Counterfeiting and Consumption Externalities - A Closer Look

Counterfeiting of trademarked products is an increasing problem in national and international trade. We contribute to the analysis of how counterfeiting affects markets by extending the work of Grossman and Shapiro (1988a) on consumption externalities in prestige good markets. We model a general aversion towards large levels of output (denoted prestige externalities) interacting with a firm-specific aversion towards the presence of copies in particular (pirate externalities). The framework is used to examine several policy-relevant questions. First, we examine how market prices depend on these externalities and provide conditions for counterfeiting as an equilibrium outcome. Second, we compare market outcomes to outcomes in otherwise identical markets that are not subject to prestige externalities. Third, we describe how the substitutability between copies and originals are related to prestige- and pirate externalities respectively. Fourth, we compare market prices to prices chosen by a benevolent social planner. Finally, we re-visit some policy issues previously discussed in the literature.