Substitute good

Substitute good

In economics, one kind of good (or service) is said to be a substitute good for another kind insofar as the two kinds of goods can be consumed or used in place of one another in at least some of their possible uses. Classic examples of substitute goods include margarine and butter, or petroleum and natural gas (used for heating or electricity). The fact that one good is substitutable for another has immediate economic consequences: insofar as one good can be substituted for another, the demand for the two kinds of good will be bound together by the fact that customers can trade off one good for the other if it becomes advantageous to do so. Thus, an "increase" in price for one kind of good (ceteris paribus) will result in an "increase" in demand for its substitute goods, and a "decrease" in price (ceteris paribus, again) will result in a "decrease" in demand for its substitutes. Thus, economists can predict that a spike in the cost of wood will likely mean increased business for bricklayers, or that falling cellular phone rates will mean a fall-off in business for public pay phones.

It is important to note that when speaking about substitute goods we are speaking about "two different kinds" of goods; so the "substitutability" of one good for another is always a matter of degree. One good is a perfect substitute for another only if it can be used in exactly the same way. In that case the utility of a combination is an increasing function of the sum of the two amounts, and theoretically, in the case of a price difference, there would be no demand for the more expensive good.

Perfect substitutes may alternately be characterized as goods having a constant marginal rate of substitution. Alternate types of soft drinks are commonly used as an example of perfect substitutes. As the price of Coca Cola rises, consumers would be expected to substitute Pepsi in equal quantities, i.e., total cola consumption would hold constant. Also, blank media such as a writable Compact Discs from alternate manufacturers would be perfect substitutes. If one manufacturer raises the price of its CDs, consumers would be expected to switch to a lower cost manufacturer.

Imperfect substitutes exhibit variable marginal rates of substitution along the consumer indifference curve.

One of the requirements for perfect competition is that the products of competing firms should be perfect substitutes. When this condition is not satisfied, the market is characterized by product differentiation.

Substitute goods exhibit no complementarities, as in a complementary good.

In other words, good substitution is an economic concept where two goods are of comparable value. Car brands are an example. While someone could argue that Ford trucks are considerably different from Toyota trucks, if the price of Ford trucks goes up enough, some people will buy Toyota trucks instead.

ee also

*list of economics topics

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