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Abstract

In the United States, the federal government is increasingly using requirements for informational labeling on food products to influence 1) consumers' knowledge and purchasing patterns and 2) manufacturers' product offerings and marketing practices. We discuss the economic rationale behind these regulations and issues related to judging their success or failure.
NE-165
Using Informational Labeling to Influence the
Market for Quality in Food Products
by
Julie A. Caswell and Eliza M. Mojduszka
Working Paper #43 July 1996
WORKING PAPER SERIES
A Joint USDA Land Grant University Research Project
Copyright © 1996 by Food Marketing Policy Center, University of Connecticut. All rights reserved.
Readers may make verbatim copies of this document for non-commercial purposes by any means, provided
that this copyright notice appears on all such copies.
USING INFORMATIONAL LABELING TO INFLUENCE THE MARKET
FOR QUALITY IN FOOD PRODUCTS
Julie A. Caswell*
Department of Resource Economics
303 Draper Hall
University of Massachusetts
Amherst, MA 01003
(413) 545-5735
(413) 545-5853 FAX
caswell@resecon.umass.edu
and
Eliza M. Mojduszka*
Department of Resource Economics
217 Draper Hall
University of Massachusetts
Amherst, MA 01003
elizam@oitvms.oit.umass.edu
Keywords: Food labeling, food quality, food safety, information
Abstract: In the United States, the federal government is increasingly using requirements for
informational labeling on food products to influence 1) consumers’ knowledge and purchasing
patterns and 2) manufacturers’ product offerings and marketing practices. We discuss the
economic rationale behind these regulations and issues related to judging their success or failure.
Julie A. Caswell is Professor and Eliza M. Mojduszka is Research Assistant, Department of
*
Resource Economics, University of Massachusetts at Amherst. This research is funded by a
USDA Cooperative State Research, Education, and Extension Service (CSREES) Special Grant
to the Food Marketing Policy Center, Universities of Connecticut and Massachusetts. This paper
was presented as a Principal Paper at the AAEA Meetings, July 29, 1996, San Antonio, Texas and
is forthcoming in the American Journal of Agricultural Economics.
1
USING INFORMATIONAL LABELING TO INFLUENCE THE MARKET
FOR QUALITY IN FOOD PRODUCTS
New technologies, scientific discoveries, information about linkages between diet and health,
and the mass communication of this knowledge to consumers leads to increased demand for
higher quality foods, especially in higher income countries. Food producers and retailers have
responded to these changes in consumer demand by modifying and extending the variety of foods
offered for sale. They are also engaging in more intensive marketing of particular attributes of
food products, especially nutritional attributes; the marketing of safety attributes is also beginning
to develop.
Government policies and regulations on labeling, in conjunction with input, process, and
performance standards for food products, significantly influence how markets for food quality
function and develop. In the United States, the federal government is increasingly using
informational labeling as a means of shaping 1) consumers’ knowledge, purchasing patterns, and
use practices and 2) manufacturers’ product offerings and marketing practices. Prominent
examples are mandatory nutrition labels on all food products and safe handling labels for fresh
meat and poultry. Our discussion here focuses on economic rationales for labeling policies and
issues related to how the success or failure of these policies should be judged.
Food Product Quality
Product quality is usefully described, using Lancaster’s approach, as a bundle of
characteristics (attributes) that determine the product’s performance. Major categories of food
product quality attributes include food safety (e.g., levels of microbial pathogens, residues),
nutritional, value (e.g., compositional integrity, taste), package, and process (e.g., animal welfare,
environmental impact) attributes (Hooker and Caswell). Food quality attributes can be regarded
2
as having a demand and supply that interact to determine a market clearing price. The demand for
food safety for example, is determined by consumers’ willingness to pay for additional safety,
reflecting the value placed upon the benefits that they derive. As with other goods, it is assumed
that consumers are willing to pay less for each additional unit of safety (Swinbank).
