Экономические науки

Elena Dundina, a 1^st year student

PhD Olena Zhukova, science and language supervisor

Donetsk state university of management

Effect of Replacement

A change in demand takes place when one of the factors assumed constant changes.

An increase in income results in a rise of the quantity demanded, provided the goods are normal.

A change in price of one good has an income effect and a substitution effect. The income effect of a price increase is to reduce the quantity demanded of all normal goods. For inferior goods, the income effect works in the opposite direction. The substitution effect leads consumers to buy less of the goods whose price has increased.

The substitution effect of a price rise will also reduce the demand for the goods that are complementary to the goods whose price has risen.

In practice, there are three types of relationships between goods: the goods may be substitutes, complements, or independent. The definition of the three types of relationships is based on the substitution effect of the price change of a good.

The substitution effect is positive for substitute goods, the price of the good (j) and the quantity of the good (i) move in the same direction. If the price of j increases, consumers tend to substitute i for j. If the price of j creases, then consumers tend to substitute the relatively cheaper j for i. In both cases, there is positive relationship between the price of j and the quantity of i. An example is butter and margarine.

The substitution effect is negative for complementary goods such as buns and hot dogs. In this case, the price of hot dog (j) and the quantity of buns (i).

Move in opposite directions. An increase in the price of j (hot dogs) means that the quantity demanded of j decrease and the quantity of the complementary good i (buns) also decrease. The same happens when the price of j decrease. In both cases there is a negative relationship between the price of j and the quantity of i.

Notice that if the goods change places in the equation, it may result in a different coefficient. Let us consider the consumption of sugar and coffee. A change in the price of coffee may have some influence on the use of sugar, but a change in the price of sugar probably will have very little influence on the use of coffee.

The substitution effect it zero for independent goods. Independence means that no substitution or complementary relationship exists between the two goods.

References

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