Giffen good

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Indifference map with two budget lines (red) depending on the price of Giffen good x Giffenen.svg
Indifference map with two budget lines (red) depending on the price of Giffen good x

In microeconomics and consumer theory, a Giffen good is a product that people consume more of as the price rises and vice versa, violating the law of demand.

Contents

For ordinary goods, as the price of the good rises, the substitution effect makes consumers purchase less of it, and more of substitute goods; the income effect can either reinforce or weaken this decline in demand, but for an ordinary good never outweighs it. By contrast, a Giffen good is so strongly an inferior good (in higher demand at lower incomes) that the contrary income effect more than offsets the substitution effect, and the net effect of the good's price rise is to increase demand for it. This phenomenon is known as the Giffen paradox.

Background

Types of goods in economics Types of goods.svg
Types of goods in economics

Giffen goods are named after Scottish economist Sir Robert Giffen, to whom Alfred Marshall attributed this idea in his book Principles of Economics , first published in 1890. Giffen first proposed the paradox from his observations of the purchasing habits of the Victorian era poor.

It has been suggested by Etsusuke Masuda and Peter Newman that Simon Gray described "Gray goods" in his 1815 text entitled The Happiness of States: Or An Inquiry Concerning Population, The Modes of Subsisting and Employing It, and the Effects of All on Human Happiness. [1] The chapter entitled A Rise in the Price of Bread Corn, beyond a certain Pitch, tends to increase the Consumption of it, contains a detailed account of what have come to be called Giffen goods, and which might better be called Gray goods. They also note that George Stigler corrected Marshall's misattribution in a 1947 journal article on the history. [2]

Analysis

For almost all products, the demand curve has a negative slope: as the price increases, quantity demanded for the good decreases. (See Supply and demand for background.)

Giffen goods are the exception to this general rule. Unlike other goods or services, the price point at which supply and demand meet results in higher prices and greater demand whenever market forces recognize a change in supply and demand for Giffen goods. As a result, when price goes up, the quantity demanded also goes up. To be a true Giffen good, the good's price must be the only thing that changes to produce a change in quantity demanded.

Giffen goods should not be confused with Veblen goods: Veblen goods are products whose demand increases if their price increases because the price is seen as an indicator of quality or status.

The classic example given by Marshall is of inferior quality staple foods, whose demand is driven by poverty 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.

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 families and raises the marginal utility of money to them so much 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.

— Alfred Marshall, Principles of Economics (1895 ed.) [3]

There are three necessary conditions for this situation to arise: [4]

  1. the good in question must be an inferior good,
  2. there must be a lack of close substitute goods, and
  3. the goods 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 goods are consumed.

If precondition #1 is changed to "The goods in question must be so inferior that the income effect is greater than the substitution effect" then this list defines necessary and sufficient conditions. The last condition is a condition on the buyer rather than the goods itself, and thus the phenomenon is also called a "Giffen behavior".

Example

Suppose a consumer has a budget of $6 per day that they spend on food. They must eat three meals a day, and there are only two options for them: the inferior good, bread, which costs $1 per meal, and the superior good, cake, which costs $4 per meal. Cake is always preferable to bread. At present, the consumer would purchase 2 loaves of bread and one cake, completely exhausting their budget to fill 3 meals each day. Now, if the price of bread were to rise from $1 to $2, then the consumer would have no choice but to give up cake, and spend their entire budget on 3 loaves of bread, in order to eat three meals a day. In this situation, their consumption of bread would have actually increased as a result of the price increase. Thus bread would be a Giffen good in this example.

Empirical evidence

Evidence for the existence of Giffen goods has generally been limited. A 2008 paper by Robert Jensen and Nolan Miller argued rice and wheat noodles were Giffen goods in parts of China. [5] Another 2008 paper by the same authors experimentally demonstrated the existence of Giffen goods among people at the household level by directly subsidizing purchases of rice and wheat flour for extremely poor families. [6] In this paper, the field experiment conducted in 2007 consisted of the province of Hunan, where rice is a dietary staple, and the province of Gansu, where wheat is a staple. In both provinces, random households were selected and were offered their dietary staple at subsidized rates. After the completion of the project, it could be found that the demands from Hunan households who are offered by the rice fell drastically. Meanwhile, the demands of wheat in Gansu implies weak evidence of the Giffen paradox.

