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Intermarket relationships can be very complex, but they’re important to the world of economics – they reveal how different markets influence one another. When we buy an item, whether it is a car or a bunch of flowers, the prices have been determined by a lot of different factors.
By examining how prices are determined, the role of complementary and substitute goods, and the impact of changes in one market on others, we can gain a clearer picture of economic interactions.
How Prices Are Usually Determined
Prices in markets are generally determined by the forces of supply and demand. The law of supply states that an increase in price results in an increase in the quantity supplied.
Conversely, the law of demand shows us that an increase in price leads to a decrease in the quantity demanded.
The intersection of the supply and demand curves determines the market equilibrium price and quantity.
Several factors influence these curves:
- Consumer Preferences: Changes in tastes and preferences can shift the demand curve.
- Income Levels: Higher incomes typically increase demand for goods and services.
- Production Costs: Changes in the cost of inputs can shift the supply curve.
- Technology: Technological advancements can reduce production costs, increasing supply. It can also make older products obsolete.
- Government Policies: Taxes, subsidies, and regulations can affect both supply and demand.
Complements and Substitutes
Studying economics you will come across these two terms and it is a good idea to understand exactly what they mean. Understanding complementary and substitute goods is crucial for grasping intermarket relationships.
Complementary Goods
Complementary goods are products that are consumed together. An increase in the demand for one typically increases the demand for the other.
Examples include cars and gasoline, printers and ink cartridges, or smartphones and apps.
If the price of a car decreases, making cars more affordable, the demand for gasoline is likely to increase as more people use their cars more frequently.
Substitute Goods and Services
Substitute goods are products that can replace each other in consumption. An increase in the price of one good can lead to an increase in the demand for its substitute. For instance, if the price of coffee rises, consumers might buy more tea instead, or switch to cheaper brands.
Transport services are another good example. If you are used to paying for an Uber to work every week but suddenly there is a bus route that you can use, this is a substitute. Taxi drivers may even reduce their prices as a result.
How Changes in a Particular Market Affect Other Markets
This is a sort of “butterfly effect” in the world of economics. Some areas are more obvious than others, but changes in one market can have significant ripple effects on other markets.
This connection is often seen through price changes and just a shift in the consumer behaviours.
Price Changes
When the price of a good rises or falls, it can affect the prices of related goods. For example, an increase in the price of crude oil can raise the cost of gasoline, heating oil, and even goods that are heavily dependent on transportation.
Demand Fluctuations
A rise in demand for one good can increase the demand for its complements. Conversely, it can decrease the demand for substitutes. For instance, a surge in demand for electric cars would increase the demand for batteries (a complement) and potentially decrease the demand for gasoline (a substitute).
Supply Shifts
Changes in supply conditions in one market can affect related markets. A technological innovation in renewable energy might reduce the demand for fossil fuels, affecting global oil prices and the energy sector at large.
The Impact of Changes in Demand, Supply, and Price
There are a lot of ways that we can look at the markets and how related markets are also involved in the picture.
Consider the increase in demand for smartphones. This led to complementary goods being needed. The demand for accessories like chargers, cases, and apps rises with new popular smartphones, and tech companies might increase production of these complements to meet the new demand.
Demand for traditional mobile phones might decline as consumers prefer the latest technology. This could be considered a substitute.
A more old-fashioned example could be the decrease in wheat. Though this still plays a big part. We saw the wheat industry take a hit during the war in Ukraine.
Products that use wheat, such as bread and pasta, would see a price increase. This might decrease their demand or prompt consumers to switch to alternatives.
An increase in wheat prices might boost demand for other substitute grains like rice or corn as consumers look for more affordable options.
Complementary and Substitute Goods: Definitions and Examples
Complementary Goods – Products that are often used together, where the demand for one is positively related to the demand for the other.
Examples: Coffee and sugar, bread and butter, smartphones and data plans.
Substitute Goods – Products that can be used in place of each other, where an increase in the price of one leads to an increase in the demand for the other.
Examples: Tea and coffee, beef and chicken, tablets and laptops.
Impact of Intermarket Relationships
Technological advances are some of the biggest impacts in the world of intermarket relationships.
Let’s look at the example of battery technology, an area changing all the time. A breakthrough in battery technology could significantly lower the cost of electric cars. This would increase the demand for electric cars and decrease the demand for gasoline-powered vehicles.
The oil market would feel the impact as the demand for gasoline declines, potentially lowering oil prices. Car manufacturers might shift their focus to producing more electric vehicles, affecting markets for components specific to gasoline engines, like exhaust systems.
Economic Shifts
Another example is a shift in the economy, which can change the approach of some people in terms of what they are buying. An economic boom in a major economy can increase the demand for luxury goods. This rise in demand can lead to higher prices for these goods and related services, such as high-end transportation and more luxurious travel destinations.
The flip side of this coin is that, in times of economic downturn, demand for luxury goods falls, impacting markets for non-essential items and services.
Conclusion
Intermarket relationships show that everything is connected, changes in one market can influence others. Prices are primarily determined by supply and demand dynamics, while complementary and substitute goods illustrate how markets are interlinked.
By examining these relationships, businesses, policymakers, and consumers can make informed decisions, anticipate market shifts, and understand the broader economic environment. Understanding these principles is key to navigating and thriving in a complex, interconnected world.
Test Your Knowledge
Select one correct response
What primarily determines the market equilibrium price and quantity?
Please select a response.
The market equilibrium price and quantity are determined where the supply and demand curves intersect. This point represents the price at which the quantity supplied equals the quantity demanded.
Which of the following is an example of complementary goods?
Please select a response.
If the price of coffee increases, what is likely to happen to the demand for tea?
Please select a response.
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