Consumer perceptions and the effects of country of origin labeling on purchasing decisions and welfare

Food Policy 37 (2012) 21–30

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Consumer perceptions and the effects of country of origin labeling on purchasing decisions and welfare Lana Awada a, Amalia Yiannaka b,⇑ a b

Department of Bioresource Policy, Business & Economics (PBE), University of Saskatchewan, 51 Campus Drive, Saskatoon SK, S7N 5A8, Canada Department of Agricultural Economics, University of Nebraska-Lincoln, 314D H.C. Filley Hall, Lincoln, NE 68583-0922, USA

a r t i c l e

i n f o

Article history: Received 30 September 2010 Received in revised form 18 August 2011 Accepted 15 October 2011 Available online 16 November 2011 Keywords: Country of origin labeling Heterogeneous consumer preferences Vertical and horizontal product differentiation Market effects and consumer welfare

a b s t r a c t The study develops a general analytical framework of heterogeneous consumer preferences to examine the effects of country of origin labeling (COOL) regulation on consumer purchasing decisions and welfare. We show that while differences in consumer perceptions about COOL information, namely, whether it is viewed as an attribute that differentiates products vertically or horizontally, do not alter the nature of the market and consumer welfare effects of mandatory COOL, the relative strength of consumer preferences for COOL are shown to be important in determining the magnitude of these effects. In addition, our results show that the benchmark used (a no COOL versus a voluntary COOL regime) is critical in evaluating the effects of the policy. We show that, under both horizontal and vertical product differentiation, a change from a no COOL to a mandatory COOL regime decreases (increases) the welfare of consumers with weak (strong) preference for COOL while a change from a voluntary to a mandatory COOL regime leads to an unambiguous loss in consumer welfare. Ó 2011 Elsevier Ltd. All rights reserved.

Introduction Food policies often aim at, and result in changing the behavior and welfare of the agents in the food supply chain. At the same time, the agents’ perceptions about a given policy can influence its effectiveness. A goal of country of origin labeling (COOL) regulation for US agricultural products has been to enable consumers to make informed purchasing decisions by requiring that retailers credibly provide information on the country of origin of covered ⇑ Corresponding author. Tel.: +1 402 472 2047; fax: +1 402 472 3460. E-mail address: [email protected] (A. Yiannaka). Mandatory COOL regulation was issued by the US congress on May 13, 2002 (the 2002 Farm Bill) for beef, lamb, pork, fish, perishable agricultural commodities, and peanuts. The law was supposed to become effective by September 30, 2004 but on January 27, 2004, Public Law 108-199 delayed its implementation for all covered commodities except wild and farm-raised fish and shellfish until September 30, 2006. On November 10, 2005, Public Law 109-97 delayed its implementation once more until September 30, 2008. The 2008 Farm Bill expanded the list of covered commodities to include chicken, goat meat, ginseng, pecans and macadamia nuts. 2 While groups representing the majority of US producers support COOL regulation (e.g., the National Cattlemen’s Beef Association (NCBA), the National Pork Producers Council (NPPC), the National Fisheries Institute (NFI), the United Fresh Fruit and Vegetable Association (UFFVA) and the Produce Marketing Association (PMA)), claiming that US producers have made significant investments to meet strict US government regulations related to food quality and safety and labeling will allow them to increase their market share and realize greater returns (Farmers’ Advance, 2004), food handlers, including processors, generally oppose COOL arguing that it is an undesirable intervention in free trade that will reduce firms’ opportunities to freely substitute between imported and domestic products and will subsequently increase firms’ costs (Schupp and Gillespie, 2001). 1

0306-9192/$ - see front matter Ó 2011 Elsevier Ltd. All rights reserved. doi:10.1016/j.foodpol.2011.10.004

commodities. Whether the policy would leave consumers better off, as well as the magnitude, nature and distribution of the costs and benefits of COOL implementation among the other agents in the food supply chain, have been much debated both in the political arena and the economic literature, resulting in a number of delays and amendments in the law which finally become effective in the Spring of 2009.1,2 The numerous studies that have examined the economic effects of COOL regulation – the costs, consumer attitudes/perceptions of, and demand for, COOL and the welfare effects of the policy – have often produced conflicting results. The lack of consensus in studies that estimate the costs of COOL implementation (e.g., USDA/AMS, 2003; VanSickle et al., 2003; Sparks/CBW, 2003; Hayes and Meyer, 2003; Davis, 2003; Hanselka et al., 2004), is mainly due to different assumptions made about the number of producers and type of products that would be affected by the policy (imported versus all products), the benchmark and the methods used to estimate labor and set up costs, and whether traceability to the origin was included in the cost estimation (for a detailed description of these studies see Awada (2005)). Studies examining consumer perceptions of and demand for COOL show that there are considerable differences in consumer attitudes and willingness to pay for COOL. For instance, the studies by Haucap et al. (1997), Hoffmann (2000), Umberger et al. (2003), Loureiro and Umberger (2003, 2005), Sterns et al. (2004) and Bernués et al. (2003) find that consumers have a strong preference for COOL and use it as an indicator of product quality and food safety while Dickinson and Bailey (2002) and Hobbs (2003) find that

