Contents
- Giffen Effect
- How It Works
- Examples of the Giffen Effect
- Criticism of the Theory
- Giffen Goods and Veblen Goods
Giffen Effect
The Giffen effect is a unique economic anomaly in which demand for certain goods increases as their prices rise. This contrasts with the usual law of demand, which states that an increase in price typically leads to a decrease in demand. For example, when car prices rise, the number of people wanting to buy them generally decreases. This paradox, known as the Giffen paradox, requires more detailed examination.
How It Works
The Giffen effect is observed only for specific goods known as Giffen goods. These goods typically include staple foods such as rice, pasta, and bread, which possess certain characteristics:
- Affordability: they are usually inexpensive;
- Lack of substitutes: there are no cheaper alternatives;
- Necessity: they cannot be foregone without risking a deterioration in living conditions.
When the price of a Giffen good rises, consumers are forced to spend a larger portion of their budget on it, cutting back on less essential goods. As a result, even with rising prices, demand for such goods may increase since they are vital for survival. This phenomenon is explained by the combination of income and substitution effects: as prices rise, consumers lose purchasing power and, lacking alternatives, increase their consumption of necessary goods.
Examples of the Giffen Effect
Historical examples of the Giffen effect can be found in various countries and times. For instance, in Ireland in the mid-19th century during the potato famine, when the price of potatoes sharply increased due to a crop shortage, demand for them also rose, as they were a staple food for the impoverished population. A similar situation occurred in Russia in 2010 when, due to drought, the price of buckwheat doubled, and demand for it increased despite rising prices.
In 2007, researchers Robert Jensen and Nolan Miller conducted an experiment in the Chinese provinces of Hunan and Gansu, where they confirmed the existence of the Giffen effect. In Hunan, rice was shown to be a Giffen good, while in Gansu, it was wheat. The results indicated that with rising prices, there was no observed decrease in demand for alternative products, as these products were essential for survival.
Criticism of the Theory
Despite the interest in the Giffen effect, its existence is subject to criticism. Economists point to the rarity of such cases and the difficulty of proving them. For example, in the aforementioned experiment with wheat in Gansu, the relationship between price and demand was not as clear-cut. Additionally, it is challenging to separate the influence of the Giffen effect from simple panic buying: when food prices rise, consumers often rush to stock up, which can also affect demand.
Giffen Goods and Veblen Goods
It is important to note that the Giffen effect should not be confused with the Veblen effect, which also demonstrates a paradoxical relationship between price and demand but applies to luxury goods. For example, high-quality items such as premium wines or jewelry may experience increased demand as prices rise, as consumers perceive them as more prestigious. This effect is driven by consumer psychology and is unrelated to Giffen goods, which are essential for survival.