Answer to Question #132424 in Microeconomics for Neba

Question

Does product differentiation have any implications on the demand for the product of a firm and its market power?

Answer 1

answer

The demand curve for a firm's goods in a competitive market is downward sloping. When a firm differentiates it's products, it may be able to price them above the marginal cost and make excess profits in the short run. This represents a shift on the demand curve to the right. However, in the long run, as new firms enter the differentiated product market, profits are pushed down back to normal levels representing a shift on the demand curve to the left.

A company has high market power if it is able to influence the pricing of a product in the market. Differentiation gives a firm market power in the short run allowing allowing it to earn extra profits. In the long run however, the firm is likely to lose market power as other firms enter the market with alternative goods.