Changes

However, the “substitution effect” goes up when the price falls.  Because the income effect and substitution effect move in opposite directions, it is difficult to predict what will happen to their sum, which is the overall demand.  A “Giffen good” is an inferior good for which the income effect dominates, and thus it has the unusual characteristic that a fall in price of the good causes a fall in demand.  It is difficult to think of an example.   

However, the “substitution effect” goes up when the price falls.  Because the income effect and substitution effect move in opposite directions, it is difficult to predict what will happen to their sum, which is the overall demand.  A “Giffen good” is an inferior good for which the income effect dominates, and thus it has the unusual characteristic that a fall in price of the good causes a fall in demand.  It is difficult to think of an example.   

It is worth defining a “Giffen good” again, this time in terms of a price increase: it is a good which experiences an increase in demand when its price increases.  This only happens for an “inferior” good that responds so negatively to an increase in income that the income effect outweighs the substitution effect.  In the 1895 edition of the classic “Principles of Economics,” Alfred Marshall wrote: “As Mr. Giffen has pointed out, a rise in the price of bread makes so large a drain on the resources of the poorer labouring [British spelling] families and raises so much the marginal utility of money to them, that they are forced to curtail their consumption of meat and the more expensive farinaceous foods: and, bread being still the cheapest food which they can get and will take, they consume more, and not less of it.”

It is worth defining a “Giffen good” again, this time in terms of a price increase: it is a good which experiences an increase in demand when its price increases.  This happens for an “inferior” good that responds so negatively to an increase in income that the income effect outweighs the substitution effect.  In the 1895 edition of the classic “Principles of Economics,” Alfred Marshall wrote: “As Mr. Giffen has pointed out, a rise in the price of bread makes so large a drain on the resources of the poorer labouring [British spelling] families and raises so much the marginal utility of money to them, that they are forced to curtail their consumption of meat and the more expensive farinaceous foods: and, bread being still the cheapest food which they can get and will take, they consume more, and not less of it.”

Another textbook example of a “Giffen good” is the potato during the terrible Irish famine of 1846-1849.  The theory is that the increase in the potato price during the famine wiped out the real income of the Irish, but the potato was an “inferior” good that saw a surge in demand due to the reduced income. Other economists suggest that tortillas are a Giffen good in Mexico today.  But further investigation shows that neither potatoes in Ireland nor tortillas in Mexico actually qualify as Giffen goods.  Rice and noodles are now described as Giffen goods among the poor in China.  Do you believe it?

Another textbook example of a “Giffen good” is the potato during the terrible Irish famine of 1846-1849.  This famine caused nearly a million Irish to die of starvation, and forced nearly another million to emigrate to the United States, Britain, Canada and Australia.  Economists say that the potato during the famine was Giffen good.  The potato crops failed and there was less supply of potatoes, which caused its price to increase.  But the poor Irish, after paying the higher price for potatoes, had less money left to buy more expensive foods.  So they had no choice but to buy even more potatoes to fill their stomachs!  In other words, the increase in the price of the potato wiped out the savings of the Irish, who then bought even more potatoes despite its increase in price.  Note that the potato could have been a Giffen good only if it was also an “inferior” good that saw a surge in demand when people had less income (less money to spend).

 

Other economists suggest that tortillas are a Giffen good in Mexico today.  But further investigation shows that neither potatoes in Ireland nor tortillas in Mexico actually qualify as Giffen goods.  Rice and noodles are now described as Giffen goods among the poor in China.  Do you believe it?

Except for the rare and possibly non-existent Giffen good, the “Law of Demand” is this: when the price of a good increases, its demand decreases.  When the price of a good decreases, its demand increases.  This is one of the most fundamental rules of Economics.

Except for the rare and possibly non-existent Giffen good, the “Law of Demand” is this: when the price of a good increases, its demand decreases.  When the price of a good decreases, its demand increases.  This is one of the most fundamental rules of Economics.