In recent years, consumers are becoming increasingly conscious about the quality, safety, suitability and environmental impacts of the goods that they demand. However, in many cases, consumers would not aware of the quality of a goods or products even after consumptions. These products are known as the credence goods. It is difficult to distinguish between two qualities of the same good, even after consumption. In such case, consumers are willing to pay a premium for the hidden attributes of the goods that they cannot observe. Such goods include ‘natural' versus genetically modified (GM) food, ‘organic' versus non-organic products, ‘fair-trade' products, ‘suitable for vegetarians' goods, ‘Kosher', and more generally ‘high-quality' versus low-quality products. However, this paper is interested to study a special type of credence goods, that is ‘Halal' versus non-Halal products or goods.

Halal is an Arabic word which means lawful or permissible. It follows the Islamic ruling known as the Syariah law. Halal covers every aspect of Muslims' life especially dietary. Halal food simply means that the food products are free from any elements which Muslims prohibited from consuming. Extended discussion on Halal is presented in Chapter 2. With Islam as the second largest religion in the world and the fastest growing, the world Halal food trade is estimated to be around US$ 150 billion to US$ 500 billion in 2007 on which US$ 80 billion alone is generated from agri-food products (Agriculture and Agri-food Canada, 2007; Brunei Halal, 2007). These factors hasten the investment in Halal products, and in some cases, producers cheat for easy access to the market. Analysis of Halal in this paper, distinguishes itself from other studies on credence goods, as it involves different levels of consumers interactions.

Any credence goods, including Halal products, comprise a special attribute or characteristic. This characteristic is not verifiable and revealed unless by experts or other professional services. Hahn (2004) suggested that real or complete credence goods would be difficult to find as consumers would have some judgement on products or services after the consumption. This is not entirely true as in case of Halal food product, especially Halal meat. It is very difficult to check if the meat is entirely Halal as claimed, as there is no existing way to check after consumption whether say the meat purchased is really slaughtered in Syariah methods, even though there is non-existence of other non-Halal ingredients. Therefore, in this sense, Halal meat is an example of a real credence good.

In many cases, consumers' concern for the special or credence attribute (eg. environmental, fair-trade, organic, Halal, etc.) is evidenced by their willingness to pay a premium for the high-quality products. The willingness to pay opens up an opportunity for low-quality producers (those which lack the special attribute) to take advantage by pretending to be that of high-quality, especially when only the producers know whether the desirable attribute exist in their products or not. Moreover, it is too expensive for individual consumer to directly monitor or verify these attributes.

Therefore, consumers could only decide their purchasing choice on subjective belief regarding the product's quality, which are based on all available information such as press report, word-of-mouth and labels when such adverse selection in credence goods market exist. Hence, producers cannot build reputation when production of low-quality imitating goods could not be detected and punished. Delayed detection of low-quality products allows its producers to imitate the strategy of their high-quality rivals, which hampered signalling use. Like other credence goods, Halal food products, through certified Halal brand/logo would improve the information asymmetry, but may carry the similar issues. These issues are discussed in Chapter 2.

It is common for credence goods to feature a communication scheme such as labels or brands to help consumers in making purchasing decisions. Moreover, these labels or brands often require authentication by legislator or a third-party organisations that have the proficiency in each field of specific credence quality attributes, thus involving additional costs.

In the Halal market, there also exist regulations by the government (eg. in Brunei, under the authority of Brunei Islamic Religious Council, Ministry of Religious Affairs) or third party organisation (eg. in United Kingdom, by Halal Monitoring Committee and Halal Food Authority, to name some). In which they certify a product through monitoring and indicating some guidelines for producers before granting a recognisable label on the products. Hence, this label helps consumers to make better decision choice. Moreover, a quality label that improves pre-purchasing information would increase welfare, and high-quality producers would always be willing to go through the necessary inspection as to reveal the products' quality to the consumers, unless the cost for verification is extremely high. The welfare affect of introducing Halal labelling is briefly discussed in the analysis, especially where Halal labelling opens up an opportunity to access additional consumers, ie. Muslims, also referred to the primary consumers.

The analysis of Halal in this paper is aimed to study the interactions of the market forces or what commonly referred to in economics as ‘invisible hand' of the demand and supply in Halal market. At the same time, considering the effects on introduction of labelling upon the level of equilibrium, in addition to other factors such as the additional demand by Muslims of primary market. This is a unique or special aspect which might not be available in previous studies on credence goods.

The following chapters are organised as follows. Halal concept is further discussed in the next Chapter 2. This chapter is intended as an expansion to the introduction (Chapter 1) in order to provide a deeper understanding on the concept of Halal, and to provide information regarding the current market for Halal food products and the issues pertaining in the Halal market on the use of Halal logo. The relevant literature reviews are discussed in Chapter 3, discussing the works by other authors on the area of credence goods which can be linked to Halal. Chapter 4 presents the economic analysis and application of Halal products as credence goods. Chapter 5 concludes this paper and provide a discussion on the policy implications generated by the study.

CHAPTER 2

2.0. A Brief Concept of Halal

Religion involves beliefs and the way of life, where group of individuals interprets and respond to what they feel is supernatural and holy (Johnstones, 1975, in Shafie and Othman, n.d.). Shafie and Othman underline that most religion prescribes or prohibits certain behaviour including that of consumption (n.d.). The concept of Halal is not new in the Islamic world, but only in recent years that its potentials have been realised by corporations and organisations around the world, which normally perform under the conventional economics.

The word Halal comes from Arabic which means permissible or lawful. It is ruled by the Islamic law known as Syariah law which is based on the Quran and Hadith (records of the life, actions and teachings of Prophet Muhammad). By not fully understanding the concept of Halal, one (non-Muslim especially in Muslim-minority country such as United Kingdom) may think that Halal only refers to meat or something to do with ‘kebabs'. Halal actually governs every aspect of life of Muslims, however, this paper only view Halal perspective on consumption of food. What is not Halal is called Haram or non-permissible. Any product which comes from swine and/or dog is strictly Haram. A special cleansing ritual must be done if a Muslim directly touched (although accidentally) these animals and/or the sources (eg. skin). Such products that contain strictly Haram ingredients or derivatives are termed as ‘non-transformable' in the analysis in Chapter 4.

