More animal welfare eggs lead to disparity in consumer welfare

(Edited by Odette Bruls)

The paper “Higher Minimum Quality Standards and Redistributive Effects on Consumer Welfare” (co-authored with Marco Kotschedoff, KU Leuven and published in Marketing Science, 2020) investigates re-distributional effects of actual and potential minimum quality regulations on consumer welfare in Germany.

Clearance of the lowest segment of the egg market

Since 2004, there has been an EU-wide requirement to state the breeding category on egg packages. Consumers typically associate the four breeding categories with increasing quality levels: battery eggs, barn eggs, free-range eggs and organic eggs. The four quality tiers are differentiated in terms of animal welfare associated with the egg production process (from low to high) and are vertically differentiated in terms of market prices.

The EU-wide ban on battery eggs led to a sudden clearance of a whole segment in the egg market. The price-sensitive German households were deprived of their preferred, lowest price alternative in the market. This raises concerns of a potential regressive impact of the regulation since price-sensitive (low-income) households have, on average, the lowest willingness-to-pay for higher quality eggs and primarily purchased battery eggs prior to the ban.

Analyzing future scenario’s

In our study, we analyze the impact of the battery egg-ban in Germany on consumer welfare. We use individual-level egg purchase information of 7,000 representative German households two years before and two years after the ban on battery eggs. The structural modeling approach employed in the paper enables us to quantify changes in households’ consumption patterns and retailers’ price adjustments for the remaining egg alternatives.

We continued analyzing hypothetical future scenarios to increase the minimum quality standard until only the highest-quality eggs remain on the market. So in the end, we hypothesized what would happen if only the organic egg remained on the market. To simplify the analysis, we abstracted away from any production capacity constraints that may occur in the transition process.

Segmentation price puzzle

We isolate an interesting price mechanism in our structural modeling analysis and find that prices of remaining higher quality tiers typically fall after increasing minimum quality standards in the German egg market. This may appear counter-intuitive at first glance since the product ban decreased the number of available egg products on the market, potentially lowering competition.

However, the solution to this price puzzle is the price-related market segmentation. After the ban, retailers have lost the lowest tier of their price discrimination ladder and seek to attract the large group of price-sensitive consumers in Germany to continue purchasing eggs.

Reversed brand-name price puzzle

Similarly, we find that prices of organic eggs would substantially drop in the long-term equilibrium if only the most sustainable egg would be allowed in a hypothetical future scenario. This price mechanism is essentially a reversed version of the so called “brand-name price puzzle” described in the prescription drug market after patent expiry.

The “brand-name price puzzle” states the seemingly odd observation that after patent expiry and entry of generic products, the price of the originally patented brand-name drug increases. Although competition intensified through losing the former monopoly awarded by the patent. The solution to the puzzle is again that it reflects market segmentation. A segment of price-sensitive consumers switches to generic drugs, which are perceived to have lower quality. So only price-insensitive consumers remain with the brand-name drug after patent expiry.

Compensate low-income consumers

Even though prices of higher quality tiers slightly drop after banning the lowest priced alternative for animal welfare reasons, low-income households face substantial losses as prices of barn eggs (the new minimum quality standard) do not drop to the pre-ban price level of battery eggs. Moreover, high-income households have, on average, a higher valuation for eggs they understand were laid by better-treated hens and even benefit due to resulting price drops of higher quality products. This re-distribution of consumer welfare from low-income to high-income households is an unintended side-effect of the regulation that needs to be addressed by policymakers.

We propose a tailored subsidy scheme that enforces prices of the new minimum quality standard to fall to previous prices of the lowest quality market alternative that got banned after regulation. For example, we find that the production of barn eggs would need to be subsidized by about 30 cents per package of 10 eggs to reach pre-ban market prices of battery eggs. The government expenditures associated with this subsidy represent the implied costs to society for raising animal welfare without harming low-income consumers.

More information?

Paper

Kotschedoff, M.J.W., & Pachali, M. (2020). Higher minimum quality standards and redistributive effects on consumer welfare. Marketing Science, 39(1), 253 – 280 https://pubsonline.informs.org/doi/10.1287/mksc.2019.1172

Academic profile: Max Pachali