Why do firms engage in product differentiation even if it increases their costs?

• A. Product differentiation reduces consumer surplus by making products less appealing to consumers.
• B. Product differentiation eliminates competition by making all products identical.
• C. Product differentiation allows firms to increase consumer surplus by offering products that better match consumers' willingness to pay.
• D. Product differentiation always leads to lower prices and reduced profits for firms.

Answer: (C)

Verified step by step guidance

1. Understand the concept of product differentiation: it refers to the process by which firms make their products distinct from competitors' products in ways that are meaningful to consumers, such as quality, features, or branding.
2. Recognize that product differentiation can increase a firm's market power by reducing the direct substitutability of its product with others, allowing the firm to have some control over pricing.
3. Analyze how product differentiation affects consumer surplus: by offering a variety of products that better match different consumers' preferences and willingness to pay, firms can increase the overall satisfaction consumers derive from their purchases.
4. Consider the trade-off firms face: although product differentiation may increase production or marketing costs, it can enable firms to charge higher prices or attract more customers, potentially increasing profits despite higher costs.
5. Conclude that firms engage in product differentiation because it allows them to better meet consumer needs and gain competitive advantages, which can lead to increased profits even if costs rise, rather than simply reducing consumer surplus or eliminating competition.