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Substitute goods are commodity which the consumer demanded to be used in place of another good. Economic theory describes two goods as being close substitutes if three conditions hold: [3] products have the same or similar performance characteristics; products have the same or similar occasion for use and; products are sold in the same ...
Cross elasticity of demand of product B with respect to product A (η BA): = / / = > implies two goods are substitutes.Consumers purchase more B when the price of A increases. Example: the cross elasticity of demand of butter with respect to margarine is 0.81, so 1% increase in the price of margarine will increase the demand for butter by 0.81
The other main category of related goods are substitutes. Substitutes are goods that can be used in place of the primary good. The mathematical relationship between the price of the substitute and the demand for the good in question is positive. If the price of the substitute goes down the demand for the good in question goes down.
The concept of the elasticity of substitution was developed by two different economists, each with their own focus. One of these economists was John Hicks, who defined elasticity of substitution as the change in percentage in the relative number of factors of production used, given a particular change in percentage in relative prices or marginal products.
If a product has a competitive product at a cheaper price in the market in which it shares many characteristics with, it is likely that consumers would deviate to the cheaper substitute. Thus, if many substitutions existed in the market, a consumer would have more choices and the elasticity of demand would be higher (elastic).
The problem arises from the fact that economic theory predicts that any profit-maximizing firm will set its prices at a level where demand for its product is elastic. Therefore, when a monopolist sets its prices at a monopoly level it may happen that two products appear to be close substitutes whereas at competitive prices they are not. In ...
Constant elasticity of substitution (CES) is a common specification of many production functions and utility functions in neoclassical economics.CES holds that the ability to substitute one input factor with another (for example labour with capital) to maintain the same level of production stays constant over different production levels.
A firm cannot charge a higher price if products are good substitutes, conversely as a product deviates from others in the segment producers can begin to charge a higher price. The lower non-cooperative equilibrium price the lower the differentiation. For this reason, firms might jointly raise prices above the equilibrium or competitive level by ...