Giffen’s Paradox
Let’s go back to basics. A normal good is a
good in which demand for it increases when income increases. Moreover, when the
price of the good increases, demand decreases. The relative price of the good
has risen and so consumers substitute the good with close, cheaper,
substitutes. Consumers’ real incomes have also fallen and so they buy less of
the good. Quantity demand decreases.
An inferior good is a good in which demand
for it decreases when income increases. The income elasticity is negative. Take
bus transport for example, or supermarket own-brand products. When the price of
the good increases, demand decreases. As with normal goods, the relative price
of the good has risen and so consumers substitute the good with close, cheaper,
substitutes. However, as consumers’ real incomes have fallen they react by
buying more of the good. But, the quantity demanded still decreases as the
substitution effect is greater than the income effect. We are still following
the laws of economics.
Now onto ‘Giffen goods’, first popularised by
Marshall in his ‘Principle of Economics’. As with both normal and inferior
goods, as the price of the Giffen good increases, the quantity demanded
decreases, due to the substitution effect. As consumers now have less income,
they buy more of the good, as with inferior goods. However, the income effect outweighs
the substitution effect and thus the quantity demanded rises. For a Giffen
good, ‘As the price increases, the quantity demanded decreases
increases’. The Law of Demand has been violated. For a good to be classed as a
‘Giffen Good’, the good has to satisfy three conditions
- be an inferior good
- have few, close, cheaper substitutes
- must take up a significant proportion of the consumer’s income- thus affecting the poorest in society.
The demand curve for a Giffen good is shown.
As the price increases, the demand for the good increases. However, at the
vertex of the curve, the good forms an extremely large part of the consumer’s
budget. As the price increases further, the demand for the good decreases as
the consumer cannot buy any more. The Law of Demand retains its hold.
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| Figure 2: The Demand Curve for a Giffen Good |
But where is the evidence, I hear you ask?
Giffen goods are usually staple goods, a textbook example being bread during
the Victorian era. Potatoes during the Irish potato famine have oft been citied
as Giffen goods, however it seems unlikely that aggregate consumption could
have increased, for the price increase was caused by the lack of potatoes in
the first instance.
More recently, Jensen and Miller have investigated
the effect of increases in the price of rice and wheat in China. As the price
of rice increases, the “urban poor” of China have less money to spend on rice,
as well as meat, a luxury, expensive good. Thus, in order to meet their daily
requirement of 1600 calories, they resort to demanding more rice, which is
still comparatively cheaper than meat.
The income effect outweighs the substitution effect. Rice in China is a Giffen
Good.
There are other such goods which seem to defy
the Law of Demand. Take Veblen goods, goods for which there is an increase in
the quantity demanded as the price increases. However, unlike Giffen Goods,
these goods are perceived as luxury goods, status symbols. The quantity
demanded is high due to the simple fact that few people can afford them; they
infer exclusivity. There are many examples of such goods, from Rolex watches,
Porsches and fine wines.
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