The model of pure competition assumes that numerous firms produce identical products. Homogeneous outputs are the norm in farming and a few other industries, but most firm’s products are at least somewhat differentiated.
Product differentiation is the process of altering goods that serve a similar purpose so that they differ in minor (either real or imagined) ways.
Some firms differentiate within their product lines. For example, GM produces Chevrolets, Buicks, Pontiacs, Oldsmobiles, and Cadillacs. Others concentrate on differentiating their products from those of competitors---ABC, CBS, NBC, and the Fox Network compete for advertisers' dollars by broadcasting slightly differentiated soap operas, sit-coms, sporting events, and news programs, while the Cable News Network (CNN) offers continuous news coverage, ESPN specializes in sports, and MTV and VH-1 offer music videos.
Product differentiation can provide society with a beneficial mix of goods and may signal competition in process. Homogeneity, on the other hand, may result from orders by some central authority. For example, covered wagons in Western movies are all quite similar because the film industry created an image and has them built to order. Few pioneers loaded their belongings into picturesque prairie schooners while migrating to the Old West. They rode, instead, in the motley assortment of wagons then available; two men reportedly moved their gear from St. Louis to Denver in a wheelbarrow in 1867.
Nevertheless, many firms accentuate product differences to try to make us value their products more than those from rival firms. You may think that gasoline is gasoline, but big oil companies expect advertising to alter customers' perceptions. Are Tide, All, Cheer, and Dash meaningfully different? Soap makers spend millions to persuade us that they are. Ford, GM, Chrysler, and numerous foreign producers all sell autos that provide the same basic transportation services. Despite their many similarities, most of us prefer certain cars based on advertising, styling, the frequency of repair, or our past experience.
Some critics believe that marketing puffery often persuades consumers to buy useless items or creates a distorted image that a particular brand product is unique. Product differences can be real or illusory. Differentiation only requires that consumers perceive differences. An example of a differentiated product that is physically homogeneous is liquid bleach. All standard liquid bleach is chemically identical, but most people buy such advertised brands as Clorox instead of cheaper generic substitutes. Why? Because marketing programs create imaginary differences among brands.
Meaningless differences are also found in aspirin-based pain relievers that ads claim contain "the ingredient that doctors recommend most." We seldom hear that the ingredient is aspirin, and that generic brands are as potent as Bayer. Some folks seem convinced that "the more you pay, the more it's worth." Of course, product differentiation may also be real. Some goods truly are superior.
Can you remember the worst advertisement you ever saw or heard? If so, the advertiser partially accomplished its goal by making an unforgettable impression. Different types of ads usually target different groups of consumers. An ad you view as obnoxious may be thought amusing or informative by most members of a targeted group. How firms gain from marketing differentiated products is obvious. Pure competitors are price takers that sell identical products. Firms try to use product differentiation to boost the demands for their goods and shrink their price elasticities. Successful differentiation provides a firm with market power; they become price makers. This enables the firm to sell more product even if it raises the price.
In Figure 1, we show how differentiation gives firms some control over price. Without this control, firms can adjust only output levels to maximize profits---the demand curve facing a pure competitor is perfectly elastic. Successful product differentiation expands the demand curve and makes it less elastic. One critical result is that each marginal revenue curve now lies below the demand curve facing the firm, much like that for the monopolist described in the previous chapter. Consequently, product differentiation allows prices to vary considerably among goods that are close substitutes.
Demands facing monopolistic competitors are much more elastic than the industry (monopoly) demand because there are close substitutes for each firm's products. Still, these firms can hike prices and not lose all their customers. Some of us will continue to eat Wheaties even if the price rises a bit, but if General Mills were to boost the price too much relative to other cereal prices, our breakfast habits would change to reflect our fading loyalty.