New to the A2 CIE syllabus is indifference curves and my A2 class recently had a multiple-choice question concerning indifference curves and giffen goods. A giffen good occurs when a rise in price causes higher demand because the income effect outweighs the substitution effect.
Suppose you have a very low income and eat two basic food stuffs rice and meat. Meat is a luxury and is much more expensive than rice. If rice increased in price, your disposable income is effectively reduced significantly therefore, you buy less meat, to compensate for less meat you buy more rice to gain enough calories. Source: www.economicshelp.org
Griffen good and indifference curves
- Good B falls in price – hence budget line moves from: 50 A – 30 B to: 50 A – 60 B.
- The move from point J to point K is the substitution effect which = +16
- The move from point K to point L is the income effect which = -20
- These make up an overall move from point J to point L is the price effect (substitution effect + income effect) = -4
As income effect is negative, substitution effect positive and overall price effect negative Good B is a giffen good.
Summary of income and substitution effects of price changes
Go to eLearn Economics for more notes on Indifference Curves.
Giffen goods are a part of most school or university economics courses and in the eyes of theoretical economists it is a good for which demand goes up when prices rise, and falls when prices go down.
A lot of textbooks use the Irish potato famine as a possible example; as the price of potatoes rose, people were so poor that they started substituting potatoes (staple diet) for meat and other unnecessary luxuries. The Irish consumed more potatoes as a result. But a famine suggests a shortage of supply which almost certainly caused an increase in the price.
However two Harvard economists (Jensen and Miller) used poor Chinese consumers who consume more rice or noodles (staple diet) as prices go up. As with the poor Irish, people need a certain amount of calories to survive. For the Chinese they get their calorie intake by eating rice, vegetables or meat. However to the poor Chinese meat is very expensive and as the price of rice goes up they can no longer afford the luxury of meat, yet they still need to get to their calories. So they eat rice instead, which is still relatively cheap compared to meat. Therefore this is a much accurate example of Giffen behaviour in action.
So if food prices start to increase like they have in the last decade will this mean the demand for the staples will go up even further?
Source: The Economist
I found this article from Michael Cameron’s blog “Sex, Drugs and Economics” – Michael is a senior lecturer in the Department of Economics at the University of Waikato, Hamilton. New Zealand. He spotted an report from The Moscow Times that said:
In the Urals, sex workers have raised prices by between 50 and 100 percent, Uralpolit.ru said Wednesday, citing unnamed clients of prostitutes.
He made a very good point in that the paper talked of an increase in sex tariff inflation with the influx of sex workers fleeing war-torn Ukraine. The new competition is forcing local sex workers to hike their rates in order to pay their bills, the report said.
If this is the case the demand curve for sex services must be upward sloping – there is an increase in the supply of sex workers but prices are going up? Normally with increased competition with more supply prices drop. These goods/services that have an upward sloping demand curve and are know as Veblen goods after economist and sociologist Thorstein Veblen who wrote about conspicuous consumption in his 1899 book The Theory of the Leisure Class. It is a term used to describe the lavish spending on goods and services acquired mainly for the purpose of displaying income or wealth. In the mind of a conspicuous consumer, such display serves as a means of attaining or maintaining social status.
That doesn’t seem a particularly likely scenario for sex services. Neither are sex services consistent with other types of goods that have upward-sloping demand (Giffen goods, goods with network effects, goods with bandwagon effects).
More likely, Uralpolit.ru and the Moscow Times have demonstrated temporary economic illiteracy. Increased supply doesn’t increase prices. On the other hand, inflation does increase prices and that is what is being observed.