Association of Chartered Certified Accountants (ACCA) Certification Practice Test

What happens to the demand for a good when its substitute's price increases?

1. The demand decreases

2. The demand remains stable

3. The demand increases

4. The supply reduces

The correct answer is: The demand increases

When the price of a substitute good increases, the demand for the original good tends to increase. This is due to the substitution effect; as consumers face a higher price for the substitute, they may choose to buy more of the original good as a replacement. For example, if the price of coffee rises, consumers may start purchasing more tea instead since it serves as an alternative. This shift in consumer behavior reflects an increase in demand for the original good, as people are looking for lower-cost options when faced with higher prices for substitutes. This principle is a fundamental concept in economics, illustrating how demand for a good is influenced by changes in the market conditions of related goods. The answers that suggest a decrease in demand or stability do not account for consumers' natural inclination to substitute goods when price changes occur in alternatives. Additionally, the option related to supply doesn't directly relate to how demand shifts in response to price changes of substitutes.