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Regulating an Experience Good Produced in the Formal Sector of a Developing Country when Consumers Cannot Identify Producers

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  • Timothy McQuade
  • Stephen Salant
  • Jason Winfree

Abstract

In developing countries, consumers can buy many goods either in formal markets or in informal markets and decide where to purchase based on the product's price and anticipated quality. We assume consumers cannot assess quality prior to purchase and cannot, at reasonable cost, identify who produced the good they are considering. Many products (meats, fruits, vegetables, fish, grains) sold both in formal groceries and, less formally, on the street fit this description. We assume that producers can adjust quality at a cost and only firms in the formal sector are subject to government regulation. In the long run, producers migrate to the sector that is more pro table. Using this model, we demonstrate how regulations in the formal sector can lead to a quality gap between formal and informal sector goods. We moreover investigate how changes in regulation affect quality, price, aggregate production, and the number of firms in each sector.
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Suggested Citation

  • Timothy McQuade & Stephen Salant & Jason Winfree, 2012. "Regulating an Experience Good Produced in the Formal Sector of a Developing Country when Consumers Cannot Identify Producers," Review of Development Economics, Wiley Blackwell, vol. 16(4), pages 512-526, November.
  • Handle: RePEc:bla:rdevec:v:16:y:2012:i:4:p:512-526
    DOI: 10.1111/rode.2012.16.issue-4
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    References listed on IDEAS

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    1. Jason A. Winfree & Jill J. McCluskey, 2005. "Collective Reputation and Quality," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 87(1), pages 206-213.
    2. Jean Tirole, 1996. "A Theory of Collective Reputations (with applications to the persistence of corruption and to firm quality)," Review of Economic Studies, Oxford University Press, vol. 63(1), pages 1-22.
    3. Marjit, Sugata & Ghosh, Sudeep & Biswas, Amit, 2007. "Informality, corruption and trade reform," European Journal of Political Economy, Elsevier, vol. 23(3), pages 777-789, September.
    4. Rauch, James E., 1991. "Modelling the informal sector formally," Journal of Development Economics, Elsevier, vol. 35(1), pages 33-47, January.
    5. Mazumdar, Dipak, 1983. "Segmented Labor Markets in LDCs," American Economic Review, American Economic Association, vol. 73(2), pages 254-259, May.
    6. Carl Shapiro, 1983. "Premiums for High Quality Products as Returns to Reputations," The Quarterly Journal of Economics, Oxford University Press, vol. 98(4), pages 659-679.
    7. Kanbur, Ravi, 2009. "Conceptualising Informality: Regulation and Enforcement," IZA Discussion Papers 4186, Institute for the Study of Labor (IZA).
    8. Marjit, Sugata & Kar, Saibal, 2011. "The Outsiders: Economic Reform and Informal Labour in a Developing Economy," OUP Catalogue, Oxford University Press, number 9780198071495.
    9. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, Oxford University Press, vol. 84(3), pages 488-500.
    10. Klein, Benjamin & Leffler, Keith B, 1981. "The Role of Market Forces in Assuring Contractual Performance," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 615-641, August.
    11. Ihrig, Jane & Moe, Karine S., 2004. "Lurking in the shadows: the informal sector and government policy," Journal of Development Economics, Elsevier, vol. 73(2), pages 541-557, April.
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    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection

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