Principles of Macroeconomics / Unit 2 MAC 0112 worked example, 60 to 90 seconds
Substitutes or Complements?
The idea
Two goods are related when the price of one shifts the demand for the other, and the direction tells you which relation it is. Ask what a fall in the price of the first good does to demand for the second. If demand for the second rises, the two are complements, used together. If demand for the second falls, the two are substitutes, used instead of each other. The test works in reverse as well: a rise in the price of one raises demand for its substitute and lowers demand for its complement.
In practice
Worked example: cheaper printers raise demand for ink, so they are complements. Cheaper tea lowers demand for coffee, so they are substitutes. Cheaper flights raise demand for hotel rooms: complements. A cheaper bus fare lowers demand for rail tickets: substitutes.
Where people slip
Do not classify by whether the goods seem similar. Tea and coffee are substitutes because of what the price change does, not because both are hot drinks, and the test is always the direction of the demand shift.
Your place on the trail
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Builds on
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