Amongst other strictly Haram animal products include blood, birds of prey, and/or carrion (dead animals without slaughtering). Alcohol is also Haram, but in some strict case it could become or change into Halal, this is discussed later on in Section 2.3 of this paper. Un-slaughtered animals such as beef and chicken are also become non-Halal, unless slaughtered by a Muslim according to Syariah practice. Such products are termed as ‘transformable' in the analysis of this paper. What lies between Halal and Haram is called Mashbooh meaning that the goods appear to be suspicious, questionable and

According to Bonne and Verbeke (2007), as product attribute, Halal refers to the nature, origin and the processing methods of the food products, which entails similarity with organic foods and those taking animal welfare or sustainability into account. Strict procedure must be followed to obtain highest standard of Halal, and that Halal products must not contact with non-Halal products; as similar to vegetarian food should not be in contact with any meat. Halal concept covers both food and non-food product category, but as mentioned earlier, this paper would only focus on the first one. Studies show that about 70 to 75 percent of Muslim strictly follows the Halal standard for their dietary (Hussaini 1993a in Bonne and Verbeke, 2007; Minkus-McKenna, 2007). The next section provides an overview of Halal food market.

2.1. Halal Food Market

The Halal market is considered as the fastest growing market globally as reported by the Borneo Bulletin (2008). The world Halal industry is estimated to worth between US$ 500 million to around US$ 2 trillion (Agriculture and Agri-food Canada, 2007; Borneo Bulletin, 2008; Brunei Halal, 2007). The market is growing around US$ 500 billion annually due to the rising Muslim population worldwide (Borneo Bulletin, 2008; Brunei Halal, 2007). It is reported that the Muslim population is known to be the fastest growing religion in the world (Bonne and Verbeke, 2007) and in Europe (BBC News, 2005).

The global Halal food trade itself in 2007 is estimated to be between US$ 150 billion (Brunei Halal, 2007) and US$500 billion with 12 percent of this or US$ 80 billion generated from agri-food products (Agriculture and Agri-food Canada, 2007). In addition, Islam is the second largest religion in the world (Riaz and Chaudry, 2004) with nearly 1.5 billion people (ibid.; Bonne and Verbeke, 2007; Din, 2006). The National Statistics Census carried out by the British Government, shows that Islam is also the second largest religion in the United Kingdom, approximately 1.6 million Muslims (2001). The statistics also revealed that Muslims are the largest household in the United Kingdom. These factors would justify that the demand for Halal food products in the United Kingdom is expanding.

The market for Halal can be divided into two namely, primary and secondary. Primary market arises from the demand by Muslims, whereas, secondary market refers to the demand by non-Muslims. These terms are used in the analysis of this paper. Agriculture and Agri-food Canada (2007) suggested that Halal is often referred to safety and of high quality by both markets. Besides these, factors for increasing Halal demand includes: increasing incomes in primary market, rising population of Muslim, and rising demand for variety in primary market (ibid.). For Muslims, consuming Halal food products are their religious obligation, however it is known that Halal food are also consumed by non-Muslims. The later often perceived as specially selected and processed to achieve highest standards of quality (Riaz and Chaudry, 2004, p. 14).

Manufacturers or producers that sells Halal products would create significant advantage compared to those that do not (Shafie and Othman, n.d.). Riaz and Chaudry (2004, p. 16) suggested that the increasing demand for Halal products as well as expanding number of Muslim population can be an inducement for producers to provide Halal products. Nonetheless, it is safe to say that these views mostly look at Muslim-majority economies such as those in Asian region. Hence, this paper provides a study in relation to Muslim-minority economy such as the United Kingdom. However, like any other food labels, Halal labelling also have some issues.

2.2. Halal Logo and Its Issues

The use of Halal logo in food products indicates that the products are Islamic or Syariah compliant. Similar to other food related logos such as ‘suitable for vegetarian' V-logo, Halal logo intends to communicate with the consumers of this product that it is fit for their consumption. Initial finding shows that some companies may use this logo even though its products might violate some rules of the Syariah law. Such situation was reported in which, some meat and other processed products from Brazil imported into the country, were being inspected by Halal Monitoring Committee, to be found a violation (2007). Another comparable situation is reported by The Tribune (2008) that the biggest meat producer in Scotland is under investigation over the supply of so-called ‘fake' Halal meat in the country.

There are some issues to which cause the problem arises. Fischer claims that the lack of a state body that is capable of inspecting the unregulated market [in the United Kingdom] has left this market open to fraud, corruption and without any kind of standards, uniform certification and standard (n.d.). Study by Fischer also shows that many British Muslims and organisations call upon the state to help recognise and standardised Halal. However for the ease of this paper's analysis, this situation is relaxed, meaning producers behave honestly when claiming their products as Halal.

Having Halal logo does not mean the products automatically accepted to be purchased by consumers especially that of primary market. Research undertaken by a university in the United Kingdom, shows that consumers prefer small shops when buying Halal meat, rather than buying from supermarkets, due to factors mentioned earlier and others including lack of marketing of Halal food (Anonymous, 2006). Like any other goods, the credence of Halal food products has to be clearly communicated such as indication on pack or on-label (Bonne and Verbeke, 2007), in addition to conventional marketing strategies, for example advertising. Moreover, this would add some utility value to the consumer and useful in the purchasing decision (ibid.). Nonetheless, to make the analysis of this paper simple, having Halal labelling is enough to induce greater demand and consumptions.

