QUALITY INSPECTION, ADVERSE SELECTION AND TRADE IN PERISHABLE COMMODITIES

The quality of many goods and services may change randomly between the time of shipment and delivery, creating disputes over quality that can result in lemons-market equilibria. We investigate the potential of third-party inspections for such inefficiencies. We consider two types of inspection, ex post verification of quality in consignment contracts and ex ante certification in FOB contracts, which were instituted for fruits and vegetables in the U.S. when national markets were emerging. We show that both types of inspection can counteract misallocations of quality found in lemons-market equilibria. Buyers prefer ex post verification to ex ante certification while sellers prefer the reverse. Government provision of inspection services may be necessary for making provision of inspection services economically viable, and may be desirable for reducing inefficiencies due to the costliness of inspection. The U.S. experience may provide lessons for developing countries in creating marketing institutions to foster economic growth.