Page 710 - Krugmans Economics for AP Text Book_Neat

What you will learn
in this Module:
• Why oligopolists and
monopolistic competitors
differentiate their products
• The economic significance of Product Differentiation
advertising and brand names
668 section 12 Market Structures: Imperfect Competition
Module 68
and Advertising
In Module 66 we saw that product differentiation often plays an important role in oli-
gopolistic industries. In such industries, product differentiation reduces the intensity
of competition between firms when tacit collusion cannot be achieved. Product differ-
entiation plays an even more crucial role in monopolistically competitive industries.
Because tacit collusion is virtually impossible when there are many producers, product
differentiation is the only way monopolistically competitive firms can acquire some
market power. In this module, we look at how oligopolists and monopolistic competi-
tors differentiate their products in order to maximize profits.
How Firms Differentiate Their Products
How do firms in the same industry—such as fast-food vendors, gas stations, or choco-
late makers—differentiate their products? Sometimes the difference is mainly in the
minds of consumers rather than in the products themselves. We’ll discuss the role of
advertising and the importance of brand names in achieving this kind of product dif-
ferentiation later. But, in general, firms differentiate their products by—surprise!—ac-
tually making them different.
The key to product differentiation is that consumers have different preferences and
are willing to pay somewhat more to satisfy those preferences. Each producer can carve
out a market niche by producing something that caters to the particular preferences of
some group of consumers better than the products of other firms. There are three im-
portant forms of product differentiation: differentiation by style or type, differentia-
tion by location, and differentiation by quality.
Differentiation by Style or Type
The sellers in Leo’s food court offer different types of fast food: hamburgers, pizza,
Chinese food, Mexican food, and so on. Each consumer arrives at the food court with
some preference for one or another of these offerings. This preference may depend on