Notes on Substitutes, Complements, Demand, and Supply

Substitutes and Complements (two relationships between goods)

• Substitutes (intuitive): two goods that serve the same purpose; consuming one reduces the need for the other. Example: Coke and Pepsi. If I’ve had Coke, I don’t need Pepsi; if Coke becomes expensive, I switch to Pepsi.

• Substitutes (technical): two goods are substitutes if an increase in the price of one leads to an increase in the demand for the other, and conversely, a decrease in the price of one leads to a decrease in the demand for the other.

  • Formal intuition: \Delta PA \uparrow \Rightarrow \Delta DB \uparrow and \Delta PA \downarrow \Rightarrow \Delta DB \downarrow

• Complements (intuitive): goods that are typically consumed together; the consumption of one increases the consumption of the other (or makes sense only with the other). Examples: smartphones and apps; college tuition and textbooks; bagels and cream cheese; cookies and milk.

• Complements (technical): two goods are complements if an increase in the price of one leads to a decrease in the demand for the other, and conversely, a decrease in the price of one leads to an increase in the demand for the other.

  • Formal intuition: \Delta PA \uparrow \Rightarrow \Delta DB \downarrow and \Delta PA \downarrow \Rightarrow \Delta DB \uparrow

• Practical takeaway: substitutes and complements explain how demand for one good responds to changes in the price of another good, holding other factors constant.

Change in taste and consumer expectations

• Change in taste (preferences): if taste becomes more favorable for a good, demand increases; if less favorable, demand decreases.

  • Example: an ad claim that orange juice lowers cholesterol might increase demand (even if the claim is dubious).

• Expectations about the future:

  • Higher expected future income → higher current demand (consumers borrow or spend more now when they expect to earn more later).
  • Higher expected future prices → buy more today (to avoid higher prices tomorrow), especially for durable goods; this can raise current demand now and potentially raise prices today (self-fulfilling loop).

• Summary of demand drivers beyond price:

  • Taste and preferences
  • Prices of related goods (substitutes/complements)
  • Income (and whether the good is normal or inferior)
  • Expectations about future income and prices

Demand vs. quantity demanded; shifts vs. movements

• Quantity demanded (a number): how many muffins I am willing to buy at a given price.

• Demand (the relationship): the entire price-quantity relationship for a good.

• Movement along the demand curve (change in quantity demanded): caused by a change in the price of the good itself; other determinants held constant.

• Shift of the demand curve (change in demand): caused by non-price determinants (taste, related goods’ prices, income, expectations, etc.); the entire curve shifts to a new position.

• Important distinction: only the good’s own price causes a movement along the demand curve; all other determinants shift the curve.

• Quick example with orange juice:

  • Price of apple juice increases (substitute relationship): demand for orange juice increases (shift of the orange juice demand curve to the right).
  • Price of orange juice falls (price change of the good itself): this is a movement along the orange juice demand curve, not a shift of the curve.
  • Consumers’ income falls (normal good): demand for orange juice shifts left (decreases).

Demand and supply: basic definitions and shapes

• Demand: the relationship between price and quantity demanded by consumers; typically downward-sloping.
• Supply: the relationship between price and quantity supplied by producers; typically upward-sloping.
• Demand curve vs. supply curve:
  • Demand curve: downward-sloping due to the law of demand (as price falls, quantity demanded rises, all else equal).
  • Supply curve: upward-sloping due to the law of supply (as price rises, quantity supplied rises, all else equal).
• Market vs. individual:
  • Individual demand vs. market demand: market demand is the horizontal sum of all individual demands.
  • Individual supply vs. market supply: market supply is the horizontal sum of all individual supplies.

Shifters of the demand curve

• The price of the good itself moves along the demand curve (not a shift).
• Non-price determinants that shift the demand curve include:
  • Tastes and preferences (change in taste)
  • Prices of related goods (substitutes and complements)
  • Income (normal vs. inferior goods)
  • Expectations about future income and future prices
  • Number of buyers (not explicitly mentioned in the transcript, but commonly included in standard analysis)

Shifters of the supply curve

• As with demand, a movement along the supply curve is caused by the price of the good itself.

