Substitute and Complementary Goods

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This Demonstration shows the dependence of market demand for a given good (indexed "0") as a reaction to price changes on the other market (indexed "1"), which can be a market for either substitute or complementary goods. Substitute goods are competitive, so an increase in the price of substitutes leads to an increase in demand, and a decrease in their prices reduces demand. The opposite holds true for complementary goods that are, by definition, consumed in conjunction with the given product. This topic is often explained using the cross-price elasticity concept, but it lacks an intuitive dynamic visualization and also hides the difference between demand and quantity of demand.

Contributed by: Timur Gareev (December 2017)
Open content licensed under CC BY-NC-SA


Snapshots


Details

Substitute goods are those whose cross-price elasticity is positive:

,

where is the demand function for some good , and stands for the price of another good , which has some relation to good . Price and demand are both non-negative quantities by definition, so the sign of the expression is determined by the term [1].

On the contrary, for complementary goods the sign of the expression above is negative.

Set the price of some good (in the left plot) with the slider. Notice that a change in price does not influence the demand curve on the left market itself. (From the right-market point of view, one observes price change on the left market, perhaps without knowing the reason).

Depending on the mode chosen by the "goods" setter bar ("substitute" or "complementary"), the results are reflected in the right plot. Relevant shifts may be seen in the demand curve.

The other slider changes the slope of demand on the left market, so it does not affect the price (i.e. supply occasionally adjusts). If the price stays unchanged, we may not expect any change in demand on the right market due to the effect in question. In this rather artificial case, cross-price elasticity is undefined (because of the term ), and we observe no relationship between the markets. Nonetheless, in general, shift in demand should affect current prices.

Reference

[1] Wikipedia. "Substitute Good." (Dec 21, 2017) en.wikipedia.org/wiki/Substitute_good.



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