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The primary reason for engaging in product differentiation is to avoid some of the ruinous effects of price competition.Anderson (2008). Producers are involved in a never-ending process of introducing new products and services and then observing economic behavior. By having several products, producers can experiment and watch economic behavior as consumers will focus on the features and products that are most desirable. The benefits of being a monopolist via differentiation are short-lived, however. Just as cattle are attracted to water, producers are attracted to excess profits.Research on cattle using global positioning system devices has shown that water is a more powerful draw than salt in attracting cattle to new grazing ground. See Ganskopp (2006). As long as profit potential makes it feasible, competitors will enter the market and begin to drive profits to zero.Becerra (2009).
In this chapter, we have illustrated that there are three approaches to price discrimination and product differentiation. Each pricing strategy is employed under various contexts in practice. The key takeaways include the following: