Prices of related Goods and Demand

Consumers’ goods may have two kinds of relationships: substitutes and complements. The two goods are substitutes in a consumption basket, if either of them could meet the consumption need. For example for many people tea and coffee are substitute goods and so are different brands of cars, scoters, cigarettes, soaps, toothpastes, etc. The degree of substitution might vary from product to product. For example, the Maruti car may be a close substitute to the Fiat car but a poor substitute to Bajaj scooter. The two goods X and Y are said to be complementary goods if consumer needs goods X when he has goods Y. For example, tea and sugar, car and petrol, cigarettes and match boxes are pairs of complementary items. Once again, the degree of complementary might vary from one pair of goods to another. For instance, car and petrol are perfect complements while tea and sugar do not have such a strong relationship.

If the two goods A and B are substitutes, an increase in the price of goods B, price of goods A remaining constant, would induce consumers to substitute goods A for goods B, because B has become relatively more expensive now than before, and thereby increase the demand for goods A. Thus, an increase in the price of substitute goods (Fiat car) would lead to an increase in demand for the goods in question that is Maruti car. Quite the opposite would happen when the price of a substitute item falls. In the case of complementary goods, the relationship is the other way round. If the price of a complementary item (petrol) goes up, the demand for the parent good (car) goes down; for since the former item (petrol) has become relatively expensive now, the consumer would like to demand less of it, and since he has less of it (petrol) now, he would need less of the latter good car as well. When the price of a complementary goods goes down demand for its parent goods goes up.

Since an item could have more than one substitute goods, and / or more than one complementary product, each of the substitutes’ prices and complementariness’ process is a vector of prices rather than just one price.

Consumers’ tastes and preferences are an important determinant of the demands for all consumers’ good. If a person is a pure vegetarian either because of religion tradition or taste, his demand for meat is zero no matter what his income and the price of meat are. Similarly, if a product goes out of fashion, or taste, its demand goes down. On the other hand, if an item becomes popular (due to improved taste for it), its demand goes up;. Television, car and most luxury items fall in the category of popular items.

Producers’ spend a lot of money on advertising their products primarily because they can influence the tastes and preferences of the consumers in their favor, and thereby achieve an increase in the demand for their own products. It is essentially this activity which enables firms to manage the demand for their products.