DIFFERENCE BETWEEN A CLOSE SUBSTITUTE AND A PERFECT SUBSTITUTE

The terms close substitute and perfect substitutes are often used interchangeably.

But, do you know that there have been marked differences?. We will be looking at these differences in this post. 

Substitute means to use something in place of another. 

A substitute good is good that consumers perceived as being similar to another good

Substitute goods are very similar to each other such that there can be used in place of another.

Substitute goods have a positive cross-price elasticity of demand indicating that the rise in the price of one good will result in a rise in the quantity demand of other goods.

What are close substitutes?

Close substitutes are similar products intended to satisfy the same needs but are slightly differentiated.

Coca-Cola and Pepsi are examples of close substitute goods.

What are perfect substitutes?

Perfect substitutes are similar goods intended to satisfy the same needs and are not differentiated.

In the eyes of the consumer, perfect substitutes have no differences at all.

The cross-price elasticity of the perfect substitutes is positive infinity there is a positive and absolute relationship between the goods 

Differences between Close substitutes and perfect substitutes

1. Close substitutes are usually differentiated whereas perfect substitutes are not differentiated. Rather, they are identical in the eyes of the consumer.

2. Demand for perfect substitutes is perfectly elastic, so if the price is raised, there won't be any demand.

For example, if goods A and goods B are perfect substitutes, then an increase in the price of goods A will result in zero quantity demanded because consumers will switch over to goods B since they perceive goods A and goods B as the same.

On the other hand, close substitutes have a relatively elastic demand, which is highly sensitive to price changes.

To illustrate, if goods A and goods B are close substitutes, then an increase in the price of Goods A, will reduce its demand significantly, but not to zero.

This is because the two goods are slightly differentiated.

3. Perfect substitutes are common in perfectly competitive markets whereas close substitutes are common in monopolistic competitive markets.

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