Is More Distinction Better? The Welfare Effects of Adjusting Quality Grades

Grading of agricultural commodities for quality is ubiquitous. By ensuring a minimum level for product qualities that can range over a broad spectrum, grading mitigates the asymmetric information problem, eliminates the repetition of costly inspection, and harmonizes pricing. Despite the potential for vast gradation by quality, only a limited number of coarse grades are typically available to consumers. While technology, costs and available information may limit the extent of grading, this coarseness, nonetheless, has important consumer and producer welfare effects. This paper shows that, even in the absence of consumer uncertainty and grading costs, both increasing the number of available grades and changing the standards of existing grades will alter and redistribute the total gains from trade. Producer or consumer groups can potentially increase their gains to trade simply by influencing the grading system. The model is related to rise of certification and branding programs in the beef industry in the last decade to supplement the longstanding grading program.