The Case of Buying More as Prices Rise – Giffen Paradox
Giffen Paradox – Let’s say you go to the market and buy a product on the shelf for 1$ each. You came home and liked this product very much. The next day when you go to the same store to buy the same product, you see that the price is 2$. Would you buy more than one of these products? If the product you buy is a Giffen product, the answer is likely to be yes.
Economic events are analyzed in two ways, one for the economy as a whole and the other for its smallest units. The former is called the macro (large) level approach and the latter is the micro (small) level approach. The micro level basically deals with human beings. The laws of supply and demand govern macro and micro-economic theories.
Economists recognize that when prices rise, demand falls and forms a downward sloping curve, while when prices fall, demand forms an upward sloping curve. In 1895, the British economist Alfred Marshall gave us a mathematical explanation of how supply and demand are formed. After laying down the general rules, he also pointed out that there could be an interesting exception.
What is the Giffen Paradox?
Marshall said that in some cases a price increase can surprisingly increase demand. The first person to point this out was Scottish Robert Giffen, a well-known economist and statistician of the time.
Giffen saw that the potato famine in Ireland in the mid-19th century raised potato prices, which increased the demand for potatoes instead of decreasing it, and investigated the reason for this reversal.
Alfred Marshall included Robert Giffen’s work in his textbook Principles of Economics. This led to the Giffen paradox. It was called the Giffen paradox because it was contrary to the law of supply and demand.
Following this definition, today, goods whose demand increases as the price increases are known as Giffen goods. When the idea of Giffen goods was first introduced, in the 19th century, bread was one of the most important food items for the poor British population.
The poorest of the working class spent most of their income on bread, which was essential for survival. As the price of bread increased, the poorer people had to spend more of their income on bread to survive. As a result, the higher the price, the higher the demand.
What is a Giffen good?
A Giffen good is a low-income, non-luxury product that defies standard economic and consumer demand theory. Demand for Giffen goods rises when the price rises and falls when the price falls. A product can only be a Giffen good if certain conditions are met.
First, it must be a basic good, such as food, for which there are a limited number of substitutes. And, of course, the people who buy it must be too poor to afford to replace the staple with better quality goods. Some common Giffen goods are rice, salt, potatoes and bread.
In 1947 US economist Georg Stigler denied this in Notes on the History of the Giffen Paradox but in 2007 US academics Robert Jensen and Nolan Miller in Giffen Behavior: Theory and Evidence: Giffen Behavior.
Examples of Giffen Goods
In fact, it is quite easy today to give examples of this paradox. Take the rise in meat prices for example. As the price of meat products increased, many of us gave up meat and started to spend our budget on more affordable food products.
As a result, the balance of supply and demand changed. Subsequently, prices of staple food products also increased. This led to the Giffen Paradox.
In the same way, families with much lower incomes could buy a few ingredients and get through the day with a simple meal and bread, but with the increase in vegetable prices, this became impossible.
As a result, the staple food for many people has become bread, which is the cheapest and most filling. As a result, as the demand for bread increased, bread started to rise more.
Similar Effect but a Contrasting Case: Veblen’s Goods
When we talk about the Giffen paradox, we are talking about another situation that leads to a strange economic contradiction. Veblen goods are named after the American economist Thorstein Veblen, who formulated the theory of “conspicuous consumption”.
These goods are peculiar because as their price increases, so does the demand for them. But unlike the worthless Giffen goods, they are considered a symbol of high status.
Conclusion
The willingness to pay more is more to advertise wealth than to achieve better quality. A true Veblen good should therefore not be of significantly higher quality than its lower-priced equivalents.
When the price falls, the rich stop buying it. Cutting prices tends to reduce sales. This is why some stores never discount at the end of the season. Those who can afford it buy it, those who can’t have to grapple with the Giffen paradox anyway.