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David Reinstein and Joon Song

Efficient Consumer Altruism and Fair Trade Products

Consumers have shown a willingness to pay a premium for products labeled as “FT” and a preference for retailers that are seen to be more generous to their suppliers/employees. A FT product is essentially a bundle of a base product and a donation to the supplier (e.g., a coffee farmer). An altruistic rational consumer will only choose this bundle if doing so is less expensive than buying the base product and making a direct donation. For FT to be sustainable either in a competitive equilibrium or in a monopolistic environment this bundling must yield an efficiency. This efficiency is generated in the following context. A supplier’s investment reduces the retailer’s cost or boosts the final product’s quality, but this investment is not immediately observable and cannot be enforced, hence there exists a moral hazard problem. In this environment, the altruism of the consumer can facilitate a more efficient contract: by paying the supplier more the retailer can both extract more consumer surplus and increase the level of contracted investment, while preserving the supplier’s incentive compatibility constraint. We assess our model in the context of the coffee industry.