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preference for COOL is low if not combined with other desirable safety attributes. It is uncertain whether the differences in consumer perceptions of COOL are responsible for differences in the market outcomes in existing studies as these studies are product/ commodity and location specific. In addition, the few studies on the welfare effects of COOL (e.g., Plain and Grimes, 2003; Lusk and Anderson, 2004; Brester et al., 2004; Hanselka et al., 2004; Schmitz et al., 2005; Plastina et al., 2011) are also product/commodity specific and even though they provide important information on the consumer and producer welfare effects of the policy for the products considered, their results cannot be generalized. More importantly, existing studies do not explicitly consider how the perceptions of the agents in the food supply chain regarding COOL or the benchmark used to evaluate the policy affect its economic impacts. The goal of this study is to provide a general analytical framework that is not product/location specific and could, thus, be adapted to examine the market and consumer welfare effects of COOL on all covered agricultural products. An important contribution of the study is that it explicitly examines whether consumer perceptions regarding the information provided by COOL affect the market and consumer welfare impacts of COOL implementation. In addition, the study shows that the benchmark used in evaluating the effects of the policy, that is, a no COOL versus a voluntary COOL regime, is critical for the results. This distinction is important as voluntary COOL has been an option for some of the products now covered by mandatory COOL (e.g., beef). Specifically, the study allows for heterogeneous consumers that view the information provided by COOL as an attribute that can differentiate the labeled products either vertically or horizontally.3 When COOL is viewed as an indicator of a product’s quality which allows consumers to uniformly utility-rank the labeled products, COOL leads to vertical product differentiation. Under this case, if the labeled products were all offered at the same price, only the high quality product would capture a positive market share (Beath and Katsoulacos, 1991). When COOL information is not a strong indicator of a product’s quality and consumers cannot use it to uniformly utility-rank the labeled products, COOL leads to horizontal product differentiation. For instance, in addition to providing information regarding a product’s production process and physical attributes, which are associated with a product’s perceived quality, COOL may allow consumers to express their support for a country’s economy, thus, their purchasing decisions may not be based only on the product’s attributes. Under horizontal product differentiation, if all labeled products were offered at the same price, they could all capture a positive market share (Beath and Katsoulacos, 1991). To be able to comprehensively examine consumer behavior (perceptions and purchasing decisions) and welfare under COOL, as well as consider different benchmarks in evaluating the effects of the policy, we do not explicitly consider the behavior of other agents along the supply chain, such as producers and retailers. The starting point in our analysis is that consumers observe the products available in the market and the market prices when they make their decisions. We, thus, consider equilibrium outcomes when we compare the vertically and horizontally differentiated product markets under the no COOL and voluntary COOL benchmarks.4 3 Note that this distinction between vertical and horizontal product differentiation encompasses all possible ways consumers may view COOL information. Obviously, if all consumers perceive that COOL does not convey any useful information, then the policy has no impact on their purchasing decisions and the market and welfare effects of COOL implementation will be identical to those under the benchmark case (i.e., no COOL or voluntary COOL regime). 4 Note that, utilizing equilibrium prices allows us to identify the market and consumer welfare effects of an increase in the price of a product, for instance, regardless of whether this increase is the outcome of increased market power or/and increased costs along the supply chain.

The rest of the paper is organized as follows. ‘The market and consumer welfare effects of mandatory COOL when COOL information leads to vertical product differentiation’ and ‘The market and consumer welfare effects of mandatory COOL when COOL information leads to horizontal product differentiation’ describe the heterogeneous consumer models and examine the market and consumer welfare effects of mandatory COOL under the two benchmarks, a no COOL and a voluntary COOL regime, when consumers view the information provided by COOL as an attribute that differentiates the labeled products vertically and horizontally, respectively. ‘Concluding remarks’ summarizes the main findings and concludes the study. The market and consumer welfare effects of mandatory COOL when COOL information leads to vertical product differentiation Model assumptions The model builds on previous work by Giannakas (2002), Fulton and Giannakas (2004) and Giannakas and Yiannaka (2008) who study vertically differentiated markets. In our model, consumers use information concerning a product’s country of origin as an indicator of the product’s quality where quality refers to both observable (search and experience) and unobservable (credence) product attributes. Consider a product that is available in two different forms related to its origin, domestically produced and imported, with the domestic version viewed as the high quality product.5 A substitute product is also available in this market and for simplicity it is assumed that it is not covered by mandatory COOL.6 Consumers are assumed to be heterogeneous, uniformly distributed in the interval [0, 1], each buying one unit of their preferred product and the purchasing decision represents a small share of their budget. The utility function of the consumer is then given by:

U s ¼ U  ps

If a unit of the substitute product is consumed

U i ¼ U  pi þ qi C

If a unit of the imported product is consumed ð1Þ

U d ¼ U  pd þ qd C If a unit of the domestic product is consumed where Us, Ui and Ud are the per unit utilities associated with the consumption of the substitute, imported and domestically produced products, respectively. The parameter U is the per unit base level of utility derived from the consumption of these products while ps, pi, and pd denote the prices of the substitute, imported and domestic product, respectively. The parameter C captures heterogeneous consumer preferences (and thus, differences in willingness to pay) for COOL and is uniformly distributed with unit density f(C) = 1 in the interval C 2 [0, 1]. The greater is the differentiating 5 Note that the qualitative nature of the results is not affected by which product is the high quality product (i.e., the domestic or the imported). A solution of the model where the imported product is the high quality product is provided in the Appendix. 6 The substitute product could belong to a class of products that are currently exempt from COOL regulation. In the US, these products include any covered product (e.g., beef, pork, lamb, fish) that is used as an ingredient in processed products (e.g., canned soup) or is processed (e.g., bacon or ham) or is sold by a retailer that has invoice costs of all purchases of produce (fresh or frozen fruits and vegetables) of less than $230,000 (USDA/AMS, 2008). The exemption of small or specialized retailers is particularly important since it allows meat sold by a butcher or fish sold in a fish market, for instance, to escape COOL (since a butcher or a fish market do not purchase produce) while requiring that these same products bear COOL when sold by a large retailer.

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consumer attribute, C, the greater is consumer reliance on COOL information as an indicator of a product’s quality. In this context, consumers with higher C values derive greater utility from consuming a product that bears COOL and have, therefore, higher willingness to pay for such a product, compared to consumers with low C values.7 The terms qi and qd are non-negative utility enhancement factors associated with the consumption of the imported and domestic product, respectively, and qd > qi > 0. For simplicity and without loss of generality, it is assumed that the utility enhancement parameter of the substitute product (qs) is equal to zero; the substitute product is the product with the lowest quality in this market. To keep the analysis simple, free entry and no market power in all product markets is assumed throughout the analysis, which imply that when the price of one of the products increases (e.g., due to an increase in production and/or labeling costs) the prices of the remaining products remain unaffected, even though their production shares change (i.e., the market equilibrium is determined by the intersection of a horizontal marginal cost curve and the market demand curve). Given that part of the costs of COOL implementation may be transferred to consumers through the product’s price, it is assumed that the price of a product covered by COOL regulation (a labeled imported or domestic product) is higher than the price of a non-labeled product.8 Finally, to keep the analysis tractable, we assume that labeling costs are the same under voluntary and mandatory COOL so the prices of the labeled products do not change when the labeling regime changes from voluntary to mandatory; in the analysis that follows we discuss the implications of relaxing this assumption. Benchmark: no labeling Without labeling (voluntary or mandatory) the imported and the domestic products are marketed together as a non-labeled product and sold at the same price, denoted by pnl, as consumers are unable to determine the origin of the product at the point of purchase. In this case, consumers have a choice between the non-labeled and the substitute product. We denote by u the probability that the non-labeled product is domestically produced so that the utility derived from the consumption of one unit of the non-labeled product is given by:

