Quality Heterogeneity and Misallocation: The Welfare Benefits of Raising your Standards

Macedoni, Luca and Weinberger, Ariel (2019): Quality Heterogeneity and Misallocation: The Welfare Benefits of Raising your Standards.

Abstract

Inefficient allocation of production across heterogeneous firms is a major source of welfare loss, but frameworks generally ignore policies that reduce the misallocation. We study the welfare effects of policies that target the selection of surviving firms. As an example of such policies, we focus on product standards that force the small, low-quality firms to exit the market. Using data from Chile, we find that more restrictive standards are associated with a reallocation of domestic sales from small to large firms. Guided by this evidence, we study the welfare effects of standards in a model with monopolistically competitive, heterogeneous firms, and a general demand system. The standard improves welfare if low-quality firms over-produce in the market allocation relative to the efficient allocation. We estimate our model across Chilean industries and find that in several instances the imposed standard is too restrictive relative to a theoretical upper bound.​

• Item Type: MPRA Paper
• Language: English
• Keywords: Allocative efficiency, variable markups, product standards
• Subjects: D - Microeconomics > D6 - Welfare Economics; F - International Economics > F1 - Trade > F13 - Trade Policy ; International Trade Organizations; L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L11 - Production, Pricing, and Market Structure ; Size Distribution of Firms

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