the conditions for the equilibrium outcome that one …rm (2

ur

adopts the industry label and the other …rm adopts the NGO label to be emerged: )2

9(

)

9( ( + 9(

)

)2

(sI s)2

0

(sI s)

(sI s)2

(2

Jo

(2

(sI s)

2 )2 (sI )

s)

( + 9(

)2 9(

2 )2 (sI )

)

(sN s)2

(sN s)

sN )- (sN

s)2

It is clear to see that in order to simultaneously satisfy the above inequalities, the condition (2

)2

must be: s< sN < sI 2s+ 9 ( ) sN . Using similar arguments, one can characterize the conditions in all other cases. The detailed analysis is available from the author upon request.

31

Proof of Proposition 2. When 2 - <

< 12 ( + ), the following equilibria exist:

(1) sN =s and sI = s ; one …rm adopts the NGO label and the other …rm adopts the industry label; (2) s< sN < se and sI = s ; one …rm is unlabeled and the other …rm adopts

the industry label; (3) sN = se and sI = s ; one …rm is unlabeled and the other …rm adopts the industry label; (4) sN = s and sI > s ; one …rm is unlabeled and the other …rm adopts the NGO label; (5) sN = s and sI =s; one …rm adopts the industry label and the other …rm

adopts the NGO label; and (6) sN > s and sI = s ; one …rm is unlabeled and the other …rm adopts the industry label. Therefore, to summarize the above results, I have Proposition 2.

Proof of Proposition 3. In order to understand Proposition 3, it is important to note <2

, the industry’s optimal standard is no longer s . The reason is

<2

, s exceeds sb, which means if a …rm provides quality s , it will

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that when 12 ( + ) that when 12 ( + )

make strictly negative pro…t. Since in all equilibria, one …rm produces environmental quality

s whereas the other …rm matches either sN or sI . The industry pro…t function can always be written as

=

( + 9(

2 )2 (s )

s) + (2 9(

which implies s
)2 )

(s

s)

s)2 . When 12 ( + )

<2

,

is an increasing function in s. Therefore, the optimal industry

<2

-p

standard is equal to sb in this case. When 12 ( + )

(s

, the following equilibria exist:

re

(1) sN =s and sI = sb; one …rm adopts the NGO label and the other …rm adopts the industry

label; (2) sN = sb and sI =s; one …rm adopts the industry label and the other …rm adopts the

NGO label; (3) sN = sb and sI > sb; one …rm is unlabeled and the other …rm adopts the NGO

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label; and (4) sN > sb and sI = sb; one …rm is unlabeled and the other …rm adopts the industry label.

C

na

Therefore, to summarize the above results, I have Proposition 3.

Appendix C

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b and E when 2 - < Proof of Proposition 4. Firstly, I will compare E b -E : De…ne E = E E = [s+ (2 27

(

)3 ] )2

[s+ (2

Jo

Then, it is clear to see that Similarly, I de…ne

=b

)[( + 2 )2 +(2 54 ( )2

)2 ]

] = (2

<

1 2(

+ ).

)( + 2 ) : 18 ( )

b>E . E > 0 always holds, which implies E d CS . In order to compare the private and CS = CS

bene…t (the sum of consumer surplus and industry pro…t) under the two regimes, I need to determine whether

+

CS is greater than 0.

32

(

=b

)2

5:5(

2 )2

( +

=

36

)2 ]:

d ; CS = CS

+

It is straightforward to show that

5

CS =

( + 2 ) [0:5 2 54 ( )

+ (4

CS > 0 if and only if

5 ) + (7 < 2 - or

>

4 , which contradicts to Assumption 1. Hence, the private bene…t is higher under eco-label

competition. Further, I de…ne

W =

W = W SN

E+

+

W LC . Clearly, I have:

CS: (2 3 (

W > 0 is equivalent to

) )

+(

+

W > 0

Solving the inequality, I have

2 )( +4 5 ) > 0: 18 ( ) if > ( + 6(22 )(5

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Appendix D

Derivation of pSN and 1

SN . 1

. In other words,

< .

eco-label competition improves welfare if 0

D

4 ) )

When …rm 1 adopts the NGO label and the other N-1 …rms

remain unlabeled, consumers will have two alternatives. The preference index of the consumer SN

(b

Let

sSN N )

).

