In a situation of decline in price of a Giffen Commodity, we find :

Question

Prepp Team · Accepted Answer

Giffen Commodity Analysis: Price Decline Effects

A Giffen commodity is a rare type of inferior good where demand increases as the price increases, and decreases as the price decreases. This behavior contradicts the standard law of demand. Understanding the effects of a price change is key.

Price Decline Impact

When the price of any good declines, it triggers two effects:

Substitution Effect: The good becomes relatively cheaper compared to substitutes. This effect always encourages consumers to buy more of the cheaper good. For a price fall, the substitution effect is positive.
Income Effect: The fall in price increases the consumer's real purchasing power. For inferior goods (including Giffen goods), an increase in real income leads to a decrease in consumption. For a price fall of an inferior good, the income effect is negative.

Giffen Good Specifics

For a Giffen commodity, the unique characteristic is that demand falls when the price falls. This happens specifically when the negative income effect is stronger than the positive substitution effect.

Let $P$ be the price of the Giffen commodity.

Consider a decline in $P$.

The quantity demanded due to the substitution effect increases (let's denote this change as $ \Delta Q_{sub} > 0 $).
The quantity demanded due to the income effect decreases (let's denote this change as $ \Delta Q_{inc} < 0 $).
For a Giffen good, the total change in quantity demanded ($ \Delta Q_{total} $) is negative when the price falls ($ \Delta P < 0 $). This means $ \Delta Q_{total} = \Delta Q_{sub} + \Delta Q_{inc} < 0 $.
This condition ($ \Delta Q_{sub} + \Delta Q_{inc} < 0 $) implies that the magnitude of the decrease caused by the income effect is greater than the magnitude of the increase caused by the substitution effect.
In other words, the positive substitution effect is less than the magnitude of the negative income effect.