Readers question: This post reminded me of a similar situation: a Giffen good. In fact, Veblen goods and Giffen goods seem to be extremely similar, and I was hoping you could clarify the difference between the two!
The law of demand says a higher price leads to lower demand. However, there are two exceptions
Veblen Good and Giffen Good. In this post, we defined a Veblen Good (sometimes known as ostentatious good).
The basic principle is that as price rises people buy more. This is because people think if it is more expensive it must be better quality. This is possible for some designer clothes e.t.c.
A Giffen good has the same affect – higher price leads to higher demand. But, it is for a completely different reason.
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.
It is quite rare and whether it really happens has a little uncertainty. But, it shows that there are two factors affecting demand price (substitution effect) and income.
2 comments ↓
Thanks very much – that really clears things up.
You say Giffen goods are rare. Either I misunderstand or you’re very wrong!
You go and stay in a hotel for a week.
Three weeks of the year you go camping.
Camping prices go up.
You still camp but go to a hotel only for a week-end.
To compensate you go camping for longer.
Hey presto!
A Giffen good.
(See my question about prostitutes and giffen goods…)
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