Substitute goods are products consumers can use as alternatives for the same purpose. Tea and coffee can be substitutes for someone choosing a hot drink. The products can differ in taste, quality, convenience or format and still meet a similar need.
The term also applies to services. A train journey and a flight may be alternatives for a particular trip, provided the route, timing and other requirements make both feasible.
How one product’s price affects another
If tea becomes more expensive while coffee’s price and other influences remain unchanged, some customers may switch towards coffee. In a demand diagram, the change in tea’s price can shift the demand curve for coffee. A change in coffee’s own price instead involves movement along its demand curve.
Economists measure the relationship using cross-price elasticity of demand: the percentage change in the quantity demanded of one product divided by the percentage change in the other product’s price. OpenStax explains why substitutes have a positive cross-price relationship, holding other influences constant.
A fictional cafe calculation
Suppose a cafe raises the price of a cup of tea from £2 to £2.40, a 20% increase. Coffee stays at £3 a cup, and weekly coffee purchases rise from 100 to 110 cups, or 10%. Assume other influences are unchanged and that the extra coffee purchases result from the tea-price increase.
Using percentage changes from the initial values, coffee’s cross-price elasticity with respect to tea is 10% divided by 20%, or +0.5. The positive sign fits substitution in this example. The figures are invented; observing two changes together in real sales data would not by itself establish what caused them.
Perfect substitutes have a separate definition
Perfect substitutes are interchangeable at a constant rate in a consumer’s preferences. The rate need not be one for one. The EconGraphs explanation by Christopher Makler sets out this constant trade-off.
For example, assume a buyer cares only about water quantity and regards two identical, equal-sized bottles as interchangeable at a constant one-for-one rate. Either bottle can replace the other throughout the combinations being considered. Tea and coffee may be less complete alternatives because the buyer prefers one taste.
An equal percentage price and quantity response would give a cross-price elasticity of +1. It would not prove perfect substitutability. Response size and the constant trade-off in preferences describe different things.
Substitutes, complements and differentiated products
Complements are products used together, such as coffee and a compatible filter. Substitutes compete for a use; complements contribute to the same use together. The relationship depends on the particular buyer, products and purpose.
Monopolistic competition involves many sellers offering differentiated products. Different cafes, for example, can compete through flavour, location and service. Their products need not be perfect substitutes.
Substitutes in Porter’s five forces
Harvard Business School’s explanation identifies rivalry among existing competitors, the threat of new entrants, buyers’ bargaining power, suppliers’ bargaining power and the threat of substitutes.
In that framework, a substitute meets the same underlying need in a different way. Videoconferencing can replace some business travel. A competing airline on the same route would usually be considered under rivalry within the industry. The framework’s categories are narrower than the general economic idea of alternative products.
Last checked and updated on November 2, 2026 by the MBN editorial team.