Imperfect Eco-labeling Signal in a Bertrand Duopoly

In a Bertrand duopoly model, we study firms’ eco-labeling behavior when certification process imperfectly signals environmental product quality to consumers. The test is noisy in the sense that brown products may be labeled while green products may not. We study how strategic interaction shapes firms’ incentives to get certified, equilibrium demand, prices and social welfare. We find that the eco-labeling policy is welfare enhancing for all parameter values. Nevertheless, the separating testing equilibrium may be too costly to sustain when the green firm probability to pass the test is small. Moreover, if the certification technology is soft, meaning that both brown and green units are awarded the label with high probability, it would be easier to sustain a separating equilibrium. This is a consequence of price strategic interaction between firms that gives firms incentives to coordinate on a separating equilibrium.