Definition of substitute goods.
- Substitute goods are two goods that could be used for the same purpose.
- If the price of one good increases, then demand for the substitute is likely to rise.
- Therefore, substitutes have a positive cross elasticity of demand.
Close Substitute Goods
- If two goods are close substitutes, there will be a high cross elasticity of demand.
- Example, if price of Sainsburys flour increases 10%, demand for Hovis flour may increase 20%. Therefore, the cross elasticity of demand is +2.0
Weak Substitute Goods.
- If goods are weak substitutes, there will be a low cross elasticity of demand.
- Example, if price of Daily Mail increases 10%, demand for the Financial Times may only increase 1%. Therefore, the cross elasticity of demand is 0.1
- If price of margarine increases 10%, demand for butter may rise 2%.
Two goods are perfect substitutes if the utility consumers get from one good is the same as another. For example, a dollar from one FOREX company, is worth exactly the same as getting a dollar from a different FOREX company.
A4 paper from Office World, gives same utility as A4 paper from WHSmiths.
Therefore, in theory, if one good was more expensive, there would be no demand as people would buy the cheaper alternative