Tuesday, June 9, 2015

Giffen Goods

Here's a fun type of inferior good that's not on our economics syllabus, but pretty cool to know about. I've actually never heard of this type of good until today. Very counter-intuitive and one of the reasons I love learning about economics.

Giffen good - Young Economists

 
A Giffen good is an extreme type of inferior good. The negative income effect of changes in price of a Giffen good is actual stronger than the substitution effect. This leads to its bizarre quality: when the price of a Giffen good rises, consumers actually buy more. Veblen goods behave the same way for very different reasons. 
To understand how this happens, consider the example of a Giffen good for which there is the best evidence that it is a Giffen good. Households in the Hunan province of China were shown to buy more rice when they had to buy it at a higher price, and less when the price they paid was subsidised. 
The reason for this is that, even when expensive, rice was still the cheapest source of calories available. Therefore, when the price of rice was cut, households had more money left over after buying rice. Some of this was spent on buying more expensive foods (meat, vegetables and fruit), which reduced their need for rice.
From Wikipedia
In economics and consumer theory, a Giffen good is a product that people consume more of as the price rises—violating the law of demand. For any good, as the price of thegood rises, the substitution effect makes consumers purchase less of it, and more of substitute goods; for most goods, the income effect (due to the effective decline in available income due to more being spent on existing units of this good) reinforces this decline in demand for the good. But a Giffen good is so strongly an inferior good (being more in demand at lower income) that this 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.

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