Adverse Selection Revisited in the Context of Food Safety

Abstract

Adverse selection is expected to occur with agricultural products because they are credence goods with respect to food safety. However, these products' safety levels are usually higher than the safety standards set by public agencies. This study suggests reasons for this phenomenon through theoretical examinations and numerical simulations, producing several results. First, even if we suppose that the cost functions of firms producing higher-quality products are in the upper regions, not only can firms producing the lowest-quality products remain in a 'market for lemons' but other firms can as well. Second, if we relax the above assumption about cost functions, even firms producing the highest-quality products can remain in a lemon market, while firms producing middle-quality products can increase their sales. Moreover, the WTP at some stage can be more than the initial WTP.