Efficient Consumer Altruism and Fair Trade

Consumers have shown a willingness to pay a premium for products labeled as “Fair Trade,” and to prefer retailers that are seen as more generous to their suppliers/employees. A fair trade 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. Thus, for fair trade to be sustainable in a competitive equilibrium, 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. This investment is non-verifiable, hence the first-best level is not achieved. 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. We provide some evidence for this model, focusing on the coffee industry. JEL Classification: D11, D64, D86