U nl ¼ U  pnl þ qnl C

ð2Þ

where qnl = uqd + (1  u)qi. For any value of u, the term qnl is a nonnegative utility enhancement factor associated with the consumption of the non-labeled product where qnl 2 [qi, qd] (note that when u = 0, qnl = qi, while when u = 1,qnl = qd). The greater is the probability that the non-labeled product is domestically produced, the higher is the utility derived from its consumption. A consumer’s purchasing decision is determined by comparing the utility derived from consuming the non-labeled product and its substitute so the consumer with a differentiating characteristic b N Þ ¼ U nl ð C b N Þ is indifferent between the b N ¼ pnl ps such that U s ð C C 1 1 1 qnl b N Þ find it optimal to buy two products. Consumers with C 2 ½0; C 1 b N ; 1 buy the the substitute product, while consumers with C 2 ½ C 1 non-labeled product (see Fig. 1). Given that consumers are uniformly distributed in the interval [0, 1], buying one unit of their preferred product, and the purchasing decision represents a small b N , also deteramount of their budget, the indifferent consumer, C 1 mines the market shares of, as well as the demands for, the substi7

Note that consumers with a value of C equal to zero place no value on COOL information and are thus indifferent between products with and without COOL when these products are offered at the same price. 8 The USDA estimates that the first-year costs of implementing COOL for covered commodities and all affected industries range from $582 million to $3.9 billion while ongoing costs are estimated to $458 million (USDA/AMS, 2003). It is worth noting that Hanselka et al. (2004) estimate the costs of COOL implementation for the beef sector alone to $1.9 billion.

Consumer utility

I

U − pd + qd U − pi + qi

D

U − pnl + qnl

U − ps U − pnl

q nl qi

U − pi

qd

U − pd X sM

X iM

X sN

X nlN Cˆ 1N

0

Cˆ 1M

Ca

X dM

Cˆ 2M

1

Fig. 1. Market and welfare effect of a change from a no COOL to a mandatory COOL regime.

tute and the non-labeled product, given by Eqs. (3) and (4), respectively (Mussa and Rosen, 1978).

b N ¼ pnl  ps X Ns ¼ C 1 qnl bN ¼ X Nnl ¼ 1  C 1

ð3Þ

qnl  pnl þ ps qnl

ð4Þ

Eq. (3) shows that for the substitute product to have a positive market share its price, ps, should be lower than the price of the non-labeled product, pnl, which is consistent with the assumption that the substitute product is the low quality product in this market. Eq. (4) shows that for the non-labeled product to have a positive market share it should be priced such that pnl < qnl + ps; otherwise the utility curve of the non-labeled product will lie below the utility curve of the substitute product for all C values and all consumers will buy the substitute product. Under mandatory COOL, consumers are able to distinguish among the domestic, imported and substitute products and their purchasing decisions are determined by comparing the utilities derived from consuming the three products, given in Eq. (1). The consumer with a differb M ¼ pi  ps such that U s ð C b M Þ ¼ Ui ðC b M Þ is entiating attribute C 1 1 1 qi indifferent between consuming the substitute and the imported prodb M ¼ pd  pi is indifferent between uct while the consumer with a C 2 qd  qi consuming the imported and the domestic product (i.e., b M Þ ¼ Ud ðC b M Þ). Consumers with relatively weak preference for Ui ðC 2

2

b M Þ), buy the substitute product, conCOOL (i.e., those with a C 2 ½0; C 1 M M b ;C b Þ consume the imported product, and consumers with a C 2 ½ C 1

2

sumers with relatively strong preference for COOL (i.e., those with a b M ; 1), consume the domestic product (see Fig. 1). The market C 2 ½C 2

shares of (and the demands for) the substitute, imported and domestic products are given by Eqs. (5)–(7), respectively.

b M pi  ps XM s ¼ C1 ¼ qi

ð5Þ

b M b M pd qi  pi qd þ ps ðqd  qi Þ XM i ¼ C2  C1 ¼ qi ðqd  qi Þ

ð6Þ

b M ðqd  qi Þ  ðpd  pi Þ XM d ¼ 1  C2 ¼ ðqd  qi Þ

ð7Þ

Eqs. (5)–(7) show that for the substitute, imported and domestic products to enjoy a positive market share, the following conditions p q þ ps ðqd  qi Þ and/or must hold, respectively: ps < pi; pi < d i qd q ðp  ps Þ ; pd < pi + qd  qi and/or qd > pd  pi + qi. qi > d i ðpd  ps Þ

