For instance, if the price of bowling increases, some customers may opt to purchase more video games instead. Although these products come from different industries and are different in nature, a portion of consumers may readily substitute one for the other. Goods that are classified as direct substitutes possess a high level of similarity and have many common characteristics. For instance, Coca-Cola and Pepsi are direct substitutes in the soda market.
Why do consumers prefer substitutes?
Companies can attract and retain customers by aligning their offerings with consumer preferences. Market research and consumer insights help companies identify trends and preferences, allowing them to develop substitute goods that cater to specific consumer needs and desires. A bike and a car are far from perfect substitutes, but they are similar enough for people to use them to get from point A to point B. The availability of substitutes are one of Porter’s 5 Forces, the others being competition, new entrants into the industry, the power of suppliers, and the power of customers. The value of cross-price elasticity tells us how close the two products substitute one another.
Various factors such as price, quality, and geography can come into play. Within-category substitutes are goods that are members of the same taxonomic category such as goods sharing common attributes (e.g., chocolate, chairs, station wagons). That is, the more the consumer can consume (in total quantity), the higher level of utility will be achieved, see figure 3. The availability of raw materials also affects the production and availability of substitute goods. If certain raw materials become scarce or expensive, it can impact the production process and limit the supply of substitute goods. Additionally, government regulations can influence the availability of substitute goods by imposing restrictions or requirements on their production or importation.
Indirect Substitute Goods
With just a few clicks on our mobile phones or laptops, we can order Substitute goods from any part of the world. A customer buys a pair of Nike shoes instead of Adidas shoes because they are cheaper. In this case, the customer is substituting one product for another because it is cheaper. However, there can also be cases where a customer buys a more expensive product because it is of better quality. Import substitution is an idea under trade policy prohibiting importing foreign products and boosting local production. The policy aims to change the country’s economic structure by replacing foreign goods with local ones.
A high change in its substitute price has little effect on the demand for a product. In contrast, cross-price elasticity will be negative if the two items complement each other. Two goods are complement if the consumption of one item requires the use of another.
CATEGORY
This is because Substitute Goods are easily replaced by other similar products. Coca-Cola and Pepsi are the two most popular carbonated beverages examples of substitute goods in the world. The companies have engaged in a long-standing rivalry, with each trying to outdo the other in terms of marketing and product innovation. As such, customers often view these products as substitutes for one another.
- Production costs are significant in determining the feasibility of producing substitute goods at competitive prices.
- For example, if the price of Coke rises substantially, consumers may opt for Pepsi instead.
- 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.
- In contrast, when the price of Pepsi rises, consumers switch to Coca-Cola.
The other products – the substitutes – have a positive cross-elasticity of demand. In cases of perfect competition, perfect substitutes are sometimes conceived as nearly indistinguishable goods being sold by different firms. For example, gasoline from a gas station on one corner may be virtually indistinguishable from gasoline sold by another gas station on the opposite corner. An increase in the price at one station will result in more people choosing the cheaper option.
Since indirect substitutes are not very common, they tend to have a weak correlation, which results in a low cross-elasticity of demand. For instance, if the price of bowling increases and its sales decline by 10 percent, the increase in video game sales may only be around 1 percent. When you examine the relationship between the demand schedules of substitute products, if the price of a product goes up the demand for a substitute will tend to increase.
In other words, it measures the degree to which a change in the price of one product affects the demand for a substitute product. Therefore, the greater the number of substitutes, the higher the probability of every consumer getting what is right for them. For example, coffee can be said to be a substitute for tea, and solar energy is a substitute for electricity. If the price of coffee goes up, the demand for tea goes up, too, and vice versa. This will only apply if we assume that the price of tea remains constant. It is unlikely to see a person drinking coffee and tea at the same time.
Consumers may turn to substitute goods if a preferred product is out of stock or difficult to find. The availability and perception of substitute goods significantly affect consumer decisions and market dynamics. Consumers may switch to substitutes in response to price changes, quality differences, or changes in personal preference. This switching behavior helps maintain a competitive market landscape, encouraging innovation and price moderation among competing brands. The benefit of substitute products is that they provide consumers with variety when choosing goods to satisfy their needs. On the other hand, companies will incur more costs to develop competitive offerings and promote them as the best in the market.
Substitute products offer consumers choices when making purchase decisions by providing equally good alternatives, thus increasing utility. However, from a company’s perspective, substitute products create a rivalry. Cross-category substitutes are products that belong to different categories or industries but can also be used as alternatives for the same purpose. For example, an increase in the price of a movie ticket can lead to increased demand for online movie streaming platforms.