Economics Of Product Differentiation For Business

Discuss about the Economics for Business of Quality Business Product.

Product differentiation is a concept used by producers of the market where there are many buyers and sellers and where the producers indulge in producing similar type of product. The producers use different methods to make the goods produced more attractive rather than price. The methods can be in form of advertisement, improving quality, discounts and attractive packaging. It is a method used to distinguish its product to sell the product in the target market. Economic profit can be defined as the profit earned by deducting opportunity cost of the inputs used for production minus the revenue. Product differentiation does not exist in all types of market structure.[1] Firms in perfectly competitive market do not earn economic profit. Hence, an appropriate once off expenditure on product differentiation will not guarantee the firms ability maximize economic profit in any type of market structure. The following part of the assignment discusses how the expenditure on product differentiation can lead few types of market to maximize the economic profit in long run.[2]

Monopolistic competition is a type of market structure where there are large number of buyers and sellers producing similar type of products. The products acts as substitutes for the consumers where they have large choice for the consumption. It is in the monopolistic type of market structure where the firms make economic profit. The main technique used by monopolistic competitive firms to make economic profit is product differentiation. That is they portray that the product is different from the other producers. The condition is applied in case of imperfect substitutes.[3]

Monopolistically competitive firm earns profit in long run along with incurring a deadweight loss. Monopolistically competitive market structure behave like monopolists in short run. This is explained with a help of diagram as shown below.

Figure: Monopolistic competition in short run[4]

Monopolistic competitive firm faces a downward sloping demand curve as the producers cannot change the price of the product unless there is change in the quantity consumed. Firms face a U shaped average cost curve due to presence of both fixed and average cost. All the firms aims at maximizing profit. The profit maximizing condition for the firm in short run is at a point where marginal revenue is equal to marginal cost. Product differentiation occurs when there is no available substitutes of a product and this occurs in case of monopoly. The above diagram shows that firms in monopolistically competitive market will produce till a point where MR is equal to MC. The price will be determined from the point at the demand curve. The firm earn positive economic profit in short run that is market in green in the above diagram. Along with earning profit the firm also faces loss that is market in blue in the diagram. Deadweight loss is a triangle measured from consumer and producer surplus. The more the product is differentiated in the market the more steeper is the demand curve. [5]

Conclusion

The monopolistically competitive firm earns positive economic profit only in short run. In long run seeing the firms earn positive economic profit, new firms enter the market. The competition of the firms increase which makes it difficult for the firms to produce goods that are differentiated in nature. Hence in long run the firms only earn normal profit due to failure of product differentiation.[6]

In case of a perfectly competitive market where there are large number of buyers and sellers, the concept of product differentiation is not applicable. This is so because the producers produce same type of products that acts as substitute for the consumers. Hence firms in perfectly competitive market also earn normal profit and the differentiation is done on the basis of price. Lower the price higher is the sale and ultimately profit.[7]   

Product differentiation enables the firms to earn positive economic profit only in short run. There are various ways through which products can be differentiated. The most common techniques used by firm is that of advertisement. Advertisement adds on to the cost of production. It is useful in conveying important messages and information to consumers. Oligopoly is a market structure with only few firms that sell similar types of products. The sellers have power of price control over their product. Hence the concept of product differentiation is not applicable in case of oligopoly. It is only applicable in case of monopolistic competition. [8]

In case of monopolistic competition market  the two main characteristics are that the competitors perceive over non price difference products and the firms have no price control over the product. The expenditures on the product differentiation is not great to eliminate the substitutes of the product. If the cross elasticities of demand of goods is high in the market the product differentiation will not allow the prices to rise. This will lead the average total cost to rise as the cost of advertisement expenditures will rise. The average total cost will exceed the price charged by the firm that will lead the firms incur loss in short run. Hence, it can be seen that product differentiation does not lead to positive economic profit in all the situations or the market condition. Profit maximization condition occurs at a biggest gap of total revenue and total cost. [9]

Conclusion

From the above discussion it is visible that expenditure on product differentiation to earn economic profit does not guarantee positive income in all the market structures and conditions. Product differentiation is a concept that is used only in Monopolistic competition where there are large number of buyers and sellers producing similar type of products. Also if the cross elasticity of demand is strong then the product differentiation will lead the firms incur loss or normal profit. Positive profit is only incurred in short run where the firms are able to differentiate its products. Product differentiation will lead to earning of positive economic profit in monopolistic competition where the firms act as monopolist. Hence, In any market structure, an appropriate once-off expenditure on product differentiation does not guarantee the firm’s ability to maximize economic profit into the future.

