Product differentiation is the key element in the theory of monopolistic competition. Under perfect competition products are homogeneous; they are identical in all respects. A buyer cannot distinguish between the product of one firm form that of another. So, the product being undifferentiated, he does not or cannot prefer product of firm A to that of firm B.
Under monopolistic competition, there is differentiation of products. The firms produced similar product but not the same product. The product is similar in the sense that product of firm B can be easily used in place of the product of firm A. this means that these products are close substitutes. They may have different names, different packing, etc. but are in essence not so different that the consumers may regard them as separate products. But at the same time they are not so identical that the consumers may remain absolutely indifferent between them. The difference is enough to make the consumers prefer the product of firm A to that of firm B or firm C. but if need be product of the other firms (B or C) can be used in place of the product of firm A.
It may be noted that there is a difference between differentiated products and different products. Products are different if they have different composition, and from say plastic. As the difference between iron and plastic is real, they are regarded as two different products. The cross elasticity between iron and plastic is very low.
But when there are no such real differences but differences are only created by giving different brand names, differences in packing and designs or by highlighting the superiority of one product over the other through publicity and propaganda, so that the consumers start regarding them as different products, though in reality they are the same or similar products, this is called differentiated product. The differences in this case are not real, but are artificial or created differences. The products are similar in nature and are thus close substitutes. The cross elasticity of demand between these differentiated products is quite high.SUBMIT ASSIGNMENT NOW!