2.3. Issues of Alcohol

Alcohol is clearly not permissible, however it is essential for certain industry processes and religious scholars are aware of this — some of them suggested that some use of alcohol may be acceptable as long as it is evaporated and not exist in the final products (Riaz and Chaudry, 2004). However, if there is an alternative to alcohol for such process, it would be preferred, as majority of Muslims would avoid products that use alcohol at any stage. It is generally known by Muslims that wine (a Haram state product) which turns ‘naturally' into vinegar thus the vinegar is considered as Halal. This situation is called Istihala or ‘change of state or properties'. A reverse situation as such that, if wine is added to Halal food, as in common cooking practise in the Western, hence the food becomes Haram. However, this issue is not represented in the analysis, for simplicity argument. It is clear that Halal can be perceived as a credence attribute, although there are numerous literatures on credence goods, only few actually discussed in relation to Halal products. Next chapter will discuss the literatures on credence products.

CHAPTER 3

3.0. Literature Review

This chapter is divided into five interrelated parts or sections. The first section provides a (general) glance on the studies or literatures on credence goods, which is applicable in the study of the market for Halal products. This is followed by the second section, of discussions on the demand for such goods. Market failure arises due to the nature of credence goods, which is discussed in the third section of this chapter. In the fourth section, a review on the solution of the market failure problem is examined. The final section deals with the issue pertaining to some of these solutions.

3.1. Credence Goods at a Glance

There are growing numbers of literatures on credence goods attribute since it was first mentioned by Darby and Karni in 1973. These literatures involve different assumptions which produce diverse outcomes. However, it is difficult to find economic literature that deals directly with Halal subject as a credence good. Nonetheless, studies on some of the credence goods can be applied to Halal concept.

Most literatures on credence goods assume that consumers are homogeneous. Hahn (2004) showed the contrast to this, in which the author grouped the consumers into two namely those who have some expertise or informed and those who do not or uninformed; This paper is slightly differs from that of Hahn (2004), where the consumers in this paper are also divided into two, namely Muslims (those who only consume Halal goods, or primary consumers) and non-Muslims. The latter is further grouped into two, ie. conventional consumers—who only consume non-Halal; and secondary consumers—who prefer to consume Halal products.

Some economists (such as McCluskey, 2000; Cho and Hooker, 2002) used game theory models on credence attribute to assess the interplays of stakeholders. These include whether producers decide to claim their products as those of high quality, then they have to decide whether to produce according to the claims or not. However, the use of game theory is out of the scope of this paper's analysis. Nonetheless, producers are assumed to produce what they intended to, without dishonesty.

Economists divide consumers' perception of food quality into a three attributes, namely: search, experience (which were pioneered by Nelson in 1970) and credence attribute (in Darby and Karni, 1973; Innes et. al., 2007; Umberger et. al., 2008). Search attributes can be determined from pre-consumption and at point of purchase such as colour, shape, brand and freshness. Experience attributes, arise from taste, juiciness, and food safety which could only be determined during or after consumption. Lastly, credence attributes refer to the process and production aspects, which the author claims that it cannot be determined before, during or after consumption of that particular food product (Umberger et. al., 2008). These food products, especially Halal as credence goods emphasise and maintain a strict quality attributes, and failure to maintain this would result a loss in its credibility, hence would brings disutility to the consumers or reduction of welfare.

Some economists such as Caswell and Mojduszka (1996, in Cho and Hooker, 2002) argued that by providing information as policy tool, credence attributes could be transformed into search attributes. However, this would require a strict environment where system of information provided is perfect and fraud could not taken place — these are less likely to be a (current) scenario of the real world. Nonetheless, this concept is used in the analysis of this paper, for simplicity reason. On the other hand, Cho and Hooker (2002) mentioned that credence goods could act like a (lagged) experience goods if they involve time duration for detection of risk (relatively quickly), eg. infected food, vice versa. Like any production or supply of consumer goods, it depends on the demand for such goods, for an equilibrium to exist in the market. The following section discusses the determinants of demand for credence goods.

3.2. Consumer Demand for Credence Attribute

Individuals would consume goods or services that yields highest utility or satisfaction level and presumed to make rational choice. However, this is subject to physical (ie. how much they can consume) and economic (ie. budget) constraint that limits the consumers' choices (Mas-Colell et. al., 1995). Moreover, the preference-based approach to consumer demand is of critical importance for welfare analysis in which, without it, evaluating the consumer's level of well-being would have no meaning (ibid.).

Dulleck and Kerschbamer (2001) identified credence characteristics in terms of utility, in which although consumers can observe the utility derived from consumption of such goods ex post, they are not sure if the utility they get is the ex ante needed one. However, in the analysis of this paper, the utility is considered in terms of welfare level obtained from consumers and producers surplus.

In addition to the conventional determinants for demand such as income, taste and preference, consumer characteristics and quality attribute become increasingly important factors nowadays. According to Antle (1999, in Senauer, 2001, p. 4), the new economics is more concerned with the markets for ‘quality-differentiated' products in which the author presented a stylised demand function which include quality factors (non-price attribute):

X = D (P, I, N, C, Q)

Where X depends on price and other goods (P), income (I), number of population (N), characteristics of the population/consumer (C), and non-price attribute of the product (Q). It shows that any product attribute which includes nutrition content, safety, production process and even inputs, would creates utility or disutility. The analysis in Chapter 4 directly deals with the two of these factors namely, consumer characteristics (ie. preferences, and religious needs) and product attribute (ie. Halal credence).

Hoehn and Deaton (2004) provided a model where consumers choose either purchasing credence (high-quality) good or conventional (low-quality) goods by comparing the consumer surplus differences. If the gain from consumer surplus from credence goods is large, compared to the opportunity cost of surplus given up from not purchasing conventional goods, the former good would be purchased. Their studies are used as a foundation for the analysis in Chapter 4 of this paper.

Most literature reflects credence goods as vertically differentiated products due to quality differences. Nonetheless, Bester (n.d., in Roe and Sheldon, 2001) provided a concept of unobserved quality into a horizontal differentiation model and suggested that unobserved vertical quality would reduce producers' incentives for horizontal differentiation via relaxing price competition amongst producers, in a way which prices act as a signal and consist of a quality premium. This is related to the second part of this paper's analysis (Section 4.2. of Chapter 4) involving a franchise market. Consumers demand and preferences for credence goods often perceived from their willingness to pay.

