Giffen Goods

A Giffen good is the one case where the law of demand fails. When its price rises, the consumer buys more of it — the demand curve slopes upward. This sounds paradoxical, but it follows directly from the Slutsky decomposition. The key conditions are: (1) the good must be inferior (negative income effect), and (2) the income effect must be so large that it dominates the substitution effect.

How can this happen in the real world? Consider a very poor household that spends almost all its income on rice (a staple) and a small amount on meat (a luxury). If the price of rice rises, the household becomes effectively poorer. It can no longer afford meat at all, so it drops meat and buys even more rice just to get enough calories. The price increase reduced real income so drastically that the household had to cut the luxury and load up on the (now more expensive) staple. The income effect swamped the substitution effect.

Giffen goods are extremely rare in practice. The most cited real-world evidence comes from Jensen and Miller (2008), who studied rice consumption in Hunan, China, and wheat consumption in Gansu, China. When the researchers subsidised rice (lowering its effective price), poor households actually consumed less rice and substituted toward meat and vegetables. When the subsidy was removed (raising the effective price), rice consumption increased. This is textbook Giffen behaviour, confirmed in a controlled experiment.

The three necessary conditions for a Giffen good: (1) the good must be inferior, (2) it must absorb a large share of the consumer’s budget (amplifying the income effect term $X^{\ast }$ in the Slutsky equation), and (3) there must be limited substitution possibilities (keeping the substitution effect small). All three are typically present only for staple foods consumed by very poor households.