Question

What effect does a price rise have on the demand for 'Giffen' goods?

• A. Increases
• B. Decreases
• C. Remains stable
• D. Becomes unstable

Hint:

Giffen goods are one of the few cases where the law of demand does not apply. They are typically inferior goods, where higher prices lead to higher demand.

Answer 1

The Correct Option is A

Step 1: Introduction to Giffen Goods:
In economics, Giffen goods are a unique class of inferior goods for which an increase in price leads to an increase in demand. This phenomenon violates the basic law of demand, which states that demand typically falls when the price of a good rises. Giffen goods typically exist under special circumstances, often involving consumer behavior driven by the income effect outweighing the substitution effect.
Step 2: Key Characteristics of Giffen Goods:
- Inferior Goods: Giffen goods are a subset of inferior goods, which are those goods whose demand increases as income decreases, and vice versa. Consumers purchase more of them as their income falls because they are typically lower-quality alternatives to more expensive goods.
- The Role of the Income and Substitution Effects: The price increase of a Giffen good leads to a paradoxical behavior: the income effect (the change in demand due to the reduced purchasing power of consumers) dominates the substitution effect (the tendency to buy cheaper alternatives). Therefore, as the price of the good increases, people may feel poorer and thus consume more of it, as it remains a necessity.
Step 3: A Real-Life Example:
A classic example of Giffen goods is the case of bread or rice in a poor economy. Suppose the price of bread rises. For a low-income family, bread is a staple good. Since their overall purchasing power decreases with the price increase, they may buy more bread (a Giffen good) because they can no longer afford to buy more expensive foods (like meat or vegetables) and thus consume even more of the basic, inferior staple.
Step 4: Conclusion and Answer:
The correct answer is (A) because Giffen goods experience an increase in demand when their prices rise due to the dominating income effect that compels consumers to buy more of the inferior good, despite its higher price.