In other words, when there is a significant correlation between the two goods, they can be regarded as direct substitute goods. Only if the two products satisfy the three conditions, will they be classified as close substitutes according to economic theory. The opposite of a substitute good is a complementary good, these are goods that are dependent on another.

What are Substitute Products?

Two goods are direct substitutes if an increase in the price of one leads to an increase in the demand for the other. For example, if the price of good A rises, then consumers will purchase more of good B. Let’s say you love drinking coffee, but the price of coffee beans suddenly goes up due to a poor harvest. As a result, you may choose to buy tea instead, as it can provide a similar caffeine boost at a lower cost. In this scenario, tea is a substitute good for coffee, and as more people switch to tea, the demand for coffee will decrease. Perfect substitutes are two products that function exactly the same way and are completely interchangeable in the eyes of the consumer.

Cross Elasticity of Demand

When consumers make buying decisions, substitutes provide them with alternatives. Substitutes occur when there are at least two products that can be used for the same purpose, such as an iPhone vs. an Android phone. For a product to be a substitute for another, it must share a particular relationship with that good.

What Are Substitute Products?

They are also known as ‘within-category substitutes’ or ‘close substitutes’. A substitute good can refer to both physical products and services, as it is any product or service that can be used in place of another. For instance, if the price of one product increases, consumers may opt for a substitute examples of substitute goods that is cheaper or more accessible. Several factors can impact the availability of substitute goods in the market.

1. Conversely, its complements include phone cases, apps, and chargers, which enhance the product’s use or are necessary for its operation.
2. Demand elasticity is how sensitive the demand for a good is to the change in other economic variables like price and consumer income.
3. A lower positive cross elasticity of demand means weak substitutes while a higher positive value means strong or close substitutes.
4. This will reduce the demand for that product but increase the demand for substitute products.
5. Customers’ preferences may be heavily influenced by any changes in variables, particularly price.
6. In this case, the customer is substituting one product for another because it is cheaper.

On the other hand, visiting a cinema and attending a theatre are considered indirect substitutes since they share a common goal of providing entertainment in two distinctive ways. Complement goods are products that are typically consumed together or enhance each other’s use, like coffee and sugar. An increase in the price of one could lead to a decrease in the demand for both. If the price of one good increases, the demand for its substitute is likely to rise as consumers look for alternatives. If the price of one product rises, the demand for the other product rises since consumers will prefer to pay a lower price if the utility derived is almost the same. If the change in price causes a significant change in quantity demanded, the product is said to be elastic.

Substitute products and services are the ones that give the same service, look and feel as the original. The consumer perceives both to be very closely comparable because they serve the same purpose. In a bid to be the lowest seller in the market, companies try to use the least amount of resources in their manufacturing process to reduce costs. However, this works against the welfare of the consumer, as it sometimes leads to the production of low-quality products.

Imperfect substitutes are products that are similar but not identical to other alternative brands. The numerical value of XED with a positive sign shows the strength of substitutes. A lower positive cross elasticity of demand means weak substitutes while a higher positive value means strong or close substitutes. Indirect substitute goods can arise from industries or categories that appear to be unrelated.