In real world situations, consumers choose foods within the context of a total diet in order to
obtain greater expected utility from their food. Part of that utility derives from using food to
maintain or improve health status (van Ravenswaay). Consumers with different risk preferences
rationally choose different bundles of foods. However, if their perceptions of the quality
attributes of foods are incorrect, consumers lose utility. For example, if their perceptions of the
risks or hazards associated with foods are incorrect, consumers either take more risks than they
would ideally like or pay more than they should for a higher than optimal level of food safety.
Food producers will supply food quality if it is profitable for them or if they are required to do
so. The contribution to profitability may stem from increased product differentiation, sales, and
perhaps prices, or from avoidance of costly events such as a foodborne illness outbreak with
associated tort liability. In general, the marginal cost of additional units of food quality is likely to
rise. Thus the market for food quality is characterized by a rising supply (marginal cost) curve
and a falling demand (marginal benefit) curve (Kinsey; Henson and Traill; Viscusi, Vernon, and
Harrington). For example, the supply of safety is determined by the cost of producing incremental
reductions in risk. The level of safety supplied by the market interaction of demand and supply
reflects a level of risks which are acceptable, not necessarily zero. Under perfect market
conditions, these curves intersect at a particular market clearing price providing the optimum level
of food safety.
3
The above scenario assumes that all market participants are fully informed about the nature of
the product, that both buyers and sellers are price takers, and finally that market prices fully
reflect all the costs borne and benefits enjoyed by the society. In such a situation, the market
price will transmit all necessary information, externalities will not exist, and government
regulation is not required. In such a market, a variety of products with different associated
quality (e.g., risk or nutrition levels) will be offered for sale at a variety of prices.
We know, however, that the market for food quality is not perfect. The most significant
imperfections are that sellers are better informed about quality attributes than consumers;
consumers may have misperceptions of the risks and hazards of consuming particular foods; and
food quality and information about food quality may have public good characteristics. In this
case, food quality (e.g., safety, nutritional quality) may be over- or under-supplied and
government often intervenes in an attempt to correct imperfections or mitigate their effects.
Economic Models of Quality and Quality Signaling
The greatest leverage in understanding how consumer markets for food quality operate is
gained by using the distinction developed by Nelson (1970, 1974) and Darby and Karni between
search, experience, and credence goods and applying it to product attributes. For search
attributes (or goods), consumers can determine a product’s quality before they buy it by
examining or researching the product. For experience attributes (or goods), consumers cannot
determine a product’s quality until they buy and use it. With credence attributes (or goods),
consumers cannot determine the product’s quality even after they buy and consume it. Because
the information environments for these three types of attributes are so different, they pose very
different issues for marketers and regulators. In addition, economic models that try to explain
markets for quality can only effectively deal with one type of attribute at a time.
4
With search attributes or goods the main issue is product selection—the quality and diversity
of goods supplied. Spence (1975, 1976) showed in his early work that the single product
producer's incentive to provide quality is related to the marginal willingness to pay for quality, for
the marginal consumer in the case of a monopolist and for the average consumer in the case of a
competitive producer. Because of the way the market for search attributes operates, they have
been a relatively minor focus of government regulatory activities. In these markets, consumer
information is relatively plentiful and easily attained so consumers can protect themselves and
their purchasing patterns provide direct incentives to producers to provide the range of quality
consumers are willing to pay for. Furthermore, in food product markets consumers make
frequent purchases and most search attributes (e.g., color) are what we term value attributes.
They are not related to safety or nutrition so the consequence of consumers being temporarily
misled is injuries to their pocketbooks but not to their health. Informational labeling programs are
less likely to be instituted for search attributes because the market functions relatively well with
respect to them.
For experience attributes, the most important issue is information and how consumers can
learn about product quality. What incentives do firms have to supply quality? What prevents
firms from taking advantage of imperfect information concerning product characteristics and
selling poor quality commodities, which cost less to produce than high quality commodities?
