Understanding Giffen Goods

A Giffen good is a special type of inferior good where the quantity demanded increases as the price increases, and vice versa. This behaviour contradicts the standard law of demand.

Income and Substitution Effects Analysis

The change in demand due to a price change can be divided into two effects:

• Substitution Effect: When a good's price decreases, it becomes relatively cheaper than other goods. Consumers substitute towards this cheaper good, increasing its demand. This effect always works to increase demand when price falls.
• Income Effect: A decrease in price increases the consumer's real purchasing power. For an inferior good, an increase in real income leads to a decrease in demand. This is a negative income effect.

Condition for Giffen Good

For a good to be classified as a Giffen good:

• It must be an inferior good (negative income effect).
• The negative income effect must be stronger than the positive substitution effect.

In mathematical terms, if P is price, Q is quantity, IE is Income Effect, and SE is Substitution Effect:

Total Effect (Change in Q due to Change in P) = IE + SE

For a Giffen good, when price decreases (ΔP < 0):

• SE works to increase demand (ΔQ > 0).
• IE (for inferior good) works to decrease demand (ΔQ < 0).
• If |IE| > |SE|, the negative income effect dominates, causing overall demand to decrease (ΔQ < 0). This means demand falls when price falls, confirming the Giffen characteristic.

The question asks for the condition when the income effect is dominant. This occurs when the income effect is negative and its magnitude is greater than the substitution effect.