Monday, March 21, 2011

Gas and Cars are considered Complements in Econ 101... But can they be Substitutes too? I guess that is learned in Econ 102....

In Microeconomics we learn that a change in price of one good can have an affect on the demand for a second related good. That relationship can be in the form of a Complement or a Substitute. Complements are goods that are separate and distinct, but are usually used together---gasoline and cars/trucks/SUV's, for example. With complements there is an inverse relationship between price and demand---If the price of gasoline INCREASES, the demand for cars, trucks and SUV's tends to DECREASE.  Is this what is happening in the passage below?

Panic buying raises prices on Prius, Fit
Americans have begun snapping up Toyota Prius, Honda Fit and other fuel-efficient models made only in Japan almost the way shoppers denude bread and milk shelves in a supermarket when a storm is predicted.

The intensity first spurred by rising gas prices has been amplified by predicted shortages of many models as the Japanese auto industry remains disrupted by the March 11 earthquake and its aftermath.
No! The price of gasoline is increasing BUT the demand for hybrids and electric vehicle is also increasing. If the price of one good, gasoline, INCREASES and the demand for a related good INCREASES (vehicles) then the goods are considered SUBSTITUTES.

Gasoline and cars substitutes?

Did I not just say they were Complements? Can they be both at the same time? Well, not really.  In this case you have to link gasoline with the alternative that a hybrid vehicle offers.

As the cost of operating  gas-powered vehicles INCREASES because of higher gas prices, the demand for hybrids/electric-powered cars INCREASES.  You are substituting a portion of your gasoline consumption with a hybrid that operates on something OTHER THAN gasoline---batteriers and/or electricity.

This is not normally and example I use when introducing students to the concepts of Complements and Substitutes because, well, it muddies the water.  Welcome to the next level in Economics...Do you feel elevated??? :)
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