Complements and Substitutes

When the price of Coke rises, we shift to Pepsi. When tea becomes cheaper, we buy less coffee. Similarly, when the price of petrol rises, the sales of petrol run cars falls and when the cost of ink falls people buy more ink based pens. These changes in demand are linked to the concept of substitutes and complements.

The Law of Demand states that, when the price of a commodity increases that demand for that good falls and when the price of a good falls the demand for that good increases. This law depends on the demand function. The demand function states that demand for a commodity depends on the price of the commodity, price of related goods, technology, tastes and preferences and miscellaneous. The concept of substitute and complimentary goods is a subset of price of related goods. Related goods are defined as:

• Substitute Goods: these are those goods that can take each other’s place/replace each other. For example, Coke and Pepsi, tea and coffee etc
• Complementary Goods: these are goods which collectively satisfy the demands of a customer. Complimentary goods are not exclusive of each other. For example, petrol and cars, ink and pens etc.

Substitute goods have positive cross elasticity of demand. This means when the price of good A increases, demand for good B also increases and vice versa. Goods that are in all aspects substitutable are called perfect substitutes. Such goods usually have a constant marginal rate of substitution. For example, CDs by different brands, re-writable disks etc.

Complementary goods have a negative cross elasticity of demand. This means when the price of good A increases, demand for good B falls and vice versa. Now, if good A can be consumed only if good B is consumed, then A and B are called perfect complements. Indifference curves for perfect complements are right angled curves (similar to an L). For example, right and left sided shoes, pairs of socks etc.

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