Tag: substitutes

Diamonds, (and Guns and Gulaabs)

“Even economics is based on the notion of “revealed preferences.” What people “think” is not relevant—you want to avoid entering the mushy-soft and self-looping discipline of psychology. People’s “explanations” for what they do are just words, stories they tell themselves, not the business of proper science. What they do, on the other hand, is tangible and measurable and that’s what we should focus on. This axiom, perhaps even principle, is very powerful but is not followed too much by researchers. Revelation of preferences is best understood by the betrothed: a diamond, particularly when it is onerous to the buyer, is vastly more convincing a commitment (and much less reversible) than a verbal promise.”

Skin in the Game, (A Brief Tour of Symmetry, Prologue, Part 2) by Nicholas Nassim Taleb

Before we move on to today’s topic, here’s some advice for you if you are just beginning your study of economics. Read as many books as you can lay your hands on by Taleb, and ask yourself why he disses economics so. You don’t have to agree with him – that is up to you – but you should try and understand where he’s coming from.

But now on to today’s topic.

Say you’ve finished learning a bit about economics, and you think you’re beginning to “get it”. Incentives matter, trade matters, prices matter yada-yada-yada. We get it. Demand curves slope downwards, and actually, if you think about it, economics is simple.

Yes?

Well, then answer me this: if the price of diamonds goes down, will demand for engagement rings increase, or decrease?

Take your time, there’s no hurry.

As I’m fond of saying in my classes, “whatever your answer, please also tell me why it is whatever it is”.

So – if you’ve learnt well, you should have predicted that demand will go up. The lower the price, the higher the demand will be!

Except, as it turns out, the world ain’t quite so simple. In the case of engagement rings, a reduction in the price of diamonds will lower the demand for ’em.

Why?

Because as both Imperial Blue and Taleb tell us, “a diamond, particularly when it is onerous to the buyer, is vastly more convincing a commitment (and much less reversible) than a verbal promise.”

That is, the point of buying the ring is to show to your betrothed that you have skin in the game. If it is cheap, it don’t count. How do you show your commitment to the relationship? By putting down an eye-wateringly large amount of money to buy a ring. If the eyes don’t water, it don’t count.

You will learn about value-in-use and value-in-exchange sooner or later as a student of economics. Turns out there is also value in signaling. And the value in signaling comes from how expensive the good is, in the case of the diamond ring.

De Beers started selling its own lab-grown diamonds in 2018 at a steep discount to the going price, in an attempt to differentiate between the two categories. The company expects lab-grown prices to continue to tumble, in what it sees as a tsunami of more supply coming on to the market, Rowley said. That should create an even bigger delta in prices between natural diamonds and lab grown, helping differentiate the two products, he said.

https://marginalrevolution.com/marginalrevolution/2023/09/a-diamond-pricing-puzzle.html

Please read the whole post, as always. But if lab-grown diamonds are indistinguishable from, well, natural diamonds, they ought to be substitutes. And if they are substitutes, a reduction in the price of one good ought to lead to a reduction in the price of its substitute. If Coca-Cola is made cheaper, Pepsi has very little choice but to follow.

Then how do we explain a company like De Beers deliberately reducing the price of a substitute? Not just reducing it! They’re saying that the reduction in the price is what helps differentiate the products!

This is a nuanced point, and worth a deeper explanation.

De Beers accepts and acknowledges that lab grown diamonds are substitutes for natural diamonds. It accepts that there is bound to be a reduction in the price of lab-grown diamonds because of the “tsunami” of the increase in supply of lab-grown diamonds.

So how do they try and ensure that the demand for natural diamonds stays the same? By reducing the price of lab-grown diamonds even more than the market price. Demand for natural diamond goes up, the cheaper the lab grown diamonds are. De Beers is simply hastening that process.

As I’m fond of saying, you should always ask a simple question: what are you optimizing for?

And in the case of diamond rings, you ain’t optimizing for saving money. You’re optimizing, in fact, for spending money.

Signaling matters!

And speaking of skin in the game, if you can’t afford a diamond ring, what might make for an acceptable substitute…?

Thinking Aloud on Teaching with ChatGPT

Say I have to teach an introductory course on the Principles of Economics to students who are just starting off on their formal study of the subject. How do I go about teaching it now that ChatGPT is widely available?

