Perfect and imperfect substitutes Perfect substitutes Perfect substitutes refer to a pair of goods with uses identical to one another. In that case, the
utility of a combination of the two goods is an increasing function of the sum of the quantity of each good. That is, the more the consumer can consume (in total quantity), the higher level of utility will be achieved, see figure 3. Perfect substitutes have a
linear utility function and a constant
marginal rate of substitution, see figure 3. If goods X and Y are perfect substitutes, any different consumption bundle will result in the consumer obtaining the same utility level for all the points on the indifference curve (utility function). Let a consumption bundle be represented by (X,Y), then, a consumer of perfect substitutes would receive the same level of utility from (20,10) or (30,0). Consumers of perfect substitutes base their rational decision-making process on prices only. Evidently, the consumer will choose the
cheapest bundle to maximise their profits. An example of perfect substitutes is butter from two different producers; the producer may be different but their purpose and usage are the same. Perfect substitutes have a high cross-elasticity of demand. For example, if
Country Crock and Imperial margarine have the same price listed for the same amount of spread, but one brand increases its price, its sales will fall by a certain amount. In response, the other brand's sales will increase by the same amount.
Imperfect substitutes Imperfect substitutes, also known as close substitutes, have a lesser level of substitutability, and therefore exhibit variable marginal rates of substitution along the consumer
indifference curve. The consumption points on the curve offer the same level of utility as before, but compensation depends on the starting point of the substitution. Unlike perfect substitutes (see figure 4), the indifference curves of imperfect substitutes are not linear and the marginal rate of substitution is different for different set of combinations on the curve. Close substitute goods are similar products that target the same customer groups and satisfy the same needs, but have slight differences in characteristics. Goods x_i and x_j are said to be net substitutes if : \left.\frac{\partial x_j}{\partial p_i}\right|_{u=const}>0 That is, goods are net substitutes if they are substitutes for each other under a constant utility function. Net substitutability has the desirable property that, unlike gross substitutability, it is symmetric: : \left.\frac{\partial x_j}{\partial p_i}\right|_{u=const} = \left.\frac{\partial x_i}{\partial p_j}\right|_{u=const} That is, if good x_j is a net substitute for good x_i, then good x_i is also a net substitute for good x_j. The symmetry of net substitution is both intuitively appealing and theoretically useful. The common misconception is that
competitive equilibrium is non-existent when it comes to products that are net substitutes. Like most times when products are gross substitutes, they will also likely be net substitutes, hence most gross substitute preferences supporting a competitive equilibrium also serve as examples of net substitutes doing the same. This misconception can be further clarified by looking at the nature of net substitutes which exists in a purely hypothetical situation where a fictitious entity interferes to shut down the
income effect and maintain a constant utility function. This defeats the point of a competitive equilibrium, where no such intervention takes place. The equilibrium is decentralized and left to the producers and consumers to determine and arrive at an equilibrium price.
Within-category and cross-category substitutes Within-category substitutes are goods that are members of the same taxonomic category such as goods sharing common attributes (e.g., chocolate, chairs, station wagons).
Cross-category substitutes are goods that are members of different taxonomic categories but can satisfy the same goal. A person who wants chocolate but cannot acquire it, for example, might instead buy ice cream to satisfy the goal of having a dessert. Whether goods are cross-category or within-category substitutes influences the utility derived by consumers. In the case of food, people exhibit a strong preference for within-category substitutes over cross-category substitutes, despite cross-category substitutes being more effective at satisfying customers' needs. Across ten sets of different foods, 79.7% of research participants believed that a within-category substitute would better satisfy their craving for a food they could not have than a cross-category substitute. Unable to acquire a desired Godiva chocolate, for instance, a majority reported that they would prefer to eat a store-brand chocolate (a within-category substitute) than a chocolate-chip
granola bar (a cross-category substitute). This preference for within-category food substitutes appears, however, to be misguided. Because within-category food substitutes are more similar to the missing food, their inferiority to it is more noticeable. This creates a negative
contrast effect, and leads within-category substitutes to be less satisfying substitutes than cross-category substitutes unless the quality is comparable. Unit-demand goods are always substitutes. ==In perfect and monopolistic market structures==