Too Dumb Economists: Substitutes and Complements

It is an exercise in mental gymnastics when we try and explain the relationships between substitute goods and complements in the class room. Typically it’s butter-margarine or blue ray players and disks. Students often don’t see why we bother.

The ongoing saga of the collapse of Borders illustrates the issue and also reinforces the need for an understanding of economics in the world of finance. An article from Bloomberg indicates that Borders in on the verge of a Chapter 11 filing, perhaps as early as next week. Borders still wants to undertake a merger with Barnes & Noble, but we can’t understand why B&N would want to take on the obligation of the additional real estate. (Click here for article)

A second article, from Venturebeat discusses Amazon.com’s latest earnings report. (Click here for article) While earnings were less than expected, the article does indicate that e-books outsold paperbacks by 15%. As we’ve been pointing out for the last little while, this is Border’s problem. Electronic delivery of books is a substitute for the printed version. In addition, the cost of shopping at Amazon is lower than at Borders making Amazon is a good substitute for Borders.

Our third article comes from Huffington Post and has to do with 4th quarter earnings at UPS. (Click here for article) As internet shopping continues to increase, the demand for shipping services also increases. They are complements. The following graph compares the relative stock price movement of the three companies over the past five years. Amazon and Borders have been moving in opposite direction, as our theory predicts. UPS has not been moving in the same direction as Amazon as we might expect. Reasons for this may include the general decline in the economy over the last 2 years and the increase in fuel costs over the time period in question. Another reason can be found by studying Amazon’s shipping policy which indicates that UPS is not the sole distributor of Amazon products.