Substitute Goods; Pens and Pencils
Substitute goods can be defined as those goods that customers views as alternative. They can also be seen as those goods that give consumers similar benefits. In other words, these goods satisfy the same needs. In most cases, the buyer takes several things into consideration before making their final decisions on the choice of the goods to buy more so in the case of substitute goods.
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In this case, pens and pencils can be considered as substitute goods. This is because they yield same benefits to the consumer. For instance, both pen and pencil are used for writing. They can be used interchangeably. Consumers may either decide to write using pen or using a pencil. Therefore, pens and pencils are perfect substitutes. This is because they are both used exactly for the same purpose, which is writing.
Impacts on supply of pens of a technological breakthrough which reduces the cost of producing pens
Substitute goods usually offer a high level of competition in the market. This is because buyers can easily substitute them any time. This aspect creates competition between these products.
In this case, if a technological breakthrough reduces the cost of producing pens, then the minimum price levels which pen producers can offer in the market will fall accordingly. This will lead to a fall in prices of pens. However, the prices of pencils will remain constant.
The quantity of a product supplied in the market is directly proportional to the prices of the product in the market (Forgang and Einolf 171). In other words, the higher the prices, the higher the quantities of a specific product that producers will be willing to provide in the market.
In this case, technological advancement has led to reduction in the cost of production of pens. This implies that the producer will be willing to supply a larger quantity of pens at the prevailing price levels. Therefore, the quantity of pens supplies in the market is more likely going to increase.
As a result of reduction in the production cost of pens, producers may decide to lower the prices. As a result, pens will become cheaper compared to pencils. Since the two commodities are substitutes, some buyers will shift from using pencils to pens.
However, this statement is based on the assumption that the consumers are behaving rationally. A rational consumer will tend to choose an alternative that maximizes their benefits and minimizes their costs.
Figure 1: Supply curve for pens
A technological breakthrough in pen manufacturing will cause the supply function of the pens to shift outwards. The quantity of pens supplied will increase significantly. This is as a result of increase in the quantity demanded as a result of a fall in prices.
Impacts on the price of pens and the quantity demanded for both pens and pencils after a technological breakthrough which reduces the cost of producing pens
Since substitute goods can be used interchangeably, they exert competitive pressure in case the prices or the quality of one of these products changes. In this case, a technological development has led to a significant reduction in the prices of pens. As a result, the quantity of pens demanded will increase.
Figure 2: The demand curve for pens.
From the graph above, it is clear that the quantity demanded is inversely proportional to the prices. In other words, the higher the prices, the lower the quantity of a product demanded and vice versa. From the graph above, the original price of pen was p1.
After a technological breakthrough, the production of pens falls significantly. As a result, the prices of pens fall from p1 to p2. At price p1, the buyers are willing to buy Q1 of pens. At price level p2, the buyers are willing to buy Q2 of pens. Therefore, it is clear that the quantity of pens demanded will increase significantly after a fall in prices.
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On the other hand, the quantity of pencils demanded will fall significantly. Since pens and pencils are substitutes and that they serve the same purpose to the consumer, most of the buyers will turn to buy pens because they will be cheaper.
The substitute goods usually have positive cross elasticity of demand. This implies that an increase in price of one of these goods leads to an increase in prices of the other good. Consequently, the quantity of pencils demanded will fall significantly.
Figure 3: Demand curve for pencils.
From the graph above, a decrease in the prices of pens will cause the demand curve for pencils to shift in. This leads to a reduction in the quantity of pencils demanded significantly.
How managers for pen-makers and pencil-makers should decide given the above answers
From the above discussion, it is clear that the technological breakthrough in production of pens will favour pen manufacturers while it will present a big threat to the pencil manufacturers.
This is because the quantity demanded of pencils will tend to fall as more people shifts from using pencils to pens which are now cheaper than before. Therefore, there is a need for the managers of pen-makers and pencil-makers to take appropriate actions in order to retain and improve their performance respectively.
For the pencil-makers manager, it is advisable to take appropriate actions which can reverse the trends of demand for pencils arising from a fall in prices of pens. One of the actions that the managers can consider is differentiation. Differentiations play a significant role in increasing the sales of substitute goods which tends to compete in the same market (Piana par 6).
According to Forgang Einolf, differentiation will also help the pencil makers from reducing prices to unprofitable levels (170). Since pens and pencils do not have exact identical features, it will be easier to differentiate the two products.
This can be through improvement in the quality and also introducing a wide variety of pencils. As a result, buyers will tend to buy the product to enjoy the unique features which are not present in the other substitutes. As a result, the demand for pencils will increase.
On the other hand, the managers for pen-makers need to apply appropriate measures in order to maximize their profits. Since the level of demand for the pens has increased, the managers should take necessary measures to increase their production in order to satisfy the increase in demand.
This will help in reducing shortages of peens in the markets. This may require expansion in their production capacities in order to satisfy this demand.
Forgang, William and Einolf, Karl. Management Economics: An Accelerated Approach. New York: M.E. Sharpe, 2007.
Piana, Valentino. “Substitute Goods.” Economics Web Institute, 2005. 24th June. 2011. <http://economicswebinstitute.org/glossary/substitute.htm>