3.2.1. Willingness to Pay

There are other factors why consumers might be willing to pay a premium besides the quality attribute, such that they perceive credence goods as fashionable, trendy, or it could be that the purchase the alternative to credence goods would offend other people (McCluskey, 2000). The later is pertinent to Halal goods, especially in a situation where the consumer lives with Muslims housemates, or in a Muslim-dominated country. Consumers would also prefer for the high-quality products, even not for the sake of quality itself but other factors. For instance, when consumers care about other quality or criterion such as animal welfare, environmental, ethical, and religious reasons, to what Antle (1999, in Carlsson et. al., 2004) referred as extrinsic quality.

If the distinctions in quality were signalled efficiently, consumers would be willing to pay a higher price or premium for products of high quality, hence compensating the higher production costs, as suggested by Kola and Latvala (2003). In their research on the effects of information on the demand for beef products credence characteristics in Finland, 59 percent of the respondents showed their willingness to pay a higher price for additional information. Whereas, 41 percent of respondents had zero willingness to pay, in which 35 percent of them are satisfied with the existing information, and 17 percent considered the information is not enough or they did not trust the information.

As credence quality of a product cannot be observed directly at a reasonable cost or without invasive testing, consumers would rely heavily on claims or information made by the producers via brands, labels or advertisements (Cho and Hooker, 2002). This paper's analysis however, only considers that consumers fully trust producers. The next section provides discussion if the information provided is insufficient or inaccurate, resulting a market failure.

3.3. Market Failure

It can be said that the credence market are prone to the problems of market failure. There are different ways for a credence market to result in inefficiency. It is mainly due to information asymmetry between producers and consumers.

3.3.1. Information Asymmetry

In credence goods, consumers cannot directly observe the quality of the goods that they consume where only the producers know the exact quality, thus resulting information asymmetry. Common intuition indicates that the solution for an information asymmetry is by providing more information. Information, as conferred by Weiss (1995, in Cho and Hooker, 2002) is the central tenet of food safety economics. Brands, logos and labels most importantly serve as a signal to inform and communicate to the consumers about products attributes, hence alleviating information asymmetry between producers and consumers.

According to Verbeke (2005), information is likely to be effective only when it addresses specific information needs of its target audience. It requires identification and detailed understanding of these needs, and proper management on the provision of the information in order to optimally address the needs (ibid.). Information regarding food quality and safety can be categorised as risk information and aims at reducing uncertainty faced by the consumers in making purchasing decisions. Hence, success would come from better understanding regarding consumers' attitude, behaviour, motives, and their perceptions (Frewer et. al., 2004, in Verbeke, 2005). There exist welfare effects to consumers for providing (Marette et. al., 1999, in ibid.) or withholding (Mazzocchi et. al., 2004b, in ibid.) food quality information.

The work done by Umberger (et. al., 2008), can be used as a foundation on the argument for the importance of Halal logo or labelling on food products in particular. The authors claimed that potential market failure would occur if consumers face limited choice and if the access to ‘innovative products' is not available, or information regarding ‘product attributes', for example the production methods, is not transparent (ibid.). With this regards, Halal products would be seen as innovative products and carry some product attributes that must be fulfilled, otherwise there might exist market failure for Halal products. Halal logo especially from organisation for Halal certification, could be used to indicate these attributes. Consequently, lack of information becomes the key factor for the inefficiency of credence market. The followings are resulted from insufficient information.

3.3.1A. Failure due to Fraud

In their studies, Dulleck and Kerschbamer (2001) divided credence attribute problems into two fold: inefficiency treatment, and overcharging. The first fold refers to the quality level (or service) of credence goods provided by producers, and inefficiency treatment can be either under- or over-treatment. On the other hand, the second fold refers to the pricing of credence goods, particularly as self-described, overcharging.

When the signal is unavailable, especially in the case where labelling is not mandatory, sellers may have the incentive to fraud by supplying products of low-quality but claiming these products as high quality. Akerlof (1970) explains this situation with automobiles market as an example, in which with asymmetric information high-quality goods (‘peach') would be driven out by the low-quality goods (‘lemons') hence resulting market failure.

Moreover, as argued by Liebie (2002), when producers of low-quality products claim to be of high-quality, this would raise doubt in consumer's mind and would not be willing to pay a premium for the high-quality goods. This in turns, would lower the profits of high-quality producer hence reducing their incentive to invest in high-quality products, in which would create further doubt to consumer. The cycle goes on until only low-quality products would be sold, even though consumers prefer high-quality products, resulting market failure.

Darby and Karni (1973) suggested that the amount of fraud depends on reputation, market conditions, and technological factors. Profit-maximising producers would have the incentive to fraud by claiming their products are of high quality if the probability of not being caught is high enough (McCluskey, 2000) or conversely if the probability of being caught is low. Such fraud issues bring uncertainty to consumers.

3.3.1B. Problems of Uncertainty

Bonroy and Constantos (2008) concluded that uncertainty by consumers on the identity of producers which produce the high-quality products put the high-quality producers in disadvantage resulting from higher cost. They argued that this disadvantage would remain even when the consumption of high-quality products benefits are well worth the cost difference and all beliefs regarding the high-quality producers are in the right direction (ibid.). Their model explains the difficulty faced by high-quality credence products to acquire the dominant market share they should have obtained from efficiency perspective (ibid.). This is however beyond the concept of this paper, as to avoid complication in the model, it is assumed that producers behave honestly in producing the products and consumers fully aware the qualities.

3.3.1C. Non-Rational Behaviour

Unavailability of credible food quality labelling, consumers would face uncertainty and would incur search cost on specific information (Hobbs, 2004, in Verbeke 2005). As a result some consumers would not behave rationally, being ignorant, or make decisions which are not maximising their expected utility. Such behaviour explained as a concept of “bounded and limited rationality” or “rationally ignorant consumer hypothesis” (as found in Kahneman and Tversky, 1973; Simon 1979a,b; Camerer and Loewenstein, 2004; in Verbeke 2005), is however beyond the concept of the study in this paper. Verbeke (2005) concluded that without quality verification, traceability was of little value to consumers, whereas quality assurances were much more valuable to them. The solutions to the problems of market failure are presented in the next section.

