Giffen good – definition
A Giffen good (named after Scottish journalist and statistician, Sir Robert Giffen, 1837 – 1910) is a good which does not appear to conform to the ‘first rule of demand’ – namely that price and quantity demanded are inversely related. For a Giffen good, people will actually demand more when the price rises.
The generally accepted explanation is that Giffen goods are a type of inferior good without a substitute, so there is no substitution effect at work when the price changes. In addition, the assumption is that spending on the good accounts for a large share of income. The classic example referred to by Giffen was the case of bread, which the poor consumed more of when its price rose – the Giffen ‘paradox’.
Example – bread and lamb
If we take a simple example of an individual who spends all of their income (Y) on bread (B), a staple food which must be eaten each day, and with any income left over being spent on a more ‘luxury’ food item such as lamb (L). The currency used is the euro (€).
We shall also assume a weekly income, Y, of €200. Bread is cheap, and priced at €4, and lamb which is much more expensive is priced at €60 per unit.
Weekly spending on these two items is:
- 5 units of bread a day – the minimum level for survival, making 35 units bought per week, costing €140;
- and the remainder, €60, is spent on one unit of the luxury good, lamb, consumed on one day a week.
So the income of €200 is allocated as (€4 x 5 x 7) = €140 to bread, and (1 x €60) = €60 for lamb.
If, now, the price of bread increases from €4 to €5, then the only way to continue to consume the necessary quantity of the staple food, bread, (5 units) is to stop purchasing lamb. Hence, weekly spending now on lamb is 0, leaving €200 available to spend on bread.
This means that at the higher price of €5 for bread, 40 units of bread can be purchased (an increase from 35 units).
If there was an alternative to bread, then there would be a substitution effect and the individual would switch from bread following the price rise – but as no substitute is available, and given that bread is an inferior good, the ‘negative’ income effect of the price rise for bread is for more to be consumed, rather than less. Hence, the ‘Giffen paradox’!