A Theoretical Basis for Determination of Grading and Sorting Schemes

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Abstract
The determination of grade standards and of the amount of product sorted in the market is analyzed by examining the individual quality valuation function (IQVF). The IQVF describes the behavior of the marginal rate of substitution between the product and the numeraire as a function of the product's quality characteristics and the purchased bundle of goods. The equilibrium grading and sorting schemes depend on the market structure and the configuration of the IQVF's. In a competitive market, grade boundaries coincide with the intersections of the IQVF's, which are located on the upper envelope curve of the IQVF's. The grading scheme is then economically efficient. Conditions which result in poor market performance are identified by analyzing the dynamics of the scheme adjustment process. It is suggested that government intervention in setting grade standards should be guided by information on the configuration of the IQVF's as derived from market experiments.

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