Posted in Finance, Accounting and Economics Terms, Total Reads: 313
Substitution is the process when a product/service fulfils the need of the consumer which another product/service fulfils. In other words , it serves as a replacement item for the original item with characteristics equivalent to the original item. A substitute good has a positive cross elasticity of demand i.e. the demand of substitute good increases when the price of other goods increases.
When the substitute good perfectly satisfies the consumer it is referred to as the perfect substitute and when it does not satisfy perfectly it is referred as the imperfect good. A laptop may be considered a perfect substitution for a desktop computer. Perfect and imperfect substitutes may vary with different people. It may so happen that economists believe that Coke is a perfect substitute for Pepsi but consumers do not believe likewise.
Examples of substitute goods are: tea and coffee , margarine and butter
For a product to become a substitution for another product it must share some characteristics with the product. When the cost of a product increases the demand for its substitute product inevitably increases because consumers will look for a cheaper alternative for the product. Similarly on the decrease in price of the goods the demand for the substitute goods decreases.
The substitution may be demand side substitution or supply side substitution. Demand side substitution means that consumers switch from one product to a substitute product due to change in their relative prices. Supply side substitution happens when, in order to satisfy the need of the consumer, the supplier increases the supply.