Coke and Pepsi, McDonald's and Burger King hamburgers, or Crest and Colgate toothpastes are examples of substitute goods. These products are substitutes because they satisfy similar consumer needs and possess significant cross-price elasticity. The price of Pepsi, for example, has a direct correlation on the demand for Coke. Pepsi's price increase yields a demand increase for Coke and vice versa.
Burger King and McDonald’s hamburgers are examples of substitute goods because they satisfy the consumer’s needs of being served quickly and eating a relatively inexpensive hamburger. These two goods also satisfy the positive cross-elasticity component of demand for substitutes. The price of one chain’s hamburger has a direct effect on the demand for the other’s and vice versa.
Two goods are defined as “close substitutes” if they exhibit a high cross-elasticity and “weak substitutes” if they exhibit a marginal cross-elasticity. Goods are defined as “perfect substitutes” if the consumer receives the exact same utility from the two goods. Therefore, consumer preference plays a part in the definition of a perfect substitute. Coke and Pepsi may be perfect substitutes to one consumer because he receives the same satisfaction from both. However, a different consumer may define Coke and Pepsi as near-perfect substitutes because he believes one tastes better than the other.
Substitute goods are born from the basic concept of competition. Substitute goods provide the consumer with the freedom to choose and force the supplier to innovate and offer a quality product at a reasonable price.