In this article, you will know about
difference between complementary goods and substitute goods. We all know that the demand for an item is mainly affected by its price, but there are several other factors that can also affect its demand. One of these factors isRelated Item Prices‘, where the term ‘related goods’ means complementary and substitution.
In simple words, Complementary goods are complementary items. This means that the items are used in conjunction with each other, which increases their value. In other words, these goods have no value if they are consumed alone.
On the other hand, substitute goods are goods that compete with each other. This means that the item can be used as a substitute for another item. The relationship described by complementarity and substitution is included in ‘Cross Demand‘.
Cross Demand or the cross elasticity of demand determines the responsiveness of consumers in the quantity demanded of one commodity, if the price of another related commodity rises or falls, while other things remain constant. The plus or minus sign plays an important role in the cross-price elasticity of demand, as it determines whether the commodity is complementary or substitute.
Definition of Complementary Goods
Complementary goods are defined as goods that are used or consumed simultaneously to fulfill certain wants. That is, the goods are needed together, to serve that purpose. For example, an increase in the price of computers will cause a decrease in the demand for software packages.
If there is a change in the price of a certain commodity, it will react against the demand for other commodities associated with the primary commodity.
Therefore, there is an inverse relationship between the price of certain commodities and the demand for complementary goods, while other things remain constant. And because the cross elasticity of demand between the two is negative, the demand curve is downward sloping.
The size of the cross price elasticity of demand is an indicator of how strongly the two goods complement each other. Because of that:
Goods are said to be weakly complementary when the cross elasticity between them is only slightly below zero.
Goods are said to be strong as complementary if the cross elasticity between the goods is negative and very high.
It should be noted the fact that it is not always necessary that goods with negative cross elasticity are complementary because when there is a very strong income effect from a change in price, the cross elasticity is also negative.
Definition of Substitute Goods
Substitute goods, as the name implies are goods that are perceived as alternatives to each other by consumers, which can be used to replace each other in consumption. These goods have the ability to satisfy human wants with the same ease.
If the two goods are developed with the same technology or contain the same ingredients, have the same purpose and the price is more or less the same, then it is called a substitution. In such a case, an increase in the price of the product causes an increase in the quantity demanded of its substitute. For example, there will be an increase in the number of train ticket bookings, if there is an increase in air ticket fares.
The cross-demand curve is positive for substitute products, which means that the curve moves upward, indicating that more and more of the commodity will be demanded when there is an increase in the price of the substitute product. The price of substitute products is assumed to be constant. Therefore, if there is an increase in the price of a certain commodity, the demand for its substitute will increase.
If the cross-price elasticity of demand is positive, its size determines how closely the good is substituted. Because of that:
The cross-elasticity between two objects is infinite if they are perfect substitutes.
The cross elasticity between two items will be positive and large if they are close substitutes.
The cross elasticity between two items will be positive and small if they are not close substitutes.
The cross elasticity between two items will be zero if they are completely unrelated.
Difference between complementary and substitute goods
The points given below are important as far as the difference between complementary and substitute goods is concerned:
Substitute goods are goods that are considered the same by consumers, so that they can be used as substitutes for each other and provide the same level of satisfaction. On the other hand, complementary goods are those that are used by consumers together and are of no use if they are consumed alone.
While substitute goods have a competitive demand, complementary goods experience joint demand.
When an increase (decrease) in the price of a related product causes an increase (decrease) in the quantity demanded of the main product, the goods are said to be substitutes. So it can be said that substitute goods have a direct relationship between the two. On the other hand, when a decrease (increase) in the price of a related good results in an increase (decrease) in the quantity demanded of the main product, then the good is said to be a complementary good. Therefore, complementary goods have an inverse relationship between price and demand.
The cross-price elasticity of demand in substitutes is positive, because an increase in the price of one commodity increases the demand for another, and causes the curve to shift to the right. However, the cross-price elasticity of demand if complementary is negative. This is due to the fact that an increase in the price of one commodity reduces the demand for another, leading to a shift to the left.
In the case of substitute products, the demand curve is upward sloping, whereas for complementary goods, the demand curve is downward sloping.
Substitute goods, for example, tea and coffee are independent of each other, i.e. they can individually fulfill certain wants. On the other hand, complementary goods, such as bread and butter, are interdependent, meaning that they are used together to satisfy certain wants.
So, with the above discussion, it is quite clear that changes in the price of the related good have a large impact on the quantity demanded of the main product. While the relationship between price and demand in substitutes is directly proportional, it is inversely related in complementary goods.