There is a moral hazard for the producer who sells an experience good without a warranty to one-
time consumers because there is no penalty for selling inferior products. Models of markets for
experience goods focus on how consumers can gain information on quality to inform their
purchases. Bagwell and Riordan, for example, considered an informed consumers model where
consumers enter the market sequentially. In this case, some consumers will know the quality and
5
some will not. Efficiency may be improved if the knowledge of the informed consumers can be
used by previously uninformed consumers. Government may play a role in increasing the number
of informed consumers by facilitating communication. An example would be inclusion of some
form of consumer rating on product labels.
Information problems in markets for experience goods may also be mitigated if consumers
make repeated purchases of a product where their choices are based on prior experience with
product quality. In economic models of this situation where reputation is important, a basic result
is that equilibria require price to exceed marginal cost (Klein and Leffler, Allen, Shapiro 1982,
1983). In repeated purchase situations, firms producing low quality would lose money. For the
reputation mechanism to work as an incentive to firms to produce quality, consumers must have
some degree of loyalty to higher quality firms. The less loyalty among customers, the higher the
price has to be to prevent firms from cheating on quality.
A key factor in determining whether markets for higher quality experience attributes operate
effectively is the success of quality signaling (e.g., labeling, advertising, warranties) by producers
to consumers. Several quality signaling models explore how communication between sellers and
consumers takes place, and as a result how markets for experience goods perform. Akerlof’s
classic “lemons” model deals with the case where quality signaling between sellers, who have
good information on product quality, and buyers, who have poor information, is totally
ineffective. In this case, a market may not exist or only the lowest quality product may be sold
because of the adverse selection problem—if quality cannot be signaled, higher quality products
cannot get a price premium, and only lower quality products will be offered for sale. On the other
hand, Grossman's "unfolding model" predicts a smoothly operating market for experience goods
when quality signaling is totally effective, costless, and truthful, and consumers can costlessly
6
verify quality after making their purchases. Price premiums for higher quality products encourage
firms to disclose the exact quality of their products and a market exists for varying levels of
quality.
Improving information (i.e., moving from the Akerlof toward the Grossman world) through
means such as advertising and labeling may solve or mitigate the quality signaling problem.
Whether consumers gain from being provided additional information depends on their relative
transaction costs for becoming informed and how receptive they are to the messages. Using
information imposes costs upon consumers. Those who attach little value to particular quality
attributes may choose to ignore information about them.
Many food quality attributes are experience attributes, with the above models giving insight
into the operation of markets for them. For example, attributes such as taste and cooking
properties can be readily assessed by consumers during use. For these attributes, reputation
models with quality signaling match how markets operate. Government is unlikely to become
heavily involved in requiring informational labeling of these attributes because with repeated
purchases the market can satisfactorily self-correct.
Food safety and nutritional characteristics are experience attributes in some respects. For
example, if a consumer eats a particular food product and experiences a foodborne illness as a
result, he or she has gained direct knowledge of the quality of that product. Several factors
interfere, however, with food safety operating as an experience attribute. In many cases
consumers may not be able accurately to link a particular product with an incidence of illness or
even be aware of a possible link. The inability to pinpoint cause and effect makes ex post
evaluation of safety as a quality attribute difficult. This is particularly true if longer periods of
time intervene between consumption of a product and ill effects as may be the case with some
7
types of residue exposure. Similarly, the ill effects of a nutritionally poor diet occur over a period
of time making links between specific products and ill effects difficult for consumers to make.
Informed consumer and reputational models of markets for experience attributes do not apply
well to food safety and nutritional attributes because of the consumer’s problem in forming a
quality judgement. Furthermore, for food safety even if cause and effect relationships are
relatively well-known (e.g., eating a contaminated product will result in illness), the probability of
a product being contaminated may not be well-known. Thus it is uncertain how well one’s former
experience predicts future experience. For these reasons, it is useful to treat food safety and
nutrition as credence attributes where the consumer has significant difficulty or cannot assess
quality even after consumption.
