Organic vs. Non-Organic Food Products: Credence and Price Competition

Summary

We analyze the organic and non-organic production choices of two firms by considering customers' trust in organic food products. In the context of customers' possible willingness to pay a premium price and their mistrust in organic food products, two firms first make choices on offering organic and non-organic food products. If offering organic products, a firm can further invest in the credence system to increase customers' trust in their organic products. At the final stage, two firms determine prices. We provide serval insights. First, we characterize the market conditions in which only one firm, both firms or neither firm will choose to offer organic food products. We find that the higher the production costs or credence investment costs for organic food products are, the more likely firms are to choose to produce non-organic food products. Second, if it is expensive enough to invest in organic credence, offering organic food products may still be uncompetitive, even if organic production cost appears to have no disadvantage compared to non-organic food products. Third, we highlight how the prices of organic food products in equilibrium are affected by market parameters. We show that when only one firm offers organic food products, this firm tends to offer a relatively low price if organic credence investment is expensive. Fourth, we highlight how one firm's credence investment decision in equilibrium can be affected by the product type choice of the other firm. We find that the investment in organic credence is lower when both firms offer organic food products compared with the case when only one firm offers organic food products.