11.13 : Differentiated Goods: Bertrand Competition

The Bertrand model with differentiated products explains how companies compete on both price and perceived value. The classic Bertrand model assumes homogeneous products, forcing firms to lower prices to marginal cost. However, in differentiated Bertrand competition, firms justify higher prices by offering unique features such as brand identity, quality, or technology. Customers are willing to pay more for products that offer unique benefits. Additionally, differentiation reduces demand elasticity, making consumers less sensitive to price changes and allowing firms to avoid direct price wars.

The degree of differentiation determines pricing power. When products are highly distinct, firms face lower cross-price elasticity, meaning consumers are less likely to switch based on price alone. This allows companies to maintain higher markups. However, when products are similar, substitutability increases, intensifying price competition. In such cases, firms must lower prices to attract buyers, reducing profit margins.

For instance, consider two laptop manufacturers, TechCore and SwiftPC. TechCore focuses on high-performance laptops with advanced features that appeal to professionals and tech enthusiasts. SwiftPC, on the other hand, produces budget-friendly models that attract students and general users. Although they still compete on price, differentiation makes price competition less aggressive. Since each firm appeals to a different consumer segment, they can charge different prices without directly undercutting each other.

To succeed, firms must strategically position their products to balance pricing power with market reach. Some firms build a loyal customer base by offering exclusive features, while others keep costs low to attract a broader audience. By leveraging differentiation, businesses can soften price competition while maximizing their market potential.