Substitutes and Complements

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.

Substitute goods

• Substitute goods are two alternative goods that could be used for the same purpose.
• They are goods that are in competitive demand
• A rise in the prices of Good S will lead to a contraction in demand for Good S
• This might then cause some consumers to switch to a rival product Good T
• This is because the relative price of Good T has fallen
• The cross-price elasticity of demand for two substitutes is positive

Examples of substitute goods:

• Tea and coffee
• Smartphone Brands
• Rival ride sharing apps
• Competing supermarket chains
• Online streaming platforms
• Cereal brands

Evaluation points on substitutes:

1. Always consider the cost of substitution – there might be switching costs for consumers if they opt for a new brand
2. Some products are close substitutes with a high (positive) cross price elasticity of demand
3. Others are weaker substitutes especially when consumer/brand loyalty is high

Complement goods

• Complementary goods are products which are bought and used together
• A fall in the price of Good X will lead to an expansion in quantity demand for X
• And this might then lead to higher demand for the complement Good Y
• Complements are said to be in joint demand
• The cross-price elasticity of demand for two complements is negative

Examples of complement goods:

• Fish and chips
• Smartphones and apps
• Solar panels & batteries
• Flights and taxi services
• Shoes and polish
• Pasta and pasta sauces

Complement goods and product bundling

• Businesses understand that complements are bought together
• Product bundling is to offer bundles of products sold together at an attractive discount