3.4. Solutions to the Problems

This section examines some of the solutions to the problems mentioned previously which are mainly caused by lack of information. The most common solution this, as stated earlier, is providing more information through labelling or signalling. But this must be accompanied with efficient monitoring.

3.4.1. The Use of Labelling as a Signal

It is generally known that labelling of credence attribute could be used as a way to certify the provision of valued attributes, hence to avoid market failure. Moreover, Caswell and Padberg (1992) claimed that information in the form of labels, word-of-mouth, advertising, and education would contribute to the completeness and accuracy of assessment by consumer concerning these attributes.

Spence (1973, in McCluskey 2000) provided an analysis on the use of signalling, where workers use education expenditure to indicate their type. Labelling schemes are reasonably specific because of their potential direct impact on consumers purchase decisions, which have a function as a cue that can be integrated by consumers in their assessment of alternative products (Verbeke, 2005). Hence, looking at the use of Halal labelling/logo, it serves as additional information on alternative goods (Halal products) from the non-Halal or conventional goods, especially for consumers in the primary market.

Innes (et. al., 2007) distinguished between labels and brands, in which the former identifies a specific product characteristics pertaining only and precisely to the product itself, for example origin or composition. On the other hand, the author claims that brands is a broader concept which captures the product characteristics, reputation, and the accumulated consumer experience with that brand name or symbol that is viewed at the point of purchase. For the purpose of this research, the use of terms brand and label are integrated, unless otherwise told.

Reo and Sheldon (2001) split labelling of credence goods into two forms namely: continuous and binary labelling. Continuous labelling referred to those credence attribute exist in consumer durable goods, for example refrigerator or air-conditioner that meet the energy efficiency, environmental friendly and using non-CFC gas. While binary labelling refers to non-durable consumer goods such as organic food, free-trade goods, free-range products, etc. This paper only uses the term ‘labelling' which refers to the binary labelling in this sense, as this paper study the area of Halal food products. Their studies also show that consumer welfare could improve through credence goods labelling as long as the administrative cost is not excessively high.

A perfect substitute for credence goods would be the conventional goods without the credence attribute in terms of consumers' direct experience (Hoehn and Deaton, 2004). Moreover, without the labelling, the two types of goods appeared to be indistinguishable (ibid.). However, this is not fully the case for Halal products especially for the consumers in the primary market (Muslims) as these consumers cannot substitute Halal products with non-Halal (conventional). Nonetheless, this is applicable for secondary market for Halal products.

Hoehn and Deaton (2004) provided an analysis and illustrations on the affects of labelling of credence good on price, quantity, and welfare, by examining with pooled and separating equilibria concepts. They referred pooled equilibrium when the market has mixed goods of high-quality (green) and low-quality (conventional) products; whereas, separating equilibrium exist when credence labelling is introduced, the market becomes two different markets. Thus, economic consequences of labelling high-quality goods are high in value to consumers and low in value for conventional goods, which the later is even lower compared to when the goods are in the market of pooled equilibrium. Moreover, they suggested that labelling provides the high-quality goods producers a routine incentive to realise gains as the expense of low-quality producers.

However, this is not entirely the case in the Halal market, where introduction of Halal labelling can be perceived not to compete for the existing consumers of conventional non-Halal goods; but to serve mainly for Muslim consumers whose would never consume the conventional goods. Their analysis is expanded in Chapter 4.

Sedjo and Swallow (2002) also produced a graphical illustration in their analysis on the market implication of labelling consumer products (eco-labelled wood). Their analysis indicated that with some reasonable circumstances, some portion of consumers are willing to pay a price premium, yet a price differential may not arise. In addition, the authors claimed that, price premium would not arise although there exist substantial willingness to pay a premium (in voluntary labelling system), if demand of the high-quality is small compared to overall demand, certification costs are insignificant, and the additional demand is modest. This situation is also used in the second part of this paper (in Section 4.2), with slightly different settings.

While labelling the whole product lines create benefit from consumers' positive experience and may spread to other products bearing the same label, the reverse could also occur when consumers had negative experience of a product, affecting the other products of same line (Liebie, 2002). In relation to Halal logo/labelling, this situation is partly true especially under self-labelling. But if the producer uses certified third-party Halal labelling and cheats by not meeting the standard, it is most likely that only particular products under the producer's brand is doubted and not other producers bearing the same third-party Halal logo. Again, this complication is avoided in the analysis as producers are assumed to be honest and information is perfect.

3.4.2. Solutions to the Problem of Fraud

Dulleck and Kerschbamer (2001) provided an analysis to what they called a unified framework on the majority of specific models of credence goods, in which the market institution could eliminate without cost, the problem of fraud by producers if there exist three factors. First, if the consumers are homogeneous; second, if the economies of scope between diagnosis and treatment are large; and third, if the treatment is verifiable. Sufficient penalty could be used to minimise incentives for producers to fake their products quality, in addition to greater level of monitoring to increase the probability of dishonest producers to be penalised.

Additionally in the real world, such fraud activity is a serious offence specifically with reference to Halal market especially of Muslim-majority economies. In most cases when producers were found faking by selling non-Halal goods, their business licences would be revoked, their business reputations are damaged, and bankruptcies are usually the common end result. This is because, once the producer is not trusted, Muslim consumers would not purchase the products from that producer (ie. boycott) and this could also be expected to create a ripple effect on the other (non-Muslim) consumers, similar to the cycle described by Liebie (2002) in Sub-Section 3.3.1A. Halal certificate would also be withdrawn if the production premise is not up to the certification standard, such as safety and cleanliness which would affect the products quality. This indicates that the level of monitoring must be adequate.