  1. Ignore the existence of ChatGPT and teach as if it does not exist.
    • I am not, and this is putting it mildly, in favor of this proposal. ChatGPT knows more about this subject (and many others) than I do now, and ever will. It may not be able to judge how to best convey this information to the students, and it may (so far) struggle to understand whether its explanations make sense to its audience, about whether they are enthused about what is being taught to them, and whether it should change tack or not. But when it comes to knowledge about the subject, it’s way better than I am. I would be doing a disservice to the students if I did not tell them how to use ChatGPT to learn the subject better than they could learn it only from me.
      So this is a no-go for me – but if you disagree with me, please let me know why!

  2. Embrace the existence of ChatGPT, and ask it to teach the whole course
    • I do not mean this in a defeatist, I’m-out-of-a-job sense. Far from it. What I mean is that I might walk into class, give the prompt for the day, ask the students to read ChatGPT’s output, and then base the discussion on both ChatGPT’s output and the student’s understanding. (Yes, they could do the ChatGPT bit at home too, but you’d be surprised at the number of students who will not. Better to have all of them do it in class instead.) Over time, I’ll hope to not give the prompt for the day too! But it will be ChatGPT that is teaching – my job is to work as a facilitator, a moderator and a person who challenges students to think harder, argue better – and ask better.

  3. Alternate between the two (roughly speaking)
    • The approach that I am most excited to try. In effect, ChatGPT and I will teach the course together. I end up teaching Principles of Economics, where ChatGPT adds in information/examples/references/points of view that I am not able to. But I also end up helping students understand how to use ChatGPT as a learning tool, both for Principles of Economics, but for everything else that they will learn, both within college and outside of it. This is very much part of the complements-vs-substitutes argument that I have been speaking about this week, of course, but it will also help me (and the students) better understand where ChatGPT is better than me, and (hopefully) vice-versa.

Whether from the perspective of a student (past or present) or that of a teacher (ditto), I would be very interested to hear your thoughts. But as a member of the learning community, how to use ChatGPT inside of classrooms (if at all), is a question I hope to think more about in the coming weeks.

Commoditize Your Complements

I wrote about a post written by Joel Spolsky last year, and one of the many positive externalities positive spillovers of writing on this blog has been the fact that I’ve gotten to know about Joel and his writing. It is a positive treasure trove, and well worth dipping into.

But the reason I’m writing about him today is because I originally meant to write a post on a recent Ben Thompson post (AI and the Big Five). While going over that article and taking notes, I came across a reference to an old article written by Joel:

Once again: demand for a product increases when the price of its complements decreases. In general, a company’s strategic interest is going to be to get the price of their complements as low as possible. The lowest theoretically sustainable price would be the “commodity price” — the price that arises when you have a bunch of competitors offering indistinguishable goods. So, smart companies try to commoditize their products’ complements. If you can do this, demand for your product will increase and you will be able to charge more and make more.

https://www.joelonsoftware.com/2002/06/12/strategy-letter-v/

I found parts of the write-up mysterious, because I’m not familiar with both the firms and the products that have been spoken about in it. Partly a function of I not knowing enough about the tech world, and partly a function of the article itself being quite old (Transmeta, Ximian, Gnome are examples, of you are wondering).

But the core insight from the article? Both spot on, and an excellent example of a TMKK in a into class about micro.

What is the core insight? A simple, almost throwaway line in micro classes:

All other things constant, the demand for a product will go up when the price of the complement goes down

And we’ve all gone through examples of how “the demand for tea will go up when the price of sugar comes down”. But consider this instead:

When IBM designed the PC architecture, they used off-the-shelf parts instead of custom parts, and they carefully documented the interfaces between the parts in the (revolutionary) IBM-PC Technical Reference Manual. Why? So that other manufacturers could join the party. As long as you match the interface, you can be used in PCs. IBM’s goal was to commoditize the add-in market, which is a complement of the PC market, and they did this quite successfully. Within a short time scrillions of companies sprung up offering memory cards, hard drives, graphics cards, printers, etc. Cheap add-ins meant more demand for PCs.

https://www.joelonsoftware.com/2002/06/12/strategy-letter-v/

Why did this matter to Microsoft? That is, why would they want to ensure cheap add-ins (complements) for PC’s, so that the demand for PC’s (the product) go up? They didn’t actually manufacture the PC’s back then, so how were they profiting?

