Economics assignment

Question-1

“Inferior goods are not those goods in case of which the law of demand fails, inferior goods are

those goods in case of which income effect is negative or these are the goods the demand for

which decreases when income increases

Yes, law of demand fails in case of GIFFIN GOODS. It is in the case of these goods that there is

{a} inverse relationship between income and demand

{b}positive relationship between price and demand”

In the light of above statement, explain the following statement with the help of an example:

“WHILE ALL GIFFIN GOODS ARE INFERIOR GOODS, ALL INFERIOR GOODS ARE

NOT GIFFIN GOODS”

Answer-1

Inferior goods are those goods whose demand decreases with rise in income of the households.

Alternatively, when rise in income of the consumers lead to fall in their demand of that good,

that is called an inferior good.

Thus there is an inverse relationship between income and demand for an inferior good.

In case of inferior good, income effect is negative i.e., when income goes up, demand for such

good falls because with extra purchasing power caused by income, people start consuming

normal or superior goods. For instance, with an increase in income, a consumer may start using

wheat in place of barley. Thus, there is an inverse relationship between income and demand for

inferior goods.

In case of an inferior good, an increase in income leads to decrease in demand at the same price

and shift the demand curve to the left but decrease in income leads to increase in demand at the

same price and shifts the demand curve to the right.

As Mr.Giffen pointed out, a rise in the price of bread makes large drain on poor people’s

resources and their marginal utility of money rises, this forced them to curtail the consumption of

meat and the other expensive foods: and, bread being still the cheapest food which they can get,

they consume more, and not less of it.

—Alfred Marshall, Principles of Economics

A Giffen good is that product or good that defies the law of demand in terms of the relationship

between price and quantity of demand. This particular economic paradox was propounded by

Scottish economist Sir Robert Giffen.

Giffen goods are a special category of inferior good in whose case, demand for a commodity

falls with a fall in its price.

In case of certain inferior goods, when their prices fall, their demand may not rise because extra

purchasing power is diverted on the purchase of superior goods.

For instance, if price of inferior food grain like ‘Jowar’ falls in India, people may demand less of

it and instead start eating wheat or rice (superior foodgrain).

Here, Jowar is a case of Giffen good whose fall in demand due to negative income effect is more

than the rise in demand due to substitution effect.

Simply put an increase in income results in a fall in demand for the good.

INCOME EFFECT – A change in the quantity demanded as a result of change in real income

caused by change in price of the commodity is called income effect.

For instance, when price of a commodity falls, lass has to be spent on purchase of that

commodity. With money thus saved, a consumer can buy more quantity of that good.

SUBSTITUTION EFFECT – Substituting a cheaper commodity for the relatively expensive

commodity is called substitution effect. For example, a rise in the price of a commodity, say

coffee, also means that price of its substitute, say tea, has fallen in relation to that of coffee even

though price of tea remains unchanged.

As a result, if people buy more of tea and less of coffee, it will be a case of substitution effect

since coffee has been substituted by tea.

LAW OF DEMAND

The law of demand explains the relationship between the price and quantity demanded of a

commodity, assuming other factors affecting the demand to be constant.

According to the law, “other things being constant, quantity demanded of a commodity is

inversely related to the price of the commodity.”

Price and demand move in the opposite direction. In other words, when the price of a commodity

rises, demand falls and when the price falls, demand rises, provided factors other than the price

remain unchanged.

In short, normally more of a commodity is demanded at lower price and less of it at a higher

price.

For example, a consumer may demand 2kg of apples at Rs.35 per kg; he may, however, demand

1kg if the price rises to Rs.40 per kg.

This has been the general human behaviour on relationship between the price of the commodity

and the quantity demanded.

Assumptions of Law of Demand:

1. There should be no change in the price of related goods (substitutes and compliments).

2. There should be no change in the income of the consumer.

3. No change in the tastes, preferences, and habits of the consumer.

4. No change in the number of family members, weather, etc.

Exceptions to Law of Demand:

1. Giffen goods:

Some special varieties of inferior goods are termed as Giffen goods. Cheaper varieties of this

category like bajra, cheaper vegetable like potato come under this category. Sir Robert Giffen or

Ireland first observed that people used to spend more their income on inferior goods like potato

and less of their income on meat. But potatoes constitute their staple food. When the price of

potato increased, after purchasing potato they did not have so many surpluses to buy meat. So the

rise in price of potato compelled people to buy more potato and thus raised the demand for

potato. This is against the law of demand. This is also known as Giffen paradox.

2. Goods expected to become scarce or costly in future:

Goods are purchased by the households in increased quantities when they suspect that the

prices would go high in the near future.

3. Status Symbol Good:

The higher the price of the diamond the higher would be its prestige value. These goods are

purchased by only rich people and not the common man. When their prices fall, the demand

also becomes poor because its luxury value gets decreased.

4. Fashion:

The demand for goods which are in fashion does not fall even when their price rises. When a

narrow shoe comes in the place of broad shoe, no amount of fall in price of the broad shoe is

enough to clear the stocks.

5. Necessities:.

The law of demand does not operate in case of necessary goods such as foodgrain, salt,

matches, milk, etc.

6. Emergency:

An emergency like war does not apply to the law of demand as the households behave in an

abnormal way.

7. Ignorance :

When a consumer is ignorant, how can changes in price of a commodity affect his demand?

He might purchase a good with high price. Also, some think that goods with higher prices are

superior in quality.

“WHILE ALL GIFFEN GOODS ARE INFERIOR GOODS, ALL INFERIOR GOODS ARE

NOT GIFFEN GOODS”

One trait by Giffen goods is unique enough to answer this question.

The income effect is negative and is always greater than the positive substitution effect (this

is true for Giffen goods, but not in inferior goods).

Since Giffen good always has a negative income effect, it can always be an inferior good.

Thus, we can say that a Giffen good is always an inferior good, but this cannot always be true

in case of inferior good as all inferior goods cannot be held synonym with Giffen Goods.

In case of inferior goods, the demand decreases when the income of the consumer increases.

This is because when you get richer, you want to have superior quality goods. When you

cannot afford high priced goods, naturally their demand falls as a result of your low income.

And, the consumer is left with nothing but to buy inferior goods.

Giffen goods are exactly the opposite. Here, people want more of Giffen goods when income

of the consumer is higher.

Example could be a BMW car. The richer a person is, the more able that person is to buy a

BMW. When the price of a BMW gets higher, the demand for it also increases because it is

more like a status symbol.

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