What is the impact of production being directed towards what appears to be endless product differentiation, for example multiple flavours of toothpaste or shampoo variations which ultimately do nothing to improve individual well being? Does this form of market operation generate employment or is it a waste of productive capacity that might be better directed towards activity that genuinely increases well being. For example, creating products that delivers a real benefit.
Does the market provide too many or too few products, relative to some social optimum benchmark? It turns out that this question does not have a simple answer. It depends on whether or not consumers are well (perfectly) informed about products' attributes, and it depends also on firms’ production costs (specifically whether or not there are economies of scale). Factors that may drive the market to supply too few varieties include the inability of producers to appropriate the full social benefits of introducing a new product (at any given price consumers typically enjoy a surplus, and this surplus is not accounted for in the firm’s break-even calculation of whether or not to develop a new product). Factors that may drive the market to have an excessive number of varieties include the business stealing effect of new market entrants (a firm that introduces a new product does not internalize the negative effect its action will have on existing firms already supplying similar products).
Henry Ford famously once said, about the Model-T, that “Any customer can have a car painted any colour he wants so long as it is black.” We have come a long way since then: not only do cars come in many colors, they also come in many shapes, types, sizes, and a cornucopia of accessories—to fit, it seems, most customers’ needs, tastes and budgets. That “variety is the very spice of life” is, perhaps, a cliché, but it describes an important aspect of real-world markets. Firms’ pursuit of product differentiation addresses the varied needs of a diverse population of consumers. However imperfect, market forces are best positioned to satisfy consumers’ appetite for variety. Most economists would agree that policy interventions in this setting are usually not desirable.