Microsoft’s goal was to commoditize the PC market. Very soon the PC itself was basically a commodity, with ever decreasing prices, consistently increasing power, and fierce margins that make it extremely hard to make a profit. The low prices, of course, increase demand. Increased demand for PCs meant increased demand for their complement, MS-DOS. All else being equal, the greater the demand for a product, the more money it makes for you. And that’s why Bill Gates can buy Sweden and you can’t.

https://www.joelonsoftware.com/2002/06/12/strategy-letter-v/

As always, do read the rest of Joel’s write-up, please.

Homework:

  1. What examples can you think of where this lesson has been applied in a modern context? Software or otherwise.
  2. How can those of us in the education sector think about the applicability of this lesson?
  3. Industrial organization remains an underrated subject. Discuss.

Complements, Substitutes, AI and the Way Forward

One of the most popular blogposts on this blog is one that I wrote over five years ago: a simple explainer post about complements and substitutes.

It’s part of the arsenal of an economist, an understanding of the concept of substitutes and complements, and it is useful in many surprising and unexpected ways. But never has its use been as important as it is in understanding the importance, the threat and the advantages of AI. A video that I have often linked to in the past, and will probably link to many times again helps make this point clear:

When Steve Jobs says computers are like bicycles for the mind, he is saying that our mind becomes more powerful when we work with computers, rather than instead of them (substitutes) or infinitely worse, without them (almost all examinations conducted in higher education in India today).

And if you want to think about your career in this brave new world of ours, you really should be thinking about working with computers. Not against, or without. As it turns out, this is surprisingly hard to do for most of us. I invite you to walk into a higher education institute of your choice and listen to professors talk about how many students are copying during examinations. Nobody seems to ask why it is right and appropriate to check how good students are at doing work without computers. Why is this a skill that we’re building for folks who will be working in the 21st century?

And if you are learning how to work “effectively” without a computer – and again, that is what we train you for when we make you write three hour pen-and-paper examinations in higher education – you are destroying your ability to earn more in the future.

I’m being quite serious.

The key questions will be: Are you good at working with intelligent machines or not? Are your skills a complement to the skills of the computer, or is the computer doing better without you? Worst of all, are you competing against the computer?

Cowen, Tyler. Average is over: Powering America beyond the age of the great stagnation. Penguin, 2013.

A lot of people are scared about job losses as a consequence of the rapid development of AI, and with good reason. AI can today do quite a few jobs better than humans can, and more than its current capabilities, what keeps a lot of us up at night is the rate of improvement. Not only is AI very good already, but it is noticeably better than it was last year. And for the pessimists among us, the scarier part is that not only will AI be even better next year, but the rate of improvement will also improve. That is, the improvement in AI’s abilities will not only be more in 2023 compared to 2022, but the difference between 2023 and 2022 will be higher than was the difference in 2022 compared to 2021. And that will be true(er) for 2025, and for 2026 and, well, there’s no telling where we’re headed.

But this is exactly why studying economics helps! Because both Steve Jobs and Tyler Cowen are, in effect, saying the same thing: so long as you plan your career by using computers/AI as a complement, you’re going to be just fine. If you think of your job as being substitutable – or if your job is, or will be, substitutable by a computer – well then, yes, you do have problems.

An underappreciated point is the inherent dynamism of this problem. While your job may not yet be a substitute for AI, that is no reason to assume that it will not be substitutable forever:


For example: is Coursera for Campus a complement to my teaching or a substitute for it? There are many factors that will decide the answer to this question, including quality, price and convenience among others, and complementarity today may well end up being substitutability tomorrow. If this isn’t clear, think about it this way: cars and drivers were complementary goods for decades, but today, is a self-driving car a complement or a substitute where a driver is concerned?

https://atomic-temporary-112243906.wpcomstaging.com/2022/04/18/supply-and-demand-complements-and-substitutes-and-dalle-e-2/

But even so, I find myself being more optimistic about AI, and how it can make us more productive. I haven’t come across a better explainer than the one that Ethan Mollick wrote about in a lovely post called Four Paths to the Revelation:

I think the world is divided into two types of people: those obsessed with what creative AI means for their work & future and those who haven’t really tried creative AI yet. To be clear, a lot of people in the second category have technically tried AI systems and thought they were amusing, but not useful. It is easy to be decieved, because we naturally tend try out AI in a way that highlights their weaknesses, not their strengths.
My goal in this post is to give you four experiments you can do, in less than 10 minutes each, with the free ChatGPT, in order to understand why you should care about it.

