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PRODUCT DIFFERENTIATION. The objective of product differentiation is to increase profits by increasing demand and decreasing the price elasticity of demand . Common forms of differentiation include location , service, physical characteristics and subjective image differences .

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  2. Theobjective of productdifferentiation is toincreaseprofitsbyincreasingdemandanddecreasingthepriceelasticity of demand. • Commonforms of differentiationincludelocation, service, physicalcharacteristicsandsubjectiveimagedifferences.

  3. Someexamples • Location: coffeefranchisers in differentshoppingmalls. (pricesmayormay not differ) • Service: companiessellingtechnologicalproducts. • Physicalcharacteristics:waterbasedpaintsandoilbasedpaints. Freshsquezedorangejuice- concentratedorangejuice. • Subjectiveimage: Bleach, detergants, toothpaste.

  4. Types of ProductDifferentiation • Horizontal p.d: consumershaveheterogenouspreferences: thincrust-thichcrust pizza, McDonalds-BurgerKing, CocaCola-Pepsi. • Vertical p.d: therearedifferences in actualquality, thereforethere is agreementbetweenconsumers. Preferencesareheterogeneous: BMW-Fiat.

  5. ProductDifferentiation in SpatialModels • HaroldHotelling (1929) consideredhow a monopolistwouldlocate her stores on a street. • His model has beendeveloped ever since.

  6. Theassumptions of the model thatwewillusenow: • Mainstreet is of length l=1 mile. • N identicalconsumers, equallyspacedamongthestreet. • R; reservationprice is thehighestpricethat a consumer is willingto pay, R includestransportationcosts. • MC=c (0 in theoriginal model) • t; transportationcost is thecost of a round-trip. • p; price of thegood. • d; consumer’sdistancefromthestore. • Consumer’s total pricefor a unit of good is; p+td • F; fixedcost of settingup an additionalstore.

  7. Giventheseassumptions, consumeronlymakes a purchaseif R≥p+td • Thequestion is; ifthemonopolistbuildsjustonestore on Mainstreet, whereshould it be? • Anotherimportantquestion is thathowmanystoreswould be profitmaximizing, howmanywill be socailly optimum.

  8. MajorImplications of ProductDifferentiation • Firmspracticeproductdifferentiation in orderto be abletoincrease tehir pricesandprofits. • Priceincreases as eitherthereservationpriceorthenumber of storesincreases. • Pricedecreases as transport costsincrease. • Firmsincreasethedegree of productdifferentiationif transport costsincrease. • Firmsincreasethedegree of productdifferentiationifthenumber of consumersincreases. • Firmsincreasethedegree of productdifferentiationifthefixedcosts of building a newstoredecreases. • Inmanycasesthenumber of storesexceedthesocially optimum.

  9. Ice-creamTruck (oligopoly) • So far wehavetalkedabout a monopoly. Let’sthinkabouttheduopolycase: • Twoice-creamstandsarelocated on differentplaces on thebeach (A and B). Output is homogenous. Weassumethatthecustomersarelocateduniformlyalongthebeach. Ice-creamconesarecostlesstoproduce (MC=0) but carryingthembacktoone’sumbrellaresults in a cost c perunit of distancetravelled.

  10. Bertrand Model of ProductDifferentiation • Twofirms: Ben&Jerry’sandHaagenDazsareproducingice-creamandobviouslytheydifferentiatetheirproducts. • IntheclassicalBertrand Model theresultwas P=MC whichweconsidered as a paradox. • What do youthinkhappenifthefirmsareproducingdifferentiatedproductsratherthanhomogenous.

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