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Fig. 1 depicts the utility curves of the available products, the market shares, and aggregate consumer welfare under no COOL and mandatory COOL when ps < pnl < pi < pd and the preference parameters are such that all products enjoy a positive market share under both regimes. In Fig. 1, the kinked dashed curve shows the effective utility curve, and the area below it the aggregate consumer welfare under no COOL. The twice kinked solid curve shows the effective utility curve, and the area below it the aggregate consumer welfare under mandatory COOL. The areas between the effective utility curves depict changes in consumer welfare due to a change in the labeling regime. As shown in Fig. 1, the introduction of mandatory COOL decreases consumer welfare by the dotted area D and increases it by the vertically hatched area I. The decrease in consumer welfare results from a decrease in the utility of consumers with weak preference for COOL (i.e., consumers with low to medium C values, b N ; C a Þ), and includes two different consumer groups; conC 2 ½C 1 bN; C b M Þ who switch their consumption from sumers with a C 2 ½ C 1 1 their preferred non-labeled product (which is no longer available) to the substitute product, which, even though is cheaper, is viewed as inferior to the non-labeled product and consumers with a b M ; C a Þ who switch their consumption from the non-labeled C 2 ðC 1 to the imported product, which is viewed as superior to the non-labeled product but is more expensive. The increase in consumer welfare results from an increase in the utility of consumers with relatively stronger preference for COOL (i.e., consumers with medium to high C values, C 2 [Ca, 1] in Fig. 1), for whom the utility increase from the consumption of the labeled imported and domestic products exceeds the utility discount from their higher prices. While Fig. 1 depicts the case where the net welfare effect of introducing mandatory COOL is positive, the outcome depends on the magnitude of the model parameters. For instance, an increase in the price of the imported product, pi, causes a downward shift of the utility curve Ui resulting in an increases in the loss of consumer welfare (area D) and in the demand for the substitute and domestic products. An increase in the price of the domestic product, pd, reduces the gain in consumer welfare (area I) and increases the demand for the imported product. An increase in the utility enhancement parameters, qi and qd, which can be represented graphically as a counterclockwise rotation of the Ui and Ud utility schedules through their intercepts at U  pi and U  pd, respectively, results in greater consumer welfare gains (area I) and smaller consumer welfare losses (area D). Finally, an increase in the probability u that the non-labeled product is domestically produced under no COOL, would cause an increase in qnl leading to a counterclockwise rotation of the Unl utility schedule through its intercept at U  pnl, resulting in smaller consumer welfare gains from introducing mandatory COOL. Result 1. When COOL leads to vertical product differentiation, a change from a no COOL to a mandatory COOL regime results in welfare losses for consumers with relatively weak preference for COOL and welfare gains for consumers with relatively strong preference for COOL. Welfare gains can exceed welfare losses when the price of the high quality (domestic) product is relatively low, the utility enhancement from consuming the labeled products is high and/or the probability that the non-labeled product is domestically produced is low.

comparing the utilities derived from consuming the substitute, the labeled imported and domestic product (Eq. (1)) and non-labeled product (Eq. (2)). In this case, the consumer who is indifferent between consuming the substitute and the non-labeled product has a differentiating b V ¼ pnl  ps , the consumer who is indifferent attribute given by C 1 qnl between consuming the non-labeled and the imported product b V ¼ pi  pnl while the consumer who is indifferent between has a C 2 qi  qnl consuming the imported and the domestic product has a b V ¼ pd  pi (see Fig. 2). The market shares of (and the demands C 3 qd  qi for) the substitute, non-labeled, imported and domestic products are given by Eqs. (8)–(11):

b V ¼ pnl  ps X Vs ¼ C 1 qnl

ð8Þ

bV  C b V ¼ qnl ðpi  ps Þ  qi ðpnl  ps Þ X Vnl ¼ C 2 1 qnl ðqi  qnl Þ

ð9Þ

bV  C b V ¼ qi ðpd  pnl Þ  qnl ðpd  pi Þ  qd ðpi  pnl Þ X Vi ¼ C 3 2 ðqd  qi Þðqi  qnl Þ bV ¼ X Vd ¼ 1  C 3

Under voluntary COOL, both the labeled and non-labeled products may be available in the market along with the substitute product, with the non-labeled product consisting of the domestic and imported product that will not be voluntarily labeled. Consumer purchasing decisions under voluntary COOL are determined by

ðqd  qi Þ  ðpd  pi Þ ðqd  qi Þ

ð11Þ

Eqs. (8)–(11) show that the substitute, non-labeled, imported and domestic products will capture a positive market share when the following conditions hold, respectively: ps < pnl ; q ðp  ps Þ þ qi ps q ðp  ps Þ ; and/or qnl > i nl pnl < nl i ðpi  ps Þ qi p ðq  qnl Þ þ pnl ðqd  qi Þ q ðp  pi Þ þ qd ðpi  pnl Þ pi < d i and/or qi > nl d ; ðqd  qnl Þ ðpd  pnl Þ pd < pi þ qd  qi and/or qd > qi þ pd  pi . Fig. 2 depicts the utility curves, market shares and consumer welfare under voluntary and mandatory COOL when ps < pnl < pi < pd and the preference parameters are such that all products enjoy a positive market share. In Fig. 2, the kinked dashed curve shows the effective utility curve, and the area below it the aggregate consumer welfare, under voluntary COOL, while the kinked solid curve shows the effective utility curve, and the area below it the aggregate consumer welfare, under mandatory COOL. A change from voluntary to mandatory COOL causes an undisputed decrease in consumer welfare shown by the dotted area (D) in Fig. 2. This welfare loss results from a decrease in the utility bV ; C b V Þ that are no longer of consumers with a characteristic C 2 ð C 1 2 able to consume their preferred non-labeled product. These Consumer utility

U − pd + qd U − pi + qi U − p nl + q nl

D

U − ps

q nl qi

U − pnl U − pi

Benchmark: voluntary labeling

ð10Þ

qd

U − pd X sM

X nlV

X sV 0

Cˆ 1V

Cˆ 1M

Cˆ 2V

X iM

X dM

X iV

X dV Cˆ 2M , Cˆ 3V

1

Fig. 2. Market and welfare effect of a change from a voluntary to a mandatory COOL regime.

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L. Awada, A. Yiannaka / Food Policy 37 (2012) 21–30

