For a Giffen good, the:
A. demand curve is positively sloped.
B. substitution effect overwhelms the income effect.
C. income and substitution effects are in the same direction.
The Correct Answer and Explanation is:
Correct Answer: A. demand curve is positively sloped.
Explanation
A Giffen good is a rare type of inferior good for which an increase in price leads to an increase in quantity demanded, violating the basic law of demand. Normally, when the price of a good rises, people buy less of it. However, for Giffen goods, the opposite occurs—the demand curve slopes upward, which is what makes option A the correct answer.
To understand this phenomenon, we need to break down the income and substitution effects:
- The substitution effect always works in the same direction: when the price of a good rises, consumers will typically substitute it with a cheaper alternative, decreasing quantity demanded.
- The income effect represents how a price change affects real income or purchasing power. For inferior goods, an increase in price may lead to an increase in demand if the income effect is strong and negative enough.
A Giffen good arises when:
- The good is strongly inferior (i.e., people consume more of it as they become poorer).
- The good constitutes a large portion of the consumer’s budget.
- The income effect is large and negative enough to outweigh the substitution effect.
Take the classic example: a poor household that mainly consumes cheap staple food (like rice or bread). If the price of rice rises, the household can’t afford to buy as much meat or vegetables, so they end up buying more rice, even though it’s more expensive, because they have to cut back on more expensive foods.
This unique case causes the demand curve to slope upward (Option A), which is the defining feature of a Giffen good. Options B and C are incorrect because, for Giffen goods, the income effect overwhelms the substitution effect, and the two effects work in opposite directions.
