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What exactly are Giffen goods and are they of purely theoretical interest or has there been empirical evidence of their existence?

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Giffen goods actually came about as an economic concept as a response to the existence of some goods that violate the first law of demand. –  rosenjcb Nov 19 at 23:32
    
This question appears to be off-topic because the answer is readily available on Wikipedia. –  Steven Landsburg Nov 29 at 18:38
    
@StevenLandsburg: It would probably be better if you raised this objection over on Meta (i.e. whether "off-topic if on Wikipedia" should be a valid reason to close a post). –  Steve S Nov 30 at 3:12

3 Answers 3

Consider the Slutsky equation, $$ \frac{\partial x}{\partial p} = \frac{\partial x^c}{\partial p} - \frac{\partial x}{\partial I} x. $$

A giffen good is the case where the income effect $\frac{\partial x}{\partial I} x$ is negative and large (in magnitude) enough so that $\frac{\partial x}{\partial p} > 0$.

From Wikipedia:

There are three necessary preconditions for this situation to arise: (1) the good in question must be an inferior good, (2) there must be a lack of close substitute goods, and (3) the good must constitute a substantial percentage of the buyer's income, but not such a substantial percentage of the buyer's income that none of the associated normal goods are consumed.

(Sufficient when (1) also adds that the good is so inferior that the income effect is greater than the substitution effect.)

A Giffen good does not generate utility directly through its price. Contrast this to a Veblen good where there the user actually derives utility directly from the price.

See this link for some info about empirical evidence.

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There is rather low probability for demand of a good to exhibit the Giffen property at market level, where averaging over heterogeneous preferences, different income levels and consequent differentiated behavior, will usually offset Giffen phenomena.

Looking at @jmbejara answer, goods that are likely to satisfy all three necessary conditions are drugs like heroin. Heroin is a "good" alright, since, although it may has negative side effects and eventually grave effects, its consumption provides positive instantaneous utility. Here we observe that:

1) Inferior good (=income elasticity negative). This comes from data: the bulk of heroin consumption is done by lower-income individuals (that were "lower-income" prior to any income-detrimental effects that the habit itself may eventually have).

2) Lack of close substitutes: heroin becomes a biological need, because it substitutes for the production of opiates that the human body normally produces itself in order to regulate its sensitivity to stimulus (this is why when the habit is not fed, the addict feels actual pain. That heroin may also induce a "get-high" state has to do with the fact that the amount of opiates that is inserted in the body by heroin injection exceeds the level that the body would itself produce). This is a very specific service offered, and substances like methadone for example, don't come close enough. More importantly, they are also not freely available, so the substitution effect, even though it may exist, may not be able to actually materialize.

3) Substantial percentage of income: heroin commands relatively high prices, due to its illegal status (and the associated risk), but also due to the exploitation from the supplier of the necessity and urgency with which the good is demanded. Combined with relatively low income, the condition is likely to be satisfied.

So there is a visible probability that rising heroin prices may lead to an increase in the demand for it, at least for a subset of individuals.

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#1 is definitely a stretch... After all, it's ceteris paribus... If a smack addict finds $10,000 in some back alley, will he decrease his consumption of heroin? No way! That dude's throwing a $10,000 smack party! –  Steve S Nov 23 at 6:41
    
@Steve S This is the elasticity of a very large arc that you describe. It may very well be positive while the elasticity for an incremental income increase may be negative. Moreover, I don't see why we should impose a single behavior on all heroin users -that tendency to throw away heterogeneity should be led to rest in economics. –  Alecos Papadopoulos Nov 23 at 16:38
    
@SteveS But most importantly, the situation you describe is a windfall gain, not an income increase, in the more long-run sense that we examine the issue, especially as regards income elasticities. Again, the observed fact that heroin consumption is done mainly by lower-level-income individuals (which comes from the data), is the empirical validation of the claim that heroin is an inferior good. –  Alecos Papadopoulos Nov 23 at 16:58

The usual textbook example of a Giffen good (i.e. a good whose demand curve slopes upwards) is the Irish potato famine. The idea is that as potatoes (a staple food) became more expensive, people could no longer afford expensive foods such as meat and so ended up buying more potatoes! However, this example has come in for criticism, not least of all because a potato famine means that the total consumption of potatoes must have been decreasing at the time. You can read a critique of the potato famine hypothesis here.

More recent work has suggested, however, that consumption of rice (also a staple) in some poor parts of China does exhibit Giffen behaviour. This research was published in a paper by Jensen and Miller in the AER in 2008 titled "Giffen Behavior and Subsistence Consumption". They ran a field experiment in which they subsidised rice consumption (i.e. decreased its apparent price) for randomly chosen households and found that the result was a decrease in rice consumption.

Alfred Marshall popularised the notion of a Giffen good in 1895, but it took until the 21st century for fairly robust evidence of Giffen bahviour to emerge. That finding such an example took so long suggests that Giffen goods are, indeed, a very rare phenomenon.

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Jensen and Miller give, I think, the best real world proof of the existence of a giffen good. –  Alex Nov 23 at 14:07

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