Economic models of quality hit a dead end when they come to discussion of credence
attributes or goods because information is so imperfect that these markets for quality simply do
not function well. As noted above, the food safety and nutritional attributes of food are largely
credence attributes. The key factor that makes them credence attributes is that it is not
practicable for individual consumers to assess the quality of the product. For example, an
individual consumer will not find it practicable to test the protein content or foodborne pathogen
contamination level of his or her food. The consumer cannot measure the quality and also cannot
learn it from his or her experience in consuming the product. Informed consumer and reputational
models of markets for quality do not apply here. Quality signaling may still be used but requires a
reputable certification agent whom consumers can trust. It is in this context that government
often chooses to play a role in making it practicable for consumers to assess quality by requiring
informational labeling.
8
Transforming Experience and Credence Attributes into Search Attributes
The presence of imperfect information, transaction costs in acquiring and using information,
and externalities may make private markets for quality work inefficiently. In these cases, policy
makers often look for correction tools. One of these tools can be direct government regulation of
production processes or product characteristics but such regulation is often criticized as
economically irrational and costly. In response to this criticism, there has been some movement
away from traditional forms of regulation toward interventions that are believed to be more
compatible with seller and consumer incentives. This has resulted in increased interest in
techniques that ensure consumers have sufficient information to protect themselves against unsafe
products or unfair seller behavior. Economists have argued that if the government has the choice
between banning a risky product or activity and providing information about the risks involved, it
should choose information provision (Magat and Viscusi).
Over the last decade, the government of the United States has placed a stronger emphasis on
use of information provision programs as a means of influencing economic behavior. Providing
additional or different information is attractive because it is a demand-led instrument, which may
be effective in giving consumers the means for making better decisions. If information problems
can be solved directly through informational regulation, more stringent forms of regulation such
as process or performance standards will not be required. These latter approaches raise concerns
because they may restrict both consumer and producer choice and increase costs unnecessarily.
Quality signaling through product labeling and information disclosure requirements encourages
market incentives with relatively limited government involvement, which is consistent with the
regulatory philosophy of many policy makers.
9
Information remedies can take a variety of forms including the: mandatory disclosure of
information about the nature of a product and how it should be used; controls on voluntary claims
in product promotion and the use of product names; provision of public information and
education; and subsidies for the provision of information. Our discussion focuses on the first two
remedies and their effect on quality and quality signaling at the interface between government
requirements, manufacturer response, and consumer demand. Mandatory information disclosures
often garner more attention than controls on voluntary claims, but both are important and they
often work in tandem.
For example, both forms of information regulation are used by the Nutrition Labeling and
Education Act of 1990 (NLEA), which went into effect in 1994. Nutrition labeling is mandatory
in the form of a standardized nutrition information panel that presents data on the macro- and
micronutrients found in a food. In addition, voluntary nutrient content claims (e.g., low sodium,
high fiber) and health claims (e.g., claims linking increased consumption of a nutrient to lower
incidence of a specific disease) that are made outside the standardized information panel are
circumscribed by the law. These types of voluntarily-provided information are regulated in order
to prevent deception and to facilitate product evaluation by consumers. Under the NLEA, a
voluntary low fat claim means the same thing whether it appears on a bag of potato chips or a can
of soup and, in fact, means that the product is low fat as defined by the regulation.
Whether they mandate information or simply circumscribe voluntarily- provided information,
labeling regulations result in a basic transformation of the information environment in markets for
quality attributes. They do so by transforming former experience or credence attributes into
search attributes. (They may also improve the information environment for search attributes
themselves.) Mandatory disclosures, for example, make it practicable for consumers to judge
10
quality before purchasing a product by establishing a quality scale, requiring testing of quality, and
mandating a reporting format. Regulation of voluntary claims serves similar purposes. The
monitoring and enforcement activities of the government then attempt to ensure that the
disclosures made are truthful and credible. For example, mandatory nutrition labeling makes
characteristics such as fat content into search attributes that can be verified by reading the
package label, while government oversight of claims increases their credibility. Thus labeling
policies are intended to improve the quantity, and often the nature, of quality signaling in markets
in order to improve the functioning of markets for quality attributes.
