Question

3. The Bertrand Model with differentiated products has given rise to the principle of "maximal product differentiation." What is this principle? Why would firms want to be maximally differentiated? Are there any situations where firms would not want to be maximally differentiated? If so, describe them.

Answer 1

Maximal differential principal comes as a solution from Bertrand Paradox. This law says to avoid the price competitiveness even in a two firm competitive market, firms try to deviate from each other relatively as much as possible.

In a homogeneous goods markets, due to the price competition all the firms are bound to produce equilibrium outcome and earn zero profit.Thus the firms try to differentiate their products from others by rankings, quality or location and availability. Thus if all the products have same price, people will go for high quality product or high ranked products. Thus to maximise own profit even in a homogeneous competitive good markets firm try to differentiate its product maximally.

Yes there are so many situations, when firm will not go for maximally differentiate products. For example, if there exist no price competition in market(monopoly) then firm will not bother about differentiating its product on the basis of quality or ranking than others.