Substitute goods or substitutes are at least two products that could be used for the same purpose by the same consumers. If the price of one of the products rises or falls, then demand for the substitute goods or substitute good (if there is just one other) is likely to increase or decline. The other products – the substitutes – have a positive cross-elasticity of demand.
Substitute goods are identical, similar or comparable to another product, in the eyes of the consumer.
Substitute goods can either fully or partly satisfy the same needs of the customers, and therefore are able to replace one another, as far as consumers are concerned.
Pepsi-Cola is a substitute good for Coca-Cola, and vice-versa. When the price of Coca-Cola goes up, demand for Pepsi-Cola is likely to rise (if Pepsi does not raise its price).
According to the Cambridge Dictionary, substitute goods are:
“Products that can satisfy some of the same customer needs as each other. Butter and margarine are classic examples of substitute goods.”
If I have no access to a car I can go by bus or bicycle, Crest and Colgate toothpaste are virtually identical, as far as I am concerned. Substitute goods are two or more products that can be used by the consumer for the same purpose.
Examples of substitute goods
Below is a list of some common substitute goods:
– Coke & Pepsi
– McDonald’s & Burger King
– Colgate & Crest (toothpaste)
– Tea & Coffee
– Butter & Margarine
– Apples & Bananas (or other fruits)
– Kindle & Books Printed on Paper
– Fanta & Crush
– Potatoes in one Supermarket & Potatoes in another Supermarket.
McDonald’s and Burger King’s hamburgers both satisfy the consumer’s requirements of being served rapidly and relatively cheap.
When the price rise of one product results in the immediate and equal increase in demand for another, they are substitute goods – there is a positive cross-elasticity of demand.
The price of Burger King’s hamburgers has a direct effect on demand for those of McDonald’s, and vice-versa – they satisfy the positive cross-elasticity component of demand for substitute goods.
If one product responds immediately to a change in price to another – if demand rises by the same percentage as the others’ price increase – it is a ‘perfect substitute’ or ‘close substitute’. If the cross-elasticity is slight – if a 20% increase in the price of one leads to just a 1% rise in demand for another – it is known as a ‘weak substitute’.
The definition of a ‘perfect substitute’ is all down to the preference of the consumer. If I receive the same satisfaction from Coke as I do from Pepsi, they are perfect substitutes. If you think one tastes better than the other, then Pepsi is a ‘near-perfect substitute’ for Coke, or vice-versa.
Substitute goods and monopolistic competition
In several markets for commonly-purchased goods, there are products that are perfectly substitutable yet are branded and marketed differently – this condition is referred to as monopolistic competition.
Imagine that the price of a can of Coke increases from P1 to P2. People would consume less Coke – the quantity declines from Q1 to Q2. For a can of Pepsi – the substitute good – the demand curve shifts out for all price levels, from D to D1, leading to a greater consumption of the substitute good. (Image: adapted from Wikipedia)
Let’s consider, for example, the comparison between a name brand and generic version of a medication. The two products may be identical, they have the same **active ingredient – they are substitute goods – but their packaging is quite different.
** The active ingredient is the part of a compound or substance that produces its biological or chemical effect – the part of a medication that treats, relieves or cures the patient’s illness or condition.
As the two goods are essentially identical, the only genuine difference between the two medications is the price – the two vendors depend mainly on branding and price to effect sales.
Video – Substitute Goods
This video explains what substitute goods are using easy-to-understand terms and simple examples.