What do you think about the price of tea in China?
This is a statement usually used to imply that something is totally unrelated to the current issue in focus. But why choose the "price of tea in China" as a comparison? This statement invokes a basic economic principle dealing with how goods are related to each other, and more generally how economists think about things.
Economists are wont to categorize things. Just like biologists like to sort the animals and the plants according to some overarching structure, so economists like to label things. These labels indicate relationships between different variables which, once the definitions are laid down, are easy to interpret and understand. Our current cliché suggests that something has nothing to do with the "price of tea in China," which in turn suggests that something else might indeed influence the price of tea in China.
Economists sort goods and services into two major categories: substitutes and complements. These divisions can be made on either the consumption or the production side. The definitions in the different contexts are a bit different in actuality but are highly related in spirit.
In consumption, goods are substitutes when they can be used in place of one another. Perfect substitutes can be substituted for each other on a one-to-one basis. For example, apples sitting in a bin may be one-to-one substitutes for each other. Likewise, gasoline by Shell and Texaco may also be perfect substitutes for some individuals. The exact proportions that goods can be substituted for is determined on an individual basis and therefore is not a perfect source of dilineation.
Goods can also be considered imperfect substitutes, in which it takes more than one unit of one good to replace a unit of another. For example, while a Mercedes and a Ford Pinto may serve the same purpose of transport from point A to point B, if one has a Mercedes it may take more than one Pinto to replace the Mercedes. Again, the actual ratio of one good being substituted for another good can only be determined on an individual level.
However, the fact that two goods are substitutes in consumption has a more definitional implication. If the price of good A increases, then the demand for good B will increase if goods A and B are substitutes. Likewise, if the price of good B increases, then the demand for good A will increase. This is because as the price of one good increases, some people are either unwilling or unable to pay the requested higher price. In turn, they seek out acceptable alternatives for the good whose price increased, that is they seek out substitutes. At this point, more individuals are willing and able to purchase the substitute good, and the substitute sees its demand increse.
Another category of goods are complements in consumption or goods that are used in conjuction with one another. Examples would include tennis balls and tennis rackets, automobiles and tires, compact discs and CD players and so forth. Again, these goods can be one-to-one complements or may take on other ratios. An example of the latter would be cars and tires. It takes four tires to safely operate an automobile.
The main implication for complements is that an increase in the price of good A will cause a decrease in the demand for good B if goods A and B are complements. To continue with the automobile example, as the price of tires increases individuals have less money to spend on automobiles and thus they demand fewer automobiles. Likewise, if the price of automobiles increases then individuals have less money to spend on tires and thus demand fewer tires.
Thus, the producers of one good need to be concerned with the prices of the substitutes and complements of their product. This is because these price changes can affect the demand for their product in a beneficial or harmful manner. But what about the meaning of the cliché?
A remaining category of goods are those which are neither complements or substitutes with each other, independent goods. These types of goods are the underlying economic lesson in our cliché. Goods that are independent of each other do not influence each other's price or demand. Thus, a good which is independent of the tea in China would not influence the price of tea in China. The statement is particular to independent goods but implies that the other two categories can exist.
While the consumption of corn in Dallas may not influence the price of tea in China, other goods or activities may indeed influence the price of tea in China, not the least being consumption and price of corn in China. It is also possible to look at how the prices of goods can be influenced by factors that arise on the productionside that may not arise on the consumption side.
Goods can also be complements or substitutes in production. Goods, in this sense, are actually the outputs that come from firms combining factors of production (land, labor and capital) with some technology. Goods which are complements in production are those goods which are produced together. Examples include lumber and sawdust, gasoline and kerosene, etc. The trick with complements in production is that if the price of one good increases, the supply of complements also increseases.
This is true because as the price of sawdust increases, sawmills desire to produce more sawdust. This increase in the quantity of sawdust being supplied necessarily causes an increase in the amount of lumber that is produced by the sawmill. The only major drawback from the point of view of the firm is that, ceteris paribus, an increse in supply will lead to an decrease in price. Thus, to supply more sawdust at a higher price may also cause a simultaneous decrease in the price of lumber.
Likewise a decrease in the price of a good motivates the firm to cut back on production and also the production of the complements in production. Thus, if sawdust suffers a decrease in price, it may be accompanied by a simultaneous increase in the price of lumber.
An alternative to complements in production are substitutes in production. Substitutes in production are those goods that can be produced in place of one another. A good example of this is an automobile assembly line. The same robots, labor and materials can be used to produce either a Sport Utility Vehicle or a family sedan, but most likely not both at the same time. Therefore, the firm must make a decision as to which product to produce.
An increase in the price of Sport Utilities will motivate the firm to produce more of this type of vehicle. Yet, at the same time, producing more SUVs will necessitate a decrease in the number of family sedans that will be produced. Therefore, the supply of family sedans will increase and, ceteris paribus, an increase in the price of family sedans will occur.
On the other hand, a decrease in the price of SUVs will motivate the firm to produce fewer of these vehicles and produce more of the family sedans in their stead. At this point, the supply of sedans will increase and cause a decrease in price, ceteris paribus.
Thus, goods can be related to each other on the production side or on the consumption side of the economy. Our cliché about tea in China is an useful vehicle with which to investigate the different categories of goods.
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