On Product Differentiation: Old Ideas Vs. New Tools

In industrial organization analysis one of the most studied subject is product differentiation. In most cases it is considered an anticompetitive strategy carried out by dominant firms. In this work we tried to ask to ourselves what is the real role played by this strategy in the market. To understand the real effects of product differentiation we removed some basic assumptions from the principal model elaborated in the economic literature. Particularly, we introduced the multi-dimensions characteristics space. The description of an n-dimensions characteristics space allowed us to introduce the powerful max-min principle, which states that firms use maximum differentiation along the nth characteristic and minimum differentiation along the n-1 characteristics. The max-min principle open the door to a long waited conciliation in economic theory on product differentiation. Indeed, on one hand some old models found that firms are led by the agglomeration effect; they locate their products close to the ones produced by other firms with the plan to gain bigger market share. In other words, firms choose minimum differentiation. On the other hand, some scholars shown how firms are dominated by the strategic effect. They decide to locate their products as far as possible from the ones sold by their competitors, with the intend to exploit market power. Through the max-min principle the agglomeration and the strategic effect can live together. Firms choose the strategic effect in the nth characteristic and the agglomeration effect in the n-1 characteristics. Finally, trough games theory tools, specially with folk theorems we described how newcomers can enter the market in horizontally differentiated markets. We interpreted the entry process as an infinitely repeated game, where at each stage there could be a new entrant who wants to sell their products. This intuition is coherent with the market structure, where incumbent gains extra profits due to product differentiation. Therefore, newcomers are attracted by these additional earnings, and desire to enter the market. Form this viewpoint the incumbent is playing an infinite entry game, every time with a different competitor.