Nova workboard

a blog from young economists at Nova SBE

When we began studying Economics the first thing we learnt was the behaviour of the demand and supply curves. As we know the demand curve is negatively sloped, i.e., when the price goes up the demand goes down, and the supply curve is positively sloped.

However, there are products that contradict these assumptions – Giffen goods in which when the price goes up the demand goes up too.

The most famous example regarding this type of goods is the potato during the Irish potato famine of the 1840s. At that time the main ingredient of the Irish food was the potato and in that year a disease commonly known as potato blight affected Europe. During this crisis the Irish families saw their income decrease and the price of potatoes increasing which caused a huge chaos. As a result, when the families bought potatoes the income left was increasingly smaller, so it was impossible to buy other goods except potatoes and therefore, families started buying more potatoes with the money that was left. As it can be seen the price and the demand of potatoes increased at the same time.

This is related to the substitution effect (when the price of a good increases, consumers tend to substitute this product with another similar good which is cheaper), so because they can’t buy meat, for example, they replace it by more potatoes.

It can also be said that rice in China is a giffen good too, but we need to pay attention that this doesn’t happen to everyone, we only can said this for the poorest people and the reason is the same as we used in the Irish case. When the price of rice increase the Chinese people can’t afford other goods.

But is the price of goods a reason to desire?

«Perception and desirability play a huge role in the pricing game. The more expensive something is, the more exclusive and, therefore, desirable it becomes. Burberry, for instance, said as recently as March that it would raise prices to increase its appeal to the upper end of its customer base and attract new, wealthier customers.»

In order to understand this is important to introduce another concept that will have the same behaviour that the previous one but in a different way- Veblen goods.

The Veblen goods are related to the luxury market, i. e., they are related with status and in some way the high prices gives consumers power and happiness. And this is why some luxury brands are increasing their prices, to turn their products more exclusive and more desirable.

Sometimes the higher, the best!

In the other hand, we have Inferior goods which are «a type of good for which demand declines as the level of income or real GPD in the economy increases» . This type of goods used to have negative income elasticity of demand. But what is that? The income elasticity of demand measures how sensitive the quantity demanded of a good is to changes of the income.

∈=(percentagechange∈quantitydemanded)/(percentagechange∈price)

For example, are drugs inferior goods? According to the Atlantic Economic Journal (2007,) it depends «on the relationship between substances abuse and time in household production, there can be a positive or negative relationship between drug use and income» .

In this study the evidences suggests that illegal drugs are normal goods for consumers in schools or colleges. However, through the study we can also conclude that illegal drugs (specifically marijuana and cocaine) are inferior goods for other categories such as working individuals and non-working individuals. The reason is the fact that the consumption of drugs is related to the «higher opportunity cost of drug consumption for the higher income people and this can explain both income inferiority for substantial part of the overall sample and the positive relationship between income and substance abuse for young adults» .

So, the best answer for those questions is: it depends!

Bibliography:
http://web.a.ebscohost.com/ehost/pdfviewer/pdfviewer?sid=efeca90e-6efe-4e16-bf9f-112f695face8%40sessionmgr4004&vid=1&hid=4104
http://www.businessoffashion.com/2013/08/fashion-inflation-why-are-the-prices-of-designer-goods-rising-so-fast.html
http://www.dictionaryofeconomics.com/article?id=pde2008_G000042&edition=current&q=giffen%20goods&topicid=&result_number=1
http://www.economist.com/blogs/freeexchange/2007/07/as_price_goes_up_so_does_deman
http://www.investopedia.com/terms/i/inferior-good.asp
http://www.investopedia.com/terms/v/veblen-good.asp

#733

Advertisements

Author: studentnovasbe

Master student in Nova Sbe

Comments are closed.