Complementary goods are products which are used together.
Examples
- DVD player and DVD disks to play in it.
- Tennis balls and tennis rackets.
- Mobile phones and mobile phone credit for making calls.
- iPhone and Apps to use with an iPhone.
- Petrol and car.
Complementary Goods and Cross Elasticity of Demand
Complementary goods will have a negative cross elasticity of demand. If the price of one good increases, demand for both complementary goods will fall. The more closely linked the goods are, the higher will be the cross elasticity of demand.
If they are weak complementary goods then there will be a low cross elasticity of demand. For example, if the price of tea increases it will only have a marginal impact on reducing demand for tea and consumption of milk.
However, if the price of Android Phones increases, it will negatively affect sales and therefore reduce demand for Android Apps.
How firms make use of complementary goods
Increase related sales. Supermarkets will place related food items close to each other. For example, next to pasta – expensive pasta sauces. The firm hopes to increase overall sales by suggesting possible related complementary goods.
Gain loyal consumers to make related sales. Another strategy a firm can implement is to offer a base product at a low price, knowing that if consumers buy ‘base product’ they can increase sales of related (and profitable) add-on items. For example, the owners of PlayStation have an incentive to cut the price of the PlayStation itself. If they do, they know they will make increases sales of licensed games, and this increase in revenue will offset the fall in revenue from a lower price.
Reducing the price of games consoles, such as Playstation may enable the firm to make more profit on licensed games.
Many printers are sold quite cheaply because firms who manufacture printers hope to make the most profit on selling compatible ink.
Related
In economics, a complementary good is a good whose appeal increases with the popularity of its complement.[further explanation needed] Technically, it displays a negative cross elasticity of demand and that demand for it increases when the price of another good decreases.[1] If
A
{\displaystyle A}
When two goods are complements, they experience joint demand - the demand of one good is linked to the demand for another good. Therefore, if a higher quantity is demanded of one good, a higher quantity will also be demanded of the other, and vice versa. For example, the demand for razor blades may depend on the number of razors in use; this is why razors have sometimes been sold as loss leaders, to increase demand for the associated blades.[3] Another example is that sometimes a toothbrush is packaged free with toothpaste. The toothbrush is a complement to the toothpaste; the cost of producing a toothbrush may be higher than toothpaste, but its sales depends on the demand of toothpaste.
All non-complementary goods can be considered substitutes.[4] If
x
{\displaystyle x}
Complementarity may be driven by psychological processes in which the consumption of one good (e.g., cola) stimulates demand for its complements (e.g., a cheeseburger). Consumption of a food or beverage activates a goal to consume its complements: foods that consumers believe would taste better together. Drinking cola increases consumers' willingness to pay for a cheeseburger. This effect appears to be contingent on consumer perceptions of these relationships rather than their sensory properties.[5]
Examples
An example of this would be the demand for cars and petrol. The supply and demand for cars is represented by the figure, with the initial demand
D
1
{\displaystyle D_{1}}
Perfect complement
A perfect complement is a good that must be consumed with another good. The indifference curve of a perfect complement exhibits a right angle, as illustrated by the figure.[6] Such preferences can be represented by a Leontief utility function.
Few goods behave as perfect complements.[6] One example is a left shoe and a right; shoes are naturally sold in pairs, and the ratio between sales of left and right shoes will never shift noticeably from 1:1.
The degree of complementarity, however, does not have to be mutual; it can be measured by the cross price elasticity of demand. In the case of video games, a specific video game (the complement good) has to be consumed with a video game console (the base good). It does not work the other way: a video game console does not have to be consumed with that game.
Example
In marketing, complementary goods give additional market power to the producer. It allows vendor lock-in by increasing switching costs. A few types of pricing strategy exist for a complementary good and its base good:
- Pricing the base good at a relatively low price - this approach allows easy entry by consumers (e.g. low-price consumer printer vs. high-price cartridge)
- Pricing the base good at a relatively high price to the complementary good - this approach creates a barrier to entry and exit (e.g., a costly car vs inexpensive gas)
Gross complements
Sometimes the complement-relationship between two goods is not intuitive and must be verified by inspecting the cross-elasticity of demand using market data.
Mosak's definition states "a good of
x
{\displaystyle x}
is a gross complement of
y
{\displaystyle y}
if
∂
f
x
(
p
,
ω
)
∂
p
y
{\displaystyle {\frac {\partial f_{x}(p,\omega )}{\partial p_{y}}}}
Proof
The standard Hicks decomposition of the effect on the ordinary demand for a good
x
{\displaystyle x}
of a simple price change in a good
y
{\displaystyle y}
, utility level
τ
∗
{\displaystyle \tau ^{*}}
∂
f
x
(
p
,
ω
)
∂
p
y
=
∂
h
x
(
p
,
τ
∗
)
∂
p
y
−
y
∗
∂
f
x
(
p
,
ω
)
∂
ω
{\displaystyle {\frac {\partial f_{x}(p,\omega )}{\partial p_{y}}}={\frac {\partial h_{x}(p,\tau ^{*})}{\partial p_{y}}}-y^{*}{\frac {\partial f_{x}(p,\omega )}{\partial \omega }}}
If
x
{\displaystyle x}
is a gross substitute for
y
{\displaystyle y}
, the left-hand side of the equation and the first term of right-hand side are positive. By the symmetry of Mosak's perspective, evaluating the equation with respect to
x
∗
{\displaystyle x^{*}}
Effect of price change of complementary goods
- Substitute good
References
- ^ Carbaugh, Robert (2006). Contemporary Economics: An Applications Approach. Cengage Learning. p. 35. ISBN 978-0-324-31461-8.
- ^ O'Sullivan, Arthur; Sheffrin, Steven M. (2003). Economics: Principles in Action. Upper Saddle River, New Jersey: Pearson Prentice Hall. p. 88. ISBN 0-13-063085-3.
- ^ "Customer in Marketing by David Mercer". Future Observatory. Archived from the original on 2013-04-04.
- ^ Newman, Peter (2016-11-30) [1987]. "Substitutes and Complements". The New Palgrave: A Dictionary of Economics: 1–7. doi:10.1057/978-1-349-95121-5_1821-1. ISBN 978-1-349-95121-5. Retrieved 2022-05-26.
- ^ Huh, Young Eun; Vosgerau, Joachim; Morewedge, Carey K. (2016-03-14). "Selective Sensitization: Consuming a Food Activates a Goal to Consume its Complements". Journal of Marketing Research. 53 (6): 1034–1049. doi:10.1509/jmr.12.0240. ISSN 0022-2437. S2CID 4800997.
- ^ a b Mankiw, Gregory (2008). Principle of Economics. Cengage Learning. pp. 463–464. ISBN 978-0-324-58997-9.
- ^ Mosak, Jacob L. (1944). "General equilibrium theory in international trade" (PDF). Cowles Commission for Research in Economics, Monograph No. 7. Principia Press: 33.
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