https://oneusefulthing.substack.com/p/four-paths-to-the-revelation

All four examples in this post are fantastic, but the third one is particularly relevant here. Ethan Mollick walks us through how AI can:

  1. Give you ideas about what kind of business you might be able to set up given your skills
  2. Refines a particular idea that you would like to explore in greater detail
  3. Gives you next steps in terms of actualyl taking that idea forward
  4. And even writes out a letter that you might want to send out to potential business collaboarators

His earlier posts on his blog also help you understand how he himself is using ChatGPT3 in his daily workflow. He is a professor, and he helps you understand what a “mechanical” professor might be able to do

To demonstrate why I think this is the case, I wanted to see how much of my work an AI could do right now. And I think the results will surprise you. While not nearly as good as a human professor at any task (please note, school administrators), and with some clear weaknesses, it can do a shocking amount right now. But, rather than be scared of AI, we should think about how these systems provide us an opportunity to help extend our own capabilities

https://oneusefulthing.substack.com/p/the-mechanical-professor (emphasis added)

Note the same idea being used here – it really is all about compementarity and substitutability.

AI can already create a syllabus and refine it; it can create an assignment and refine it; it can create a rubric for this assignment; it can create lecture notes; and it can write a rap song about a business management concept to make the content more interesting for students. I loathe the time spent in creating documentation around education (every single teacher does) and it would take me a long time to come up with even a halfway possible rap song about substitutes and complements.

That last statement is no longer true: it took me twenty seconds.

Here are examples from outside the field of academia:

The question to ask isn’t “how long before I’m replaced?. The question to ask is “what can I do with the time that AI has saved me?”. And the answer to that question should show that you are thinking deeply about how you can use (and continue to use!) AI as a useful complement.

If you don’t think about this, then yes, I do think that you and your job are in trouble. Get thinking!

Complements, Substitutes and Examinations

Writing all of what I wrote in February 2020 was a lot of fun, and gave rise to a series of interesting, and interlinked ideas.

In today’s essay, I want to explore one of these interlinked ideas: I want to riff on the concept made famous by Steve Jobs: the computer as a bicycle for the mind. But with an Econ 101 twist to the topic!

I’ve already linked to the video where Steve Jobs speaks about this, but just in case you haven’t seen it, here’s the video:

As I mentioned in the post “Apple Through Five Articles“, Steve Jobs was essentially saying that the computer is a complementary good for the mind: that the mind becomes far more powerful, far more useful as a tool when used in conjunction with a computer.

A complement refers to a complementary good or service used in conjunction with another good or service. Usually, the complementary good has little to no value when consumed alone, but when combined with another good or service, it adds to the overall value of the offering. A product can be considered a compliment (sic) when it shares a beneficial relationship with another product offering, for example, an iPhone complements an app.

One way to understand Apple is to understand that Jobs effectively ensured that Apple built better and better computers. Apple has continued to do that even after Jobs has passed on, but they’ve been building computers all along. You can call them Macs and iPhones and iPads and Apple Watches, but they’re really computers.

But that’s not the focus of this piece. The focus of this piece is to think about this as an economist. If the mind is made more useful when it is able to complement the processing power of the computer, then the world is obviously more productive now that many more minds are being complemented with many more computers. I writing this piece on my laptop, and you reading it on your device is the most appropriate example – or so we shall assume.

But viewed this way, I would argue that we get the design of most of our examinations wrong. Rote memorization, or “mugging up” is still the default method for evaluating whether a student has learnt a particular subject. Mugging up is just another way of saying that we need to substitute for the computer, not complement it!

When we reject open book examinations, when we reject the ability to write a paper using laptops/tablets that are connected to the internet, when we force students to substitute for computers, rather than use them to write better, richer, more informed answers, we’re actively rejecting the analogy of the bicycle for the mind.

To say nothing, of course, of the irrelevance of forcing people to write examinations for three hours using pen and paper. But that’s a topic for another day.

Right now, suffice it to say that when it comes to examinations in India, Steve Jobs would almost certainly have not approved.

Bottom line: If computers are a complement, our examinations are incorrectly designed, and we end up testing skills that are no longer relevant.

And the meta-skill you might take away from this essay is the fact that a lot of ideas in economics are applicable in entirely surprising and unexpected areas!