3.4.3. Monitoring of Labelling

For a credence good (organic) market to be efficient, McCluskey (2000) suggest that it is necessary for a third-party agency to monitor the claims made by the producers. Moreover, there is a need for standardisation on the meaning and the term ‘organic' as this would reduce the cost of monitoring and enforcement (McCluskey, 2000). This is true in the sense of the term Halal, as there are many different criteria of Halal with different organisations which granted Halal certifications. Study by Fischer (n.d.) also shows that many British Muslims and organisations call upon the state to help recognise and standardised Halal. Nonetheless, for simplicity of the analysis of this paper (in Chapter 4), producers are assumed to be honest by introducing labels of true quality, eliminating the need for monitoring.

In relation to organic foods as a credence good, McCluskey (2000) suggested producers may signal by allowing consumers to visit their premises to inspect production process. On the other hand, producers may obtain labels from a credible third-party agency, hence the labels act as a guarantee (McCluskey, 2000). The use of third-party labelling agency can be considered as costly compared to self-labelling by producers themselves, nonetheless, the later is considered as cheap talk (Baksi and Bose, 2007; Farrell, 1993, in McCluskey 2000), as no third-party to monitor their activities. Nonetheless, self-labelling is sufficient presumably where producers are honest in their actions, which is the case in the analysis of this paper.

Furthermore, McCluskey (2000) claimed that if there is no monitoring for credence good, there would be no premium for claiming organic or high-quality products. However in practice, consumers are willing to pay a premium for these products even if there is no monitoring (especially if they are self-labelled) as consumers have some degree of trusting the producers, until legitimately proven wrong. The following final section discusses the limitations of the solutions to market failure of credence goods.

3.5. Limitations of the Solutions

There are a number of limitations emerge around the solutions of inefficiency in credence goods market themselves. The solutions which are supposed to reduce inefficiency could become a ‘double-edged sword' if not treated well. The following sub-section briefly discussed some of them.

3.5.1. Inefficient Monitoring

A study suggests that it could be economically effective in reducing search time and correcting asymmetric information that may exist between consumers and suppliers through labelling of credence attributes (Umberger et. al, 2008, pp. 5-6). However, the integrity of this labelling must be maintained otherwise, market failure would result. For instance, if private benefits from labelling exist (in such a way the products carry a Halal logo brings a premium in the market) but the cost of producing these attributes (maintaining Halal quality) are high, there could be incentives for producers to cheat by selling goods that are not up to Halal standards. These factors must also be considered by producers if they want to transform their production into Halal, as describe at the end of Chapter 4.

Monitoring can only eliminate cheating if it is fully effective. Anania and Nisticò (2003) provided a theoretical study on credence goods in which the incentive of low-quality producers to cheat depend on the level of effectiveness and credibility of public regulation in the provision of information to the consumers. Random inspections of high-quality would always reveal the true quality. Hence, if a producer of low-quality goods is caught faking the goods as of high-quality, hence a fine is imposed. Furthermore, in their model, the producers who had cheated would not be allowed to sell in the high-quality market, but the producers can still sell in the low-quality market where their products should belong. Since producers, in the analysis in Chapter 4, are assumed to be honest, the need for monitoring is eliminated.

3.5.2. Information Overload

Another limitation is the level of information itself. As mentioned earlier, provision of more information will alleviate inefficiency caused by asymmetric information. Nonetheless, too much information would hinder the improvement of informational asymmetry especially for food products with credence attribute. According to Caswell and Padberg (1992), producers perceive limited regulation on labelling as desirable for maximum flexibility, nonetheless, excessive freedom would be detrimental, which undermine the credibility of producers' communication, if it allows false claims. Selaun and Flores (2001, in Verbeke, 2005) pointed out that increasing amount of information on the label could overload the package, thus resulting consumers with limited time or ability to process such information to ignore the products resulting excess cost. Labelling in the analysis of this paper, is assumed to provides sufficient information and does not lead to information overload. The following Chapter 4 provides the economic analysis.

CHAPTER 4

4.0. Economic Analysis

The major assumptions in this analysis are as follows. Producer chooses either Halal (high-quality) or conventional (non-Halal or low-quality) products, and none of any combinations of the two types. For simplicity of analysis, the producers act honestly, ie. do not cheat by introducing fake labelling. The term labelling here also reflect the additional cost that would have been undergone by producers in producing or transforming into Halal production. Consumers on the other hand, perceive and trust the quality or types of goods exactly as informed by producers. In other words, information is perfect. Furthermore, it is assumed here that producers produce homogenous products and that some or all of the conventional products are transformable into Halal products (by following the Syariah compliant methods hence obtaining Halal logo as discussed in previous chapters).

The welfare effects from introducing labelling, indicated by the consumers and producers surpluses, are briefly concluded at the end of this chapter. It is necessary to point out that the combinations of consumer types are different in each of the analysis. These types of consumers (interactions) can be illustrated as the following Diagram 2 below. The next Section 4.1. provides a basic foundation for the analysis. Subsequently, sub-section (4.1.1) only considers the left-side and the overlapped oval areas of the diagram below. An analysis with the inclusion of the right-side of the diagram is provided in sub-section (4.1.2). On the other hand, Section 4.2. only deals with the right-side and also the overlapped oval areas of Diagram 2.

4.1. Basic Model

Studies by Hoehn and Deaton (2004) provided a foundation that can be applied into modelling of Halal (credence) products. Here, it can be assumed that all of the products are transformable. Following their analysis, the demand for conventional (non-Halal) products at a given price and at the absence of Halal logo is,

(1)

where is the demand for conventional products, is the demand intercept, is the slope of demand absolute value, is the price of conventional good. Hence, implies as the conventional product quantity demanded is a function of the price of conventional product. Here, equation (1) is referred as unconditional demand for conventional product.

The reservation price schedule for conventional product is the inverse of Equation (1), thus,

(2)

where and corresponds to the reservation price as a function of quantity of unconditional conventional product.

