4 responses 01/28

Rakshith work:

The Substitution Effect

The substitution effect refers to a decrease in product sales as consumers switch from one good to another as the price of the current good increases, thus forcing the consumers to switch to more affordable products (Froeb et al., 2015). Generally, substitution effects start when the price of products increases, but their income remains the same, their purchasing power remains at the same level as before since their real income remains constant. Consumers may adjust accordingly to remain in the same utility without substituting the products in case of an income effect. However, though goods follow the substitution effect principle, there is a package of specific goods known as Giffen goods where the increase in price increases demand and thus sales. The same applies to the Veblen luxurious goods used to appeal for status or as a symbol of power, such as luxury cars and designer perfumes, among many others (Hirschey & Bentzen, 2016).

In this case, I will use E-books and regular books as substitute products. The Covid 19 pandemic disrupted many activities globally, including the social and academic schedules. The lockdowns and the restriction of movements to curb the disease's spread forced the learning institutions to adopt a new normal by creating E-learning platforms that replace the real classroom setting to induce knowledge to students. This means that the prices of E-learning resources such as the E-books hiked compared to the regular books.

The price of regular books hence dropped since many consumers preferred the E-books to them, the reduction of price has seen an increase in demand of regular books as many consumers and reading enthusiasts take the opportunity created by the low prices to stock their libraries in anticipation of normalcy in recent days. As E-books' price increased, consumers have substituted them with the regular books whose price is low. The trend portrayed by these two products makes them perfect substitutes since the decrease in regular books' price causes a decrease in demand for e-books. Additionally, as the demand for regular books increases with the increase in the price of E-books, an aspect known as the cross elasticity of demand (Baye & Prince, 2017).

 

 

References

Baye, M. R., & Prince, J. T. (2017). Managerial economics and business strategy (9th ed.). McGraw-Hill Education ISBN 9781259290619

Froeb, L. M., McCann, B. T., & Ward, M. R. (2015). Managerial economics. Cengage learning.

Hirschey, M., & Bentzen, E. (2016). Managerial economics. Nelson Education.

Dushyanth Work:

  According to the Corporate Finance Institute (n.d) report, substitution effect is the change in demand after a commodity’s price changes relative to its substitutes. Thus, if a commodity’s price rises, the move makes it less affordable compared to other available commodities. It necessitates consumers to shift their consumption to other substitutes. The inference shows that we have to assume the consumer’s income remain cost. The demand change results from relative price changes, holding other factors constant.

            The report also gave the example of rice costing $ 5 per pound and pasta being costs $ 10 per pound. The prices allow consumers to consume more pounds of rice and less of pasta. However, technological advances makes it cheaper to produce rice. The price of rice becomes $ 2 per pound, while that of pasta remains $10 per pound (Corporate Finance Institute, n.d). The change in price leads to more consumption of rice as the consumption of pasta reduces.

            La Cava (2016) gave the real case example of reducing house prices increased demand for homes (p.2). The price decline resulted from declining nominal interest rates. Therefore, the costs of possessing homes reduced and people increased their demand for housing. The trend led to reduced demand for renting, as the consumers opted for lending funds to build their homes. However, the trend occurs if the households have access to credit. The accessibility streamlines acquisition of mortgages and building homes. The author noted that the rise in demand does not depend on the household’s income (La Cava, 2016). The consumers use the reduced price of homes, given their income remains constant.

References

 Corporate Finance Institute. (n.d). Substitution Effect. Retrieved from https://corporatefinanceinstitute.com/resources/knowledge/economics/substitution-effect/

La Cava, G. (2016). Housing Prices, Mortgage Interest Rates and the Rising Share of Capital Income in the United States. BIS Working Papers, No 572, pp. 1- 38