Question

If the price of a substitute (Y) of good X increases, what impact does it have on the equilibrium price and quantity of good X?

Answer 1

X and Y being substitute goods, if the price of Y increases, then it will reduce the demand for Y and people will switch to X, which will raise the demand for X. Thus, the demand curve will shift from D₁D₁ to D₂D₂ . At the existing price P₁, there will be an excess demand. Due to the pressure of excess demand, the existing price will increase. Consequently, the new equilibrium occurs at E₂, where the new demand curve D₂D₂ intersects the supply curve S₁S₁. The new equilibrium price is P₂, which is higher than P₁ and equilibrium quantity is q₂, which is higher than q₁. Therefore, due to the increase in the price of substitute good Y, the equilibrium price of X will rise and equilibrium output of X will also be higher.