• Non-price determinants that shift the supply curve include:

  • Input prices (costs of factors of production like wages, beef patties, bread, mayo, etc.)
  • Technology (improvements can make production cheaper or easier)
  • Number of sellers (more sellers increase overall supply)
  • Expectations about future prices (if suppliers expect higher prices, they may restrict or expand current supply accordingly)

• Example: hamburgers at a McDonald’s drive-thru

  • If input prices (beef, bread, wages, mayo) fall, production becomes cheaper, increasing profitability, so supply increases.
  • This change causes a rightward shift of the supply curve (an increase in supply).

• Directional caveat (the transcript’s focus on intuition):

  • For demand, a rightward shift means an increase in demand.
  • For supply, a rightward shift means an increase in supply.
  • Because the supply curve is upward-sloping, a vertical shift up (the curve moving higher) can be interpreted as a decrease in supply (a leftward shift in practical terms), while a vertical shift down can be interpreted as an increase in supply. The key is: horizontal shifts correspond to changes in quantity supplied at each price (increase = rightward shift; decrease = leftward shift), and vertical moves are typically reinterpreted as changes in price needed to achieve a given quantity.

• Alternative interpretation of the supply curve:

  • You can read the supply curve as: given a price, how many units will I supply? (price-to-quantity interpretation)
  • Or: given a target quantity, what is the minimum price at which I am willing to supply that quantity? (quantity-to-price interpretation)
  • A decrease in input prices makes it easier to produce, so the minimum price to supply a given quantity falls (shift to the right in the price-for-quantity interpretation).

Practice question: law of demand (conceptual)

• Given a scenario where the price of coffee changes and quantity demanded responds, the law of demand says:
  • When the price of coffee rises, quantity demanded falls (holding other determinants constant).
  • When the price of coffee falls, quantity demanded rises.
• In the transcript’s example (numbers imperfect in the text), the question asked which outcome is most likely when price changes from a given level:
  • Expectation: higher price → fewer cups demanded (i.e., they will buy fewer than the previous quantity).
  • The correct option aligns with the law of demand: higher price leads to lower quantity demanded.

Key takeaways and quick recap

• Demand vs. quantity demanded:
  • Quantity demanded is a single number at a given price (movement along the demand curve).
  • Demand is the overall relationship between price and quantity demanded (shift of the curve due to non-price determinants).
• Substitutes vs. complements:
  • Substitutes: price rise in one increases demand for the other; price fall in one decreases demand for the other.
  • Complements: price rise in one decreases demand for the other; price fall in one increases demand for the other.
• Demand shifters (non-price determinants): taste, prices of related goods, income, expectations, number of buyers.
• Supply shifters (non-price determinants): input prices, technology, number of sellers, expectations about the future.
• Movement along vs. shifts:
  • Movements along curves are caused by price changes of the same good.
  • Shifts are caused by non-price determinants and imply a new relationship between price and quantity.
• Market concepts:
  • Market demand and market supply are sums of individual demands and supplies across all sellers and buyers.

ext{Substitutes: } \Delta PA \uparrow \Rightarrow \Delta DB \uparrow, \quad \Delta PA \downarrow \Rightarrow \Delta DB \downarrow
\text{Complements: } \Delta PA \uparrow \Rightarrow \Delta DB \downarrow, \quad \Delta PA \downarrow \Rightarrow \Delta DB \uparrow
\text{Demand movement along curve (price change of the good): } \Delta QD \text{ along the demand curve} \text{Demand shift (non-price determinant): } D \rightarrow D' \text{ (curve shifts)} \text{Supply movement along curve (price change of the good): } \Delta QS \text{ along the supply curve}
\text{Supply shift (non-price determinant): } S \rightarrow S' \text{ (curve shifts)}