Marketing Orders, Grading Errors, and Price Discrimination

Some marketing orders allow an agricultural industry to regulate the flow of product to market. We examine a more common, but less controversial, aspect of marketing orders, the setting and enforcement of grades, and show that purposefully introducing error into the grading process reduces farmers' incentives to produce high-quality product, thus partially sustaining the adverse selection problem that would exist in the absence of grades. Because demand for high-quality product is generally inelastic relative to demand for low-quality product, grading error can increase industry profit. In principle, an industry can achieve through grading error the same allocation of product between high- and low-quality outlets as attainable through direct volume regulation.