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Definition of Perfect Substitute:
A perfect substitute
is a good or service that regardless of what company furnishes the good, consumers regard the product furnished by all of the companies as identical. A buyer is indifferent as to which good is purchased. Standardized products are perfect substitutes.
Two goods are substitutes if they can be used for the same function, but they are not the same product. Fuji and Gala apples are substitute goods. Whether two goods are perfect substitutes depends on the consumer’s preference. To illustrate the difference between substitutes and perfect substitutes, suppose Mark is shopping for apples. The Gala and Fuji apples are $0.50 each. Mark chooses the Gala apples because he prefers Gala apples. One week later, Mark returns to the grocery store and notices the Gala apples are selling for $.50, but the Fuji apples are selling for $0.47. Mark purchases the Gala apples. The price difference is not worth changing. In the third week, the price for Fuji apples is reduced to $0.45. Mark chooses the Fuji apples because of the price difference. In Mark’s case, the Gala and Fuji apples are substitutes, but not perfect substitutes. Mark prefers Gala apples and is willing to pay a slightly higher price for them. Two goods are perfect substitutes when a consumer is indifferent between the two. Mark would not have cared which apple he purchased and would have switched to the Fuji apples on the second day if Mark viewed Gala and Fuji apples as perfect substitutes. Price is the only factor influencing a buying decision when choosing between perfect substitutes.
Standardized products are perfect substitutes. Examples of standardized products include agricultural products (such as grain and milk), most mined minerals, and fish. A buyer of wheat cannot tell who produced the bushels of wheat. Furthermore, the buyer does not care because the grains are identical. If several lobsters are placed in a tank, a buyer could not tell which lobster was caught by a given fisherman, nor would the buyer care. A buyer cares about the price of the lobster, not who provides it.
Many companies invest large sums of money to differentiate its good or service from others. Their objective is usually to justify selling their good at a higher price. In these cases, a company is trying to convince buyers that the substitute good it offers is better than the competition’s good. For example, petroleum companies produce a standardized product – gasoline – but companies may market their gasoline as superior because of an additive, or they may try to build brand loyalty by developing a better image than their competition. Whether or not gasoline is a perfect substitute depends on the consumers’ response. Suppose two gasoline companies serve the same neighborhood. One company, Company A, advertises extensively, while the other, Company B, does not. If consumers do not differentiate between companies and purchase from the lowest priced provider, then gasoline remains a perfect substitute, but if they choose Company A – even though its price is slightly higher, then Company A successfully differentiated its gasoline, and the two brands of gasoline are no longer perfect substitutes.
Dig Deeper With These Free Lessons:
Market Structures Part I - Perfect Competition and Monopoly
Market Structures Part II - Monopolistic Competition and Oligopoly
Supply and Demand - When Consumer Tastes Change