difference between inferior goods and giffen goods

In economics, a giffen good is an inferior good with the unique characteristic that an increase in price actually increases the quantity of the good that is demanded.  This provides the unusual result of an upward sloping demand curve.

This happens because of the interactions of the income and substitution effects.  Depending on whether the good is inferior or normal, the income effect can be positive or negative as the price of a good increases.  Imagine an inferior good being Top Ramen (an inexpensive noodle dish, common among students).  As your income rises, you actually consume less Top Ramen, because you may begin to buy more spaghetti, or steak, or something you enjoy more than Top Ramen.  But if you lose your job, and your income goes down, you will consume more Top Ramen, because it is inexpensive.

Next we have to consider the substitution effect.  No matter type of good, the substitution effect will be negative as the price of that good goes up.  So if the price of Top Ramen rises, the substitution effect will dictate that you will buy more spaghetti, or steak because that good has become relatively cheaper.

The interesting thing about a giffen good, is that when the price of a giffen good rises, the income effect is greater than the substitution effect.  So if a good is inferior, the income effect will be positive and larger than the negative value from the substitution effect.

Summary:  if a good is inferior, a drop in income (represented by a price increase) increases the quantity of the good that is demanded.  The substitution effect is negative for any good that experiences a price increase.  A giffen good faces an upward sloping demand curve because the income effect dominates the substitution effect, meaning that quantity demanded increases as price rises.



However, a good cannot have an upward sloping demand curve forever, because eventually the consumer will run out of money.  Remember that giffen goods have to be inferior goods, which implies that the consumer purchasing them has little money to begin with.  At some point, the rising price of the giffen good takes over the consumer’s entire budget, and a price increase will actually lower the amount of the good the consumer is able to buy.  This means that at high enough prices, we will see the traditional downward sloping demand curve.

Let’s go through an example of a giffen good, using potatoes and steak as the choice set of the consumer.  Imagine the consumer has a budget of $30, and the cost of a potato begins at $0.50 and the price of a steak is $10.00.  Also consider that the consumer needs to buy meals for 10 days.

With the original budget and prices, the consumer may choose to consume 2 steaks, at $20, and 20 potatoes for $10 over this time frame to use up their entire budget.  This is a satisfactory amount because they will have on average 2 potatoes a day, and 2 steaks over the period.

Now imagine a price increase of potatoes to $1 each.  The consumer could still buy 2 steaks, but could now only buy 10 potatoes.  This might leave them hungry, so it is possible they will buy less steak, and more potatoes in order to get their calories.  This means that 20 potatoes will still be purchased, but now only 1 steak is purchased.

If the price of a potato increased again, say to $1.25, then the consumer would only be able to get 16 potatoes for $20, which may not be enough calories to survive.  They will decrease their steak consumption by one, and use that money to buy more potatoes in order to get the necessary energy.  In this example, potato consumption would rise to 24 ($30/$1.25) and steak consumption would drop to zero.  This shows how consumption of a good would rise with a price increase (thus an upward sloping demand curve).

At this point, the consumer’s entire budget is taken up by the giffen good, so any price increase now will result in a decrease of the amount of good the consumer is able to buy.  Thus, we will have our typical downward sloping demand curve.

Comments

  1. StevenHWicker26 April 2019 at 23:43

    This is a really informative knowledge, Thanks for posting this informative Information. Implementation plan for organization

    ReplyDelete

Post a Comment

Popular posts from this blog

Work certified and uncertified

Meaning of Work Certified  When contractor takes the contract to complete any construction work, it may complete in 4 or 5 years. but contractor has to pay different expenses for material, labor and others. So, it is very necessary to pay him some money of contract. This money is given on the basis of work done. So, any part of construction which is completed by contractor will be work certified if it is certified by an authority. Authority may be independent engineer or architect who can estimated the work. He will issue the certificate of work done after certifying the work of construction. On this work certified, contractor has right to get money of contract. Meaning of Work Uncertified Work uncertified means work done but not certified by authority. So, contractee will cut some money on the basis of work uncertified and will keep in his pocket. This will be retention money. Accounting Treatment of Work Certified and Work Uncertified  (I) Work  certified...
Read more

factors influencing choice of advertising agency

The Advertiser looks for an advertising agency whose services and expertise meets his requirements. Following factors should be considered while selecting an advertising agency:- Services offered by Ad-agency  - There are different agencies provides different services, some provides all the services, some provide selected services, some provides only media services. It depends on the requirement of advertiser whether he need a fulls service agency, creative boutique, media buying service agency, or a  sweet shop . Experience of Agency  - An experienced agency performs better then a new agency  because it is familiar with different components of marketing environment like- competitors' policies, taste of consumer, income of consumer, consumer responses, fashions and trends, reputation of different media etc. Location  - A major factor to be considered while selecting ad-agency is location of office of agency. A considerable amou...
Read more

Environment of International Marketing

Image
Apple is so successful because of their effective marketing efforts. They are good in identifying relevant environmental factors and trends which helps in taking advantage of opportunities and minimising threats.  New technological developments, global economic conditions, worldwide population changes, increased competition, legislative requirements, and political events are some of the factors affecting current and future marketing activities of the organisations around the world. Combination of such factors makes the International Marketing Environment. The long term performance of any organisation depends on its ability to identify and respond effectively to the key changes in its marketing environment.  Meaning of International Marketing Environment  International Marketing Environment is the combination of various factors external to an organisation that can affect the international marketing decisions of the organisation in international market. These fac...
Read more