Question

If the rise in the price of service A leads to a fall in the price of service \(B\), we may conclude that __________. (LO2) a) services A and B are substitutes b) services \(A\) and \(B\) are complements c) services A and B are neither substitutes nor complements

Short answer

b) services A and B are complements

Step-by-step solution

Understand the information provided

The information states that when the price of service A increases, the price of service B decreases. We will use this information to see which option among a, b, and c accurately describes their relationship.

Analyze Option a)

Option a) states that services A and B are substitutes. In economics, substitute goods are goods that can be used in place of one another. When the price of one good (such as service A) increases, the demand for its substitute good (such as service B) would typically increase as well, leading to an increase in the price of the substitute good. However, in this case, when the price of service A increases, the price of service B decreases. Therefore, services A and B are not substitutes.

Analyze Option b)

Option b) states that services A and B are complements. In economics, complementary goods are goods that are used together or have a positive relationship in their demands. When the price of one good (such as service A) increases, the demand for its complementary good (such as service B) would typically decrease, leading to a decrease in the price of the complementary good. In this case, when the price of service A increases, the price of service B decreases. This scenario matches the definition of complementary goods. Therefore, services A and B are complements.

Analyze Option c)

Option c) states that services A and B are neither substitutes nor complements. Based on our analysis in steps 2 and 3, we have concluded that services A and B are complements. Therefore, this option is not correct.

Choose the correct option

Based on our analysis of the given information and options, we conclude that services A and B are complements. Thus, the correct answer is option b).

Key concepts

Substitute Goods

Substitute goods are products or services that can replace each other in consumption. They have a competitive relationship because consumers perceive them as alternatives. For example, tea and coffee are substitutes. If the price of coffee goes up, people might switch to drinking more tea instead.
When the price of a substitute increases, the demand for the other substitute usually goes up as well. This happens because consumers look for cheaper alternatives to meet their needs.
There are key points to remember about substitute goods:

• They satisfy similar needs or wants.
• If the price of one goes up, the demand for its substitute rises.
• They have a positive cross-price elasticity of demand.

This means if we see that the price of one service is rising, and at the same time, its substitute is becoming more expensive, we confirm they are substitutes. However, in our exercise, services A and B did not show this pattern.

Price Elasticity

Price elasticity measures how the quantity demanded of a good responds to changes in price. It tells us if a product's demand is sensitive to price changes. There are two main types:

• Price Elasticity of Demand (PED): This measures how demand varies with price changes. If a small change in price leads to a large change in demand, the good is considered elastic. Examples include luxury items.
• Price Elasticity of Supply (PES): This measures how supply changes in response to price changes. If producers can easily adjust the quantity supplied, the supply is elastic.

For substitute goods, the price elasticity of demand is important. Higher elasticity means consumers will replace a good with its substitute easily if prices change. But, with complements, like services A and B in our example, price elasticity shows a negative relationship, as when one's price goes up, the other's price and demand go down.

Economic Relationships

Understanding economic relationships between goods is crucial in economics. Products and services can either be substitutes or complements.

• Substitutes: As discussed, they can replace each other. Their relationship is characterized by competition.
• Complements: These products are used together. Consider smartphones and apps; buying one can increase the need for the other.

These relationships affect consumer choices and pricing strategies in markets. In our exercise, the price of service B fell when service A's price rose. Such a scenario indicates that they are complements. Complementary goods have a joint demand; how much consumers are willing to buy one affects the other. Recognizing these relationships helps in predicting market behavior and can guide efficient business strategies.