• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar
  • Skip to footer

Penpoin

Better knowledge. Sharper Insight.

  • Management
  • Economics
  • Finance
Blog

How substitution affects elasticity?

Updated on March 20, 2020 · By Ahmad Nasrudin

How substitution affects elasticity
You are here: Home / Blog / How substitution affects elasticity?

The presence of substitution affects elasticity because it provides alternative choices in consuming products or services

Advertisement

If a substitute product is available, consumers tend to turn to these alternative products when the price of a product or service rises. Of course, by switching, they get lower prices. Product demand is inelastic when there is no substitute or little available. In contrast, when there are many substitutions available, the demand is elastic. 

Definition of substitute product and elasticity

Substitute product is an alternative product that provides similar satisfaction. Remember, in economics, another term for product satisfaction is utility. When alternative products offer the same utility, we say they are perfect substitutions. When not the same, they are imperfect substitutes or close substitutions.

Perfect substitutes exist in perfect competition markets. Its availability in the market makes producers only as price takers. Once they raise prices above market prices, consumers will switch and ask for substitute products.

How responsive is demand when the price of a product changes, that is what we call own-price elasticity of demand. We measure it by dividing the percentage change in the quantity of demand for an item by the percentage change in its price.   

Why does substitution affect elasticity

In economics, economists assume consumers as rational beings. When faced with two items with similar utilities, they will choose the cheapest.

Because substitute products offer a similar utility, they will choose it when the price of an item rises. Thus, the availability of substitute goods affects the elasticity of demand for goods or services.

Demand for goods or services with many elastic substitutes because consumers have many choices. That means, when the price of an item rises slightly, consumers will switch to its substitute.

Advertisement

Consider two soap products with different brands. Both offer the same quality. A decrease in price in one brand encourages you to buy it. In contrast, a price increase encourages you to purchase an alternative brand.

Likewise, with Pepsi and Coca Cola. An increase in Coca Cola prices encourages you to prefer Pepsi, and the opposite effect applies when Coca Cola prices go down.

Furthermore, when there is little or no good substitute for an item, demand is inelastic. Consumers will continue to buy products even if prices rise because they have no alternative.

Consider the cancer drugs you take while you are on treatment. If two pills per day keep you alive, you can’t possibly reduce purchases even if the price goes up. Also, you are not likely to increase purchases even if prices fall.

Does only the price of substitute products affect consumer demand?

No, the other determining factor is switching costs. That is the cost that the consumer bears (such as transportation costs and time) to get a substitute product.  

Economic Growth and Economic Development: Their Differences and Relationships

Economic growth has a close relationship with economic development. We need economic growth to support

Economic Growth: Factors, Importance, Impacts, How to Measure It

Economic growth refers to an increase in output in an economy over time. It can be short term or long term. In the short

Gini Coefficient: Meaning, Calculation Method, Data, Pros, and Cons

What's it: Gini coefficient is a statistic of economic inequality in a society. It tells you the distribution of income

Advertisement

Needs: Definition, Example, Type

What's it: Needs means requiring something because it is essential. For example, we need food, water, and shelter

Wants: Definition and Examples

What's it: Wants are hopes to have or fulfill something. If we want something, we expect to be able to buy it and

Hedge Funds Strategy: Macro, event-driven, relative value, and equity hedge strategies

Hedge funds rely on several strategies to make money. Hedge Fund Research, Inc. (HFRI) divides them into four

Hedge Funds:  Examples And What Do They Do?

What's is: Hedge funds are pooled investment funds by private investors, established in limited partnerships, and

Primary Sidebar

TOPIC

Accounting and Finance Business and Strategy Financial Statements Human Resources Investment Macroeconomics Marketing Microeconomics Operation

Advertisement

LATEST POST

  • Hedge Funds Strategy: Macro, event-driven, relative value, and equity hedge strategies
  • Leveraged Buyout (LBO): How it Works, Funding Sources, Criteria for Target 
  • Private Equity: Examples, Strategies, Targets, Its Ways To Make Money
  • Economic Growth and Economic Development: Their Differences and Relationships
  • Where Do Comparative Advantages Come From?
  • Three Injections In The Economy

MOST POPULAR

  • Business Size: Definition, Measurement, Classification
  • Span of Control: Importance, Types, Advantages, Disadvantages
  • The Role of Business in Society and the Economy
  • Government Intervention: Examples, Reasons, and Impacts
  • Sociocultural Environment: Meaning, Variables, Impact on The Business
  • Public Goods: Meaning, Characteristics, Examples

Footer

SEARCH

POPULAR

  • Business Size: Definition, Measurement, Classification
  • Span of Control: Importance, Types, Advantages, Disadvantages
  • The Role of Business in Society and the Economy
  • Government Intervention: Examples, Reasons, and Impacts
  • Sociocultural Environment: Meaning, Variables, Impact on The Business

TOPIC

Accounting and Finance Business and Strategy Financial Statements Human Resources Investment Macroeconomics Marketing Microeconomics Operation

Copyright © 2023 · About Us  · Privacy Policy and Disclaimer  ·  Terms of Use  ·  Comment Policy  ·  Contact Us