It is easier to demonstrate 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 human subjects: in this study, cigarette smokers chose between puffs on their preferred brand and puffs on a cheaper, inferior one with equal nicotine. As the price of the inferior brand increased, smokers purchased more of them, thereby maintaining nicotine levels. [7]

In 1991, Battalio, Kagel, and Kogut published an article arguing 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. [8]

Giffen goods are difficult to study because the definition requires a number of observable conditions. One reason for the difficulty in studying market demand for Giffen goods is that Giffen originally envisioned a specific situation faced by individuals in 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. 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. For this reason, many text books use the term Giffen paradox rather than Giffen good.[ citation needed ]

Some types of premium goods (such as expensive French wines, or celebrity-endorsed perfumes) are sometimes called Giffen goods—via the claim that lowering the price of these high status goods decreases demand because they are no longer perceived as exclusive or high status products. However, to the extent that the perceived nature of such high status goods actually changes significantly with a substantial price drop, this behavior disqualifies them from being considered 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[ who? ] 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 product. [9] However the theoretical distinction between the two types of analysis remains clear, which one should apply to any actual case is an empirical matter. Based on microeconomic consumer theory, it assumes that the consumer could value a good without knowing the price. However, when the consumers who were constrained by income and price need to choose the optimal goods, the goods must be valued with available prices. Because, in some degrees, the higher price indicates higher values of goods offering to the consumers.

Great Famine in Ireland

Potatoes during the Irish Great Famine were once considered to be an example of a Giffen good. Along with the Famine, the price of potatoes and meat increased subsequently. Compared to meat, it is obvious that potatoes could be much cheaper as a staple food. Due to poverty, individuals could not afford meat anymore; therefore, demand for potatoes increased. Under such a situation, the supply curve will increase with the rise in potatoes’ price, which is consistent with the definition of Giffen good. However, Gerald P. Dwyer and Cotton M. Lindsey challenged this idea in their 1984 article Robert Giffen and the Irish Potato, [10] [11] 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 Rosen of the University of Chicago in his 1999 paper Potato Paradoxes. [12] Rosen showed that the phenomenon could be explained by a normal demand model.

Charles Read has shown with quantitative evidence that bacon pigs showed Giffen-style behaviour during the Irish Famine, but that potatoes did not. [13] [14]

Other proposed examples

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 shochu , a Japanese distilled beverage, could be a Giffen good. In both cases, the authors offered supporting econometric evidence. However, this evidence is considered incomplete.

It is worth noting that a good may be a Giffen good at the individual level, but not at the aggregate level (or vice-versa). As shown by Hildenbrand's model, aggregate demand will not necessarily exhibit any Giffen behavior even when we assume the same preferences for each consumer, whose nominal wealth is uniformly distributed on an interval containing zero. This could explain the presence of Giffen behavior for individual consumers but the absence in aggregate data. [15]

See also

Related Research Articles

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<span class="mw-page-title-main">Supply and demand</span> Economic model of price determination in a market

In microeconomics, supply and demand is an economic model of price determination in a market. It postulates that, holding all else equal, in a competitive market, the unit price for a particular good or other traded item such as labor or liquid financial assets, will vary until it settles at a point where the quantity demanded will equal the quantity supplied, resulting in an economic equilibrium for price and quantity transacted. The concept of supply and demand forms the theoretical basis of modern economics.

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<span class="mw-page-title-main">Conspicuous consumption</span> Concept in sociology and economy

In sociology and in economics, the term conspicuous consumption describes and explains the consumer practice of buying and using goods of a higher quality, price, or in greater quantity than practical. In 1899, the sociologist Thorstein Veblen coined the term conspicuous consumption to explain the spending of money on and the acquiring of luxury commodities specifically as a public display of economic power—the income and the accumulated wealth—of the buyer. To the conspicuous consumer, the public display of discretionary income is an economic means of either attaining or of maintaining a given social status.

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<span class="mw-page-title-main">Inferior good</span> Concept in economics

In economics, an inferior good is a good whose demand decreases when consumer income rises, unlike normal goods, for which the opposite is observed. Inferiority, in this sense, is an observable fact relating to affordability rather than a statement about the quality of the good. There are many examples of inferior goods, including cheap cars, public transit options, payday lending, and inexpensive food. The shift in consumer demand for an inferior good can be explained by two natural economic phenomena: the substitution effect and the income effect.