On the other hand, the unconditional demand for Halal product is therefore,

(3)

where is the willingness to pay (hereafter, WTP) by consumer for the (Halal) ‘credence attribute' per unit of the Halal product, which varies from zero to other positive value depending on consumer perception (eg. studies by Kola and Latvala, 2003). For simplicity of the analysis, is a real positive value and larger than zero, ie.. It can be considered that as the level of WTP for the marginal consumer, whose reservation price is just equal to the marginal cost of Halal producers.

According to Hoehn and Deaton (2004), in some cases the share of consumers with positive WTP is small compared to the quantity supplied of credence good. Their model consider this as a special case of market saturation in which at the point of price determination for credence good involves WTP equalling zero, ie. , when quantity supplied is more than threshold quantity , specifically for .

Hence these provide a basis of which is better suited for the Halal market in the economy of Muslim-minority economies, such as in the United Kingdom and other European countries.

Equivalent to Equation (2) in obtaining reservation price schedule for conventional product, the aggregate reservation price schedule for Halal product is,

(4)

where for , and for . Equation (4) is different from that of Equation (2) as in the former, as there exists a fixed intercept shifter between reservation price loci. This is the WTP a ‘premium' for the Halal product.

Producers' production functions are constant return to scale, but when output increases, input costs rise indicating the supplies for both conventional and Halal product are inelastic. The relationship between marginal cost and quantity supplied by the former products' industry is therefore,

(5)

where is the intercept, is the slope of marginal costs of conventional products industry in terms of the industry output. Hence, the above equation is the supply function for conventional product. On the other hand, the marginal cost and quantity supplied relationship of Halal industry is,

(6)

where is the intercept, indicates the slope of marginal cost in market share, represents a fixed unit labelling cost.

4.1.1. Equilibrium with certified Halal logo

It is obvious that when a producer has a certified (high-quality) logo or labelling, it separate itself from the conventional products which do not have a quality related logo. This is also the case of having certified Halal logo. Again, following model by Hoehn and Deaton (2004) of separating equilibrium, that demand of conventional product market is conditional on the availability of the (relative) Halal products. In other words, conventional market losses the x unit when consumer purchases x unit of Halal goods. Hence, conventional products demand is a conditional, residual demand. In practise, this reflects the demand by secondary (non-Muslim) consumers, as they can consumer either Halal or conventional products but prefer the sooner, in this sense.

From the above conditions, the conventional product residual demand is the conventional product demand (from Equation (1)) less consumer demand reallocated to the credence market (first line, second term of Equation (4)). Mathematically this is shown as,

(7)

where is the prevailing price of Halal product with certified logo. Equivalently, the residual reservation price schedule for conventional product's market is the reservation price which is reduced by the amount of conventional good which consumers reallocate to the Halal market, ie. . Hence, the residual price for conventional product is,

(8)

The second line in the above equation (8) is obtained by adding and subtracting to the first line followed by substituting the reservation price for the marginal Halal consumer. In other words, the intercept for reservation price of conventional aggregate is the marginal reservation price of Halal product adjusted downward by the incremental WTP of for the Halal product. The last line of equation (8) shows that the residual price of conventional product depends on the quantity demanded for its product give or conditional to the shift in quantity demanded for Halal good.

A consumer chooses a product that yields the largest relative gain in individual welfare measured by money metric consumer surplus, given by market prices for both types of products (Hoehn and Deaton, 2004). Consumer surplus is the reservation price minus market price of that type of product. It is known that primary (Muslim) consumers will only consume Halal products. On the other hand, the secondary consumers may choose either Halal or conventional products. In doing so, secondary consumers compare the consumer surplus obtained from purchasing Halal product with the opportunity cost of consumer surplus loss by foregoing the purchase of conventional product. If the gain is larger than the opportunity cost, secondary consumer hence purchases Halal products. In other words, Halal product is purchased whenever the difference between surplus gain and opportunity cost is positive, vice versa. Therefore,

(9)

where, the first line of the above Equation (9) is the net surplus condition. This ensures consumer surplus is maximised by the consumers from their purchases. The second line shows that at a price where the marginal product earns zero rent, Halal market clears. The last two lines indicate the prices and quantities for conventional markets to clear, requiring price to equal marginal costs. The Diagram 3 below (adapted from Hoehn and Deaton, 2004), shows the existence of (separating) market equilibrium for Halal and conventional markets as a result of the introduction of Halal labels.

An introduction of primary consumers into the above analysis will distinguish this paper from the works of these authors. The following sub-section provides an analysis that takes into account of ‘non-overlapped' consumers. It takes into account of additional demand of the primary consumers (specifically Muslims) whose only be willing to consume Halal products (or nothing if the products are those of conventional non-Halal).

4.1.2. Primary Consumers Demand

In reflecting the effect of labelling on primary consumers, another WTP for a ‘premium' by Muslim consumers is added to Equation 4. Hence, the aggregate reservation price schedule for Halal product for both primary and secondary consumers becomes,

(10)

where the superscript B refers to both primary and secondary consumers, and is the additional WTP a premium by primary consumers. Demand by primary consumers does not affect the conventional market as Muslims only consume Halal products.

Following from Equation 3, the additional demand by primary market result,

(11)

where is the WTP by consumer for the Halal ‘credence attribute' per unit of the Halal product. In this case, is the WTP by the additional primary market. A shift in supply is expected to cope with the additional primary consumers demand. With the rest of the equations remain the same, as the demand for conventional products are the residue of demand by secondary consumers. These changes are graphically illustrated in the following Diagram 4.

4.2. Producers Motivation for Transformation

This section provides an analysis looking at the motivation for producer to transform production of conventional products into that of Halal. From the previous sub-section (4.1.1.), it is clear that due to the existence of willingness to pay (WTP) for Halal product, its market price is greater than that of conventional product price, ie. . Differences in the prices may induce producer to transform their production, however prices alone cannot determine profitability. It is assumed that production of Halal products involve additional costs. The following section provides an analysis in which prices between the two types of products are the same, rather than one having a premium. Furthermore, it is assumed here that only some of the products are transformable.

