On the Use of Consumer Information to Address Externalities: The Economics of Eco-Labeling

An intriguing alternative to traditional methods for regulating externalities is the provision of information about firms’ environmental attributes. An increasingly important example of this approach is “eco-labeling,” where a third party certifies firms’ products. Such schemes are currently are currently used in a variety of countries. This paper investigates the equilibria that may occur with eco-labeling, and the attendant welfare effects. I model certification as a noisy test, with green firms more likely to pass than brown firms. While likely to increase the fraction of green units in the market, the introduction of eco-labeling can either increase or decrease welfare.