Question

a. Discuss two ways that product differentiation affects demand for the product.

b. Explain the difference between collusive and competitive oligopolistic market models and give an example.

Answer 1

a) Product differentiation is a marketing strategy that strives to distinguish a company's products or services from the competition. Two ways that product differentiation affects demand for the product are -

• Differences in quality which are usually accompanied by differences in price
• Differences in functional features or design
• Ignorance of buyers regarding the essential characteristics and qualities of goods they are purchasing
• Sales promotion activities of sellers and, in particular, advertising

b)

Collusive Oligopoly

Sometimes, firms may try to remove uncertainty related to acting independently and enter into price agreements with each other. This is collusion. Collusion is either formal or informal. It can take the form of cartel or price leadership.

A cartel is an association of independent firms within the same industry which follow the common policies relating to price, output, sale, profit maximization, and the distribution of products.

Price leadership is based on informed collusion. Under price leadership, one firm is a large or dominant firm and acts as the price leader who fixes the price for the products while the other firms allow it.

The best example of a cartel today is the Organization of Petroleum Exporting Countries, otherwise known as OPEC, which comprises 12 oil-producing nations that supply 60% of all oil traded internationally. Prices are maintained by restricting each country of the OPEC cartel to a specific production allocation. The OPEC cartel is largely responsible for the large fluctuations in gasoline prices that have occurred in the United States since 1973, although recently, speculation in the commodity markets has also increased volatility.

Competitive oligopolies

When competing, oligopolists prefer non-price competition in order to avoid price wars. A price reduction may achieve strategic benefits, such as gaining market share, or deterring entry, but the danger is that rivals will simply reduce their prices in response.

This leads to little or no gain, but can lead to falling revenues and profits. Hence, a far more beneficial strategy may be to undertake non-price competition.