<span class="mw-page-title-main">Normal good</span> Good that increases in demand when incomes rise

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<span class="mw-page-title-main">Veblen good</span> Luxury good for which the demand increases as the price increases

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<span class="mw-page-title-main">Law of demand</span> Fundamental principle in microeconomics

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<span class="mw-page-title-main">Luxury goods</span> Good for which demand increases more than what is proportional as income rises

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<span class="mw-page-title-main">Demand curve</span> Graph of how much of something a consumer would buy at a certain price

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In microeconomics, a consumer's Hicksian demand function or compensated demand function for a good is their quantity demanded as part of the solution to minimizing their expenditure on all goods while delivering a fixed level of utility. Essentially, a Hicksian demand function shows how an economic agent would react to the change in the price of a good, if the agent's income was compensated to guarantee the agent the same utility previous to the change in the price of the good—the agent will remain on the same indifference curve before and after the change in the price of the good. The function is named after John Hicks.

An ordinary good is a microeconomic concept used in consumer theory. It is defined as a good which creates an increase in quantity demanded when the price for the good drops or conversely a decrease in quantity demanded if the price for the good increases, ceteris paribus. It is the opposite of a Giffen good.

In economics, the income elasticity of demand (YED) is the responsivenesses of the quantity demanded for a good to a change in consumer income. It is measured as the ratio of the percentage change in quantity demanded to the percentage change in income. For example, if in response to a 10% increase in income, quantity demanded for a good or service were to increase by 20%, the income elasticity of demand would be 20%/10% = 2.0.

This glossary of economics is a list of definitions of terms and concepts used in economics, its sub-disciplines, and related fields.

References

  1. ↑ Masuda, E.; Newman, P. (1981). "Gray and Giffen Goods". The Economic Journal. 91 (364): 1011. doi:10.2307/2232507. JSTOR   2232507.
  2. ↑ Stigler, George (1947). "Notes on the History of the Giffen Paradox". Journal of Political Economy. 55 (2): 154. JSTOR   1825304.
  3. ↑ Marshall, Alfred (1895). Principles of Economics. Vol. III. Ch. VI, Para. III.VI.17.
  4. ↑ Marshall, Alfred (1895). Principles of Economics.
  5. ↑ Jensen, R. T.; Miller, N. H. (2008). "The impact of food price increases on caloric intake in China". Agricultural Economics. 39 (1): 465–476. doi:10.1111/j.1574-0862.2008.00352.x. PMC   3101574 . PMID   21625411.
  6. ↑ Jensen, Robert; Miller, Nolan (2008). "Giffen Behavior and Subsistence Consumption". American Economic Review . 97 (4): 1553–1577. doi:10.1257/aer.98.4.1553. JSTOR   29730133. PMC   2964162 . PMID   21031158.
  7. ↑ DeGrandpre, R. J.; Bickel, W. K.; Rizvi, S. A.; Hughes, J. R. (1993). "Effects of income on drug choice in humans". Journal of the Experimental Analysis of Behavior. 59 (3): 483–500. doi:10.1901/jeab.1993.59-483. PMC   1322132 . PMID   8315366.
  8. ↑ Kagel, John H.; Battalio, Raymond C.; Green, Leonard (1995). Economic Choice Theory: An Experimental Analysis of Animal Behavior . Cambridge University Press. pp.  25–28. ISBN   978-0-521-45488-9.
  9. ↑ Piros, Pinto, Harris, Christopher, Jerald, Larry (2013). Economics for Investment Decision Maker. America: Wiley. ISBN   978-1-118-41624-2.{{cite book}}: CS1 maint: multiple names: authors list (link)
  10. ↑ Dwyer, Gerald P. Jr.; Lindsay, Cotton M. (1984). "Robert Giffen and the Irish Potato". American Economic Review. 74 (1): 188–192. JSTOR   1803318.
  11. ↑ Kohli, Ulrich (1986). "Robert Giffen and the Irish Potato: Note". American Economic Review. 76 (3): 539–542. JSTOR   1813371.
  12. ↑ Rosen, Sherwin (1999). "Potato Paradoxes". Journal of Political Economy . 107 (6): 294–313. doi:10.1086/250112. JSTOR   2990755. S2CID   222454869.
  13. ↑ Read, Charles (May 2013). "Giffen Behaviour in Irish Famine Markets: An Empirical Study" (PDF). Cambridge Working Papers in Economic and Social History No. 15.
  14. ↑ C. Read, ‘The Irish Famine and Unusual Market Behaviour in Cork’, Irish Economic and Social History 44:1 (December 2017) pp. 3-18. [http://doi.org/10.1177/0332489317705461].
  15. ↑ Hildenbrand, W (1983). "On the law of demand". Econometrica. 51 (997): 1018. doi:10.2307/1912048. JSTOR   1912048.

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