In
economicsEconomics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
and
consumer theoryConsumer choice is a theory of microeconomics that relates preferences for consumption goods and services to consumption expenditures and ultimately to consumer demand curves. The link between personal preferences, consumption, and the demand curve is one of the most closely studied relations in...
, a
Giffen good is one which people paradoxically consume more of as the price rises, violating the
law of demandIn economics, the law of demand is an economic law that states that consumers buy more of a good when its price decreases and less when its price increases ....
. In normal situations, as the
price-Definition:In ordinary usage, price is the quantity of payment or compensation given by one party to another in return for goods or services.In modern economies, prices are generally expressed in units of some form of currency...
of a
goodGood may refer to:* Good and evil - The distinction between positive and negative entities* Good - Objects produced for market* Form of the Good - Plato's macrocosmic view of goodness in living* Good...
rises, the substitution effect causes consumers to purchase less of it and more of
substitute goodIn economics, one way we classify goods is by examining the relationship of the demand schedules when the price of one good changes. This relationship between demand schedules leads economists to classify goods as either substitutes or complements. Substitute goods are goods which, as a result...
s. In the Giffen good situation the income effect dominates, leading people to buy more of the good, even as its price rises.
Evidence for the existence of Giffen goods is limited, but microeconomic mathematical models explain how such a thing could exist. Giffen goods are named after Scottish economist
Sir Robert GiffenSir Robert Giffen KCB , was a Scottish statistician and economist. He was born at Strathaven, Lanarkshire.He entered a solicitor's office in Glasgow, and while in that city attended courses at the university. He drifted into journalism, and after working for the Stirling Journal he went to London...
, who was attributed as the author of this idea by
Alfred MarshallAlfred Marshall was an Englishman and one of the most influential economists of his time. His book, Principles of Economics , was the dominant economic textbook in England for many years...
in his book
Principles of EconomicsPrinciples of Economics was a leading political economy or economics textbook of Alfred Marshall , first published in 1890. It ran into many editions and was the standard text for generations of economics students.-Writing:...
. Giffen first proposed the
paradoxSimilar to Circular reasoning, A paradox is a seemingly true statement or group of statements that lead to a contradiction or a situation which seems to defy logic or intuition...
from his observations of the purchasing habits of the
Victorian eraThe Victorian era of British history was the period of Queen Victoria's reign from 20 June 1837 until her death on 22 January 1901. It was a long period of peace, prosperity, refined sensibilities and national self-confidence...
poor.
For most products,
price elasticity of demandPrice elasticity of demand is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. More precisely, it gives the percentage change in quantity demanded in response to a one percent change in price...
is negative (note that, although they are negative, price elasticities of demand are often reported as positive numbers; see the mathematical definition for more). In other words, price and quantity demanded pull in opposite directions; if price goes up, then quantity demanded goes down, or vice versa. Giffen goods are an exception to this. Their price elasticity of demand is positive. When price goes up, the quantity demanded also goes up, and vice versa. In order to be a true Giffen good, price must be the only thing that changes to get a change in quantity demand, and a Giffen good should not be confused with products bought as status symbols or for
conspicuous consumptionConspicuous consumption is spending on goods and services acquired mainly for the purpose of displaying income or wealth. In the mind of a conspicuous consumer, such display serves as a means of attaining or maintaining social status....
(such a situation would indicate a Veblen good).
The classic example given by Marshall is of inferior quality
staple foodA staple food is one that is eaten regularly and in such quantities that it constitutes a dominant portion of a diet, and that supplies a high proportion of energy and nutrient needs. Most people live on a diet based on one or more staples...
s, whose demand is driven by
povertyPoverty is the lack of a certain amount of material possessions or money. Absolute poverty or destitution is inability to afford basic human needs, which commonly includes clean and fresh water, nutrition, health care, education, clothing and shelter. About 1.7 billion people are estimated to live...
that makes their purchasers unable to afford superior foodstuffs. As the price of the cheap staple rises, they can no longer afford to supplement their diet with better foods, and must consume more of the staple food.
Giffen goods are also related to
experience goodIn economics, an experience good is a product or service where product characteristics such as quality or price are difficult to observe in advance, but these characteristics can be ascertained upon consumption...
s and credence goods in that the two often exhibit increases in demand with price, yet different in that close substitutes are available for the latter types.
Analysis
There are three necessary preconditions for this situation to arise:
- the good in question must be an inferior good
In consumer theory, an inferior good is a good that decreases in demand when consumer income rises, unlike normal goods, for which the opposite is observed. Normal goods are those for which consumers' demand increases when their income increases....
,
- there must be a lack of close substitute good
In economics, one way we classify goods is by examining the relationship of the demand schedules when the price of one good changes. This relationship between demand schedules leads economists to classify goods as either substitutes or complements. Substitute goods are goods which, as a result...
s, and
- the good must constitute a substantial percentage of the buyer's income, but not such a substantial percentage of the buyer's income that none of the associated normal good
In economics, normal goods are any goods for which demand increases when income increases and falls when income decreases but price remains constant, i.e. with a positive income elasticity of demand...
s are consumed.
