A substitute good is a product or service that a consumer sees as the same or similar to another product. In economic terms, when the price of one good rises, the demand for its substitute is likely to increase because consumers will start looking for cheaper alternatives. This relationship showcases how closely the demand for one product is linked to the price of another. In conclusion, substitutes provide alternative products for consumers to satisfy their needs. Substitutes are the choices that encourage competition between firms in the marketplace.
If the change in price causes a small change in demand, it is called inelastic demand. Consumer preferences and tastes can also affect the demand for substitute products. Effective marketing and promotion of substitute products can influence consumer preferences and drive up demand. This will enhance their sales and attract new customers to their products.
Price elasticity of demand (Revision Presentation)
However, it is not hard to find an entity that uses both solar energy and electricity. Substitute goods (substitutes) are alternatively demanded goods, while complementary goods (complements) are jointly demanded goods. A complementary good is a good that adds value to another, or, a good that cannot be used without each other.
Explaining Price Elasticity of Demand and Total Revenue
In this micro video on the theory of demand, we look at substitute and complementary goods. You will come across these when you cover cross price elasticity of demand in introductory microeconomics. They are usually close substitutes, meaning that they satisfy the same needs or purposes. If substitute goods are close substitutes, then an increase in the price of the Substitute good will lead to a decrease in the demand for the good in question. Substitutes that are not identical to the original have a low cross-elasticity of demand. A 1% increase in the price of good A would lead to less than a 1% decline in the quantity demanded of good A.
Increased Competition
- This is because Substitute Goods are easily replaced by other similar products.
- As incomes rise, the price of a good becomes less of a factor when considering substitute goods.
- When you examine the relationship between the demand schedules of substitute products, if the price of a product goes up the demand for a substitute will tend to increase.
- There exist two types of substitute goods, namely direct and indirect substitutes.
- There may be two supermarkets; one that is on the way home from work, and another that is 15 minutes out of the way.
This means if the price of one product increases, the demand for the other increases. As a result, businesses may incur high marketing and promotional costs when competing for market share, which, in turn, reduces operating profits. Some companies are even put out of business due to substitute products significantly outperforming their own offerings.
Consumer Choice
Different car models and brands for soda are examples of substitute goods examples of within-category substitutes. Close substitutes are products that bear a close resemblance in terms of features, functionality, price, etc. For example, some smartphones have similar features and can be considered as close substitutes.
The concept is more theoretical than practical as it’s rare to find goods that are exactly alike in reality. However, for analytical purposes, if consumers are indifferent between two products based on price alone, those products can be considered perfect substitutes. For example, bread and cakes can be said to be substitutes, but they are imperfect since some consumers will buy bread, but still want cake additionally. That is, consumption of one product reduces or replaces the need for the other. For example, if you are moving from point A to B, you can only use a car, bicycle, or another mode of transportation. However, the demand and pricing of substitute products exhibit a positive correlation.