The market for ethical goods

This paper studies how consumers and producers sort themselves in markets for ethically labeled goods, such as “organic” or “child-labor-free,” considering both extrinsic and intrinsic motives. I show how greenwashing arises from the interplay between prosocial motives and equilibrium sorting. A positive demand shock leads more producers to adopt the label, including some with weaker ethical motives. This lowers the expected environmental and social quality of labeled, but also unlabeled goods. The optimal subsidy for producing ethically labeled goods is smaller than the Pigouvian subsidy, and in some cases, it may even be optimal to tax these goods.