DO ALL DEMAND CURVE SLOPE DOWNWARD
Normally, when the price of a good rises, people buy less of it. This usual behavior, called the law of demand is reflected in the downward slope of the demand curve As a matter of economic theory, however, demand curves can sometimes slope upward. In other words consumers can sometimes violate the law of demand and buy more of a good when the price rises. To see how this can happen, consider Figure 12. In this example, the consumer buys two goods-meat and potatoes. Initially, the consumer’s budget constraint is the line from point A to point B. The optimum is point C. When the price of potatoes rises, the budget constraint shifts inward and is now the line from point A to point D. The optimum is now point E. Notice that a rise in the price of potatoes has led the consumer to buy a larger quantity of potatoes.
Figure 12 A Giffen Good
In this example, when the price of potatoes rises, the consumer’s optimum shifts from point C to point E. In this case, the consumer responds to a higher price of potatoes by buying less meat and more potatoes.
Why is the consumer responding in a seemingly perverse way? The reason is that potatoes here are a strongly inferior good. When the price of potatoes rises, the consumer is poorer. The income effect makes the consumer want to buy less meat and more potatoes. At the same time, because the potatoes have become more expensive relative to meat, the substitution effect makes the consumer want to buy more meat and less potatoes. In this particular case, however, the income effect is so strong that it exceeds the substitution effect. In the end, the consumer responds to the higher price of potatoes by buying less meat and more potatoes .
Economists use the term Giffen good to describe a good that violates the law of demand. (The term is named for economist Robert Giffen, who first noted this possibility.) In this example, potatoes are a Giffen good. Giffen goods are inferior goods for which the income effect dominates the substitution effect. Therefore, they have demand curves that slope upward. Economists disagree about whether any Giffen good has ever been discovered. Some historians suggest that potatoes were in fact a Giffen good during the Irish potato famine of the 19th century. Potatoes were such a large part of people’s diet that when the price of potatoes rose, it had a large income effect People responded to their reduced living standard by cutting back on the luxury of meat and buying more of the staple food of potatoes. Thus, it is argued that a higher price of potatoes actually raised the quantity of
potatoes demanded Whether or not this historical account is true, it is safe to say that Giffen goods are very rare The theory of consumer choice does allow demand curves to slope upward. Yet such occurrences are so unusual that the law of demand is as reliable a law as any in economics.
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