Welcome back to model 8 dedicated to "Geographical Indications".

My name is Luisa Menapace and I am Professor for Governments in International Agribusiness

at the Technical University of Munich. This module is divided into 2 lessons.

In the first lesson, we learn about the concept of Geographical Indications,

the relevance of GIs in the EU market and key facts related to the system of GI protection.

In this second lesson, I will present a model that shows how GIs can

improve market efficiency. The model is based on an article published in the

European Review of Agricultural Economics that I have coauthored together with Gian Carlo Moschini.

After completing this lesson you will be able to explain

how Geographical Indications can improve market efficiency. This lesson builds on

the model of firm reputation by Shapiro that we discussed in lesson 2 of modul 5.

It might be helpful to review the lesson before continuing with this video.

Here is a brief summary of the concept of individual firm reputation as

developed by Shapiro. A firm's reputation can be seen as the quality that consumers

expect from that firm's product's, and these expectations are based on the quality

delivered by the firm in the past. Over time, reputation evolves based on

the actual quality that is delivered. Because reputation evolves with some delay,

it is clear that a firm is able to "cheat" on consumers in the short run and make a

short run profit. In this context, cheating means selling low quality products at high prices.

Disappointed consumers, once they have discovered the low quality of the product,

will then simply buy from another producer.

This fear of losing consumers gives firms the incentive to continue producing high quality.

Hence, thanks to the reputation attached to the private trademark,

quality can survive in the market. Finally firms initial costs to build reputation

(for example by selling high quality products at low prices to induce consumers to try those products).

In lesson 2 of module 5 we discussed the

market implications of the use of trademarks that carry firms' reputations.

These are: Firms are willing to produce high quality but only at a premium above marginal cost.

Because a premium is needed to induce firms to maintain quality,

we can say that reputation via trademarks is an imperfect mechanism for assuring quality in the market.

In what follows, I will argue That GIs complement trademarks by

helping firms build reputation, ultimately increasing market efficiency.

Specifically, in our analysis, we show that when firms can certify a product as

GI in addition to using a trademark, the premium needed to support higher quality decreases,

leading to efficiency gains. These efficiency gains are obtained because GI

certification reveals information about the quality of the product.

By definition, GIs are quality products: products for which there is a quality-geography link.

The GI certification makes clear to consumers that GI certified products are of high quality.

There might be several ways to interpret the meaning of the quality-geography link.

In economic terms, we could interpret this link in terms of

the relative cost of producing quality. Consider this picture.

You might remember the green dotted curve from module 5. This represents the marginal cost of producing quality.

Imagine that this marginal cost of quality is the

marginal cost of producing quality using a standard production technology.

Now consider a second technology, which I have referred to as the GI technology.

This GI technology can be considered to be the technology that is available in the GI area.

The blue dotted curve represents the marginal cost of producing quality using the GI technology.

The picture illustrates the case of a GI technology with a cost advantage

(meaning lower costs) in the production of high quality

and a standard technology with a cost advantage in producing low quality.

Let me provide an example of this cost-based interpretation of the quality-geography link.

Take apple production. Apples can be cultivated on plain areas

where mechanization of cultivation activities is relatively easy or on mountainous areas

where mechanization is difficult. The latter is the case of the GI "Val di Non" for apples.

These are PDO apples that are grown in a valley, "Val di Non"

in the Italian Alps on a terrain that is unsuitable for mechanization,

and where most of the work is done by hand.

Compared to a plain area, the production of 'standard quality' apples is simply too costly in Val di Non.

Plain areas have a cost advantage in the production of 'standard quality' apples.

But in "Val di Non" there are naturally-occurring environmental conditions

related, for example, to the altitude, the soil and the daily temperature swings,

that favor the attainment of excellent quality apples:

these conditions would be very costly to artificially replicate in the plain areas.

Val di Non has a cost advantage in the production of high quality.

Now, let me illustrate how market efficiency can be improved when GIs are used,

in addition to trademarks, to build firm reputation. As explained, this picture

represents the marginal cost of production, under the assumption

that two production technologies exist, a standard technology and a GI technology.

The lower envelope of the two cost curves, represented by the dashed black curve,

indicates, for each quality, the cheaper marginal cost at which that quality can be produced.

Quality levels up to q tilde can be more cheaply produced using a standard technology.