consumers are divided into two groups; consumers with a bV ; C b M Þ who have relatively low preference for COOL and unC 2 ðC 1 1 der mandatory COOL consume the cheaper inferior substitute bM; C b V Þ who have relatively product, and consumers with a C 2 ð C 1 2 stronger preference for COOL and under mandatory COOL consume the more expensive, higher quality, imported product. Note that, an increase in the price of the imported product, pi, and/or a decrease in the quality enhancement parameter qi would cause, respectively, a downward shift of the Ui utility schedule and a clockwise rotation of the Ui utility schedule through its intercepts at U  pi, resulting in an increases in the loss of consumer welfare (area D). Similarly, an increase in the probability u that the non-labeled product is domestically produced under no COOL, would cause an increase in qnl leading to a counterclockwise rotation of the Unl utility schedule through its intercept at U  pnl, resulting in greater consumer welfare losses. Result 2. When COOL leads to vertical product differentiation, a change from a voluntary to a mandatory COOL regime results in an unambiguous loss in aggregate consumer welfare that stems from a decrease in the utility of consumers with relatively weak preference for COOL; the welfare of consumers with relatively strong preference for COOL remains unaffected. The consumer welfare losses are greater, the greater is the price of the imported product, the lower is the utility enhancement from its consumption and the greater is the probability that the non-labeled product is domestically produced. The above analysis was conducted under the assumption that the labeled product prices are the same under voluntary and mandatory COOL. If, however, mandatory COOL is more costly than voluntary COOL, and part or all of these costs are passed onto consumers, the consumer welfare losses will be even greater. This case could be shown graphically by drawing two additional utility curves in Fig. 2, for the imported and domestic product under mandatory COOL, that would lie below the respective utility curves for these products under voluntary COOL (due to their higher prices). This would cause the effective utility curve under mandatory COOL (kinked solid line) to be below the effective utility curve under volb V ; 1 values and untary COOL (kinked dashed line) for all C 2 ð C 1 would generate welfare losses for all consumers with a differentiating characteristic in the above interval. As is evident from the above analysis, while a move from a no COOL to a mandatory COOL regime creates both winners and losers, so the net effect on the aggregate consumer welfare is inconclusive and very much dependent on the magnitude of the model parameters, a move from a voluntary to a mandatory COOL regime implies no welfare change for some consumers and welfare losses for others resulting in an undisputed loss in aggregate consumer welfare. If we relaxed our assumption that consumers are uniformly distributed in the unit length interval with respect to their differentiating characteristic and, for instance, allow the distribution to be skewed to the left (right) so that more consumers have a weak (strong) preference for COOL, then the welfare losses from implementing mandatory COOL are greater (smaller) under both benchmarks. The market and consumer welfare effects of mandatory COOL when COOL information leads to horizontal product differentiation Model assumptions Salop’s unit circle model is used to examine the market where a product is available in two different forms related to its origin, imported and domestically produced and consumers view them as being horizontally differentiated (Salop, 1979). In the circle model, consumers are assumed to be heterogeneous, uniformly distrib-

uted around a circle of unit circumference, each buying one unit of their preferred product and the purchasing decision represents a small share of their budget. The products available in the market are located at an equal distance from each other, and a consumer’s location in the unit circle represents her most preferred product form/variety associated with the product’s country of origin. The further away a consumer is located from an available product, the greater is the disutility derived from consuming that product (i.e., the greater is the difference between the consumer’s most preferred country of origin for a given product and the product origins that are available in the market). The utility function of the consumer is given by:

U j ¼ U  pj  tjRj  R j

ð12Þ

where Uj is the per unit utility associated with the consumption of product j ¼ fnon-labeled; imported; domesticg, the parameter U is the per unit base level of utility derived from the consumption of product j and is constant across consumers, pj denotes the price of product j, and t is the rate at which consumer utility decreases as a consumer is unable to consume her most preferred product of origin and is constant across all consumers. The terms Rj, and R⁄ denote a product’s country of origin and a consumer’s most preferred country of origin for the given product, respectively. To keep the analysis simple, it is assumed that the utility derived from consuming product j is greater than the utility derived from consuming a substitute product for all consumers located on the circle (i.e., U j > U s P 0). Finally, similar to the vertical differentiation model, we assume free entry and no market power in all product markets and that labeling costs are the same under voluntary and mandatory COOL. Benchmark: no labeling Under no COOL all product forms (imported and domestic) are marketed together as a non-labeled product and sold at the same price. The utility function of the non-labeled product is given by:

    U Nnl ¼ U  pnl  t RNnl  R 

ð13Þ

where pnl, denotes the price of the non-labeled product and RNnl is the location of the non-labeled product under no COOL. Given the assumption that the substitute product is viewed as inferior by all consumers on the circle, the non-labeled product will capture all consumers located at a distance   Up  N  nl . Due to symmetry, the market share of, and Rnl  R  6 t the demand for, the non-labeled product is then given by:





vNnl ¼ 2RNnl  R  ¼ 2

ðU  pnl Þ t

ð14Þ

Thus, under no COOL the non-labeled product will be in the market as long as pnl 6 U. Under mandatory COOL consumers can choose between the imported or the domestic product and their purchasing decisions are determined by comparing the utilities derived from consuming either product given by Eqs. (15) and (16).

   M  UM i ¼ U  pi  t Ri  R  If a unit of the imported product is consumed

ð15Þ

   M  UM d ¼ U  pd  t Rd  R  If a unit of the domestic product is consumed

ð16Þ

where pi and pd denote the prices of the imported and domestically produced products, respectively. Given that the products are located on a unit circle and at an equal distance from each other, the distance between them is 1/2.

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Non-labeled product utility under NO COOL

U − pi

U − pd

U − p nl

Non-labeled product utility under NO COOL

Imported product utility under MCOOL

Domestic product utility under MCOOL

U − p nl D2

D1

t t I

t t t

t

R

N nl

R

M d

Rˆ

M 1

M i

R

Ra

R

N nl

Fig. 3. Market and welfare effect of a change from a no COOL to a mandatory COOL regime. M Consumers located at RM i and Rd receive maximum utility (no disutility) from consuming the imported and domestic products, since M  M M R ¼ RM i so that U i ¼ U  pi and R ¼ Rd so that U d ¼ U  pd , respectively. The consumer who is indifferent between consuming the b M ¼ pi  pd þ 1 domestic and the imported product is located at R 1 4 2t b M Þ ¼ UM ðR b M Þ). Consumers located in the interval ð R (i.e., U M 1 1 d i b M ; RM Þ consume the imported product while consumers loR 2 ðR 1

i

bM cated in the interval R 2 ðRM d ; R 1 Þ consume the domestic product (see Fig. 3). Due to symmetry, the market share of, and the demand for, the imported and domestic product are given by:

vMi vMd

  1  b M  ¼ pd  pi þ 1 ¼ 2  R 1  2 2 t   p p 1 bM i d ¼ 2 R þ 1  ¼ 2 t

ð17Þ ð18Þ

Eqs. (17) and (18) show that the domestic and imported product will enjoy a positive market share when pd < pi þ 2t and pi < pd þ 2t , respectively. Fig. 3 depicts the utility curves of the available products, the market shares and consumer welfare under no COOL and under mandatory COOL. Note that, in Fig. 3, the unit circle, where the horizontally differentiated products are located, is stretched into a line, pnl < pi < pd and the model parameters are such that all products enjoy a positive market share.9 In Fig. 3, the kinked dashed curve shows the effective utility curve, and the area below it the aggregate consumer welfare under no COOL, while the kinked solid curve shows the effective utility curve, and the area below it the aggregate consumer welfare under mandatory COOL. The introduction of mandatory COOL decreases consumer welfare by the dotted areas (D1) and (D2) and increases it by the vertically hatched area (I) in Fig. 3. The decrease in consumer welfare under mandatory COOL is due to a decrease in the utility N of consumers located in the intervals ðRNnl ; RM d Þ and ðRa ; Rnl Þ which are the consumers with relatively weak preference for country of origin labeling (i.e., consumers located close to the relatively cheaper non-labeled product) and under mandatory COOL can no longer consume their preferred non-labeled product.10 The 9 The assumption pi < pd is made only for demonstration; if pd ¼ pi both labeled products would receive a positive market share equal to 1/2. 10 Ra gives the location of a consumer who is indifferent between consuming the non-labeled product under a no COOL regime and the imported product under mandatory COOL (i.e., U Nnl ðRa Þ ¼ U M i ðRa Þ).

