Giffen Goods and an Upward-Sloping Demand Curve

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Is an Upward-Sloping Demand Curve Possible?

In economics, the law of demand tells us that, all else being equal, the quantity demanded of a good decreases as the price of that good increases. In other words, the law of demand tells us that price and quantity demanded move in opposite directions and, as a result, demand curves slope downward.

Must this always be the case, or is it possible for a good to have an upward-sloping demand curve? This counterintuitive scenario is possible with the presence of Giffen goods.

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Giffen Goods

Giffen goods, in fact, are goods that have upward-sloping demand curves. How can it be possible that people are willing and able to buy more of a good when it gets more expensive?

To understand this, it's important to keep in mind that the change in quantity demanded as a result of a price change is the sum of the substitution effect and the income effect.

The substitution effect states that consumers demand less of a good when it goes up in price and vice versa. The income effect, on the other hand, is a bit more complex, since not all goods respond the same way to changes in income.

When the price of a good increases, consumers' purchasing power decreases. They effectively experience a change akin to a decrease in income. Conversely, when the price of a good decreases, consumers' purchasing power increases as they effectively experience a change akin to an increase in income. Therefore, the income effect describes how the quantity demanded of a good responds to these effective income changes. 

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Normal Goods and Inferior Goods

If a good is a ​normal good, then the income effect states that the quantity demanded of the good will increase when the price of the good decreases, and vice versa. Remember that a price decrease corresponds to an income increase. 

If a good is an inferior good, then the income effect states that the quantity demanded of the good will decrease when the price of the good decreases, and vice versa. Remember that a price increase corresponds to an income decrease.

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Putting the Substitution and Income Effects Together

The table above summarizes the substitution and income effects, as well as the overall effect of a price change on the quantity, demanded of a good.

When a good is a normal good, the substitution and income effects move in the same direction. The overall effect of a price change on quantity demanded is unambiguous and in the expected direction for a downward-sloping demand curve.

On the other hand, when a good is an inferior good, the substitution and income effects move in opposite directions. This makes the effect of a price change on quantity demanded ambiguous.

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Giffen Goods as Highly Inferior Goods

Since Giffen goods have demand curves that slope upwards, they can be thought of as highly inferior goods such that the income effect dominates the substitution effect and creates a situation where price and quantity demanded move in the same direction. This is illustrated in this provided table.

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Examples of Giffen Goods in Real Life

While Giffen goods are certainly theoretically possible, it's quite difficult to find good examples of Giffen goods in practice. The intuition is that, in order to be a Giffen good, a good has to be so inferior that its price increase makes you switch away from the good to some degree but the resulting poorness that you feel causes you to switch toward the good even more than you initially switched away.

The typical example given for a Giffen good is potatoes in Ireland in the 19th-century. In this situation, an increase in the price of potatoes made poor people feel poorer, so they switched away from enough "better" products that their overall consumption of potatoes increased even though the price increase made them want to substitute away from potatoes.

More recent empirical evidence for the existence of Giffen goods can be found in China, where economists Robert Jensen and Nolan Miller find that subsidizing rice for poor households in China (and therefore reducing the price of rice for them) actually causes them to consume less rather than more rice. Interestingly, rice for poor households in China serves largely the same consumption role as potatoes historically did for poor households in Ireland.

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Giffen Goods and Veblen Goods

People sometimes talk about upward-sloping demand curves occurring as a result of conspicuous consumption. Specifically, the high prices increase the status of a good and make people demand more of it.

While these sorts of goods do in fact exist, they are different from Giffen goods because the increase in quantity demanded is more a reflection of a change in tastes for the good (which would shift the entire demand curve) rather than as a direct result of the price increase. Such goods are referred to as Veblen goods, named after the economist Thorstein Veblen.

It's helpful to keep in mind that Giffen goods (highly inferior goods) and Veblen goods (high-status goods) are at opposite ends of the spectrum in a way. Only Giffen goods have a ceteris paribus (all else held constant) positive relationship between price and quantity demanded.

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Beggs, Jodi. "Giffen Goods and an Upward-Sloping Demand Curve." ThoughtCo, Oct. 7, 2017, thoughtco.com/overview-of-giffen-goods-1146960. Beggs, Jodi. (2017, October 7). Giffen Goods and an Upward-Sloping Demand Curve. Retrieved from https://www.thoughtco.com/overview-of-giffen-goods-1146960 Beggs, Jodi. "Giffen Goods and an Upward-Sloping Demand Curve." ThoughtCo. https://www.thoughtco.com/overview-of-giffen-goods-1146960 (accessed January 22, 2018).