Product Differentiation
Consumer goods are available in a variety of styles and brands. Product differentiation refers to such variations within a product class that (some) consumers view as imperfect substitutes. The store Foods of all Nations in Charlottesville, Virginia, USA
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product differentiation
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product differentiation 1 Overview
some market power (due to the special features that distinguish them from their rivals' products); they can set prices without a completely elastic response by consumers. It also means that the product itself becomes a choice variable and firms differentiate to avoid the Bertrand outcome. However, many models of product differentiation do not treat this choice explicitly, and instead assume a framework (representative consumer, discrete choice and symmetric location models) that generates a demand system. It is not so much the framework used but rather the structure of product differentiation that is critical to the predictions and results. Indeed, common models of one type may be recast within another framework and be formally equivalent. Instead, the important feature for performance is whether each product is equally substitutable with all others or if each has only few close substitutes which are chain-linked to other products in the industry. Equal substitutability describes global competition where each firm competes with each other firm. Chain-linking corresponds to local competition. Local competition models naturally apply in geographical space since nearby stores are closer substitutes for consumers than distant ones. Likewise, in a characteristics setting, a consumer with a sweet tooth will find sugary products closer substitutes for any sweet product than for a saltier one. The next section describes models of product location (in geographical space or its characteristics analogue) and distinguishes horizontal from vertical differentiation. Section 3 compares the common approaches to product differentiation used to analyse the market provision of variety. In these models, product decisions are suppressed and product selection is determined by entry. Section 4 describes how the market variety diverges from the equilibrium one. Section 5 elaborates on this th
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