Definiton
Substitute goods are similar items that may fill a specific consumer demand. In other terms, two different goods may be used for the same purpose. Consumers may search for a substitute good when their first-choice product increases significantly in price. The secondary choice item must operate sufficiently when compared to the original good. The need for substitutes is also necessary when an original good becomes low in supply or very rare in the immediate economic market. Large economies tend to produce a greater amount of original and substitute goods.
Reasons for Substitute Goods
Price is often the greatest factor that leads a consumer to choose a substitute good over a preferred good. Economically speaking, as individual incomes fall, less discretionary money is available. This requires consumers to spend more wisely in order to maintain a good quality of life. Thus, consumers must locate less expensive economic goods.
Many times, economic circumstances are driven by outside influences that individuals cannot control. For example, commodity prices, money supply, or inflation can alter a consumer ’s spending patterns. During periods of increased inflation, an economy typically experiences too many dollars chasing too few economic goods. Hence, price increases abound for many different economic goods, triggering changes to consumer buying habits as more affordable substitute goods receive higher demand.
Scarce economic goods are other scenarios that may be out of a consumer ’s control. A scarce good is simply an item that has low supply even though demand is relatively high. When the preferred product is unavailable, consumers will start to look for a replacement good.
In today ’s global economy, consumers could begin seeking alternate economic goods in other countries. This allows consumers to find very similar – but oftentimes lower quality goods – at relatively similar prices. However, shipping, freight, or tariff costs can add significantly to these alternate goods. Consumers must take all these additional costs into account when finding the cheapest substitute good. Additionally, the time it takes to receive the item is also a consideration. If it takes too long to receive the goods, consumers, may not be happy with this waiting period.
Basic Examples of Substitute Goods
A simple – but very common example – of a substitute good is ground beef rather than steak. The current costs of the latter good will typically drive demand for the former good. When steak prices rise above what consumers are willing to pay, the demand for cheaper substitutes, i.e. ground beef, increase.
Another example occurs when a natural resource is rare in a specific geographic region. For example, coal is very plentiful in the northeastern United States. States in close proximity to coal production may therefore find this a cheap energy source. When coal prices rise above certain levels, however, consumers may look to alternate – or substitute, in economic terms – sources.
Substitute goods may also be in demand as coal supplies run low and fail to meet current demand. Common substitutes here may include natural gas, solar, or nuclear energy sources. The purpose of such a substitute is that one source may be just as useful for the other source in terms of economic scarcity. When scarcity occurs, price may become less important for substitute goods; whichever good is more plentiful and can meet current demand may be the best alternative.
Further Economic Analysis on Substitute Goods
Economists measure substitute goods using the cross elasticity of demand. This formula is very simple. It divides the percent change in quantity demanded for Product A by percent change in price for Product B. The result is a positive or negative figure that determines if the good is a substitute or a complement. The size of the resulting number determines the strength of the substitute or complement good.
The following table and paragraphs demonstrate this theory in practical terms.
Cross Elasticity of Demand for Substitute and Complement Goods
SUBSTITUTE GOODS
Close Substitutes
The example above indicates a close substitute. Economists use this formula to mathematically prove whether goods are a substitute or complement. While petroleum and natural gas may be common substitutes, economists look for varying items to determine if non-standard substitute goods exist.
Negative Substitutes
Let ’s change the above example slightly. If petroleum prices increase 10 percent, then demand for fuel inefficient vehicles decrease 15 percent. The formula result is:
-15% / 10% = -1.5
Therefore, a negative cross elasticity of demand exists. Consumers will purchase fewer SUVs (i.e. fuel inefficient vehicles) when petroleum prices increase drastically.
Weak Substitutes
Two other common substitute goods are margarine and butter. Let ’s imagine that butter prices increase 10 percent and demand for margarine only rises three percent. The formula result is:
3% / 10% = .3
This indicates that margarine demand does not increase as much when butter prices increase dramatically. Therefore, consumers find margarine a weak substitute for butter.
Perfect Substitutes
Some goods may be perfect substitutes. For example, A2 paper from Company A is the same as A2 paper from Company B. Price increases do not necessarily matter, as the utility of each company ’s paper is the same for consumers.
COMPLEMENT GOODS
Complement goods are those items that have a negative cross elasticity of demand. In short, the demand for a good will increase when another good ’s price decreases. The petroleum/fuel inefficient example above represents complementary goods. Only when petroleum prices decrease, and subsequent gas prices decrease, will demand for SUVs increase.
Another – and less mathematical example – of complement goods are hot dogs and hot dog buns. These items are usually consumed together rather than separately. The same goes for hamburgers and hamburger buns. While a consumer can use either bun as a substitute for the other, it is certainly not preferred. In truth, individuals might likely avoid eating hot dogs or hamburgers in order to avoid substituting buns for either of the original product.
Perfect Complements
Some perfect complements exist. For example, a left shoe and right shoe is necessary to make a pair of shoes. These are perfect complements. So are specific video games and video games consoles. Most video game console manufacturers ensure only their video games work on the console. Hence, a perfect complement exists for these goods.
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