Breaking the laws of demand, the Giffen Goods Theory

The law of demand happens in our daily lives, for example, you will probably buy less frequently if the price of your favorite food suddenly increases by 30%. Because the higher the price of goods the lower the demand, and that is the fundamentals of economics. But there is one thing that does not follow the law of demand, and that is the Giffen Good theory.

Basics of the law of demand

To understand Giffen Good, we should first explain the basics of the law of demand. It is a common concept in economics, it works with the law of supply to explain how market economies allocate resources and determine the prices of goods and services that we observe in everyday transactions. The law of demand shows the relationship between the price and the demand quantity. When the conditions for everything are equal, the quantity demanded will decrease as the price of goods increases. In other words, when the price increase, people's desire to buy goods will decrease, leading to a decline in demand.

Law of Demand

Point A: When the product price is RM 4; the demand quantity is 200 units
Point B: When the product price is RM 5; the demand quantity is 100 units

According to the law of demand, when the price increase from RM 4 to RM 5, the demand quantity will decrease from 200 units to 100 units.

Example from daily scenario:

 

Discovery of Giffen Goods

In the 19th century, an economist Robert Giffen discovered a scenario that does not follow the Law of Demand. It was in 1845, when the Irish came across a Great Famine, causing the price of potatoes to keep increasing. At that time, potatoes were one of the more affordable foods for the poor, especially the Irish farmers who heavily relied on potatoes in their daily lives.

 
But even with the price kept increasing due to the Great Famine, the Irish farmers did not decrease their demand, but rather they increased their spending on the potatoes. This shows that the increase in the price of potatoes did not stop, or decrease the demand for potatoes. As Robert Giffen discovered this scenario, therefore people named it “Giffen Goods”.

Why do Giffen Goods Happen?

This is the graph to explain Giffen's goods

At point A: Due to poverty, people can only afford inferior goods, the income effect of the higher prices leads to more demand for inferior goods.

 
At point B: The Giffen goods had reached the maximum income, where people cannot afford the Giffen goods anymore. In this example, 0.30 had reached the maximum income.

 
At point C: When people no longer afford even the Giffen good, the demand will decrease.

A real case study from the Great Famine.

When there are special periods, for example, the Great Famine, the price of food (bread, potato, meat) will increase and people’s income will decrease at the same time. But due to poverty, people could not afford the more expensive bread and meats, hence the demand for potatoes increased. (Even the price of potatoes increased, but it’s still the cheapest food). This will cause the price of potatoes to increase faster than other food, and this is the reason Giffen Goods occurs.

Other than Giffen Goods, do you still know any other goods that break the rule of the law of demand?

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