Giffen good

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.
View other properties of goods

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.

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.

Alternative explanations for apparent Giffen goods

Just because the demand 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 demand 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 demand 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 demand

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

Evidence

Historical 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.

Relation with other properties

Weaker properties

Inferior good

References

Journal references

Experimental confirmation of the existence of a Giffen good by Raymond Battalio, John Kagel and Carl Kogut, American Economic Review, Volume 81,Number 4, Page 961 - 970(September 1991): ^{JSTOR link}^{More info}