denote the pro…t of …rm 1. Firm 1 maximizes its pro…t,

(sSN N SN 1

…rm 1 is

SN = 1 SN s) s+ sSN + (s N N . 2

re

SN 1

=

SN = s)2 , by setting pSN 1 . One obtains p1 ( 4(

)2 SN (s ) N

(sSN N

s)

D1SN (pSN 1

The pro…t for

s)2 :

lP

1

DSN =

-p

b = p1SN s . The demand who is indi¤erent between the quality s and the quality sSN N is sN s 1 SN b for the labeled product is D1 = ( ). The demand for the unlabeled product is

Proof of Proposition 5. The NGO program solves the following optimization problem: maxE SN =

na

sSN N

Rb

s:t: s

sf ( )d +

R

s+ 4(

sSN N

b (

sSN N f ( )d )2 : )

)2

(

ur

I obtain the following solution: sSN . N =s+ 4 ( ) Proof of Lemma 5. To de…ne consumer demand, denote consumer e as indi¤erent be-

tween the unlabeled product and the product of quality sL , and consumer b as indi¤erent

Jo

between the product of quality sL and the product of quality sH . e and b are characterized as follows e = ps2 ps3 ; b = sp1 ps2 . The market is covered and demand is de…ned by

D1 =

…rm:

1

1

(

L

b); D2 =

= D1 (p1

sH )

1

(b

H

L

e); D3 =

(sH

s)2 ;

2

1

(e

= D2 (p2

). I determine the pro…t function for each sL )

(sL

s)2 ;

3

= D3 (p3

s).

First order conditions for pro…t maximization yield the best response functions in prices, and

33

simultaneously solving the three best response functions using Mathematica yields equilibrium prices for the three …rms.

E

Appendix E

Additional simulations. To check the sensitivity of my results to the choice of parameters, I have performed several additional simulations. In summary, as shown in Table 5, label competition can lead to strictly higher environmental bene…t and social welfare than a single NGO label. These results lead to Observation 1 in the main text.

F

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< Insert Table 5 here >

Appendix F

Proof of Lemma 6. To de…ne consumer demand, denote consumer e as indi¤erent between the unlabeled product and the product of quality sL , and consumer b as indi¤erent between

e=

pL s b sL s ;

=

pH pL sH sL .

-p

the product of quality sL and the product of quality sH . e and b are characterized as follows The demand for the labeled product of quality sL is DL = 1 (b

re

The demand for the labeled product of quality sH is DH = 1 (

e).

b). I determine the pro…t

function for the …rm adopting the label with standard sH and the …rm adopting the label with standard sL :

H

= DH (pH

sH )

(sH

s)2 ;

L

= DL (pL

sL )

(sL

s)2 .

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First order conditions for pro…t maximization yield the best response functions in prices, and simultaneously solving the three best response functions using Mathematica yields equilibrium

Jo

ur

na

prices.

34

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[5] Basu, A.K., Chau, N.H., Grote, U., 2004. On export rivalry and the greening of agriculture— The role of eco-labels. Agricultural Economics 31, 135-147.

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[6] Ben Youssef, A., Lahmandi-Ayed, R., 2008. Eco-labelling, competition and environ-

ment: endogenization of labelling criteria. Environmental and Resource Economics

re

41, 133–154.

[7] Berry, S., Waldfogel, J., 2010. Product quality and market size. Journal of Industrial Economics 58, 1-31.

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[8] Bjørner, T.B., Hansen, L.G., Russell, C.S., 2004. Environmental labeling and consumers’choice— an empirical analysis of the e¤ect of the Nordic Swan. Journal of Environmental Economics and Management 47, 411-434.

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[9] Blend, J.R., van Ravenswaay, E.O., 1999. Measuring consumer demand for ecolabeled apples. American Journal of Agricultural Economics 81, 1072-1077. [10] Bonroy, O., Constantatos, C., 2015. On the economics of labels: how their introduc-

ur

tion a¤ects the functioning of markets and the welfare of all participants. American Journal of Agricultural Economics 97, 239-259.

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Table 1. Payo¤ matrix of the label choice game

sI < sN

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Table 2. Normal form of the labeling sub-game if s

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Table 3. Comparison between a single NGO label and label competition

= 0; = 1;

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Parameters for this calculation are:

40

= 31 , and

= 12 .

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Table 4. Comparison between a single NGO label and label competition

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Table 5. Comparison between a single NGO label and label competition

41