Module 68: Product Differentiation & Advertising Duffka School of Economics

Key Economic Concepts For This Module: If a firm can create real or perceived product differences, the firm will have some degree of market power. The firm can differentiate products in three ways: by style/type, by location, and by quality differences. Advertising could be viewed as a socially inefficient use of a firm’s resources if it does not provide useful information about the product. If advertising is used to create a strong identifiable brand name, firms can successfully raise the price even if the product itself is identical to lower-priced, and identical, rival products. Duffka School of Economics-68

Module Layout I. How Firms Differentiate Their Products A. Differentiation by Style or Type B. Differentiation by Location C. Differentiation by Quality II. Controversies About Product Differentiation A. The Role of Advertising B. Brand Names Duffka School of Economics-68

I. How Firms Differentiate Their Products In monopolistic competition, firms engage in product differentiation because it allows the firms some degree of pricing power. In oligopolies, firms differentiate their products as a form of non- price competition to take market share from close rivals. How is this done? Differentiation can be real (a truck with four-wheel drive is different from a truck without) or perceived (bleach is bleach, no matter what Proctor and Gamble tries to tell you). If a consumer believes your firm’s product is better, your firm can charge a higher price and reap higher profits. Duffka School of Economics-68

I. How Firms Differentiate Their Products A. Differentiation by Style or Type B. Differentiation by Location C. Differentiation by Quality Duffka School of Economics-68

II.Controversies About Product Differentiation The formula for household chlorine bleach is NaClO, sodium hypochlorite. This is the key bleaching ingredient in every single brand that one can find at the grocery store. The leading brand, Clorox, has about 65% of the market share for household bleach, and spends millions of dollars to maintain this dominance. Economists wonder if advertising dollars are the best use of economic resources. Duffka School of Economics-68

II.Controversies About Product Differentiation The Role of Advertising Brand Names Duffka School of Economics-68

Practice Question #1 1. Which of the following is a form of product differentiation?    I. style or type    II. location    III. quality a. I only b. II only c. III only d. I and II only e. I, II, and III Duffka School of Economics-68

Practice Question #2 2. In which of the following market structures will individual firms advertise?    I. perfect competition    II. oligopoly    III. monopolistic competition a. I only b. II only c. III only d. II and III only e. I, II, and III Duffka School of Economics-68

Practice Question #3 3. Advertising is an attempt to affect which of the following? a. consumer tastes and preferences b. consumer income c. the price of complements d. the price of substitutes e. input prices Duffka School of Economics-68

Practice Question #4 4. Brand names generally serve to a. waste resources. b. decrease firm profits. c. confuse consumers. d. decrease information. e. signal quality. Duffka School of Economics-68

Practice Question #5 5. Which of the following is true of advertising expenditures in monopolistic competition? Monopolistic competitors a. will not advertise. b. use only informational advertising. c. waste resources on advertising. d. attempt to create popular brand names. e. earn long-run profits through advertising. Duffka School of Economics-68

Duffka School of Economics-68

Duffka School of Economics-68