Giffen good

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This article defines a property of goods: a property that makes sense in the context of a good being bought and sold, and evaluated from the perspective of the buyer, seller, or others affected by it.
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APPARENT COUNTEREXAMPLE: The topic of this article is an apparent (or possibly real) counterexample to a generally accepted law or principle of economics.
View other apparent counterexamples

History

The notion of a Giffen good first appeared in Alfred Marshall's book Principles of economics.

Definition

A Giffen good is a good satisfying the following equivalent conditions:

  • Its price-elasticity of demand is positive even though the value people place on it does not change with changes in price.
  • ceteris paribus, an increase in the price of the good leads to an increase in the quantity demanded, despite the fact that buyers do not value the good more at a higher price.
  • ceteris paribus, a decrease in the price of the good leads to a decrease in the quantity demanded, despite the fact that buyers do not value the good less at a lower price.
  • It is an inferior good for which the demand increases with increase in its price, because buyers shift more of their consumption to it from superior, costly substitutes in order to compensate for the extra cost.

In other words, Giffen goods appear to violate the law of demand.

Conditions for Giffen goods

Total consumption on the good forms a large part of the budget

The total amount the consumer spends on the good should form a large fraction of the consumer's budget. Only in such a case does an increase in the price of the good create a budget shortage significant enough to cause a shift in other consumption patterns. In other words, an increase in its price should produce a significant income effect.

The good must be inferior

The good must be an inferior good in order for the budget shortage on the part of consumers to cause an increase in consumption. In other words, the good must be inferior for the income effect to increase its consumption due to substitution away from costly and superior alternatives.

Close substitutes must be absent but not-so-close substitutes must exist

Finally, the cost difference with substitutes must be sufficiently substantial that even with the increase in price, it is still attractive as an inferior good. In other words, the substitution effect created by an increase in its relative price should be too small to counter the income effect created by the increased costs.

Hidden assumption challenged

The existence of Giffen goods appears to challenge the law of demand. This is explained as follows:

The law of demand says that, ceteris paribus, an increase in price leads to a decline in demand. The exogenous parameters that we assume to remain constant are the determinants of demand: the prices of substitutes, the prices of complements, the tastes and preferences of the households, expectations about future prices, and the household income. However, an increase in the price of a Giffen good effectively alters the household income.

One way to think about this is to break down consumption of the Giffen good into two parts: a necessary part, and an optional part. The consumption for the necessary part reduces the effective income. Now, the inferior good nature increases consumption at the increased price.

Alternative explanations for apparent Giffen goods

Just because the quantity demanded for a good increases with increases in its price does not imply that the good is a Giffen good. To qualify as a Giffen good, the quantity demanded must increase despite the fact that the substitution effect works against it: in other words, the value that buyers place on the good does not increase.

The problem of causality

What appears to be an increase in quantity demanded due to an increase in price may well be an increase in price due to an increase in demand, which in turn happens due to totally unrelated factors. Asserting that something is a Giffen good requires one to rule out the possibility that other factors have driven up demand.

Alternative explanations for rising price driving rising quantity demanded

Another kind of good for which rising price drives rising quantity demanded is a Veblen good. A Veblen good is a good where a larger price makes the good more valuable.

Evidence

Historical (non)-example: Irish Potato Famine

The Irish Potato famine of 1845-1849 has been cited as an example of a Giffen good in the real world, with the potato being the Giffen good. As the price of potatoes increased due to scarcity, demand for potatoes also increased.

In 1984, in the paper Robert Giffen and the Irish Potato, Dwyer and Lindsay published an analysis of the Irish Potato Famine (1845-49), arguing that this explanation was flawed. In a later paper, Potato paradoxes, Sherwin Rosen further exposed the flaws in this argument.

An experiment with rats

An experiment by Battalio, Kagel and Kogut demonstrated the existence of Giffen goods for rats. In their experimental setup, rats had a choice of two drinks: root beer and quinine. Root beer was the expensive and superior drink, while quinine was the cheaper inferior drink. Rats had to pay for the drinks by pushing levers. The experimenters observed that when the price of quinine went up, rats consumed more of the quinine. This was explained by saying that quinine functioned as a Giffen good: as its price went up, the rats' budget got more stressed, so they shifted consumption away from the expensive root beer to the cheaper quinine.

A study in China

A study in two provinces of China (Hunan and Gansu) involving two staples, wheat and rice, showed positive evidence for the existence of Giffen goods.

Relation with other properties

Weaker properties

References

Online dictionary/encyclopedia entries

Weblog entries/articles

Journal references

General-purpose economics textbook references

These are texts intended for use in undergraduate/graduate economics teaching.

Book Pages Chapter/section More comments Link
Price theory and applications by Steven E. Landsburg, 10-digit ISBN 0324579934, 13-digit ISBN 978-0324579932More info 84, 94-95 Google Books (Page 84), Google Books (Page 94)
Principles of Economics by N. Gregory Mankiw, 10-digit ISBN 0324589972, 13-digit ISBN 978-0324589979More info 472-473 Google Books (Page 473 onward, 472 unavailable for preview)
Economics by Paul Krugman and Robin Wells, 10-digit ISBN 0716771586, 13-digit ISBN 978-0716771586More info 265, 297 Google Books (Page 265), Google Books (Page 297)
Price theory and applications: decisions, markets, and information by Jack Hirshleifer, Amihai Glazer, David HirshleiferMore info 113-118 Google Books

Textbook references