We analyze a two-country model of trade in both legitimate and counterfeit products. Domestic firms own trademarks and establish reputations for delivering high-quality products in a steady-state equilibrium. Foreign suppliers export legitimate low-quality merchandise and counterfeits of domestic brand-name goods. Heterogeneous home consumers either purchase low-quality imports or buy brand-name products, rationally expecting some degree of counterfeiting of the latter. We characterize a counterfeiting equilibrium and explore its properties.
We describe the positive and normative effects of counterfeiting in comparison with a no-counterfeiting benchmark.
Finally, we provide a welfare analysis of border inspection policy and of policy regarding the disposition of counterfeit goods that are confiscated at the border. Grossman and Shapiro study international trade in counterfeit products. They develop a two—country, equilibrium model of counterfeiting, in which foreign firms produce legitimate, low—quality ( “generic”) merchandise as well as forgeries of brand—name domestic products.
The authors use their model to study the effects of counterfeiting on domestic consumers, domestic trademark owners, and on foreigners.
They also provide a welfare analysis of border inspection policy and of policy regarding the disposition of counterfeit goods that are confiscated at the border. Despite the importance of counterfeiting (which the authors document), the economics literature contains no models of counterfeit_product trade. Grossman and Shapiro partially orrect for this omission by analyzing deceptive counterfeiting, i. e. , the sale of fakes that consumers cannot easily distinguish from genuine items.
This type of counterfeiting must be analyzed as a problem in the economics of information.
Counterfeiting thus involves the twin problems of imperfect information (by consumers) and imperfect property rights (for trademark owners). In the presence of counterfeiting, trademark owners compete subject to two constraints. First, each price—quality offer must be credible, i. . , the manufacturer must find it optimal to supply the promised quality rather than to run down his reputation. In a steady—state equilibrium, credibility requires that each firm price its product above marginal cost and earn a flow of quasi—profits that provide a competitive rate of return to the firm’s reputation. Second, each firm must account for (actual and potential) competition by counterfeiters. Brand—name manufacturers must avoid price/quality combinations that offer positive profits to counterfeiters.
Counterfeiters produce abroad and enjoy a cost advantage, but face the possibility of confiscation at the border. Detection is more likely if the genuine product is of higher quality. Counterfeiting also becomes more costly as the aggregate supply of counterfeits rises, driving up foreign factor prices. In this model, counterfeiting provides an additional avenue of export for the foreign country. The possibility of counterfeiting thus raises foreign factor prices and the price of imported generic products.
Counterfeiting harms consumers of brand—name products who may unwittingly purchase a fake (despite their rational expectations about the probability of this event) Finally, counterfeiting alters the price/quality mix offered by brand—name products. If quality—enhancement greatly increases the chance that customs agents will catch counterfeits at the border, then counterfeiting leads domestic firms to raise their quality (and price). If, however, confiscation is insensitive to product quality, then counterfeiting causes trademark owners to lower their price (and quality) in an effort to escape the counterfeiters.
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