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Market and welfare effects of quality misperception in food labels

The size and distribution of surplus in markets where credence quality attributes of goods are conveyed through some informational mechanism (typically labels) crucially depend on 1) how information changes consumers’ perception of quality and 2) producers’ strategic choice of quality provision in response to changes in consumers’ perception of quality. While there is a growing empirical literature on consumers’ perception of quality, there is a dearth of empirical studies regarding firms’ reactions to changes in consumers’ perception of quality. A major reason underlying this dearth of empirical studies is that consumers’ perceived, as opposed to actual–quality, is unobservable to the researcher. Based on previously derived theoretical predictions, I design an experiment in the laboratory where I emulate changes in consumers’ perception of quality and examine their effects on producers’ provision of quality and market surplus. The experiment indicates that overvaluation of high-quality products relative to their lower-quality competitors (e.g., 100% organic relative to organic or made with organic) and undervaluation of low-quality products (e.g., presence of GM inputs relative to GM-free) result in a significant increase in quality and prices at the higher end of the spectrum, increase in profit for the high-quality seller, and increase in total welfare. Misperception produces ambiguous changes at the lower quality end. Efficiency measures show that effective informational-based policies should focus on high-quality products, but distributional measures show that efficiency gains are at the expense of the low-quality segment of the market. Information-based mechanisms identifying unobserved credence attributes (e.g., labels) have proliferated in the markets of food products. Their increasing popularity is based on the assumption that they help consumers making better choices by eliminating informational asymmetries (Roe and Sheldon, 2007; Bonroy and Constantatos, 2015; Lusk et al., 2018). However, evidence provided by choice experiments reveals that consumers often fail to understand the information conceived in labels (Kiesel and Villas-Boas, 2013; Lee et al., 2013; Liaukonyte et al., 2015; McFadden and Lusk, 2018), which implies that consumers can miss-perceive (overor undervalue) the true quality of labeled products. Economic intuition suggests that misperception can distort consumers’ choices and change sellers’ strategic responses (e.g. quality choice, price charged), impacting the size and distribution of welfare in the market. However, there is a dearth of empirical studies examining sellers’ strategic reactions to consumers’ misperception. This is partly explained by the unobserved nature of consumers’ misperception and the difficulty of finding data with observational variation to misperception (Dranove and Jin, 2010). To circumvent these limitations, I report a laboratory experiment that analyzes the degree to which the intensity of consumers’ misperception alters sellers’ strategic responses. In this paper, I manipulate the intensity of consumer misperception in a laboratory experiment to test the direction and magnitude of the effects of misperception of quality on market outcomes (qualities and prices), and welfare outcomes (consumer surplus, profits, and total welfare). My experimental design is based on the comparative statics from Scott and Sesmero (2020) which modifies the canonical model of competition by vertical differentiation to include the effects of consumers’ misperception of quality. They consider a market where two single-product sellers— one serving the high-quality segment of the market and the other the low-quality segment— imperfectly compete on quality and prices. The authors assume quality is determined by credence attributes that can be conveyed by some costly informational mechanism to be adopted by sellers (e.g., labels), but consumers may misperceive the