Question

In recent years the price of a computer has fallen. What effect is this price change likely to have on the demand for software? Explain your answer.

Short answer

The fall in the price of computers—a complementary good to software—will likely increase software demand. This is because more affordable computers lead to larger customer bases, which in turn increases the pool of potential software users.

Step-by-step solution

Principle of complementary goods

Understand the basic economic concept of complementary goods. These are pairs of goods where the use of one good complements the use of another. In our case, computers and software are complementary goods. Because the use of software requires a computer.

Complementary goods relationship

Next, comprehend the relationship between a decrease in the price of one complementary good and the demand for its counterpart. Generally, if the price of one complementary good falls (e.g., computers), the demand for its counterpart (e.g., software) increases.

Reasoning for Increased Demand

Now, reason why the fall in the price of computers leads to an increased demand for software. With cheaper computers, more people are likely to afford and buy them. Consequently, the pool of potential software users increases, leading to a rise in software demand.

Key concepts

Price Elasticity

Price elasticity is crucial to understand how the quantity demanded of a good changes when its price changes. It is measured as the percentage change in quantity demanded divided by the percentage change in price. For complementary goods, like computers and software, the concept of cross-price elasticity is important. Cross-price elasticity measures how the quantity demanded of one good responds when the price of another related good changes. When two goods are complements, a decrease in the price of one (such as computers) may lead to an increase in the demand for the other (like software). This happens because they are typically used together, and the lowered cost of one encourages more usage of both.

• Complements have a negative cross-price elasticity.
• A decrease in the price of one good can lead to an increase in the demand for its complement.

For example, if computers become cheaper, more people can buy them, which in turn increases the demand for software. This ripple effect highlights the interdependence of complementary goods in the market.

Demand Increase

When the price of a computer drops, more consumers find it affordable and worthwhile to purchase. This increase in purchases causes a ripple effect in the demand for complementary goods, like software. This is known as a 'demand increase' in economic terms.

• The decrease in computer prices boosts affordability and accessibility.
• Increased computer purchases directly lead to higher software demand.

Think about it in simple terms: if you buy a new computer, you'll probably also need software to make the most out of it. Whether it's operating systems, word processors, or games, the need for software naturally rises with more computers in consumers' hands. Thus, demand increases occur when more consumers in the market decide to all make similar purchases shortly after a complementary good's price drop.

Economic Principles

Economic principles help us understand trends and relationships in the market, such as the interplay between complementary goods. The concept revolves around linked demand drivers and how various goods influence each other's consumption. Several economic principles can explain the observed phenomena when computer prices fall:

• Substitution effect: Fewer substitutes may be purchased if cheaper computers fulfill consumer needs better.
• Income effect: Consumers feel richer when prices drop, leading them to buy more, including complementary products like software.

Together, these economic principles elucidate why a decrease in the price of one good doesn’t only affect that good alone but also spills over to boost the demand for associated products. The synergy between different economic agents showcases how interconnected our markets are and how pricing strategies can lead to significant changes in consumer behavior.