Eco-design of eco-labels with coarse grades

We consider a third-party eco-label certifier that aims to reduce the total environmental impact of production on non-target resources and the total consumption rate of target resources. With these objectives the certifier determines the environmental standards for coarse grades of certification. Eco-labeled production involves a fixed investment cost, a larger marginal production cost, and a restricted access to supply, while eco-labeled products command a price premium. In response to a given grading scheme, we analytically characterize the subgame perfect equilibria for a two-stage game of environmental quality investment and quantity competition in a duopolistic setting. We then conduct numerical experiments to gain insights into whether and when multi-grade eco-labels may be more useful than single-grade eco-labels by providing better environmental protection in the dual objectives of the certifier. While multiple grades of an eco-label may appear in a market with asymmetric firms, our results indicate that multiple grades can indeed be useful under additional conditions: (i) when the investment costs are asymmetric, (ii) when the investment and production costs are asymmetric, either if the firm with the cost advantage has sufficiently low production cost under mild supply restrictions or if the production costs are very different, or (iii) when the supply bases are only moderately asymmetric and sufficiently large. Our findings uncover the role the cost and supply characteristics of the market play in eco-design of eco-labels, calling into question the common practice of offering single-grade eco-labels.