Shawn has a masters of public administration, JD, and a BA in political science.
Sometimes if a price for a particular product is high, you may decide to purchase something cheaper that will work. In this lesson, you'll learn about substitute goods and related concepts, and you can look at some examples.
Substitute Goods Defined
Substitute goods are products that purchasers may interchange because of limitations of supply or due to price. Some products are more amenable to substitute than others. For example, substituting a Fuji apple for a Gala apple is a better substitute than substituting a Fuji apple for a banana, and a pork chop is even less of a good substitute.
Substitution and Cross Elasticity of Demand
In order to get a solid understanding of substitute goods, we need to look a bit at the economic concepts of demand and elasticity. The law of demand simply states that, all things being equal, as the price of a good or service increases, the quantity demanded for the good or service will decline. However, all things are not always equal. Demand for some goods, such as food and water, are not as responsive to price as other goods, such as opera tickets. You can live without seeing Georges Bizet's Carmen, but not so much without food or water.
Price elasticity of demand is a measure of how responsive (or flexible) demand for a good or service is to changes in price. If price doesn't affect demand all that much, then demand is said to be inelastic. On the other hand, if price has a large effect on demand, then demand is elastic. So, what does this have to do with substitute goods?
The degree to which one good can be substituted for another is based upon the cross elasticity of demand, which is a measure of the responsiveness of demand for one good when the price of another good changes. If there is a positive cross elasticity of demand between two products, then when the price of one of the products increases, demand for the other product will increase as consumers switch to the cheaper product.
If the price of one of the products goes down, then the demand for the other product will go down as consumers once again switch to the cheaper product. This is known as the substitution effect, or the process of switching between goods based on a change in the relative price of each good.
Example of Substitution
Don't you just love economists? The concept of substitute goods is much less complex than it sounds. Let's use a simple example of substitution based on cross elasticity of demand that many of us experience all the time.
Let's imagine that Connie the consumer is an avid diet soda drinker. In fact, she can be seen shopping for a case of soda on a weekly basis. She usually buys Brand A. However, if the store increased the price of a case of Brand A, Connie will buy a case of Brand B if it's cheaper. In fact, if Brand B is on sale and Brand A is not, Connie will opt for the sale price and buy Brand B.
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If Connie's store decides to price gouge on Brands A and B, but Brand C is on sale, she buys Brand C. Next week, if Brand A soda is back to its normal price and is no more expensive than Brands B or C, Connie will go back to Brand A, her favorite soda. Those are the basics of substitute goods, cross elasticity of demand, and the substitution effect.
Let's review. A substitute good is a good that a consumer may substitute for another good if the price of the consumer's normal choice rises too high or the consumer's preference is unavailable. Substitution will occur if the products are similar enough to meet a consumer's need and there is a positive cross elasticity of demand. Cross elasticity of demand occurs when the price of one product increases, which causes the demand of another product to increase, such as when the price of one brand of soda increases and results in a soda drinker purchasing a cheaper brand of soda.
Substitute Goods Overview
products that purchasers may interchange because of limitations of supply or due to price
Law of demand
as the price of a good or service increases, the quantity demanded for the good or service will decline
Price elasticity of demand
a measure of how responsive (or flexible) demand for a good or service is to changes in price
Cross elasticity of demand
a measure of the responsiveness of demand for one good when the price of another good changes
the process of switching between goods based on a change in the relative price of each good
With your learning in mind, the lesson focuses on the above areas in order to help you to:
Recognize the meaning of substitute goods
State the law of demand
Contrast price elasticity and cross elasticity of demand
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