increase in consumer welfare under mandatory COOL results from an increase in the utility of consumers located in the interval ðRM d ; Ra Þ, who have a relatively strong preference for country of origin labeling (i.e., they are located closer to the imported and domestic product), and switch their consumption from the non-labeled to the labeled product. For these consumers the utility received from the consumption of the labeled imported and domestic products exceeds the utility discount due to the products’ higher prices. Fig. 3 depicts the case where the net effect of introducing mandatory COOL on aggregate consumer welfare is negative. Notice that a decrease in the price of the labeled domestic and imported product, which can be represented in Fig. 3 as an upward shift of the kinked solid schedule, will increase the consumer welfare gain (area (I)) and decrease the consumer welfare loss (areas (D1) and (D2)) and could lead to a positive net consumer welfare effect. Result 3. When COOL leads to horizontal product differentiation, a change from a no COOL to a mandatory COOL regime results in welfare losses for consumers with relatively weak preference for COOL and welfare gains for consumers with relatively strong preference for COOL. The lower is the price of the labeled products, the greater is the likelihood that welfare gains will exceed welfare losses.

Benchmark: voluntary COOL Under voluntary COOL, the non-labeled, imported and domestic products could all be available in the market. Given that the products are located on a unit circle and at an equal distance from each other, the distance between them is 1/3. Consumer purchasing decisions under voluntary COOL are determined by comparing the utilities derived from consuming the three products, given by Eqs. (19)–(21).

    U Vnl ¼ U  pnl  t RVnl  R 

If a unit of the non-labeled product is consumed

ð19Þ

    U Vi ¼ U  pi  t RVi  R  If a unit of the imported product is consumed

ð20Þ

    U Vd ¼ U  pd  t RVd  R  If a unit of the domestic product is consumed RVnl ,

RVi

ð21Þ

RVd

Consumers located at, and receive maximum utility (no disutility) from consuming the non-labeled, imported and domestic product, since R ¼ RVnl so U Vnl ¼ U  pnl , R ¼ RVi so U Vi ¼ U  pi and R ¼ RVd so U Vd ¼ U  pd , respectively. The consumer who is indifferent between consuming the domestic and b V ¼ pd  pnl þ 1 (i.e., non-labeled product is located at R 1 6 2t b V Þ ¼ UV ðR b V Þ), the consumer who is indifferent between the U Vd ð R 1 1 nl b V ¼ pi  pd þ 1 (i.e., domestic and imported product is located at R 2 6 2t b V Þ ¼ UV ðR b V Þ) and the consumer who is indifferent between U Vd ð R 2 2 i the imported and the non-labeled product is located at b V Þ ¼ UV ðR b V Þ). b V ¼ pnl  pi þ 1 (i.e., U V ð R R 3 3 3 i nl 6 2t Under voluntary COOL, consumers located in the intervals b V Þ and ð R b V ; RV Þ prefer the non-labeled product, those located ðRV ; R nl

1

3

nl

b V  buy the domestic product and b V ; RV  and ðRV ; R in the intervals ½ R 1 2 d d V b b V  buy the imported those located in the intervals ð R ; RV  and ðRV ; R 2

i

i

3

product (see Fig. 4). Given the above, the market share of (and the demand for) the non-labeled, imported and domestic product under voluntary COOL are given by:

L. Awada, A. Yiannaka / Food Policy 37 (2012) 21–30

Fig. 4. Market and welfare effect of a change from a voluntary to a mandatory COOL regime.





 1 3

 

vVnl ¼  Rb V1  þ   Rb V3  ¼  1

 

 1

 

vVi ¼   Rb V2  þ Rb V3 ¼ 3 



pd þ pi  2pnl 1 þ 3 2t

pnl þ pd  2pi 1 þ 3 2t

vVd ¼   Rb V1  þ  Rb V2  ¼ 3

pnl þ pi  2pd 1 þ : 3 2t

ð22Þ

ð23Þ

ð24Þ

Eqs. (22)–(24) show that under voluntary COOL the non-labeled, imported and domestic products will all have a positive market p þ pi t þ , share when the following conditions hold: pnl < d 3 2 pnl þ pd t pnl þ pi t pi < þ and pd < þ . 3 3 2 2 Fig. 4 depicts the utility curves of the available products, purchasing decisions/market shares and aggregate consumer welfare under voluntary and mandatory COOL, where the horizontally differentiated product circle is stretched into a line, pnl < pi < pd and the model parameters are such that all products available in the market enjoy a positive market share under voluntary and mandatory COOL. In Fig. 4, the kinked dashed curve gives the effective utility curve, and the area below it the aggregate consumer welfare under voluntary COOL, while the kinked solid curve gives the effective utility curve, and the area below it aggregate consumer welfare under mandatory COOL. As shown in Fig. 4, the introduction of mandatory COOL decreases consumer welfare by the dotted areas D1 and D2 which results from a decrease in the utility of consumers who are no longer able to consume their preferred (and relatively cheaper) non-labeled product and now switch their consumption to the relatively more expensive, labeled, imported and domestic products. For consumers who consumed the imported or domestic product under both voluntary and mandatory labeling, there is no change in their consumption choices and, thus, no change in their welfare. Notice that, an increase in the price of the labeled imported and domestic product, which can be shown as a downward shift of the kinked solid schedule in Fig. 4, would result in greater consumer welfare losses. Result 4. When COOL leads to horizontal product differentiation, a change from a voluntary to a mandatory COOL regime results in an unambiguous loss in aggregate consumer welfare that stems from a decrease in the utility of consumers with relatively weak preference for COOL. The higher are the prices of the labeled imported and domestic products, the greater is the consumer welfare loss.

