Last updated on October 23rd, 2024 at 04:59 pm
This is a straighforward explaination of the economics concept called as substitution effect. And if you have been wondering around with the dilema of what is substitution effect then you search ends here.
What is Substitution Effect?
The substitution effect refers to the change in demand for goods and services as a result of a change in the price of the goods compared to that of other substitute goods. If the price of any good rises, the consumers tend to switch to its substitute. Any product may lose market share for many reasons, but the substitution effect is purely a result of frugality.
Understanding Substitution Effect
Whenever the price of a product or service increases but the buyer’s income stays the same, the substitution effect kicks in. This is evident in consumer behaviour. A manufacturer faced with a price hike for an essential component from a domestic supplier may switch to a cheaper version produced by a competitor.
Practical Example:substitution effect
John eats rice that costs $5 per pound and pasta that costs $10 per pound. The relative price of 1 pound of pasta is 2 pounds of rice. At their current prices, John consumes 1 pound of pasta and 2 pounds of rice.
Due to some technological advances in rice cultivation, there is a fall in rice prices from $5 a pound to $2 a pound. The relative price of 1 pound of pasta has now increased from 2 pounds of rice to 5 pounds of rice. Therefore, John switches away from pasta and into the rice. The change in consumption occurs purely due to the changes in the relative price of the goods and not because of a change in income.
It is necessary to incorporate practical examples in an article on the substitution effect, especially when outlining how changes in prices influence the consumption patterns of consumers. The following are some of the examples that you can use in your article, each of them contextualized as follows:
Substitution of Public Transport for Private Cars
Due to recent increases in fuel prices, many people are starting to reconsider their means of getting places. For example, when there is an increase in the price of petrol, people who have private cars tend to choose them less often as it becomes too expensive via driving. Because of this, many commuters may decide to substitute driving with public transport like buses or trains. Here the substitution effect explains how consumers deal with the situation where the price increase of goods or services that they frequently consume – in this case, petrol for private cars – makes them to seek for other cheaper options.
The Dynamics of Branded versus Generic Products
A completely different example of substitution effect can be seen in the practice of grocery shopping. A lot of consumers start buying generic or store-brand products instead of more expensive branded products like cereals or cleaning supplies, as their prices tend to rise. For example, a user may opt for store-brand cereal which is reasonably priced and of comparable quality to an expensive name-brand product that he or she would have otherwise purchased. This change happens because the cheaper alternative is now a better deal than the branded product, which has now become more expensive.
Technology and the Substitution Effect
The technology industry lends itself nicely to the concept of substitution effect most notably with waves of new technology innovation. For example, as technology advances and the cost of tablets falls, many consumers may decide to replace their laptops with lower-cost and more portable options like tablets. Most situations are similar to this and occur with gadgets like smartphones, laptops, or cameras for instance. If the price of a smartphone that comes with excellent camera features is much lower than that of a DSLR camera, which can do one task only, consumers may prefer the first product and switch to it instead.
Dining Out vs. Preparing Food at Home
When faced with economic hardships or high inflation, going out to eat may seem like a luxury that only a few can afford.?? If prices in restaurants and cafes increase due to higher costs of food and wages, then many people will turn to cooking meals at home which is cheaper than going out. This demonstrates the substitution effect in action, as it relates to how people are able to cope with rising costs of going out by finding other cheaper options, that of preparing food at home.
Energy Substitution: Gas vs Electricity
Energy market is another place wherein the substitution effect can be observed. If the price of electricity skyrocketed, consumers can seek substitute means to electricity in order to minimize expenses. For instance, as long as the price of natural gas is lower than electricity, the customers will use gas for heating instead of electricity, so as to minimize their energy expenses. In the same manner, companies can move production around in order to utilize cheaper sources of energy and restructure their business models to gain the most cost efficiency.
Cheap Replacements of Luxury Goods
In luxury markets, it can be seen that when prices go up, consumers get lower-priced alternatives to high-end products. For example, if the price of a fashionable and popular brand’s high end handbags goes up a lot, the consumers who are still interested in the styles will turn towards slightly more affordable brands or even used luxury handbags that are more affordable. This substitution effect is evident in the behavior of consumers who begin to seek alternatives that are less expensive when the market for luxury items is too expensive.
Changing Movie Theatres for Streaming Services
The emergence of streaming platforms such as Netflix and Amazon Prime for their subscribers’ use is an instance of substitution as a result of improved technology and cost. With the increasing cost of tickets to movie theaters and the possibility of watching films at home, the internet has substituted many people’s visits to the cinema with online streams of films. Such behavior depicts the substitution effect which occurs when consumers decide to spend less and choose more convenient purchasing options, when the prices of going out to the movies get too high.
The examples illustrate how the substitution effect works in different parts of the economy, affecting how consumers behave or make decisions when prices change. Using such examples can help you balance the tone of your article and the focus on the way the substitution
