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Why does a price increase of a substitute decrease the current supply? Why don't the...

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neiluhz | eNoter

Posted May 22, 2013 at 1:06 PM via web

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Why does a price increase of a substitute decrease the current supply? Why don't the producers abuse that and just charge a higher price for their product instead of changing to the other product?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted May 22, 2013 at 1:39 PM (Answer #1)

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The main reason for this is that the rising price of a substitute does not in any way mean that the consumers of the current good are going to be willing to buy the same amount now but at a higher price.  In other words, the demand for the current good does not rise and so there is no way that the producer can raise prices and still sell the same amount of the good.

Let us say that I have a clothing factory and I could make shorts or jeans with the facilities I have on hand.  Let us say I am making shorts but the price of jeans goes up and I want to change to make them.  You are asking why I don’t raise the price on shorts.  The answer is that there is not any greater demand for shorts than there used to be.  The consumers are not going to say “hey, I heard that jeans are getting to be more expensive so I think I’ll pay more for my shorts.”  The demand does not change, so I cannot just raise my prices and expect to be able to sell the same amount of shorts.   

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neiluhz | eNoter

Posted May 22, 2013 at 2:16 PM (Answer #2)

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You're talking about a 'substitutes-in-production' case in the frame of a single firm which can convert it's production from one good to another(again, having in mind that the both goods are substitutes-in-production and they're made of the same resources). In my case, it's a bit different. I am talking about different firms, each specialized at producing a different substitute(i.e. margarine, butter, etc..). Example here will be the production of fizzy drinks. Let's say Pepsi and Coca Cola. If the price let's say of Coca Cola goes up, the demand for Coke will inevitably go down and switch to Pepsi. This leads to a greater quantity demanded for Pepsi. In this case, Pepsi can take the decision to follow the price increase of Coca Cola and in a way to balance the old demand but with a higher prices, thus increasing their profit on Coca Cola's back. What's the story now? And, I'm very thankful for the quick response you gave me, I hope you can give me a hand this time too.

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