5.5 complements & substitutes

• Substitution Effect:

  • The substitution effect refers to the tendency for consumers to substitute away from a good when its price rises, and move toward a good whose price has fallen.
  • No matter how income is affected, the substitution effect is always negative for the good whose price increased.
• In a Two-Good World:

  • If you're only dealing with two goods, they are necessarily substitutes for each other because when the price of one rises, you can only substitute with the other good.
• In a Multi-Good World:

  • In real life, we have more than two goods. Some goods are often consumed together (like pipes and pipe tobacco or bread and cheese). These are called complements.
• Substitution Away from Complements:

  • Even with many goods, when the price of one good rises, you will substitute away from goods consumed jointly with the good whose price increased (complements).
• Cross-Price Elasticity for Complements:

  • The relationship between complements is shown through negative cross-price elasticity. This means:
  • As the price of one good rises, the demand for its complement decreases.
• Perfect Substitutes:

  • Perfect substitutes are goods that are viewed as exactly the same by consumers.
• • Example: If Coca-Cola and Pepsi are perfect substitutes for you, you will always buy whichever one is cheaper.
• Perfect Complements:

  • Perfect complements are goods that are always consumed together in fixed proportions.
• • The indifference curves for perfect complements are L-shaped because more of one good alone doesn't increase your satisfaction—you need both goods in fixed amounts.
• Perfect Substitutes:

  • The indifference curves are downward-sloping straight lines because you are always willing to trade one unit of one good for a unit of the other.
• Perfect Complements:

  • The indifference curves are L-shaped because you only get utility (satisfaction) from consuming the two goods together in fixed proportions