Minimum Quality Standard Regulation Under Imperfect Quality Observability
This is a pre-print of an article published in Journal of Regulatory Economics. The final authenticated version is available online at: DOi: 10.1007/s11149-011-9165-0
22 Pages Posted: 28 Jan 2010 Last revised: 29 Nov 2018
Date Written: September 15, 2011
Minimum quality standards (MQS) constitute an important regulatory tool that can be used to raise product qualities, to benefit consumers and to increase market participation. One of the main assumptions in the existing literature is that firms must comply with standards. Nevertheless, in many industries, and in particular the service industry, quality observability and enforceability are not perfect. Some low quality firms do not comply with standards. What are the welfare implications of an MQS regulation in such an environment? We develop a price competition model of vertical differentiation that accounts for these empirical observations. Contrary to well-established results in the literature, MQS can increase quality disparity between firms and raise hedonic prices. Some consumers get hurt and market participation decreases.
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