The microeconomic law of demand states that all other factors remaining equal, If the price of a good or service increases then naturally demand will decrease, the same occurring in the opposite fashion. A Giffen good defies this law and increases in demand as the price increases and vice versa. The term was first coined by Alfred Marshall in his book Principles of economics where he attributed the origins of this idea after Robert Giffen a Scottish economist prominent in the late 19th century and early 20th century. Giffen’s theory has long been actively debated due to the theory clearly showcasing its existence but no empirical evidence being used as proof meaning it is therefore paradoxical in nature. (Jensen and Miller, 2008)
“There are however some exceptions. For instance, as Sir R. Giffen has pointed out, arise 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. But such cases are rare; when they are met with, each must be treated on its own merits.” (Marshall, 1920)
There are three preconditions necessary to be able to define a good as showing Giffen behaviour and those are; the good must be an inferior good, a good which demand decreases as consumers income rises. There must be a lack of substitutes meaning it is too integral to be left out and the final precondition is that the good must be an integral part of consumer’s income making up the majority of spending. Evidence for the existence of giffen goods is limited but mathematical models help to explain how such behaviours could exist in reality. As the price of any good rises the substitution effect comes into play and makes the consumer purchase less of it and more of said substitute good. Another effect called the income effect also increases decline in the demand of a good due to an increase in consumer income but a giffen good counteracts both effects and the effect of the rising price of a good leads to an increase in its demand.
Panel B depicts the reactions to an increase in price. Showcasing a downward sloping demand curve to illustrate the writer’s theories.
Panel A depicts the indifference curves for a typical consumer choosing how much of “basic and “fancy” goods to consume.
The example most commonly cited is that of potatoes during the Irish potato famine. Potatoes being the staple part of the diet they were, when the price of potatoes increased and there weren’t any close substitutes the demand also increased. This theory was debunked by Sherwin Rosen due to a lack of evidence that supports the claim. (Jensen and Miller, 2008). This opinion was also argued by Dwyer and Lindsay who point out that a supply reduction due to famine should have decreased the price of potatoes if the fit the preconditions necessary for a Giffen good. A more contemporary example found by two Harvard economists Robert Jensen and Nolan Miller is that of two regions in china namely the Gansu and Hunan regions where rice and wheat are showing signs of Giffen behaviour. In the region of Hunan evidence shows that when the price of rice decreased artificially using subsidies the demand for rice decreased and when this process was reversed it had the opposite effect (Mankiw, 2007). The argument for Giffen behaviour in the region of Gansu with regards to wheat lacks two basic conditions it didn’t not meet, those being, that wheat should have limited substitutions and that a large portion of household incomes should be spent on the good. (Elvis Picardo, 2015) The Giffen behaviour is clear to see as it is vital that the people of these provinces intake enough calories to survive and the lack of close substitutes forces them to spend more on the calories and less on luxury foods. Interestingly Giffen behaviour is exempt from the overly wealthy as well as the overly impoverished as the wealthy don’t feel the impact of an increase in food prices and the poor can’t accommodate a change in prices of a staple food so is forced reduce consumption which cancels out potential giffen Behaviour. This means it is strictly a certain economic class that feel the effects of a giffen good. (Jensen and Miller, 2008)
A study done by Battalio, Kagel and Carl in 1991 found that lab rats were exhibiting signs of Giffen behaviour when choosing between quinine water and root beer, quinine water being the inferior good and less expensive than root beer but having the same nutritious advantages. The rats were given a “Currency” in the form of amount of times they could pull each lever for each substance, the researches increased and decreased prices and changed income levels which lead to the research suggesting the quinine water acted as a Giffen good when the price was increased as well as when income had changed. (Battalio, Kagel and Kogut, 1991) This is a prime example of the number of parameters needed to simultaneously be in place for a good to show Giffen behaviour. In conclusion the theory of Giffen goods seems concrete yet the number of conditions that need to simultaneously be met makes it impossible to gather empirical evidence from studies. If empirical evidence is discovered it usually is at an individual level and not market level meaning it doesn’t meet the criteria that a good needs to display giffen behaviour.