Quality Choice, Competition and Vertical Relationship in a Market of Protected Designation of Origin

Protected Designation of Origin (PDO) is a public label that is used by the European Union as a tool to sustain the competitiveness and the profitability of agricultural sector and in particular to maintain rural activity in less favored areas. However, in PDO supply chain, many farmers deal with relatively few processing firms. In this framework, it is not clear that producers under such protective policy would have incentive to adopt costly measures to improve their product qualities and accept the restrictions on their production practices. Taking into account the vertical structure of the PDO supply chain, we develop a model of oligopoly and oligopsony competition to investigate the conditions under which PDO producers set high quality requirements on the production of the agricultural input. We find that even if raising quality does not imply additional willingness to pay from consumers, there is still scope for the PDO producers to choose a higher level of quality than the minimum quality standard. The outcome depends on the demand and technology characteristics, which will affect the oligopoly and oligopsony power of processors. In particular, farmers will prefer a higher quality standard than processors when the demand for PDO market is inelastic and the increase in quality generates an additional reduction in farmers’ return to scale.