If two goods are substitutes, what happens when the price of one rises?

Question

BlackTom AI · Accepted Answer

First, let’s restate the scenario and the options to ensure clear understanding. We’re told two goods are substitutes, and the price of one rises. The options are:
- Supply for one good will increase.
- Demand for both goods increases.
- Demand for the first good decreases.
- Demand for the other good will increase.

Now, evaluate each option one by one:
Option 1: 'Supply for one good will increase.' This is not correct. A change in the price of one good does not cause a shift in the supply curve of either good; supply is determined by factors like production costs and technology, not by the price of a substitute in consumption. So this statement confuses price effects with supply behavior.

Option 2: 'Demand for both goods increases.' With substitutes, when the price of one good rises, consumers substitute toward the other good, so the demand for the second good increases. However, the demand for the first good does not rise due to its own price increase; in fact, for the first good, quantity demanded would fall as price rises. Therefore, saying demand for both increases misstates the effect on the first good's demand.

Option 3: 'Demand for the first good decreases.' This statement mixes up the distinction between demand and quantity demanded. A rise in the price of the first good typically leads to a decrease in the quantity demanded of that good along its own demand curve, not a decrease in the demand (which would shift the entire curve). Since the prompt concerns the price change of the first good, we should be careful to use 'quantity demanded' rather than 'demand' for the first good. Because the option uses 'demand,' it is not an accurate description of the typical effect, and thus is incorrect.

Option 4: 'Demand for the other good will increase.' This is the correct reaction to a price rise for a substitute good: consumers switch to the substitute, increasing its demand (a rightward shift of the demand curve for the other good).

In summary, the only option that correctly describes the standard substitution effect when the price of one substitute rises is that the demand for the other substitute increases. The other options either misstate market mechanics (supply changes) or confuse demand with quantity demanded, or wrongly assert that both demands rise. The correct understanding hinges on the substitution effect: higher price of one substitutes pushes buyers toward the other, increasing its demand.

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