Quality levels beyond q tilde can be more cheaply produced using the GI technology.

In a market with only trademarks the equilibrium price-quality schedule

that would emerge in the market is represented by the orange curve.

This curve differs from the price-quality schedule

seen in module 5 because of the existence of two technologies.

In this case, all qualities up to quality q tilde are produced with the standard technology.

This lower range of qualities is cheaper to produce with the standard technology.

All qualities above q tilde are produced using the GI technology.

Indeed, it is cheaper to produce this upper quality range with the GI technology.

When both GI identification and a trademark can be used by a firm,

the equilibrium price-quality schedule is represented by the blue curve.

For low qualities, the blue and orange curves overlap perfectly.

This means that GI certification does not bring any efficiency gains for the production of low qualities.

But for all the qualities above q_hat, the equilibrium price

that now prevails is closer to the underlying cost structure,

hence the market for those qualities is more efficient

when GI certification can be used in addition to trademarks.

How does GI certification improve efficiency?

This is the mechanism at work: Consider a GI-certified producer who already has a

reputation for a given high quality.

This producer could attempt to reduce costs by reducing quality.

The producer is allowed to do so by GI certification,

as long as it continues using the GI technology.

Because the producer is bound to use the GI technology in order to keep

GI certification, at best, the cost of production can be reduced to cG(qnot).

This is equal to the cost of producing the minimum quality using the GI technology.

The case of a non-GI-certified producer is different.

For a non-GI-certified producer the cost of cutting qualities is only c(qnot).

This is the cost of producing the minimum quality using the standard technology.

Therefore, it is less attractive for GI-certified producers

to cut quality compared to non-GI certified producers.

Given that GI-certified producers have less incentive to reduce quality,

a lower price is sufficient for them to make it

worthwhile to maintain their quality (and their reputation). This is why the blue curve,

which again represents the price-quality schedule in the case where both

trademarks and GI certification are used, is below the orange curve representing

the price-quality schedule in which only trademarks are used.

Put differently, the GI certification reveals to consumers

that the product has been produced with a technology

that makes it not worthwhile for producers to reduce quality.

Finally, recall that GI certification requires producers to write product specifications.

When the product specifications impose a

stricter minimum quality standard for GI products, meaning a quality standard

above qnot, even larger efficiency gains are possible.

Suppose, for example, that the GI minimum quality is qG not.

In this case the price-quality schedule

moves further down toward production costs, leading to an additional gain in efficiency.

Why is this the case? Again the mechanism of work concerns

the revelation of information to consumers through GI certification. In this case, GI certification

reveals not only that the GI-certified product is produced with the GI-technology

but also that it must meet a stricter minimum quality standard.

At this point, you might wonder why firms use trademarks in addition to GIs.

To understand that, ask yourself what is the maximum quality for which

a firm could build reputation by using GI certification without a trademark?

The answer is the GI-specific minimum quality standard.

Any firm that tries to build reputation for a quality above the GI-specific minimum quality standard

using only GI certification is vulnerable to the competition of other GI firms

who produce the GI-specific minimum quality standard under the same GI label.

Such firm can only partially capture the premium associated

with the additional quality, specifically it can only capture the premium associated

with the increase in the average quality of the GI labelled product,

but bears the full cost of the additional quality.

Instead, a firm that produces a quality in excess of the GI-specific

minimum quality standard and uses a trademark in additional to the GI certification

can entirely capture the premium associated with the additional quality,

since consumers, through the trademark, can trace back the product's quality

to the specific individual firm. Hence a firm that wants to build reputation

for a quality above the GI-specific minimum quality standard is better off

using a trademark in addition to GI certification.

Finally we can summarize the insights regarding the effect of GI certification

on market efficiency as follow.

GI certification makes it more costly for GI-certified producers to reduce quality.

This means that a lower price will be sufficient for GI-certified producers

to maintain quality compared to the price needed by producers

who build up reputation using only trademarks.

GI specifications that impose a stricter minimum quality standard have

the potential to increase market efficiency by further reducing the asymmetry of information

concerning the quality of the product between consumers and producers.

With this slide, I conclude the second lesson of Module 8 on Geographical Indications.

Thanks for being with me in this lesson.

GIs and market efficiency

The Economics of Agro-Food Value Chains

Meet the Instructors