In economics, a giffen good is an inferior good with the
unique characteristic that an increase in price actually increases the quantity
of the good that is demanded. This
provides the unusual result of an upward sloping demand curve.
The upward sloping demand curve for a giffen good is the result of the interactions between the income and
substitution effects. The income effect dictates how much the quantity demanded will change because a users remaining budget is affected by price changes while the substitution effect shows us how much the quantity demanded of a good will change based on preferences between two goods that serve the same function.
Depending on whether the good is inferior or normal, the income effect can be positive or negative as the price of a good increases. An inferior good will see less consumption as income rises while a normal good will see a positive relationship between more income and quantity demanded.
For example, imagine an inferior good being Top Ramen (an inexpensive noodle dish, common among students). As your income rises, you would expect to consume less Top Ramen, because you may begin to buy more spaghetti, or steak, or something you enjoy more than Top Ramen. But if you lose your job, and your income goes down, you will consume more Top Ramen because it is inexpensive.
Depending on whether the good is inferior or normal, the income effect can be positive or negative as the price of a good increases. An inferior good will see less consumption as income rises while a normal good will see a positive relationship between more income and quantity demanded.
For example, imagine an inferior good being Top Ramen (an inexpensive noodle dish, common among students). As your income rises, you would expect to consume less Top Ramen, because you may begin to buy more spaghetti, or steak, or something you enjoy more than Top Ramen. But if you lose your job, and your income goes down, you will consume more Top Ramen because it is inexpensive.
Next we have to consider the substitution effect. No matter type of good, the substitution
effect will be negative as the price of that good goes up. So if the price of Top Ramen rises, the
substitution effect will dictate that you will buy more spaghetti, or steak
because that good has become relatively cheaper.
The interesting thing about a giffen good, is that when the
price of a giffen good rises, the income effect is so large that it ends up being larger than the
substitution effect. So if a good is
a giffen good, it must be an inferior good AND the income effect will be larger than the negative value
from the substitution effect.
Summary: if a good is
inferior, a drop in income (represented by a price increase) increases the
quantity of the good that is demanded.
The substitution effect is negative for any good that experiences a
price increase. A giffen good faces an
upward sloping demand curve because the income effect dominates the substitution
effect, meaning that quantity demanded increases as price rises.
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| Example of an upward sloping demand curve (Giffen Good) |
However, a good cannot have an upward sloping demand curve forever because eventually the consumer will run out of money (they will spend their entire budget on the inferior good). Remember that giffen goods have to be
inferior goods, which implies that the consumer purchasing them has little
money to begin with. At some point, the
rising price of the giffen good takes over the consumer’s entire budget, and a
price increase will actually decrease the amount of the good the consumer is able
to buy. This means that at high enough
prices, we will see the traditional downward sloping demand curve--because the consumer runs out of money.
Let’s go through an example of a giffen good, using potatoes
and steak as the choice set of the consumer.
Imagine the consumer has a budget of $30, and the cost of a potato
begins at $0.50 and the price of a steak is $10.00. Also consider that the consumer needs to buy
meals for 10 days.
With the original budget and prices, the consumer may choose
to consume 2 steaks, at $20, and 20 potatoes for $10 over this time frame to
use up their entire budget. This is a
satisfactory amount because they will have on average 2 potatoes a day, and 2
steaks over the period.
Now imagine a price increase of potatoes to $1 each. The consumer could still buy 2 steaks, but
could now only buy 10 potatoes. This
might leave them hungry, so it is possible they will buy less steak, and more
potatoes in order to get their calories.
This means that 20 potatoes will still be purchased, but now only 1
steak is purchased.
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| Giffen Good Graph |
At this point, the consumer’s entire budget is taken up by
the giffen good, so any price increase now will result in a decrease of the
amount of good the consumer is able to buy.
Thus, we will have our typical downward sloping demand curve.
Some examples of giffen goods that economists have identified include agricultural staples such as: potatoes, rice, and corn. They will only be true giffen goods to those in poverty who have limited options.
Other tongue in cheek examples include fine wines or stocks in the stock market. The idea here is that high prices signal better quality goods which increase the demand for them (keep in mind that this is NOT the traditional definition of a giffen good).
Some examples of giffen goods that economists have identified include agricultural staples such as: potatoes, rice, and corn. They will only be true giffen goods to those in poverty who have limited options.
Other tongue in cheek examples include fine wines or stocks in the stock market. The idea here is that high prices signal better quality goods which increase the demand for them (keep in mind that this is NOT the traditional definition of a giffen good).
