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Last updated on 2024年5月28日

How do you identify and respond to changes in the demand for substitutes and complements?

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Substitutes and complements are two types of goods that affect the demand for each other. Substitutes are goods that can replace each other, such as tea and coffee. Complements are goods that are used together, such as bread and butter. Knowing how to identify and respond to changes in the demand for substitutes and complements can help you make better decisions as a consumer or a producer.

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1 Cross elasticity of demand

The key concept to understand the relationship between substitutes and complements is cross elasticity of demand. This is a measure of how the quantity demanded of one good responds to a change in the price of another good. It is calculated by dividing the percentage change in quantity demanded of one good by the percentage change in price of another good.

Cross elasticity of demand can be positive, negative, or zero. A positive cross elasticity of demand means that the goods are substitutes. When the price of one good increases, the quantity demanded of the other good increases, and vice versa. For example, if the price of tea increases, the quantity demanded of coffee increases, as some consumers switch from tea to coffee.

A negative cross elasticity of demand means that the goods are complements. When the price of one good increases, the quantity demanded of the other good decreases, and vice versa. For example, if the price of bread increases, the quantity demanded of butter decreases, as some consumers buy less bread and butter.

A zero cross elasticity of demand means that the goods are independent. The price of one good does not affect the quantity demanded of the other good. For example, the price of milk does not affect the quantity demanded of pens.

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Connor Donnelly, MBA/MS

Sustainability Consultant at Deloitte
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When I taught micro econ as a Graduate Student Instructor at the University of Michigan, I told students they already understood the concept of cross price elasticity of demand. However, it was likely their first time using new vocabulary to articulate economic changes. Tangible, real world examples often work best; the example I always used for cross elasticity of demand is how the quantity demand for pencils changes amongst students when 1) the price of erasers (a compliment) increases/decreases and 2) the price of pens (a substitute) increased/decreases. Since there is a price change, there is no shift of the demand curve, only a movement along the demand curve. Hence, this is a change in the quantity demanded, not a change in demand.

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Davide Ricciardi
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When I identify changes in demand for substitutes and complements, I rely on cross elasticity of demand. If a competitor drops their prices (substitute), I might see my sales dip. To stay ahead, I keep an eye on market trends and competitors. If their price cuts impact me, I might run promotions or highlight what makes my product better. For complements, like if coffee prices go up, demand for coffee makers might drop too. I watch related markets closely. If I see a trend, I could bundle products or offer discounts to keep sales steady. Staying flexible and informed helps me adapt quickly to these changes and keep my business on track.

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2 Identifying substitutes and complements

To identify substitutes and complements, you need to observe how the demand for one good changes when the price of another good changes. You can use market data, surveys, experiments, or intuition to estimate the cross elasticity of demand. The closer the cross elasticity of demand is to zero, the less related the goods are. The farther it is from zero, the more related they are.

You can also use the concept of opportunity cost to identify substitutes and complements. Opportunity cost is the value of the next best alternative that you give up when you make a choice. Substitutes have a high opportunity cost, as choosing one means giving up the other. Complements have a low opportunity cost, as choosing one means using more of the other.

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Alexander Coffman

Engineer & Speaker | Mentoring young professionals to increase productivity and develop professionally | Exploring emerging technology, economic, and policy solutions to the polycrisis
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In my role as an energy auditor and engineer, I've learned to identify substitutes and complements by monitoring market trends and tech advancements. For instance, during energy audits, I noticed a trend towards LED lighting over traditional bulbs, a more efficient substitute. This led to recommending LED upgrades to clients, complementing their other energy-saving measures like solar panels. Key advice: Stay informed about industry developments and be proactive. Regularly review trade journals and engage in professional networks for actionable insights.

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3 Responding to changes in demand for substitutes

If you are a consumer, you can respond to changes in the demand for substitutes by comparing the prices and benefits of different goods and choosing the one that gives you the most satisfaction. If you are a producer, you can respond to changes in the demand for substitutes by adjusting your prices, output, and marketing strategies to attract more customers and increase your profits.

For example, if you are a consumer and you notice that the price of coffee has increased, you can compare the price and benefits of coffee and tea and decide whether to switch to tea or stick with coffee. If you are a producer and you notice that the demand for coffee has increased, you can increase your price, output, and advertising of coffee to take advantage of the higher demand and earn more revenue.

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4 Responding to changes in demand for complements

If you are a consumer, you can respond to changes in the demand for complements by considering how the prices and benefits of both goods affect your total satisfaction. If you are a producer, you can respond to changes in the demand for complements by coordinating your prices, output, and marketing strategies with the producers of the complementary goods to maximize your joint profits.

For example, if you are a consumer and you notice that the price of bread has decreased, you can consider how the price and benefits of bread and butter affect your total satisfaction and decide whether to buy more or less of both goods. If you are a producer and you notice that the demand for bread has increased, you can coordinate your price, output, and advertising of butter with the producers of bread to take advantage of the higher demand and earn more revenue.

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5 Applications and implications

Understanding how to identify and respond to changes in the demand for substitutes and complements can help you make better decisions in various situations, such as saving money or increasing your utility. You can also predict how changes in the market conditions will affect the demand for different goods, or develop competitive or cooperative strategies with other producers. However, you should be aware of some limitations and challenges of using cross elasticity of demand, such as it may vary depending on the time period, the income level, or the degree of differentiation of the goods. Additionally, it may not capture the full effects of other factors that influence the demand for goods, and it may be difficult to measure accurately or reliably due to data limitations.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How do you identify and respond to changes in the demand for substitutes and complements?

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1 Cross elasticity of demand

2 Identifying substitutes and complements

3 Responding to changes in demand for substitutes

4 Responding to changes in demand for complements

5 Applications and implications

6 Here’s what else to consider

Microeconomics

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