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Differentiate between Inferior goods and Giffen goods in the cont...

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Differentiate between Inferior goods and Giffen goods in the context of income effect and substitution effect

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  • March 2014
  • 1358 Words
  • 2 Views
  • Course: Managerial Economics
  • Professor: Margaret Okillo
  • School: Mount Kenya University- Kigali
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COURSE TITLE: MANAGERIAL ECONOMICS

In economics, an inferior good is a good that decreases in demand when consumer income rises, unlike normal goods, for which the opposite is observed. Normal goods are those for which consumers' demand increases when their income increases. This would be the opposite of a superior good, one that is often associated with wealth and the wealthy, whereas an inferior good is often associated with lower socio-economic groups. In economics and consumer theory, a Giffen good is one which people paradoxically consume more of as the price rises, violating the law of demand. In normal situations, as the price of a good rises, the substitution effect causes consumers to purchase less of it and more of substitute goods. In the Giffen good situation, the income effect dominates, leading people to buy more of the good, even as its price rises. All Giffen goods are inferior goods, but not all inferior goods are Giffen goods. Giffen goods are difficult to find because a number of conditions must be satisfied for the associated behavior to be observed. One reason for the difficulty in finding Giffen goods that is Giffen originally envisioned a specific situation faced by individuals in a state of poverty. Modern consumer behavior research methods often deal in aggregates that average out income levels and are too blunt an instrument to capture these specific situations. Furthermore, complicating the matter are the requirements for limited availability of substitutes, as well as that the consumers are not so poor that they can only afford the inferior good. It is for this reason that many text books use the term Giffen paradox rather than Giffen good. Income Effect

The income effect is defined as the result of a change in a product's price relative to the consumer's disposable income. When the price of a good changes, the real, or actual, income of the consumer who...