In this type of market structure, all the sellers are price takers, which mean that the sellers have no control over the price of their products. Price is perhaps the most common reason why customers consider substituting goods. For instance, in a restaurant, a pint of beer may cost $10 while a cola may cost $3. In such a scenario, the customer would need to believe that the beer is worth an additional $7 to them. Each individual places a certain value on each product, and they make their decision based on their preference for one product over the other. Substitute goods fulfill consumer needs when there is a change in a particular variable.
Factors Affecting Demand
Some examples of complementary products are, tooth paste and tooth brush, car and petrol, pen and examples of substitute goods ink, computer and hard disk, mobile and battery. Brand substitutes are products from different brands that are used for similar purposes. Both are used for photography and videography and are known brands in the marketplace. In economics, the relationship between any two goods can be explained by using the concept of cross elasticity of demand (XED) or cross-price elasticity of demand. In the above diagram, we have two graphs comparing two substitute goods. In the left graph, we have the market for Pepsi Cola, and the initial equilibrium is at E0.
Substitute Products
If two brands of cereal have the same prices before one’s price is raised, we can expect sales to fall for that brand. Price elasticity of demand measures how sensitive the demand for a product is to changes in its price. Regarding substitute goods, price plays a crucial role in consumer decision-making. If the price of one substitute good increases significantly, consumers may switch to a cheaper alternative. For example, if the price of Coke rises substantially, consumers may opt for Pepsi instead. Two goods are perfect substitutes when consumers get the exact same utility.
Geography is also a crucial variable to consider when purchasing substitute goods. There may be two supermarkets; one that is on the way home from work, and another that is 15 minutes out of the way. The geographical location of the store provides convenience for the customer, and they take this into account when deciding on a product. If someone doesn’t have access to a car they can travel by bus or bicycle. Substitute goods are two or more products that the consumer can use for the same purpose. As Substitute goods are cheaper and offer more discounts and deals, it becomes easier for consumers to save money.
Alternative products can cut into companies’ profitability, as consumers may end up choosing one more over another or see market share diluted. Furthermore, the monopoly market works if there is no substitution (or very low). That way, monopolists can control the market, and consumers want to buy their products. If substitutions are present and operate competitively, then consumers will turn to them because the price will tend to be cheaper and of better quality. In Porter’s Five Forces Model, substitution presents a threat to a company or industry profitability.
- This is where the utility of the product or service is pretty much identical.
- Paul Boyce is an economics editor with over 10 years experience in the industry.
- Many factors may contribute to the preference, but it is mostly due to comfort.
- However, from a company’s perspective, substitute products create a rivalry.
- Consumers have different preferences when it comes to product features, quality, design, and overall experience.
Quality
In a market where there are fewer substitute products, there is a higher probability of earning greater profits. If a substitute becomes more readily accessible, demand for it may increase. To stand out in a crowded market, substitute products may innovate or differentiate themselves to offer unique features or benefits to consumers. The availability of substitute goods can affect demand by providing consumers with alternative options, which can lead to a shift in demand away from a particular product or service. In particular, direct substitute goods exhibit a high cross-elasticity of demand. If the price of Coca-Cola increases and its sales drop by 10 percent, then the sales of Pepsi may rise by approximately 10 percent.
The increased availability of digital substitutes has transformed the marketplace by giving consumers more choices and flexibility in their consumption habits. In this market structure, consumers can easily switch to substitute products and get the same utility without bearing switching costs. The graph indicates that as the price of good A increases, the demand for substitute good B will also increase. This is because consumers will switch to the substitute good as it becomes a more attractive and affordable option.
If the price of a substitute good increases, consumers may switch to a lower-priced alternative. Although an imperfect substitute may be replaceable, it may have a degree of difference that can be easily perceived by consumers. A consumer may choose Coke over Pepsi—perhaps because of taste—even if the price of Coke goes up. If a consumer perceives a difference between soda brands, she may see Pepsi as an imperfect substitute for Coke, even if economists consider them perfect substitutes. Conversely, when a good’s price decreases, the demand for its substitute may also decrease. In formal economic language, X and Y are substitutes if demand for X increases when the price of Y increases, or if there is positive cross elasticity of demand.
Holding an MBA in Marketing, Hitesh manages several offline ventures, where he applies all the concepts of Marketing that he writes about. Margarine is usually cheaper than butter and can be used as a substitute in many recipes. In today’s era, substituted goods are easily available in the market as compared to the original good. The availability of substituted goods has become easier because of globalization and technological advancement.
Impact of Digital Goods as Substitutes
In another scenario, tea and coffee can be perceived as substitute goods for some consumers. If the price of coffee increases significantly, tea drinkers might see it as a more appealing option given its similar caffeine content, leading to an increase in tea demand. If substitute products are readily available in all corners of the market, there is a likelihood of consumers switching more often.
