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

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. This pape assumes 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. This paper also assumes 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 profitable. Using this model, we demonstrate how regulations in the formal sector can lead to a quality gap between formal and informal sector goods. Moreover, the paper investigates how changes in regulation affect quality, price, aggregate production, and the number of firms in each sector.