27

The above results are based on the assumption that the prices of the imported and domestic product do not change under mandatory COOL. If mandatory COOL were more costly than voluntary COOL and consumers incurred part or all of these costs through higher product prices, the welfare loss due to the introduction of mandatory COOL would be even greater. This case could be shown graphically in Fig. 4 by adding two utility curves for the imported and domestic product under mandatory COOL that would lie below the utility curves of these products under voluntary COOL so that the effective utility curve under mandatory COOL (kinked solid curve) would lie below the effective utility curve under voluntary COOL for all consumers creating a greater area of welfare loss. In addition, our results are based on the assumptions that consumers are uniformly distributed on a unit circle and the rate at which consumer utility is lowered as a consumer is unable to consume her most preferred product of origin, t, is constant across all consumers. The relaxing of these assumptions has welfare implications. For instance, if the distribution of consumers is skewed towards the non-labeled (imported or domestic) product, the decrease in consumer welfare under mandatory COOL will be greater (smaller). This result is similar to the case of vertical product differentiation where if the distribution of consumers with respect to their differentiating attribute C is skewed to the left (indicating weaker preference for COOL), the welfare losses from mandatory COOL implementation will be greater. In addition, if the rate at which consumer utility decreases as a consumer is unable to consume her most preferred product form is smaller (greater) for the non-labeled product than it is for the labeled imported and domestic products, the utility curve of the non-labeled product will be flatter (steeper) and the loss in consumer welfare under mandatory COOL will be greater (smaller). Result 5. Under both vertical and horizontal product differentiation, a change from a no COOL to a mandatory COOL regime generates both welfare gains (for consumers with strong preference for COOL) and welfare losses (for consumers with weak preference for COOL) while a change from a voluntary to a mandatory COOL regime leads to an unambiguous loss in consumer welfare (for consumers with weak preference for COOL). The weaker (stronger) is consumer preference for COOL and the greater is the number of consumers that share this preference, the greater (smaller) are the consumer welfare losses associated with the introduction of mandatory COOL under both types of product differentiation and benchmarks.

Concluding remarks Numerous studies have shown that consumer perceptions of country of origin labeling are not homogenous. COOL information may be used to make inferences about a product’s quality attributes but also to express political and/or economic support for a given country/economy, in which case, purchasing decisions are not based solely on product attributes. It is unclear whether variations in market outcomes and welfare effects among existing studies are due to differences in perceptions about COOL as these studies are product and location specific. This paper sheds light on the effects of country of origin labeling on market outcomes and consumer welfare by examining how consumer perceptions about COOL information and the benchmark used to evaluate the policy affect the results. Specifically, we develop a general analytical framework of heterogeneous consumer preferences where consumers may perceive COOL information as an attribute that differentiates covered products either vertically or horizontally and evaluate the market and consumer welfare effects of mandatory COOL under two benchmarks, a no COOL and a voluntary COOL regime.

28

L. Awada, A. Yiannaka / Food Policy 37 (2012) 21–30

Our results show that the market outcomes and the welfare effects of mandatory COOL are similar regardless of whether COOL information is viewed as a quality indicator that is used to uniformly utility-rank the available products, leading to vertical product differentiation or represents attributes consumers may not agree on and, thus, cannot use to generate uniform utility rankings, leading to horizontal product differentiation. On the other hand, we find that the benchmark used to evaluate the effects of COOL is critical for the market and welfare outcomes. Specifically, our results show that, under both vertical and horizontal product differentiation, the market effects of mandatory COOL depend on the relative prices of the products available in the market, the distribution of consumer preferences, and the strength of consumer preferences for country of origin labeling information. In general, the greater the price of the labeled product (imported or domestically produced) and/or the weaker the consumer preference for information conveyed through country of origin labeling, the smaller the market share of the labeled products (imported and domestically produced) under mandatory COOL. In addition, while a change from a no COOL to a mandatory COOL regime generates both welfare losses and welfare gains a change from voluntary to mandatory COOL leads to an undisputed welfare loss under both vertical and horizontal product differentiation. Specifically, when the benchmark is no COOL, consumers with relatively weak preference for COOL experience a welfare loss due to mandatory COOL while those with strong preference for COOL experience a welfare gain. The net welfare effect is ambiguous and depends on the relative product prices, the distribution of consumer preferences, consumer expectations about the composition of the non-labeled product and the strength of consumer preferences for COOL. When the benchmark is voluntary COOL, the introduction of mandatory COOL limits consumer choices since the non-labeled product is not available in the market and leads to a decrease in the welfare of consumers with relatively weak preference for COOL, while keeping the welfare of consumers with relatively strong preference for COOL unchanged. As our results suggest, while differences in consumer perceptions about the nature of COOL information do not lead to differences in consumer welfare outcomes, the relative strength of consumer preferences for COOL must be assessed and taken into account when evaluating the effects of mandatory COOL on any covered agricultural product as these affect the magnitude of the market and welfare effects of the policy. In addition, the status quo regarding the labeling policy needs to be carefully assessed as the economic outcomes of COOL implementation have been shown to be very much dependent on the benchmark used for analysis.

b M Þ ¼ Ui ðC b M Þ). Consumers with relthe imported product (i.e., U d ð C 2 2 b M , buy the atively weak preference for COOL, those with a C 2 ½0; C 1

bM; C b M  consume the substitute product, consumers with a C 2 ½ C 1 2 domestic product and consumers with relatively strong preference for COOL, those with a C 2 ½C M 2 ; 1, consume the imported product (see Fig. A.1). The market shares of (and the demands for) the substitute, domestic and imported products are given by Eqs. (5a), (6a) and (7a), respectively.