Informational labeling for food safety attributes is currently in an early stage of development.
As with nutrition, labeling of food safety attributes transforms credence into search attributes,
although several special circumstances make the information environment for food safety distinct
from that of nutrition. One of these circumstances is that some food safety attributes such as
foodborne pathogen levels can change considerably after the product leaves the processing plant
raising questions about the point at which quality should be measured and labeled. Another is
whether labeling of safety levels is acceptable to policy makers, food companies, and consumers.
Labeling to inform users about recommended food handling practices is yet a different case.
For example, in the wake of the E. coli O157:H7 outbreak in the western United States in early
1993, the U.S. Department of Agriculture required all fresh meat and poultry products to carry
safe handling labels. These labels communicate safe handling practices including recommended
storage, cooking temperature, and sanitation practices. They do not differentiate between beef
products, for example, because all products carry the same label, but may serve to differentiate
between meat products in general and other food products that do not carry specific handling
instructions. How this type of informational labeling functions in practice as a quality signal
11
depends on whether consumers interpret it as an indicator of poor quality (e.g., the product poses
a significant risk) or simply as a reminder to use good kitchen practices.
Are Labeling Policies Effective?
How do the changes labeling policies make in the information environment affect the market
for quality in food products? And how do those changes in markets affect the ultimate targets of
policy such as the health status of consumers? A significant problem with evaluating the
effectiveness of informational labeling requirements is that the programs are often complementary
to or coincidental with other forces influencing markets for quality. Measuring a separate, distinct
effect for labeling programs is difficult in these circumstances.
For example, markets for nutritional quality were already changing significantly prior to
implementation of the NLEA in 1994. Ippolito and Mathios found that in the late 1980s
consumers were changing their purchasing patterns for ready to eat cereal as they became
informed of the health benefits of cereal consumption and that advertising was an important
source of information. Frazão and Allshouse used scanner data for the years 1989-1993 to
document strong growth in the availability of nutritionally-improved versions of foods in 37 food
categories. Zarkin and Anderson suggest that the direction and magnitude of demand changes as
a result of implementation of the NLEA depend on whether consumers initially over- or
underestimated the nutrient content of foods. However, distinguishing the impact of nutrition
labels from that of other factors such as press coverage of links between nutrition and health or
doctors’ recommendations is difficult. Research that attempts to do just that is underway.
A second complicating factor in evaluating labeling policy is that it influences markets for
quality in a variety of ways. Caswell and Padberg argued that the role of labeling should be
viewed in a much broader sense that goes beyond its influence as a direct shopping aid for
12
consumers. These roles include influencing product design, advertising, consumer confidence in
food quality, and consumer education on diet and health.
Finally, relationships between levels of consumer information and behavior are complex. For
example, extensive work by Viscusi and Magat (1987, 1992) examined how people alter their
behavior in response to hazard warnings and risk labeling in a variety of settings. Their findings
provide specific directives for when different types of information provision instruments are
effective and when they are not, as well as which kinds of instruments will have the greatest
impact. The implications of this and other empirical and theoretical research on policies that
provide information is that labels can change consumers’ levels of understanding about quality
attributes and alter their consumption behavior. However, variation across consumers in their
responses to the information can be expected.
We think informational labeling requirements are likely to have a significant impact on demand
patterns and the dynamics of markets for food quality. As information about product quality and
use characteristics improves, manufacturers will compete for market shares from sales to
attribute-conscious, label-using consumers. Products and industries with less desirable quality
profiles may reformulate or redesign processes to avoid unfavorable comparisons with other
products. As labeling solutions to information problems in markets for food product quality are
relied upon more heavily, it is important to make the ex post effort to evaluate what impact this
informational labeling is having.
13
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