Informal input suppliers, quality choice and welfare
Keywords: 
Informal sector
Product differentiation
Supply chain
Welfare economics
Issue Date: 
2021
Publisher: 
Springer
ISSN: 
1617-7134
Note: 
This article is licensed under a Creative Commons Attribution 4.0 International License
Citation: 
Daga, S. (Sergio); Mendi, P. (Pedro). "Informal input suppliers, quality choice and welfare". Journal of Economics. (136), 2021, 149 - 176
Abstract
This paper proposes a theoretical model in which a formal upstream firm competes against informal input suppliers, which constitute an alternative, albeit lower-quality input source for formal downstream firms. The existence of an alternative source increases competition in the industry, which tends to be welfare-increasing. However, it may also distort the incentives of the formal upstream firm to invest in quality upgrading. Assuming quantity competition downstream, we analyze how these incentives change and whether the negative welfare effect of a reduced investment by the upstream firm may more than offset the positive welfare effect of increased competition brought about by informal input suppliers. We find that there are parameter values such that this is the case, and welfare decreases if informal input suppliers are present. We analyze the robustness of this result to alternative modeling assumptions, such as price competition downstream and the use of two-part tariffs by the formal upstream firm.

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