Substitute Goods: What it is, 11 Examples & Types

Some companies are even put out of business due to substitute products significantly outperforming their own offerings. 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. The goods which are used together to satisfy a specific want, like bread and butter are known as Complementary Goods. The price of a complementary good and demand for the given commodity inversely relates to each other.

As a result, it becomes one of the significant reasons why Substitute goods are preferred over original goods. In a monopoly, only one firm produces a good or service with no close substitute goods. A substitute, or substitutable good, in economics and consumer theory refers to a product or service that consumers see as essentially the same or similar-enough to another product. Put simply, a substitute is a good that can be used in place of another. That is, the more the consumer can consume (in total quantity), the higher level of utility will be achieved, see figure 3.

Fruit punch is a sweet fruit drink like lemonade, so it acts as a substitute good. As mentioned above, they are generally used for the same purpose or are able to satisfy similar needs for consumers. Substitute goods are two goods that can be used in place of one another, for example, Dominos and Pizza Hut. By contrast, complementary goods are those that are used with each other.

Related Differences

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. Substitutes play an important part in the marketplace and are considered a benefit for consumers. They provide more choices for consumers, who are then better able to satisfy their needs.

All goods fall under the term price elasticity of demand, which means that the demand for a good will change significantly or very little based on the price. A price inelastic good will not have a big change in demand if the price changes, while a price elastic good will have a significant change. Although an imperfect substitute may be replaceable, it may have a degree of difference that can be easily perceived by consumers. So some consumers may choose to stick with one product over the other. A consumer may choose Coke over Pepsi—perhaps because of taste—even if the price of Coke goes up.

Factors that Increase the Risk of Substitute Products

Substitute goods are important for maintaining a competitive environment, which helps to keep prices down and quality up. When the price of one good increases, the demand for a substitute good tends to increase as well. Since there are always new entrants and the market might not be growing at the same pace, there are risks of examples of substitute goods obsolete stock even for the best sellers in the market. Thus, companies will adjust by reducing prices or production to prevent it from becoming flooded with too many products. 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.

This would include a plastic food storage container, a vase, or even a glass. A substitute good is a good that a consumer may substitute for another good if the price of the consumer’s normal choice rises too high or the consumer’s preference is unavailable. Substitution will occur if the products are similar enough to meet a consumer’s need and there is a positive cross elasticity of demand.

Customers choose based on price, and other factors have no influence on demand. Therefore, it is impossible to build brand equity so that customers prefer one. For example, bread and cakes can be said to be substitutes, but they are imperfect since some consumers will buy bread, but still want cake additionally. In this market structure, consumers can easily switch to substitute products and get the same utility without bearing switching costs.

Substitute goods and monopolistic competition

The other four are existing customers, new customers, barriers to entry, and suppliers. A frozen yogurt shop sells the same goods as another frozen yogurt shop nearby. McDonald’s and Burger King’s hamburgers both satisfy the consumer’s requirements of being served rapidly and relatively cheaply. Substitute goods are identical, similar, or comparable to another product, in the eyes of the consumer.

For instance, if the last iced-ringed doughnut is sold out at the local grocery store, customers may look for substitute goods instead. There exist two types of substitute goods, namely direct and indirect substitutes. A direct substitute is a scenario where two commodities can be interchanged without difficulty, such as Pepsi and Cola. This means that substitute goods can be seen as similar products that can serve the same purpose or function. For instance, the iPhone and Galaxy Note can be considered substitutes since they both act as mobile phones. In this way, they provide consumers with different options to fulfill the same need.

Cross Elasticity of Demand of Substitute Goods

Perfect substitute goods have a constant marginal rate of substitution instead of decreasing marginal rate of substitution. We all know that demand for a product is mainly affected by its price, but there are some other factors which can also affect its demand. One such factor is ‘Price of Related goods’, wherein the term ‘related goods’ means complements and substitutes. In simple words, Complementary Goods are the goods that complete each other.

For instance, if the price of one product increases, consumers may opt for a substitute that is cheaper or more accessible. 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.

The companies, in addition to taking into account similar products of the competition, also take into account, in general, all substitute goods or products. They only show the relationship between demand for a given commodity and price of the related good. Butter and margarine are two common spreads used in cooking and baking. While butter is made from cream, margarine is made from vegetable oil. Margarine is usually cheaper than butter and can be used as a substitute in many recipes.

• Any item that is purchased instead of the doughnut can be regarded as a substitute good.
• Two goods are complement if the consumption of one item requires the use of another.
• On the other hand, a good narrowly defined will be likely to not have a substitute good.
• Fresh or canned tuna and salmon are two of the most frequently found fish in sushi restaurants.
• Direct substitutes are also understood as perfect substitutes, while indirect substitutes are also known as imperfect substitutes or less perfect substitutes.
• The price of substitute goods directly affects the demand for a given commodity.

On the other hand, substitute goods are those goods that compete with each other. Meaning that these goods can be used as a replacement for another good. The relationship depicted by complements and substitutes are covered under ‘Cross Demand‘. Substitute goods refer to two or more goods that meet similar needs, so they become alternatives to each other. As Substitute goods are cheaper and offer more discounts and deals, it becomes easier for consumers to save money.

Substitute Goods Examples

You will come across these when you cover cross price elasticity of demand in introductory microeconomics. So, with the above discussion, it is quite clear that the change in the price of related goods has a great impact on the quantity demanded of the main product. While the price and demand relationship in the case of substitutes is directly proportional, it is inversely proportional in the case of complements. 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. If a product can be substituted with another, it is called a perfect substitute, for example, the different brands of bread can be said to be perfect substitutes.

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. Indirect substitute goods typically have a low cross-elasticity of demand. For example, a customer might go to a store to buy a doughnut, but if none are available, they may decide to purchase a banana instead. These two items are entirely different, yet they can still be substituted for one another. In particular, direct substitute goods exhibit a high cross-elasticity of demand.

But what happens if the consumer realizes that the cheaper product works the same or the substitute product works better than the original? The economic term used to describe this is the substitution effect. The most common occurrence of the substitution effect happens when a brand loyal consumer has to switch to a different brand for a number of reasons. If the consumer decides to change permanently, it’s most likely because the price was better or the substitution worked the same or better.

The value of cross-price elasticity tells us how close the two products substitute one another. 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. An increase in the car price causes sales to fall, reducing demand for gasoline.