4.2.1. Homogenous in Pricing

The following analysis attempts to model producer incentive to transform production of conventional products into Halal products, particularly in a market where the market prices denoted as , cannot be different between the two types. This requires the prices to be equal, ie. . In this case, one of the assumptions is relaxed, precisely some of the conventional products are transformable into Halal. This model is more likely to suit the producers under franchise market, for example KFC, McDonald's, Subway, etc. This may seem as unprofitable for producers to produce Halal product as production of such goods involve additional labelling cost as mentioned in previous section, while keeping prices unchanged. Hence, the quantity demanded in the market for conventional (non-Halal) franchise products before transformation is,

(12)

where is the portion of products which can transformed into that of Halal, and is corresponding portion of non-transformable product which cannot be sold in the Halal market, whereas is the quantity demanded for the conventional products in the franchise market. Consequently, the quantity demanded that would have been in the market for Halal products is,

(13)

where is the perceived quantity demanded of Halal product. The first line of Equation 13 shows that for the producer to transform production into producing only Halal products, the non-transformable portion is removed from the production. Hence, the second line shows that the transformable portion of non-Halal products is transformed into Halal, denoted by. For this reason, producers might not want to transform production into Halal as, as shown in Diagram 5. In this case, producers only consider secondary market for Halal, without looking at primary market potentials.

Nonetheless, by introducing Halal products, the producers would gain an additional demand as now, not only secondary consumers (non-Muslims who would consume the products) but also the additional consumptions by primary (Muslim) consumers. Therefore, the real quantity demanded for Halal products of that franchise is,

(14)

where is the additional WTP for Halal credence by primary consumers. Combining both Equation (3) and Equation (14) give,

(15)

If the WTP by both secondary and primary consumers are absence, ie., then the above Equation (15) indicate that the quantity demanded (hence supplied) in the franchise market would be the same as those franchises with all conventional products. Nonetheless, in this case is expected as the WTP by secondary and primary consumers are positive, and that the WTP by primary consumers are greater than the former as Muslims are presumed to have higher preferences for consuming Halal products.

Hence, , indicating that the quantity demanded in Halal franchise is greater than the quantity demanded in conventional franchise including the opportunity cost of the quantity demanded that would have been gained from producing conventional products, through transformation into Halal franchise. However, in this model, an important assumption must be made, that is the portion of transformable products is sufficiently larger than non-transformable portion, ie. . This is a sufficient reason for producers to gain from production transformation into that of Halal in such franchise market.

Similar to Equation 10, the price of Halal franchise is,

(16)

where and are the WTP a premium for Halal products by secondary and primary consumers respectively. However as the prices of products in the franchise are assumed to be fixed, hence, these WTP would be equal to zero, ie. .

Following this, the marginal cost and quantity supplied relationship of Halal industry is the same as that of in Equation (6),

(17)

where is the intercept, indicates the slope of marginal cost in market share, represents a fixed unit Halal labelling cost or other additional costs incurred in attaining Halal attribute, in other sense. With additional cost, the marginal cost for Halal production franchises are greater that those of conventional franchises, ie.. Nonetheless, this provides a second reason for producers to be willing to transform into Halal production if the weight of additional quantity demanded is greater than the additional labelling cost. This can be seen from the additional producer surplus gain from transformation. Diagram 5 shows a simple illustration for the above analysis, in which the dotted lines are the expected demand and supply after transformation.

4.3. Discussion on Welfare Effects

It can be seen that by introducing Halal labelling, it is likely to increase the consumption of such products. In a market where price is not controlled (in Section 4.1.), the introduction of Halal labelling will create a price premium, at the same time, generate greater overall quantity demanded for Halal products. This brings a greater welfare to producers and consumer shown by the producer and consumer surplus respectively. For a market in which introduction of Halal logo does not produces a price premium (in Section 4.2.), such as a franchise, these surpluses are also greater compared to the conventional products, as long as the portion of transformable products dominate non-transformable, otherwise larger opportunity cost incurred from transformation. Hence, welfare in both environments (normal market and franchise) are greater from introduction of Halal products compared those when only conventional products are produced.

CHAPTER 5

5.0. Final Annotations

This final chapter is divided into two sections. The first section concludes the analysis of this paper where results are briefly discussed. This is followed by a section which covers the policy implications of the analysis, which gives a view of the models if it can be used practically and for future developments.

5.1. Conclusions

Credence goods are those which the quality cannot be observed by consumers even after consumption. Among many credence goods, Halal product can be seen as a special type of credence good. Production of Halal products opens up an additional market, which is referred in this paper as primary market of Muslims consumers as they only consume Halal products. Primary market exists with the secondary market of Halal which the later is the result of consumers demand which reallocate from consuming conventional non-Halal products to those of Halal. The analysis is better fit for Muslim-minority economies, such as the United Kingdom.

Producer may take the opportunity to produce Halal products based on the higher producer welfare that would be generated from a price premium. This is the situation when the market becomes separated, with price of conventional goods being relatively lower. Adapting to the study of Halal market in similar environment also produces the same outcomes, but with interaction from the effect of primary consumers give clear distinctions that resulted in greater welfare effects

In another analysis, different configuration involving the absent of premium pricing from Halal labelling is presented. In this case, initially producers may hesitate to produce or transform production into that of Halal due to the lower expected demand with same price. Nonetheless, this view does not look into additional primary consumers demand. Considering this additional factor, producers would have the incentives to transform their production from conventional to Halal products, but depending on the level or portion of transformable products, as this affects their opportunity costs for transformation.

5.2. Policy Implications

The analysis in this paper provides a new window of opportunity for development on the studies of credence goods. The models presented are simple yet have potentials as it describes the current situation with regards to the accelerating growth of Halal food production. The analysis also helps to explain the situation for Halal demand in an economy which is dominated by conventional demand and production. The core of the study can be applied in practise if a producer decides on whether to transform the production into Halal, in order to obtain larger positive gains. However, these models only take into account of honest labelling by producers. Like other credence goods, labelling brings some issues to any credence goods including those of Halal products. These issues can be incorporated for future studies on Halal products as credence goods.