A Giffen good, a concept commonly used in economics, refers to a good that people consume more as the price rises. Therefore, a Giffen good shows an upward-sloping demand curve and violates the fundamental law of demand.
It is important to note that all Giffen goods are inferior goods, but not all inferior goods are Giffen goods.
History of Giffen Good
The term Giffen good was named after Scottish economist Sir Robert Giffen. The term Giffen good was developed by the economist after he noticed, in the poor Victorian era, that the rise in the price of a basic food increased the demand for that particular food.
The Intuition Behind a Giffen Good
The concept of a Giffen good sounds counterintuitive – why would an individual consume more of a good if its price increases?
Consider a poor household with a maximum monthly expenditure on food at $400 and a minimum consumption of grains at 50 kg. The household consumes two goods to meet their grain consumption demand: rice and wheat.
Rice is considered an inferior good, is cheaper than its substitutes, and represents a large portion of the household’s spending.
Wheat is considered a normal good.
The following illustrates the household’s consumption of rice and wheat:
Consider a scenario where the price of rice increases to $6. In this situation, to maintain its current consumption, the household would need to spend $440:
Therefore, for the household to get its total expenditure to remain at $400 and meet its consumption level of 50 kg, it would need to consume more rice and less wheat to meet its consumption demand:
As we noted, the demand for rice rose from 40 kg to 43 kg despite its increase in price. Therefore, rice is an example of a Giffen good.
Conditions for a Giffen Good
As noted in the example above, there are certain conditions for a Giffen good:
1. The good must be inferior
The good must be an inferior good as its lower comparable costs drive an increased demand to meet consumption needs. In a budget shortage, the consumer will consume more of the inferior goods.
As indicated in the example above, since rice is an inferior good, the household will consume more rice to maintain their household budget of $400.
2. The good must form a large percentage of total consumption
The total amount spent on the good must be large relative to the consumer’s budget. Only in such a scenario will an increase in its price create a significant income effect.
As indicated in the example above, rice represents 80% of the quantity demanded of grains. In addition, rice forms half of the household’s expenditure.
3. There must be a lack of close substitute goods
The good must either have a lack of close substitutes or the substitute good must have a higher cost than the good. Even if there is an increase in the price of the good, the current good should still be an attractive option for the consumer. In other words, the substitution effect created by the increase in the price of that good must be smaller than the income effect created by the increased cost requirement.
As indicated in the preface of the example above, rice is cheaper than its substitutes.
Practical Example of a Giffen Good: Hunan and Gansu
In 2007, Harvard economists Robert Jensen and Nolan Miller conducted an experiment where they studied two provinces in China: Hunan and Gansu. In Hunan, the staple food is rice, whereas in Gansu, the staple food is wheat.
The experiment indicated that:
In Hunan, Giffen behavior was exhibited – lowering the price of rice through a subsidy decreased the demand for rice while removing the subsidy increased the demand for rice.
In Gansu, Giffen behavior was relatively weaker due to the availability of substitute goods and the fact that households were so poor that they only consumed staple foods.