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An economic dogma

The discussion around Giffen goods is going on for more than 100 years, more precisely since Alfred Marshal pointed out this statistical possibility in 1895 [1].

A Giffen good behaves in the opposite way of what we consider to be a normal good; the demand of the Giffen good, instead of going up when the income grows, and all else held constant, goes down. In addition if prices go up the demand will follow that movement, contradicting the Law of Demand and the normal market behavior.

To better analyze the properties of this uncommon good we should consider the effect a change in price has over demand. Through the Slutsky identity we know that that change could be divided in two effects: the rate you substitute one good for the other, along with the change in purchasing power [2]. Furthermore we can use this to determine the outcome of the change in prices by analyzing the signs of both effects in the equation.

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For a normal good both effects have a negative sign, meaning that an increase in price would make demand decrease since both effects go opposite of the change in price.

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On the other hand, for an inferior good, for instance, the income effect is positive. And if we consider a Giffen good the income effect would be so much greater than the substitution effect that it would overcome it, making the change in quantity to be positive.

The most common example used as a Giffen good is the potato during the Irish famine (1845-1850). However despite the frequent use of this example there are some that consider it as being dubious due to the data used, or to the lack of it. Nonetheless there are other arguments that one can present refuting this idea, one of which would be that the change in price of the good, in this case, as due to a shortage of supply, which drove the prices upwards. This would mean that one of the assumptions under the Giffen good couldn’t be verified once the supply was smaller, it would be impossible to consume more than before (in absolute terms). Moreover the shortage in supply affected all Europe making it impossible to compensate for the national shortage by importation [3].

J. R. Hicks stated that “Consumers are likely to spend a large portion of their income on what is for them an inferior good if their standard of living is very low.” And perhaps following this idea Nolan Miller and Robert Jensen ran an experiment in two extremely poor regions in China where they subsidized the price of rice and wheat, which compose the dominant diet of those populations.  They discovered that the subsidy (which made the goods cheaper) made the consumption of both goods go down.  This paper has possibly given us the first non apocryphal proof of a Giffen goods and therefore an important step to understand the consumption behavior of the extreme poor (1 billion people living below the World’s Bank extreme poverty line) [4].

At the light of this study we can assume that under some particular circumstances we can find evidence of a Giffen good. If we look at extremely poor households with a simple diet, in which a basic food compromises most of the income, once price of that basic food changes, perhaps we may observe this sort of behavior.

Furthermore these circumstances might not hold for poor households only in developing countries. For instance consider fast food in U.S.A, which is the basic food for many impoverished households, wouldn’t an increase in price make that family consume more of this good and less of other more expensive one.

[1] Alfred Marshall – Principles of Economics 1895

[2] Hal. R. Varian – Intermediate Microeconomics – Page 137

[3] Gerald. P. Dwyer, JR. and Cotton M. Linday – Robert Giffen and the Irish Potato

[4] Robert Jensen and Nolan Miller – Giffen Behavior – Theory and Evidence 2007 – Page 4

Tiago Branco #664

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Author: studentnovasbe

Master student in Nova Sbe

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