I hope some of you disagree, and we can argue a bit about this. I look forward to it! 🙂

EC101: Links for 3rd October, 2019

  1. Everything is correlated.
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  2. For students at Gokhale Institute for sure, but elsewhere too: the Stiglitz essay prize.
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  3. Capitalim vs Socialism.
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  4. On reforming the PhD.
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  5. On complements, substitutes, YouTube and reading.

Links for 29th May, 2019

  1. “And so India will continue to grow at her sluggish pace; socialism will continue to thrive; Air India will continue to fly; and Modi will continue to waste a fifth of our yearly budget on PSUs. Modi always knew that the secret to winning elections is socialism. What he has learnt now is the secret to running India. It is to gamble.”
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    I have posted this link not because I agree with the conclusion (I don’t), but because I share the sense of pessimism when it comes to matters pertaining to economic reforms, or the lack of them. India needs me, and the author, to be completely wrong about our pessimism.
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  2. “Zahran Hashim, 33, radical preacher and alleged ringleader, found little acceptance in his hometown Kattankudy, in eastern Batticaloa. Mosques in the predominantly Muslim town rejected him outright. Their members even complained to authorities, before he went absconding in 2017 after a clash with a fellow priest who challenged his interpretation of Islam.But soon, a team of young Muslim men — and one woman — from other, mostly Sinhala-majority, areas eagerly joined him on his Easter mission to carry out a suicide attack on churches and high-end hotels in and around Colombo and Batticaloa. All nine bombers were in their 20s and 30s.”
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    A mostly depressing, but also revealing, portrait of the nine people who perpetrated the terror attacks in Sri Lanka recently.
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  3. “There are striking parallels between the philosophies of Trump and NIMBY urbanists. Trump asserts that America is “full” and so wants to restrict the flow of immigrants. The urbanists, who tend to be Democratic and highly educated, assert that their cities are too crowded and so want to restrict the supply of housing. The cultural valence of the two views is quite different, but the practical implications have a lot in common — namely, a harder set of conditions for potential low-skilled migrants to the U.S.”
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    As he so often does, Professor Cowen reminds us why studying economics is entirely worth our time. In this case, he explains why NIMBYism, and high minimum wages are at least as anti-immigration as are, well, walls.
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  4. “Our goal is to defeat the snail in a race.”
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    Possibly the shortest extract I have put up ever, but it is hard to improve on that sentence. For once, I won’t speak about what the link is about. Try guessing what it might be about before clicking here!
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  5. “What’s happening here is much more complicated than an imagined zero-sum game between the defenders of books and library futurists. The decline in the use of print books at universities relates to the kinds of books we read for scholarly pursuits rather than pure pleasure, the rise of ebooks and digital articles, and the changing environment of research. And it runs contrary to the experience of public libraries and bookstores, where print continues to thrive.”
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    The Atlantic on substitutes and complements. On books actually, but read this article to understand how to think about the implications of thinking about complements and substitutes

Own Price, Cross Price and Income Elasticity

We studied elasticity in a previous post:

The percentage change in quantity demanded, given a percentage change in price.

In today’s post, we expand the definition of elasticity a little. That naturally makes it a little complicated, but it also enriches our understanding of it – a good bargain.

What if the price of a substitute changes? What if, that is, the price of Coke changes a little. By what percentage will the quantity demanded of Pepsi change? The measurement of such a thing is called cross price elasticity (substitute).

The percentage change in quantity demanded, given a percentage change in the price of a substitute.

The first definition above is therefore the definition of own price elasticity, while the second one is of cross price elasticity. Cross price elasticity, naturally, will be of twp types – that of complements, and that of substitutes.

There is yet a fourth type of elasticity, called income elasticity of demand. As you might imagine, it is

The percentage change in quantity demanded, given a percentage change in income.

Say your income in a particular month goes down by 10 percent. Is it reasonable to imagine that you will therefore cut back on your consumption of movies in a theatre, or dinners in restaurants? Unless you are a hardcore movie buff, or love eating out a lot, the answer would probably be yes. The income elasticity of demand for these goods is therefore high.

On the other hand, will you cut back your consumption of pills prescribed by your doctor? Almost definitely not, right? The income elasticity of demand for these goods is therefore low.

And that concludes our series on the basics of supply and demand!