If precondition #1 is changed to "The good in question must be so inferior that the income effect is greater than the substitution effect" then this list defines necessary and sufficient conditions. As the last condition is a condition on the buyer rather than the good itself, the phenomenon can also be labeled as "Giffen behavior".
This can be illustrated with a diagram. Initially the consumer has the choice between spending their income on either commodity Y or commodity X as defined by line segment MN (where M = total available income divided by the price of commodity Y, and N = total available income divided by the price of commodity X). The line MN is known as the consumer's budget constraint. Given the consumer's preferences, as expressed in the
indifference curveIn microeconomic theory, an indifference curve is a graph showing different bundles of goods between which a consumer is indifferent. That is, at each point on the curve, the consumer has no preference for one bundle over another. One can equivalently refer to each point on the indifference curve...
I
0, the optimum mix of purchases for this individual is point A.
If there is a drop in the price of commodity X, there will be two effects. The reduced price will alter
relative priceA relative price is the price of a commodity such as a good or service in terms of another; i.e., the ratio of two prices. A relative price may be expressed in terms of a ratio between any two prices or the ratio between the price of one particular good and a weighted average of all other goods...
s in favour of commodity X, known as the substitution effect. This is illustrated by a movement down the indifference curve from point A to point B (a pivot of the budget constraint about the original indifference curve). At the same time, the price reduction causes the consumers' purchasing power to increase, known as the income effect (an outward shift of the budget constraint). This is illustrated by the shifting out of the dotted line to MP (where P = income divided by the new price of commodity X). The substitution effect (point A to point B) raises the quantity demanded of commodity X from X
a to X
b while the income effect lowers the quantity demanded from X
b to X
c. The net effect is a reduction in quantity demanded from X
a to X
c making commodity X a Giffen good by definition. Any good where the income effect more than compensates for the substitution effect is a giffen good.
Empirical evidence
Evidence for the existence of Giffen goods has generally been limited. A 2002 preliminary working paper by Robert Jensen and Nolan Miller of
Harvard UniversityHarvard University is a private Ivy League university located in Cambridge, Massachusetts, United States, established in 1636 by the Massachusetts legislature. Harvard is the oldest institution of higher learning in the United States and the first corporation chartered in the country...
made the claim that
riceRice is the seed of the monocot plants Oryza sativa or Oryza glaberrima . As a cereal grain, it is the most important staple food for a large part of the world's human population, especially in East Asia, Southeast Asia, South Asia, the Middle East, and the West Indies...
and
wheatWheat is a cereal grain, originally from the Levant region of the Near East, but now cultivated worldwide. In 2007 world production of wheat was 607 million tons, making it the third most-produced cereal after maize and rice...
/
noodleThe noodle is a type of food, made from any of a variety of doughs, formed into long thin ribbons, strips, curly-cues, waves, helices, pipes, tubes, strings, or other various shapes, sometimes folded. They are usually cooked in a mixture of boiling water and/or oil. Depending upon the type, noodles...
s are Giffen goods in parts of
ChinaChinese civilization may refer to:* China for more general discussion of the country.* Chinese culture* Greater China, the transnational community of ethnic Chinese.* History of China* Sinosphere, the area historically affected by Chinese culture...
by tracking prices of goods. A further 2007 working paper by the same authors (now published in the September 2008 issue of American Economic Review) experimentally demonstrated the existence of Giffen goods among humans at the household level by directly subsidizing purchases of rice and wheat flour for extremely poor families. It is easier to find Giffen effects where the number of goods available is limited, as in an experimental economy: DeGrandpre et al. (1993) provide such an experimental demonstration. In 1991, Battalio, Kagel, and Kogut proved that quinine water is a Giffen good for some lab rats. However, they were only able to show the existence of a Giffen good at an individual level and not the market level.
All Giffen goods are
inferior goodsIn consumer theory, an inferior good is a good that decreases in demand when consumer income rises, unlike normal goods, for which the opposite is observed. Normal goods are those for which consumers' demand increases when their income increases....
but not all inferior goods are Giffen goods.
Giffen goods are difficult to find because a number of conditions must be satisfied for the associated behavior to be observed. One reason for the difficulty in finding Giffen goods is Giffen originally envisioned a specific situation faced by individuals in a state of poverty. Modern consumer behaviour research methods often deal in aggregates that average out income levels and are too blunt an instrument to capture these specific situations. Furthermore, complicating the matter are the requirements for limited availability of substitutes, as well as that the consumers are not so poor that they can only afford the inferior good. It is for this reason that many text books use the term
Giffen paradox rather than
Giffen good.
