How does the price of related goods influence demand?

The price of related goods influences demand through the principles of substitutes and complements.

In economics, the demand for a product can be significantly influenced by the prices of other related goods. These related goods can be categorised into two types: substitutes and complements.

Substitutes are goods that can be used in place of each other. For example, tea and coffee are substitutes. If the price of coffee increases, consumers may switch to drinking tea instead, leading to an increase in the demand for tea. This is known as the substitution effect. It's important to note that the closer the substitutes, the more responsive the demand will be to changes in price.

On the other hand, complements are goods that are typically used together. For example, bread and butter are complements. If the price of butter increases, consumers may decide to buy less bread as a result, leading to a decrease in the demand for bread. This is known as the complementary effect.

The price elasticity of demand (PED) is a measure used to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. For substitutes, the PED is positive, meaning that as the price of a substitute good increases, the demand for the other good increases. For complements, the PED is negative, meaning that as the price of a complementary good increases, the demand for the other good decreases.

Understanding the relationship between the price of related goods and demand is crucial for businesses and policymakers. For businesses, it can help in pricing strategies and predicting changes in sales. For policymakers, it can assist in understanding the potential impacts of taxes, subsidies, and other policy measures on the demand for goods and services.

IB Economics Tutor Summary: In simple terms, the demand for products can change based on the prices of goods that are either substitutes (like tea and coffee) or complements (like bread and butter). When substitutes get pricier, people might switch to other options, increasing demand for those. If complements become more expensive, demand for related goods can drop. This concept helps businesses and policymakers make informed decisions.