Here’s a quick recap:

The demand (and supply) of a good depends upon:

  1.  it’s own price
  2. the price of complements and substitutes
  3. it’s own price elasticity
  4. the cross price elasticities
  5. the income elasticity
  6. changing tastes and preferences
  7. changing incomes

As you can no doubt see, thinking about demand is fairly complex – but it is, nonetheless, rewarding. In the next post, we’ll give you a list of resources for learning more about demand and supply (as we did for the Solow model), and then begin a new topic.

Tastes, Preferences and Income

Remember CD’s? They used to be the last word in convenient storage, and if you are of a particular age or higher “AVSEQ01.dat” will be a very evocative term indeed.

CD’s these days are available for around 15 rupees each, down from about 50 rupees a while ago, and maybe even higher. The law of demand that we have been learning about all this while suggests that the demand for CD’s should go up, since the price has come down.

Ah, but who uses CD’s these days? All the music you’d ever want to listen to and more is available on multiple streaming services. YouTube ensures that you have more video content to watch than is humanly possible, while services such as Netflix and Amazon Prime have made CD and DVD players ancient relics.

In other words, tastes and preferences of people have changed, and they will not want to buy CD’s, no matter the cost. So it’s not just the price of a good, nor that of complements and substitutes that matters – it also is whether or not you want to buy the good at all or not.

And to complicate matters even further, it’s not just tastes and preferences – it’s also income!

Remember dalda? Every Indian household used to use it in the 1980’s, but families today won’t go within sniffing distance of the stuff. That’s because, generally speaking, incomes have been rising, and households now have the money to make health-conscious choices – which means dalda is out, not matter the price.

And you could say the same thing for landlines, cassette recorders, cathode ray televisions, desktops, dumbphones – and that’s just from the world of electronics. As societies progress, they experience a rise in incomes and a change in tastes and preferences – and these things impact both the demand and supply of goods.

So, in a nutshell:

The price of a good, its elasticity, the price of its complements and substitutes, changes in incomes, tastes and preferences all impact the demand (and supply) of a particular good.

Next, we’ll take a look at cross price elasticity and income elasticity.

Complements and Substitutes

Two simple concepts, but really important ones.

When we speak about the demand of, and the supply of any particular thing, it is impacted by a variety of factors. One of these factors is the existence of substitutes and complements.

What are substitutes, and what are complements?

Say you walk into a store at the height of summer, thirsting for a nice, ice-cold cola. If you ask for a can of Coke, and upon being told that Coke isn’t available but Pepsi is, drink that can of Pepsi – well, then, you have “substituted” Pepsi for Coke. Goods that can act as a replacement for each other are substitutes.

These substitutes can be near/far substitutes. If no cola drink is available, and you drink nimbu sharbat instead, that is also a substitute. If you just have a glass of water instead of  a cola, well, that is also a substitute. Pepsi would be a close substitute, while water, arguably would be a not so close substitute.

Complements, on the other hand, are things that go well with, or must be used with, the good in question. Who ever heard of a flat screen TV without a set-top box? Of what use is a plate of pakoras in the monsoons without a hot cup of adrak wali chai? These become complements.

Now the reason these concepts are important is because they help us predict demand better. Say Coke sells its cans for 30 rupees, but Pepsi lowers prices to 20. Will the demand for Coke go up or down? Down, naturally, because a close substitute is available at a lower price.

When the price of a close substitute goes up, the demand for the good in question rises, and vice versa.

Generally speaking the closer the substitute, the more worried you should be about the price. Maruti Suzuki won’t lose sleep over its pricing of the Alto if Rolls Royce ups the prices on its models. Strictly speaking, these are substitutes – but not really. On the other hand, if Hyundai lowers the price on Eon (a very close substitute to the Alto), Maruti Suzuki will pay very, very close attention.

Also, the higher the number of susbtitutes, the lesser your ability to raise prices. Who ever heard of a chaiwalla selling tea at 20? It simply doesn’t make sense, because you can typically walk less than 100 meters to find a another chaiwalla selling an equally good cup of tea for the going rate.

And what about complements? Well, it’s easy to think through this. If the price of set-top boxes rises, the demand for flat-screen TV’s will go down. Think about it – you have to factor in not just the cost of the TV, but also the thing that makes the TV useful in the first place. So as a whole package, if the cost is going to go up, well, demand will go down.

When the price of a complement goes up, the demand for the good in question falls, and vice versa.

Complements and substitutes affect the demand for goods, and are also important concepts in the field of marketing.

Next up, we’ll take a look at changing tastes and preferences.