Some types of premium goods (such as expensive French wines, or celebrity-endorsed perfumes) are sometimes claimed to be Giffen goods. It is claimed that lowering the price of these high status goods can decrease demand because they are no longer perceived as exclusive or high status products. However, the perceived nature of such high status goods changes significantly with a substantial price drop. This disqualifies them from being considered as Giffen goods, because the Giffen goods analysis assumes that only the consumer's income or the relative price level changes, not the nature of the good itself. If a price change modifies consumers' perception of the good, they should be analysed as Veblen goods. Some economists question the empirical validity of the distinction between Giffen and Veblen goods, arguing that whenever there is a substantial change in the price of a good its perceived nature also changes, since price is a large part of what constitutes a
productIn general, the product is defined as a "thing produced by labor or effort" or the "result of an act or a process", and stems from the verb produce, from the Latin prōdūce ' lead or bring forth'. Since 1575, the word "product" has referred to anything produced...
. However the theoretical distinction between the two types of analysis remains clear; which one of them should be applied to any actual case is an empirical matter.
Great Famine in Ireland
Potatoes during the Irish Great Famine were long believed to be the only example of a Giffen good. But this theory was debunked by Gerald P. Dwyer and Cotton M. Lindsey in their 1984 article
Robert Giffen and the Irish Potato, where they showed the contradicting nature of the Giffen "legend" with respect to historical evidence.
The Giffen nature of the Irish potato was also later discredited by
Sherwin RosenSherwin Rosen was an American labor economist. He had ties with many American universities and academic institutions including the University of Chicago, the University of Rochester, Stanford University and its Hoover Institution. At the time of his death, Rosen was Edwin A. and Betty L...
of the
University of ChicagoThe University of Chicago is a private research university in Chicago, Illinois, USA. It was founded by the American Baptist Education Society with a donation from oil magnate and philanthropist John D. Rockefeller and incorporated in 1890...
in his 1999 paper
Potato Paradoxes. Rosen showed that the phenomenon could be explained by a normal demand model.
Other proposed examples
It has been suggested that a number of other goods might be Giffen. While the arguments are theoretically sound (i.e., they accord with Marshall's basic intuition), in each case the supporting empirical evidence has been found to be unconvincing.
Anthony Bopp (1983) proposed that kerosene, a low-quality fuel used in home heating, was a Giffen good. Schmuel Baruch and Yakar Kanai (2001) suggested that
shochuis a Japanese distilled beverage. It is typically distilled from barley, sweet potatoes, or rice, though it is sometimes produced from other ingredients such as brown sugar, buckwheat or chestnut. Typically shōchū contains 25% alcohol by volume...
, a Japanese distilled beverage, "might" be a Giffen good. In both cases, the authors offered supporting econometric evidence. However, the empirical evidence has been generally considered to be incomplete. In a 2005 article, Sasha Abramsky of
The NationThe Nation is the oldest continuously published weekly magazine in the United States. The periodical, devoted to politics and culture, is self-described as "the flagship of the left." Founded on July 6, 1865, It is published by The Nation Company, L.P., at 33 Irving Place, New York City.The Nation...
conjectured that gasoline, in certain circumstances, may act as a Giffen good. However, no supporting evidence was offered, and evidence from the large increases in oil prices in 2008 would suggest that quantity demanded for gasoline did actually fall as a result of increased prices. Of course, the lack of evidence at the aggregate level does not rule out that the proposed goods may have been Giffen for certain groups of consumers—in particular for poor consumers.
The great recession has raised the possibility that very safe financial assets (Treasuries, cash, gold) become Giffen goods in liquidity trap scenarios or during bad economic times. As investors fear lower returns in equities and other investments they minimize risk by purchasing more of a low return, higher price asset that is considered safer.
See also
- Supply and demand
Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers , resulting in an...
- Price elasticity of demand
Price elasticity of demand is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. More precisely, it gives the percentage change in quantity demanded in response to a one percent change in price...
- Consumer theory
Consumer choice is a theory of microeconomics that relates preferences for consumption goods and services to consumption expenditures and ultimately to consumer demand curves. The link between personal preferences, consumption, and the demand curve is one of the most closely studied relations in...
- Ordinary good
An ordinary good is a microeconomic concept used in consumer theory. It is defined as a good which creates increased demand when the price for the good drops or conversely decreased demand if the price for the good increases, ceteris paribus...
- Inferior good
In consumer theory, an inferior good is a good that decreases in demand when consumer income rises, unlike normal goods, for which the opposite is observed. Normal goods are those for which consumers' demand increases when their income increases....
- Normal good
In economics, normal goods are any goods for which demand increases when income increases and falls when income decreases but price remains constant, i.e. with a positive income elasticity of demand...
- Capital good
A capital good, or simply capital in economics, is a manufactured means of production. Capital goods are acquired by a society by saving wealth which can be invested in the means of production....
- Veblen good
External links