Giffen good

For most products, price elasticity of demand is negative. In other words, price and
demand pull in opposite directions; price goes up and quantity demanded goes down, or
vice versa. Giffen goods are an exception to this. Their price elasticity of demand is
positive. When price goes up the quantity demanded also goes up, and vice versa. In
order to be a true Giffen good, price must be the only thing that changes to get a change
in demand.

Giffen goods are named after Sir Robert Giffen, who was attributed as the author of this
idea by Alfred Marshall in his book Principles of Economics.

The classic example given by Marshall is of inferior quality staple foods whose demand
is driven by poverty, which makes their purchasers unable to afford superior foodstuffs.
As the price of the cheap staple rises, they can no longer afford to supplement their diet
with better foods, and must consume more of the staple food.

Marshall wrote in the 1895 edition of Principles of Economics:

As Mr. Giffen has pointed out, a rise in the price of bread makes so large a drain
on the resources of the poorer labouring families and raises so much the
marginal utility of money to them, that they are forced to curtail their
consumption of meat and the more expensive farinaceous foods: and, bread being
still the cheapest food which they can get and will take, they consume more, and
not less of it.

Analysis of Giffen goods

There are three necessary preconditions for this situation to arise. They are:

1. The good in question must be an inferior good,

2. There must be a lack of close substitutes,
3. And the good must comprise a substantial percentage of the buyers income.

If precondition #1 is changed to "The good in question must be so inferior that the

income effect is greater than the substitution effect" then this list defines necessary and
sufficient conditions.
 alt text

The Giffen Paradox

This can be illustrated with a diagram. Initially the consumer has the choice between
spending their income on either commodity Y or commodity X as defined by line
segment MN (where M= total available income divided by the price of commodity Y,
and N= total available income divided by the price of commodity X). Given the
consumers preferences toward the two products, as expressed in indifference curve Io, the
optimum mix of purchases for this individual is point A. Now if there is a drop in the
price of commodity X, there will be two effects. The reduced price will alter relative
prices in favour of commodity X, known as the substitution effect. This is illustrated by a
movement down the indifference curve from point A to pointB. At the same time the
price reduction causes the consumers’ purchasing power to increase, known as the
income effect. This is illustrated by the budget line that pivots out from MN to MP
(where P=is the total available income divided by the new price of commodity X). The
substitution effect (point A to point B) raises the quantity demanded of commodity X
from Xa to Xb while the income effect lowers the quantity demanded from Xb to Xc. The
net effect is a reduction in quantity demanded from Xa to Xc making commodity X a
Giffen good by definition. Any good where the income effect more than compensates for
the substitution effect is a Giffen good.
Empirical evidence for Giffen goods
Despite years of searching, no generally agreed upon example has been found. A 2002
preliminary working paper by Robert Jensen and Nolan Miller made the claim that rice
and noodles are Giffen goods in parts of China. It is easier to find Giffen effects where
the number of goods available is limited, as in an experimental economy: DeGrandpre et
al (1993) provide such an experimental demonstration. One reason for the difficulty in
finding Giffen goods is Giffen originally envisioned a specific situation faced by
individuals in a state of poverty. Modern consumer behaviour research methods often
deal in aggregates that average out income levels and are too blunt an instrument to
capture these specific situations. It is for this reason that many text books use the term
Giffen Paradox rather than Giffen Good.

Some types of premium goods (such as expensive French wines, or celebrity endorsed
perfumes) are sometimes claimed to be Giffen goods. It is claimed that lowering the price
of these high status goods can decrease demand because they are no longer perceived as
exclusive or high status products. However, the perceived nature of such high status
goods changes significantly with a substantial price drop. This disqualifies them from
being considered as Giffen goods, because the Giffen goods analysis assumes that only
the consumer's income or the relative price level changes, not the nature of the good
itself. If a price change modifies consumers' perception of the good, they should be
analsed as Veblen goods. Some economists question the empirical validity of the
distinction between Giffen and Veblen goods, arguing that whenever there is a substantial
change in the price of a good its perceived nature also changes, since price is a large part
of what constitutes a product. However the theoretical distinction between the two types
of analysis remains clear; which one of them should be applied to any actual case is an
empirical matter.

A Giffen good is a good whose consumption

increases as its price increases. (For a normal good,
as the price increases, consumption decreases.) Thus,
the demand curve will be upward instead of
downward sloping.
“””A giffen good has an upward sloping demand
curve because it is exceptionally inferior. It has a
strong negative income elasticity of demand such
that when a price changes the income effect
outweighs the substitution effect and this leads to
perverse demand curve.”””
Read more:
http://wiki.answers.com/Q/Demand_curve_of_a_giffen_good#ixzz2qIjr9KXz

Normal Good
“”“An item for which demand rises when income rises and falls when income falls.
Name brand cereal (compared to store brand cereal) would be an example of a normal
good.”””

In economics
, normal goods are any goods for which demand
Demand (economics)
In economics, demand is the desire to own anything and the ability to pay for it and
willingness to pay . The term demand signifies the ability or the willingness to buy a
particular commodity at a given point of time....

increases when income increases and falls when income decreases but price remains
constant, i.e. with a positive income elasticity of demand. The term does not necessarily
refer to the quality of the good.

Depending on the indifference curve

s, the amount of a good bought can either increase, decrease, or stay the same when
income increases. In the diagram below, good Y is a normal good since the amount
purchased increases from Y1 to Y2 as the budget constraint
shifts from BC1 to the higher income BC2.

In economics
Economics
Economics is the social science that analyzes the production, distribution, and
consumption of goods and services. The term economics comes from the Ancient Greek
from + , hence "rules of the house"...

, normal goods are any goods for which demand

Demand (economics)
In economics, demand is the desire to own anything and the ability to pay for it and
willingness to pay . The term demand signifies the ability or the willingness to buy a
particular commodity at a given point of time....

increases when income increases and falls when income decreases but price remains
constant, i.e. with a positive income elasticity of demand. The term does not necessarily
refer to the quality of the good.

Depending on the indifference curve

Indifference curve
In microeconomic theory, an indifference curve is a graph showing different bundles of
goods, each measured as to quantity, between which a consumer is indifferent. That is, at
each point on the curve, the consumer has no preference for one bundle over another. In
other words, they are all equally...
s, the amount of a good bought can either increase, decrease, or stay the same when
income increases. In the diagram below, good Y is a normal good since the amount
purchased increases from Y1 to Y2 as the budget constraint
Budget constraint
A Budget constraint represents the combinations of goods and services that a consumer
can purchase given current prices with his or her income. Consumer theory uses the
concepts of a budget constraint and a preference map to analyze consumer choices...

shifts from BC1 to the higher income BC2. Good X is an inferior good
Inferior good
In consumer theory, an inferior good is a good that decreases in demand when consumer
income rises, unlike normal goods, for which the opposite is observed. Normal goods are
those for which consumers' demand increases when their income increases....

since the amount bought decreases from X1 to X2 as income increases.