New label law has unintended effect

This article describes a new regulation requiring sesame to be listed as an allergen on food labels and its unintended consequences. The manufacturing and selling of a good is a complex system that involves supply, demand, and market equilibrium. A regulation that doesn’t take these factors into account is an example of a simple system trying to regulate a complex system. In this article, the regulation was trying to protect people with allergies but the outcome was counterproductive. We analyze why this happened through the lens of economics and the key concept of social surplus.

Figure 1: Social Surplus on Supply and Demand Curve Diagrams

Figure 1A shows the supply and demand curves. The various quantities of a good a firm is willing and able to supply at different possible prices are modeled using the supply curve. Similarly, the demand curve models the quantities of a good consumers are willing and able to buy at different prices. Market equilibrium is when the quantity demanded equals the quantity supplied and this determines the price of the trade. The figure also shows the consumer surplus, which is the benefit to the consumer, and the producer surplus which is the benefit to the producer. Together, the consumer and producer surplus is called the social or community surplus.

The supply and demand curves need not have complimentary slopes. As shown in Figure 1B, the quantity demanded could be less sensitive to the price than that of the supply curve.

Figure 2: Social Surplus with Various Strategies

The initial state of affairs is shown by supply curve S1 and demand curve D in figure 2A. As a consequence of the regulation, the manufacturer has to ensure that not only does the end product not contain any sesame, but it did not come in contact with sesame at any point during production. This requires significant upfront and continuing expenditure, which leads to an increase in the cost of production. In terms of the supply curve, this is a non-price determinant of supply and leads to the supply curve shifting to the left from S1 to S2. The original equilibrium point was at price P1 and quantity Q1. On curve S2, the quantity that firms are willing and able to supply at price P1 is Q1’ which is lower than the original quantity Q1. This puts upward pressure on price. Producers react by increasing prices. The new equilibrium is at the intersection of S2 and D, corresponding to price P2 and quantity Q2. As is expected and can be seen, both the consumer and producer surplus has reduced. Therefore, the social surplus as compared to (P1, Q1) is also reduced.

What are the alternatives to blindly following the regulation? Of course, producers do not intend to do anything illegal but do want to maximize their profits. Consider what would happen if sesame is added to products that don’t have sesame. Consumers allergic to sesame will choose not to buy these products which reduces the demand. This is a non-price determinant of demand and the demand curve will shift to the left from D1 to D2 in figure 2B. At the same price, the quantity demanded has reduced from Q1 to Q1’ and thus there is less demand at the original equilibrium price, which puts downward pressure on price. Producers reduce their prices. As is visually obvious, in this case, the producer and consumer surplus is more than in the situation in figure 2A. The quoted article only states that producers chose the path of adding sesame as it was less expensive. The concept of social surplus explains why this happens.

We note that this situation occurs specifically because of the slopes of the demand and supply curves that we have chosen. Also, producers did not make this choice for societal gain but for their personal gain.

When the regulators were making this policy, they were only thinking about the consumers with the allergy and left out other stakeholders like the producers and consumers without the allergy. The benefit is only to the consumers who have the allergy but the cost is borne by everyone. The alternative of simply adding sesame benefits everyone except for the consumers with the allergy. If the regulators had taken the social surplus into consideration rather than a single group, we would have avoided the unintended consequence highlighted in the article and would have designed a better solution.