Substitutes economics is a very important concept of economics as well as marketing because once a company understands this economics than it helps the company in deciding both the products as well as pricing strategies of the company. A Substitute means alternative and in the case of economics it refers to availability of alternatives for any product or service and the reason why substitutes economics is important is because in real life there are only a few products or services which are without substitutes while most of the time one has the luxury of selecting substitutes for any product or service.
Substitutes economics should be looked from two angles, while one angle is elastic demand and another angle is inelastic demand, so if the product of company is one with elastic demand than it implies that consumers of the company are very sensitive to price of the product and once the company raises the price consumers will shift to substitutes of the product under question and conversely if the company reduces the price than consumers will buy more of company’s products. One of the most common examples of substitutes goods having elastic demand is Pepsi and coca cola and that is the reason why the price of both remains almost same all over the world because the moment they increase or decrease the price it will lead to fall or rise in demand of the product. Hence in a way companies which produce elastic goods have less pricing power and also they have no option but to follow the competitors when it comes to lower pricing so if Pepsi reduces the price than coca cola will have to respond and lower their price also if they want to retain consumers.
Another angle of substitutes economics is inelastic demand so if the company produces products having inelastic demand than company has some pricing power because products having inelastic demand are less affected by price increase implying that if company increases the price of product than demand for the product will not fall that drastically as is the case with elastic demand products. The most common example of inelastic good is the price of gas and petrol where the consumers will not shift to substitutes easily like electric cars even if the price of gas and petrol increases. Hence companies which produce inelastic good or service enjoy pricing power and can increase the price of products without any fear of customer switching to substitutes.
As one can see from the above that substitutes economics is very important as far as the company is concerned because if company producing elastic goods try to adopt policy of company producing inelastic goods then it will be a failure and if company producing inelastic goods does not know its pricing powers than also it will be in loss.