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Question
If the price of a substitute Y of good X increases, what impact does it have on the equilibrium price and quantity of good X?
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Solution
X and Y being substitute goods, if the price of Y increases, then it will reduce the demand for Y and people will switch to X, which will raise the demand for X. Thus, the demand curve will shift from D1D1 to D2D2 . At the existing price P1, there will be an excess demand. Due to the pressure of excess demand, the existing price will increase. Consequently, the new equilibrium occurs at E2, where the new demand curve D2D2 intersects the supply curve S1S1. The new equilibrium price is P2, which is higher than P1 and equilibrium quantity is q2, which is higher than q1. Therefore, due to the increase in the price of substitute good Y, the equilibrium price of X will rise and equilibrium output of X will also be higher.
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