Substitute Good
(noun)
A good that fulfills a consumer need in a way that is similar to another good.
Examples of Substitute Good in the following topics:
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Cross-Price Elasticity of Demand
- The cross-price elasticity may be a positive or negative value, depending on whether the goods are complements or substitutes.
- A positive cross-price elasticity value indicates that the two goods are substitutes.
- For substitute goods, as the price of one good rises, the demand for the substitute good increases.
- Conversely, the demand for a substitute good falls when the price of another good is decreased.
- Two goods that are substitutes have a positive cross elasticity of demand: as the price of good Y rises, the demand for good X rises.
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Determinants of Price Elasticity of Demand
- A good's price elasticity of demand is largely determined by the availability of substitute goods.
- Availability of substitute goods: The more possible substitutes there are for a given good or service, the greater the elasticity.
- When several close substitutes are available, consumers can easily switch from one good to another even if there is only a small change in price .
- Conversely, if no substitutes are available, demand for a good is more likely to be inelastic.
- The relative high cost of such goods will cause consumers to pay attention to the purchase and seek substitutes.
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Market Demand
- The demand schedule represents the amount of some good that a buyer is willing and able to purchase at various prices.
- In general, this means that the demand curve is downward-sloping, which means that as the price of a good decreases, consumers will buy more of that good.
- A market demand schedule is a table that lists the quantity of a good all consumers in a market will buy at every different price.
- However, special cases exist where the preference for the good or service may be perverse.
- Two different hypothetical types of goods with upward-sloping demand curves are Giffen goods (an inferior but staple good) and Veblen goods (goods characterized as being more desirable the higher the price; luxury or status items).
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Applications of Principles on Consumer Choices
- The substitution effect is closely related to that of the income effect, where the price of goods and a consumers income will play a role in the decision-making process.
- In the substitution effect, a lower purchasing power will generally result in a shift towards more affordable goods (substituting cheaper in place of more expensive goods) while a higher purchasing power often results in substituting more expensive goods for cheaper ones.
- This translates to the graph above as the consumer makes choices to maximize utility when comparing the price of different goods to a given income level, substituting cheaper goods and more expensive goods dependent upon purchasing power.
- This two-part graphical representation of the substitution effect identifies the relationship between the price of a given good and the quantity purchased by a given consumer.
- Explain the labor-leisure tradeoff in terms of income and substitution effects
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Characteristics of Pure Competition
- Sellers cannot charge a price above the market price because sellers see all other goods in the market as perfect substitutes.
- They can buy those goods at the market price.
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Impact of Income on Consumer Choices
- As a result, it is useful to outline the differences in income effects on normal, inferior, complementary and substitute goods:
- Inferior:Inferior goods, or goods that are less preferable, will demonstrate inverse relationships with income compared to normal goods.
- Complementary: Complementary goods are goods that are interdependent in consumption, or essentially goods that require simultaneous consumption by the consumer.
- Substitutes: Perfect substitutes are essentially interchangeable goods, where the consumption of one compared to another has no meaningful impact on the consumer's utility derived.
- Substitutes are goods that a consumer cannot differentiate between in terms of the need being filled and the satisfaction obtained.
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Demand Function
- The behavior of a buyer is influenced by many factors; the price of the good, the prices of related goods (compliments and substitutes), incomes of the buyer, the tastes and preferences of the buyer, the period of time and a variety of other possible variables.
- An individual's demand function for a good (Good X) might be written:
- A superior good is a special case of the normal good.
- Goods may be related as substitutes (consumers perceive the goods as substitutes) or compliments (consumers use the goods together).
- If goods are substitutes, (shown in Figure III.A.3) a change in PY (in Panel B) will shift the demand for good X (in Panel A).
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Mapping Preferences with Indifference Curves
- A consumer would be just as happy with any combination of Good X and Good Y on the curve .
- Perfect Substitutes: To understand what a indifference curves will look like when products are perfect substitutes, please see .
- Perfect substitutes are often homogeneous goods.
- In this particular series of indifference curves it is clear that 'Good X' and 'Good Y' are perfect substitutes for one another.
- Describe the indifference curves for goods that are perfect substitutes and complements
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Changes in Demand and Shifts in the Demand Curve
- Movements along the demand curve are due to a change in the price of a good, holding constant other variables, such as the price of a substitute.
- Shifts in the demand curve are related to non-price events that include income, preferences and the price of substitutes and complements.
- An increase in income will cause an outward shift in demand (to the right) if the good or service assessed is a normal good or a good that is desirable and is therefore positively correlated with income.
- Alternatively, an increase in income could result in an inward shift of demand (to the left) if the good or service assessed is an inferior good or a good that is not desirable but is acceptable when the consumer is constrained by income .
- A change in preferences could result in an increase (outward shift) or decrease (inward shift) in the quantity level desired for a specific price; while a change in the price of a substitute, could result in an outward shift if the price of the substitute increases and an inward shift if the substitute's price decreases.
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Properties of Indifference Curves
- Indifference curves trace the combination of goods that would give a consumer a certain level of utility.
- This is based on the assumption that a consumer is always better off consuming more of a good, so as quantity consumed of one good increases, total satisfaction would increase if not offset by a decrease in the quantity consumed of another good.
- This also assumes that the marginal rate of substitution is always positive.
- It is technically possible for indifference curves to be perfectly straight as well, which would imply that the two goods are identical (perfect substitutes).
- Similarly, all indifference curves will naturally identify diminishing rates of substitution as the quantity increases for a certain good compared to another, and can create demand projections of prospective supply.