Income Effect For Giffen Goods

Giffen goods are goods where the negative income effect dominates the positive substitution effect.

Income effect for giffen goods. The income effect is negative. But income effect in this case is q 2 q 3 which is so large that it outweighs the income effect. It is because an inferior good reacts differently to a change in income. We analyze the effect of a price decrease on the consumption of a giffen good breaking this down into income and substitution effects.

Giffen goods involve the same increase in demand as the price increases but here the effect is even less intuitive. 12 and 13 show price effect for inferior goods. Its demand increases with decrease in income and vice versa. The name comes from sir robert giffen who was the first to observe this pattern in the late 1800s.

X axis represent giffen goods commodity x and y axis denotes superior goods commodity y. So the net effect of a fall in the price of a giffen good is a fall in the quantity demanded. Suppose x is a giffen good and the initial equilibrium point is r where the budget line pq is tangent to the indifference curve l 1. In case of an inferior goods also called giffen good the income effect and substitution effect work in opposite directions i e.

The net effect equal the difference between substitution effect and income effect. Assume that price of giffen goods decreases. In figure 1 the consumer s initial equilibrium point is e 1 where original budget line m 1 n 1 is tangent to the indifference curve ic 1. This is illustrated in figure 12 21.

In the case of a giffen good the positive income effect is stronger than the negative substitution effect so that the consumer buys less of it when its price falls answered by toppr.