The Indiana Jones of Economics, Part I

A few years back the Wall Street Journal dubbed me the Indiana Jones of economics.

JensenRobert Jensen

In reality, that title more rightfully belongs to Robert Jensen, an economist at Brown University who is doing some of the most interesting and adventurous economics studies these days. Jensen has documented how cell phones revolutionized fish markets in India, how simply telling students in the Dominican Republic once about the high value of an additional year of school can impact their choices years later, and how introducing T.V. into rural India affects the position of women.

The real reason I call Jensen the Indiana Jones of economics is because of another paper he has written in which he and co-author Nolan Miller set out to find one of the elusive Holy Grails of economics: a Giffen good. A Giffen good is one where increasing the price for the exact same good actually leads people to buy more of the good. In economic terms, the price elasticity of such a good is positive, rather than negative. The way economists measure elasticities is often by looking at what is called an “arc elasticity.”

Jensen tells his story in three parts which we will post over the next three days, aptly entitled “Raiders of the Lost Arc Elasticity.”

Raiders of the Lost Arc Elasticity, Part I

By Robert Jensen

Several years ago, my colleague Nolan Miller and I set out on a thrilling adventure. OK, this being economics, both “thrilling” and “adventure” are relative terms. But, the story does involve the search for an elusive, fabled prize shrouded in mystery, travel to far-off lands, and the promise of immortality. We had set out to find a Giffen good, a journey we just recently completed.

So, what’s a Giffen good? It’s a (theoretical) violation of one of the most sacred and holy laws of economics: the Law of Demand. It has excited and intrigued economists for over a century, though no verified example had ever been found.

The Law of Demand says that if the price of a good goes up, the quantity demanded decreases. A Giffen good is one where when the price goes up, the quantity demanded increases. It’s named after Sir Robert Giffen, a 19th century British civil servant and economist who is believed to have first suggested the possibility.

How might this happen?

Imagine you are extremely poor, just barely able to afford enough to eat. And for simplicity, pretend there are only two foods: a basic, staple food like bread that gives you a lot of calories and fills your stomach at a relatively low cost, and a luxury food like meat, that tastes good (indulge me, vegetarians) or adds variety to your diet, but is very expensive, offering few calories per dollar.

So, if you’re really poor, you’ll eat a lot of bread to fill your stomach and get your calories — then with whatever money you have left over, you buy a bit of meat to make yourself happy.

You’re going merrily along like this, until the price of bread goes up. Now you can’t afford the same bundle of bread and meat you were buying before. You have two choices:

1. Eat less bread and more meat.
2. Eat more bread and less meat.

Actually, if you enjoy being alive, you really only have one choice: option two.

The problem with option one is that if you cut back on bread, you lose a lot of calories and a lot of bulk to fill your stomach. And because meat is so expensive, you get very few calories from the small amount you add to your diet. So, since you were just barely getting enough to eat before, you would end up with too few calories and a grumbling stomach. Eventually, you might even end up dead.

But if you instead cut back on meat and eat even more bread than before — while you may enjoy your diet less — you’ll at least get enough calories and fill your stomach. Really, you have little choice. So you break the Law of Demand: the price of bread goes up, and you end up eating more of it.

Anyone who has ever sat through introductory economics has probably heard about Giffen goods. Maybe you were told about potatoes during the Irish famine. If so, you were mislead. The potato example has been disproved.

The search for an alternative example has lead economists to explore crazy, far-out cases, like the demand for fermented whale bile among river-dwelling southern Kazoo from 1873 to 1875. But these searches always came up empty.

In fact, just a few years before his death, Nobel Laureate George Stigler wrote that the best proof that no Giffen good exists is that whoever found one would attain immortality (in the economics profession, anyway, which is one-half a step above being the most famous asphalt engineer) — and since this is such a great reward, people must have already looked everywhere for one.

Despite this declaration, we were determined to find the elusive Giffen good!

