Giffen goods

Giffen goods are a special category of goods in economics that display an exceptional behaviour contrary to the basic law of demand. Normally, when the price of a good rises, its demand falls, and when the price falls, its demand increases. However, in the case of Giffen goods, demand rises as the price increases and falls when the price decreases. This peculiar pattern is known as the Giffen paradox.
The concept is named after Sir Robert Giffen, a 19th-century Scottish economist, who observed this phenomenon among poor households in Britain, where people bought more bread even when its price increased because they could not afford more expensive foods.

Definition

A Giffen good is an inferior good for which the income effect outweighs the substitution effect, resulting in a positive relationship between price and quantity demanded.
In simpler terms, when the price of a Giffen good increases, people end up buying more of it because the rise in price effectively reduces their real income, forcing them to cut back on better substitutes and consume more of the cheaper staple good.

Theoretical Explanation

1. Law of Demand and Exceptions: Under the normal law of demand, there is an inverse relationship between price and demand. However, Giffen goods represent a rare exception, where this relationship turns positive.
2. Income Effect and Substitution Effect: When the price of a good changes, two forces influence consumer behaviour:
   • Substitution Effect: Consumers substitute cheaper goods for costlier ones when prices rise.
   • Income Effect: A price increase effectively reduces a consumer’s purchasing power (real income), influencing demand.

   In the case of Giffen goods, the negative income effect is so strong that it overrides the substitution effect. Thus, higher prices lead to higher demand.

3. Example in a Consumption Bundle: Suppose a low-income household spends most of its income on two commodities—an inferior staple (like coarse rice or bread) and a luxury food (like meat).
   • When the price of the staple rises, the household’s real income decreases.
   • It can no longer afford the luxury food and must spend more on the staple for basic sustenance.
   • Hence, even though the staple has become costlier, consumption of it increases.

Conditions for a Good to be Giffen

For a commodity to qualify as a Giffen good, the following conditions must be met:

1. Inferior Nature: The good must be inferior, meaning demand for it increases as income falls.
2. Large Share in Budget: It must constitute a substantial portion of the consumer’s total expenditure so that price changes significantly affect real income.
3. Lack of Close Substitutes: The good should have no close alternatives available for substitution when its price changes.
4. Strong Negative Income Effect: The income effect of a price change must dominate the substitution effect.

Because these conditions are rare in real-world markets, Giffen goods are considered more of a theoretical or exceptional concept.

Example of Giffen Goods

1. Classical Example – Bread or Coarse Grains: In 19th-century England, low-income households consumed bread as their staple food. When bread prices rose, poor consumers could no longer afford expensive foods like meat and butter, so they ended up buying more bread to meet their basic calorie needs.
2. Modern Examples (Hypothetical):
   • Rice or Bajra in Rural India: In certain low-income rural areas, if the price of rice increases, households might buy more rice and less of other costly items.
   • Potatoes during the Irish Famine (1840s): Sometimes cited as a Giffen case, though later studies suggest otherwise.
3. Non-Giffen Inferior Goods: It is important to note that all Giffen goods are inferior goods, but not all inferior goods are Giffen goods. For example, low-quality clothing or public transport are inferior goods, but they do not show a positive price-demand relationship.

Graphical Representation

In a normal demand curve, the slope is downward from left to right, showing that demand falls as price increases.In the case of Giffen goods, the demand curve slopes upward, indicating that demand rises with price.

Price ↑
| /
| /
| /
| /
| /
|__/________________ Quantity →

This upward-sloping demand curve represents the Giffen paradox.

Giffen Goods vs. Inferior Goods

Importance in Economic Theory

The concept of Giffen goods is significant in microeconomic theory as it:

• Demonstrates that the law of demand has exceptions.
• Illustrates the importance of distinguishing between income and substitution effects.
• Highlights the behaviour of low-income consumers under budget constraints.
• Aids in policy formulation concerning price controls and food subsidies, especially for essential goods.

For example, if a government subsidises staple foods to reduce prices, demand for them may paradoxically fall among poorer sections who now have more real income to buy superior substitutes—showing the complex link between prices and consumption.

Criticism and Real-World Rarity

While the concept is theoretically sound, identifying real Giffen goods has proven difficult:

• Modern markets offer numerous substitutes, reducing the likelihood of Giffen behaviour.
• Improved incomes and diversified consumption patterns have made such conditions rare.
• Empirical evidence for true Giffen goods is limited, though some experimental studies in China (2007) on rice and wheat provided partial confirmation.