A Giffen good is a theoretical violation of the law of demand. When the price of a good rises, the quantity purchased of that good normally declines. Sir Robert Giffen is credited by Alfred Marshall with making the observation that, under certain circumstances, price and quantity demanded may move in the same direction, not the opposite direction.
When the price of a product decreases the consumer is subjected to both substitution and income effects. The substitution effect is the result of the change in relative price. When the price of good ‘A’ falls, good ‘B’ becomes relatively more expensive. Consumers purchase more ‘A’ and less ‘B’. Consumers substitute the relatively cheaper product for the relatively more expensive product.
Consumers also face an income effect. When the price of good ‘A’ falls, the purchasing power of their nominal income rises. An increase in real income leads to an increase in the demand for normal goods and a decrease in demand for inferior goods.
When a good is normal, the substitution and income effects work in the same direction and demand curves are unambiguously downward sloping. When goods are inferior, however, it is theoretically possible that the negative income effect is greater than the positive substitution effect and demand curves are upward sloping.
A recent Victoria Times-Colonist article tells about the BCFerries Corporation’s decision to increase fares “due to rising operating costs, increased capital expenditure and lower-than-anticipated traffic levels” (italics added).
It seems that BC Ferries may be trying to increase their traffic levels by increasing their fees. Perhaps they believe that their service is a Giffen good and we can add that to rice and wheat as discussed in blogs by Greg Mankiw (July 18, 2007) and Timothy Taylor (January 4, 2102).
Or perhaps they are flexing an inelastic demand muscle and raising revenue by raising prices?
ReplyDeleteAh, but if demand is inelastic, marginal revenue must be negative.
ReplyDelete