i am reading an intro to macroeconomics…i can follow most of it, so far, but one concept at this stage has me stumped.
the quote is that when the price of a substitute in production increases, the supply of the ‘original’ good will fall. this doesn’t make sense to me. wouldn’t an increase in the price of a substitute show an increase in demand for all similar goods? that seems to be the case in a substitute on the demand side of the equation.
thanks
hh
Yes, and as the “demand for all similar goods” increases, more people are buying them, and the supply decreases (until they start making more).
panache45 , you are confusing “supply” with “availability”. There will be a decrease in availability yes, but this does not mean there is less of the product being produced.
I’m also a little confused here, handsomeharry, because as you said, an increase in the price of a substitute will lead to an increase in demand at the same price of the “original” good - which in turn should result in an increase in supply.
The other thing that confuses me is that that seems like a microeconomics question to me.
If the price of a substitute good increases, producers will shift production from the original good towards the substitute in hopes of capturing a greater margin.
As a result, less of the original good will be produced, leading to a decrease in supply.
Like you said, an increase in the price of a substitute will lead to an increase in demand at the same price. An increase in demand causes an increase in the quantity supplied, not supply. If the price stays the same, there is no inducement to increase supply.
It is a macro issue, not micro.
welp, i’m still mystified.
so, KidCharlemagne, just to help me get straight (and in my definitions)
say a sport shoe, the Nike xz123ke etc… goes for one hundred dollars a pair, and a substitute for it would be a new balance 101Winter sport jogger deluxe at the same price. given an increase in the Nike to, say, 120 bucks, then the supply of the new balance would drop because…well, that’s where my problem is.
wouldn’t the new balance people still be selling at 100, thus getting a substitute at the same price…and also eating up some of Nike’s 100 per pair market share, yielding an increase in quantity supplied? that being the case, supply would be the same, wouldn’t it?
thanks everyone for your answers!
hh
I think in your running shoe example, you aren’t talking about substitute goods. You’re talking about competitors making a single good: “sport shoes.” Aside from branding issues and whatever made-up technological advance Nike has come up with this season, the shoes are essentially the same.
Perhaps a better example would be rice and corn. The two goods are substitutes in that people could have either one for dinner, but the more rice they eat, the less corn they’ll need. If the price of rice goes up, there will be corn farmers who quit growing corn and decide to produce rice next season, because they can get more money back for the same amount land and labor.
I’m going to explain it in terms of butter and margarine rather than two competing brands of sneakers because brand names will have a certain inelasticity of supply; i.e, Nike can’t just start making New Balance sneakers and it will be harder to conceptualize a change in production.
Let’s assume that when margarine and butter both sell for $100/lb, producers of each sell 1000 units a year. Now let’s assume that butter producers, for whatever reason, raise their price to $120/lb. Price-conscious consumers, who previously bought butter, may now be willing to buy the relatively cheap margarine instead. At $120/lb butter, perhaps 200 butter users will switch to margarine at a price of $100/lb margarine so now a total of 1200 units of margarine are demanded at that price. If butter rose to only $110, maybe only 100 butter users would switch. Since more margarine will be demanded at each price, we say that demand has increased (if you have a S/D graph in front of you, the entire demand schedule would move to the right).
When producers of margarine see that butter is now selling at a $20 premium to margarine, some margarine producers will say, “Fuck this, I’ve got the infrastructure to produce butter just as easily as margarine. At $20/lb more I’ll just make butter!” With butter selling at $120, and margarine at only $100, perhaps two producers of margarine, who previously supplied 100 units total, will switch to making butter. Now only 900 units of margarine are offered at $100, where previously 1000 units were offered at that price. Since fewer units are offered at any given price, supply has decreased. On a S/D graph, the supply curve will have shifted left.
If consumers are now willing to buy 200 more units of margarine and suppliers are now supplying 100 units less, there is a 300 unit “shortage” at a price of $100. Since demand is exceeding supply, the price must rise. Of course, rather than switch production, the margarine producers would just say, “Fuck this, I’m raising my prices too,” but the mechanism of supply and demand is still the same.
Hope that helps.
Auntie and Kid
thank ya, thank ya, thank ya!
both of you helped clear my thinking substantially! now, i’m much smarter!
thanks again,
hh