(Oh, the blog title. For technical reasons, the way you explore demand is through estimating an “elasticity,” which tells you how the quantity demanded changes when the price changes — all in percent terms.

In the Giffen case, where quantity demanded increases when price increases, you would have a positive price elasticity. And for even more technical reasons, you really want to estimate the “arc” price elasticity. Yes, a long way to go just for a bad pun).

So, to rephrase: We were determined to find the elusive positive arc price elasticity of demand!

Next time: Catastrophe strikes!

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  1. Mark S Nadel says:

    I don’t follow you. I agree that an increase in the price of bread (i.e. calories) will increase the dollars you spend on bread, but not the total quantity of bread that you buy.

    I would expect that you would try to purchase THE SAME QUANTITY of bread as you previously purchased since it appears that you treat the bread as a quasi-necessity and the meat as a luxury item. If you have enough to purchase that same quantity of bread, you will be left with less money for meat and purchase less of that luxury good, but the same amount of bread.

    What am I missing?

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  2. Dan says:

    well you still need the same amount of calories in your diet, so if you are eating the same amount of bread and less meat you will be hungry. So you need to make up the calories you lost by cutting out the meat by buying more bread.

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  3. Bob says:

    Re: Mark

    Say you need 1000 calories to not starve. Say that bread is 100 calories a serving and meat is 25. When bread is cheap you might buy 9 servings of bread and 4 of meat.

    As the price of bread increases though, you might instead by 10 servings of bread and none of meat, since presumably the 1 serving of bread is cheaper than the 4 servings of meat. You cut the meat out of your diet to get the same amount of calories for cheaper.

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    • S. Basir says:

      So the point is that meat is a luxury or a variety. If the price of bread increases one may change the quality of meat bought, or buy a new luxury (variety).
      The calorie issue will fix itself because hunger is within proximal horizons.

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  4. frankenduf says:

    this one’s easy- the griffin good is water- in the silly american market, people ignored water until they were charged (more) for it- now every red blooded american drinks more water- but even on a grander scale, as water becomes more scarce globally, the price will go up, and consumption/expropriation by the wealthy countries will also go up in order to avert shortages/political turmoil

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  5. Andrew says:

    No, since you would have less money to spend on meat (which was expensive) you would have to make up for those lost calories as well. Which would mean you would have to purchase a little more bread. This is assuming you are keeping your total calories stable.

    Scenario 1:
    Bread = $1 and 10 Calories
    Meat = $3 and 5 Calories
    You have $10, so you buy 2 pieces of meat and 4 loaves of bread giving you a total of 50 calories.

    Scenario 2:
    Bread = $2 and 10 Calories
    Meat = $3 and 5 Calories.
    You still only have $10 and you still need to eat at least 50 calories. So you end up buying all bread in order to get to the 50 calories. You bread purchase went up and the meat went down.

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  6. Jakob says:

    Mark,

    While you’re keeping the same amount of bread, if you have less money left over for meat you also get less meat causing your total amount of calories to drop. Therefore to keep the total number of calories equal to before the price increase of bread you need to increase the amount of bread => buying more bread when price increases.

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  7. Josh says:

    After reading the blog and the first 10 pages of the actual article linked above, I have to agree with Mark above that something is missing. Why would he increase his consumption of bread? Wouldn’t the poor person just increase their spending on bread?

    The only thing I can think of is that since meat is so expensive, that with his remaining money in the new market he can no longer afford any sizable amount of meat, so he just buys more bread with the remaining money.

    What’s the answer?

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  8. Scott says:

    It isn’t that you would have to eat more bread quantity wise just more as a percentage of your diet. If you had $50, and before you would buy $35 for bread and $15 for meat, and the price of bread went up 14%, you would now spend $40 on bread and $10 on meat. Although the amount of bread is the same, 70% of your diet was bread before but it has increased to 80% of your diet after the raised price.

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