Before we begin with discussing Giffen's paradox and proceed to look at what goods and items come under the purview of this paradox, let us first have a brief refresher of the law of demand. According to the law of demand, with everything else remaining constant, the demand for a particular good increases with a decrease in its price and decreases with an increase in its price. As such, there is an inverse relationship between the price of a product and the quantity demanded. Demand for a product is, therefore, a function of its price and this relation can be mathematically depicted as:
Qx = f(Px)
Where, x is the product, Qx is the quantity demanded of the product and Px is the price of the product. Giffen's paradox constitute of those phenomena or demand scenarios that violate the law of demand and various examples of Giffen goods act as exceptions to the law of demand.
What are Giffen Goods?
A Giffen good, as stated above, is that product or good that defies the law of demand in terms of the relationship between its price and quantity of demand. This particular economic paradox was propounded by Scottish economist, Sir Robert Giffen (after whom it's named). According to this paradox, which Sir Robert Giffen arrived at after observing the purchasing tendency of the poor Victorian subjects, the demand for a particular good tends to increase even when its price increases. Sir Robert Giffen had observed that when the price of necessary staple goods such as bread, food grain, vegetables, etc., rose, the poorer sections of the Victorian society, who relied heavily on these basic staple items, gave up on purchasing other goods and concentrated all their purchasing power on procuring the necessary staples. This kept the demand for these good high despite an increase in their price.
Conversely, when the prices of these staples go down, the consumer would, out of the consumer's surplus (the price he has always paid and is ready to pay for the good minus the decreased price) difference that has occurred due to the price plunge, prefer to buy less of the staples and more of superior substitutes for consumptions.
However, there are some pre-conditions so as to explain the Giffen's paradox:
- The goods taken should be inferior goods.
- There should be no close substitute.
- The goods should cover substantial percentage of the income of the buyer, but not so much that the buyer can't buy any other normal good.
Example 1: The price of 1 kg. of potatoes (a staple) goes down from $6 to $2. The vegetable budget of the consumer is, say, $12. Previously he used to purchase 2 kg. of potatoes for $12 every month. After the price plunge, he would want to buy just one kg of potatoes for $2 and with the remaining $10, he can buy a larger variety of other vegetables.
Example 2: Rice being a staple food of China, it was observed that when the price of rice was lowered the poor people of China behaved in the Giffen manner; reducing their demand for rice and in the remaining amount purchased more meat. When the price of rice was increased, then the demand for rice also increased as they reduced their purchase of meat.
Example 3: Same kind of behavior was also noticed in some places where bread was the staple food. When the price was lowered, people bought less bread and when the prices became high they consumed more of the bread, thus explaining the Giffen's paradox.
More Categories of Giffen Goods
Besides staples, there is a second category of goods, known as inferior goods, that qualify as examples of Giffen goods. Basically, it is one of the conditions to prove the Giffen paradox that the goods should be inferior goods. These goods are those for which the demand rises when the price that must be paid to procure them forms a relatively substantial part of the buyer's income without eating into the amount of income set aside for the consumption of other regular items. For instance, take for example, comfort or semi-luxury goods like cars. An increase in the income of the buyer would result in a perceived decrease in the price of a cheap car for the prospective buyer. He would, now that he can afford it, prefer to go for a comparatively expensive car rather than the cheap car although the latter costs less than the former. Here, the cheap car is an inferior good, not in terms of quality but in terms of perception owing to the ease of affordability. Here, the quality of life, expected to improve on acquisition of a superior quality item, is given preference rather than quality of good when making a purchase decision.
A third category of Giffen goods comprises what is known as experience goods. The viability, utility and characteristics of certain goods and services can be observed and decided only after using those products or services. The quality of the good or service of such items can only be ascertained upon their consumption. In such cases, a drop in price is often interpreted by the prospective consumer as a drop in quality or utility of the product or service. Examples of Giffen goods in this category are health and beauty care services. There is a sub-category of experience goods, the credence good or post experience goods, which also fall under this category. These items are such that the credibility of their quality and utility is difficult to exactly ascertain even after consumption and usually third party opinions and testimonials are heavily relied upon to differentiate between close substitutes.
That was a simplified overview of what a Giffen good is, enumerating the various different categories of goods that qualify for inclusion under this paradox. Various other mechanics and theories of economics such as price and income elasticity, income effect, substitution effect and indifference curve analysis come into play in explaining the metrics of Giffen's paradox. However, I have deliberately refrained from including them in this article so that the reader gets a clear understanding of this economic concept without getting confused by the numerical contraptions.
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