b M pd  ps XM s ¼ C1 ¼ qd

ð5aÞ

b M b M pi qd  pd qi þ ps ðqi  qd Þ XM d ¼ C2  C1 ¼ qd ðqi  qd Þ

ð6aÞ

b M ðqi  qd Þ  ðpi  pd Þ XM i ¼ 1  C2 ¼ ðqi  qd Þ

ð7aÞ

Eqs. (5a), (6a), (7a) show that for the substitute, imported and domestic products to enjoy a positive market share, the following p q þ ps ðqi  qd Þ conditions must hold, respectively:ps < pd; pd < i d qi q ðp  ps Þ ; pi < pd þ qi  qd and/or qi > pi  pd + qd. and/or qd > i d ðpi  ps Þ Fig. A.1 depicts the utility curves of the available products, the market shares and aggregate consumer welfare under no COOL and mandatory COOL, when ps < pnl < pd < pi and the preference parameters are such that all products enjoy a positive market share under both regimes. In Fig. A.1, the kinked dashed curve shows the effective utility curve and the area below it the aggregate consumer welfare under no COOL. The twice-kinked solid curve shows the effective utility curve and the area below it the aggregate consumer welfare under mandatory COOL. The areas between the effective utility curves capture changes in consumer welfare due to a change in the labeling regime. The introduction of mandatory COOL decreases consumer welfare by the dotted area D and increases it by the vertically hatched area I. The decrease in consumer welfare results from a decrease in the utility of consumers with weak preference for COOL (i.e., consumers with low to medium C values, b N ; C a Þ), and includes two different consumer groups; conC 2 ½C 1 bN; C b M Þ who switch their consumption from sumers with a C 2 ½ C 1 1 their preferred non-labeled product (which is no longer available) to the substitute product, which, even though is cheaper, is viewed as inferior to the non-labeled product and consumers with a b M ; C a Þ who switch their consumption from the non-labeled C 2 ðC 1 to the domestic product, which is viewed as superior to the

Appendix A. The case where the imported product is the high quality product in the vertically differentiated market Consumer utility

I

In ‘Model assumptions (vertical)’, assume that the imported product is the high quality product, qi > qd > 0, all other assumptions remain the same. Benchmark: no labeling b N , X N and X N remain the same as Under no COOL, the terms C 1 s nl when the domestic product is the high quality product; as defined in ‘Benchmark: no labeling (vertical)’. Under mandatory COOL, the consumer with a differentiating b M ¼ pd  ps is indifferent between consuming the attribute C 1 qd substitute and the domestically produced product (i.e., b M Þ ¼ Ud ðC b M Þ) while the consumer with a C b M ¼ pi  pd is indifUs ðC 1 1 2 qi  qd ferent between consuming the domestically produced product and

U − pi + qi U − pd + qd

D

U − pnl + qnl

U − ps U − pnl

q nl qd

U − pd

qi

U − pi X sM X sN

0

X iM

X dM X nlN Cˆ 1N

Cˆ 1M

Ca

Cˆ 2M

Fig. A.1. Market and welfare effect of a change from a no COOL to a mandatory COOL regime.

L. Awada, A. Yiannaka / Food Policy 37 (2012) 21–30

Consumer utility

U − pi + qi U − pd + qd U − p nl + q nl

D

U − ps

q nl qd

U − pnl U − pd

qi

U − pi X sM X 0

X dM V s

X Cˆ 1V

V nl

X Cˆ 1M

X iM

V d

Cˆ 2V

consumer welfare shown by the dotted area (D). This welfare loss results from a decrease in the utility of consumers with a characb V ; C V Þ that are no longer able to consume their preteristic C 2 ð C 1 2 ferred non-labeled product. These consumers are divided into b V ; C M Þ who have relatively two groups; consumers with a C 2 ð C 1 2 low preference for COOL and under mandatory COOL consume the cheaper inferior substitute product, and consumers with a b M ; C V Þ who have relatively stronger preference for COOL C 2 ðC 2 1 and under mandatory COOL consume the more expensive, higher quality, domestic product. References

X iV V Cˆ 2M , Cˆ 3

29

1

Fig. A.2. Market and welfare effect of a change from a voluntary to a mandatory COOL regime.

non-labeled product but is more expensive. The increase in consumer welfare results from an increase in the utility of consumers with relatively stronger preference for COOL (i.e., consumers with medium to high C values, C 2 [Ca, 1] in Fig. A.1), for whom the utility increase from the consumption of the labeled imported and domestic products exceeds the utility discount from their higher prices. Benchmark: voluntary labeling Under Voluntary COOL, the consumer who is indifferent between consuming the substitute and the non-labeled product has b V ¼ pnl  ps (as in the case a differentiating attribute given by C 1 qnl when qd > qi > 0), the consumer who is indifferent between consuming the non-labeled and the domestic product has a b V ¼ pd  pnl while the consumer who is indifferent between conC 2 qd  qnl b V ¼ pi  pd . suming the domestic and imported products has a C 3 qi  qd The market shares of (and the demands for) the substitute, non-labeled, imported and domestic products are given by Eqs. (8a), (9a), (10a), (11a):

b V ¼ pnl  ps X Vs ¼ C 1 qnl

ð8aÞ

bV  C b V ¼ qnl ðpd  ps Þ  qd ðpnl  ps Þ X Vnl ¼ C 2 1 qnl ðqd  qnl Þ

ð9aÞ

bV  C b V ¼ qd ðpi  pnl Þ  qnl ðpi  pd Þ  qi ðpd  pnl Þ X Vd ¼ C 3 2 ðqi  qd Þðqd  qnl Þ

ð10aÞ

b V ¼ ðqi  qd Þ  ðpi  pd Þ X Vi ¼ 1  C 3 ðqi  qd Þ

ð11aÞ

Eqs. (8a), (9a), (10a), (11a) show that the substitute, non-labeled, imported and domestic products will capture a positive market share when the following conditions hold, respectively: ps < pnl ; q ðp  ps Þ þ qd ps q ðp  ps Þ ; and/or qnl > i nl pnl < nl d ðpd  ps Þ qd p ðq  qnl Þ þ pnl ðqi  qd Þ q ðp  pd Þ þ qi ðpd  pnl Þ pd < i d and/or qd > nl i ; ðqi  qnl Þ ðpi  pnl Þ pi < pd + qi  qd and/or qi > qd + pi  pd. Fig. A.2 depicts the utility curves, market shares and consumer welfare under voluntary and mandatory COOL when ps < pnl < pd < pi and the preference parameters are such that all products enjoy a positive market share. In Fig. A.2 a change from voluntary to mandatory COOL causes an undisputed decrease in

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