Economics has difficulty in explaining why wage rates for individuals vary across occupations and industries and within occupations and industries.

Wage rate is not uniform for all the occupation and industries. It varies on the skills that the employees posses and the budget that firms have for the production of goods and services. Economics can explain the reason for the differences in the wages as it occurs through the differences in the demand and supply of labor and goods in the market. Theories of minimum wage, wage differentials, compensation are used to explain the reason for the differences in wages for occupations and industries. Differences in  the demand and supply of labor in the market leads to variations in the wages of employees in same occupation as well. Since no two jobs has same characteristics this is the major reason for the wages to vary. Economics and statistics can be used to show the and discuss the reason for the variation in wages of labor in the market. The differences occur due to differences in education and desirability of the job[10].

Minimum wage theory is a theory that explains the minimum amount of the pay that the employer must pay the employees. The main purpose of the minimum wage theory is to support the unskilled workers for their living. The minimum wage is set by the government. The theory of minimum wage has both the advantages and disadvantages. Minimum wage theory helps in increasing employment level but it reduces the pay of the employees that are skilled and trained. The critics says that minimum wage does not have any impact of the level of employment.[11]

Figure: Minimum wage theory[12]

The wage differential theory states five reasons for the differences in wages that are:

Occupational differences

Inter firm differentials

Regional differences

Inter industry differences

Personal wage differences[13]

Wage differentials is also known as inter firm or inter area differentials. Method of percentile wages is used to measure the differences in the wages of employees in industries and occupation. Wage difference is the difference between the wages of high earners and low earners. It is statistics that explains the reasons for the differences in wager by using the technique of percentile wage while economics is used to explain the reason for the differences in the wages of employees.[14] Reasons for the differences in wages of employees are as follows:

Credentials- The main reason for the differences in wages of employees is difference in the educational qualification and the training that the employee has undergone. People with higher degree and qualification get higher wages than the ones with lower wages.

Experience and skill- higher the experience higher is the productive capacity of an employee. Workers who have in demand skills earns higher money than the ones who don't.

Industry or employer- Occupational wages across industry and employer. The wages differ from one to the other due to differences in the working conditions, training requirement, company name and clientele.

Job tasks-The individual tasks of all the employees vary. Employees who are indulged in doing complex tasks get higher wages than the ones who do simpler tasks.

Geographic location- Wage highly depends on geographic location as well. Some states and areas have higher wages than the other. Wages depends on the cost of living and geographic factors.

Occupational differences of wages encourages people to take more challenging and complex tasks as skilled people get higher wages than the unskilled people. Human capital that is the skills that is required to enter the job market varies in people that causes the differences to arise in wages. [15]

Inter firm differentials

Wages also depends on the quality of labor employed, imperfections in the labor market and the differences in the efficiency of equipment and supervision. A firm despite of being in same location and area ,may vary in  the amount of wage that it pays to its employees. Managerial efficiency and other facilities also adds on to the differences in  the wages.[16]

Inter Industry differences

Inter industry differences of wages exists in case of same occupation and same area. It also exists in same industries as well. The reasons for these variations are the  nature of the product market that  it functions in, ability to pay, skill requirement and unionization.[17]

Compensating wage differentials 

Higher wages can also be in form of reward for risk taking jobs and also in form of compensation.

Reward for human capital

In a competitive labor market it is the wages that compensates the opportunity cost that they have to incur that is in form of education or leisure activity.

Labor productivity and revenue creation

An employee who has highest efficiency and contributes in generating higher revenue for the company is awarded with higher wages.

Trade unions and their collective bargaining power

Trade unions are the group of employees with equal demand from employees. Bargaining power is the power that they hold to fight with Their employees over the demand. If the unionization is strong in a particular area then the wages of those employees is higher than the others.[18]     

Conclusion

Hence, the above analysis shows that economics can explain the reason for the differences in wages of employees across occupation and industries. Various economic theories such as minimum wage theory and wage differentials is used to explain then reason for the variation in wages of employees. Wages depends on the skills, type of work, occupation, education and market in which they work. Both statistics and economics can be used to explain the differences in the wages of employees. Minimum wage theory is the upper ceiling set by the government to help the poor.

References

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