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!


LBM

If the perception of value (purses mentioned earlier) count as a Giffen Good, there are plenty of examples. Mazda Miatas, in the first year, were scarce, and sold for more than sticker price. So what other property is necessary to make something a Giffen Good?

Daniel

The real challenge in finding a Giffin good isn't finding a good where the price rises and consumption goes up -- there are plenty of examples of that. The real trick is to find a good for which the price rises and *all else equal* consumption goes up.

If there's an outbreak of a particular disease, likely the price of the vaccene would go up, and so would quantity demanded, but that doesn't make it a Giffin good. If a band becomes popular, tickets to their concerts become more expensive, and the number of tickets sold rises. Clearly that wouldn't count as a Giffin good.

But what about a context of imperfect information where consumers use price as information about product quality? If the price of a good drops dramatically, and consumers buy less of the good because they assume if the price went down so much, there must be something wrong with the priduct? The only thing that changed is price, but the mechanism is quite different than what Giffin envisioned. Would that be a Giffin good?

Read more...

Seth Roberts

In the bread & meat example, the property of {price goes up, buy more} is due to the whole situation, not just the bread. To call the bread a Giffen Good makes the bread sound special. It's the whole situation that has this special property. It would be more accurate to refer to a Giffen Basket (of goods).

Mike

I think HS is onto something. I've always wanted to do a study of the price elasticity in high-end clubs and strip clubs - the kinds where the clientele are on expense accounts entertaining clients. Or LV casinos. I believe that INCREASING the price of a bottle of liquor or champagne, for instance, on the drink menu, can actually INCREASE demand for that. In these situations, often times the APPEARANCES are what is being payed for, not the liquids themselves, so the same bottle can actually be more desirable at $1000 than at $500. Are there any studies of this kind, and is this a Geffen good?

Anybody? Mrs. Levin, Dubner, and Jensen?

Will

I read an article about a small liberal arts college, somewhere on the east coast last year that may be a decent example (I'm an engineer, not an economist).

This college suffered from low applications and conducted a study on schools this college thought they were comparable to. One of their findings was a wide difference in price. This college was significantly cheaper - $10,000 - than it's presumed peers. The next year they raised tuition for incoming students to more closely resemble the schools comprising the study. Surprisingly enough, the school saw a huge spike in applications, perhaps 30%. I don't remember the data exactly, but I spent half an hour searching for the article to no avail.

Ryan

Seems like housing in the U.S. was a Giffen Good during the bubble expansion, at least in certain markets. As prices rose, more people wanted in on it a "can't lose" investment, increasing demand, increasing prices...

TR

I thought an example of the Griffin Good case was a type of beer that when priced the same as others had low demand, but when the price was increased demand increased because people saw it as a high-end product?

SM

This is very interesting in light of the recent increases in price of rice worldwide. I am curious whether Mr Jensen has been able to monitor the consumer reactions recently, which would be able to further confirm his identification of Giffen Goods.

GLK

Years ago I knew a guy that was trying unsuccessfully to sell an old beat-up Porsche. He was at the point that he was considering giving it away. I told him to double his original asking price. The car sold in a week.

Years later when I was in business for myself I mistakenly quoted a customer my cost for an item and he, thankfully for me, walked away from the deal of the century.

Conversely, I've seen people militantly defend paying too much.

Let's face it "Brand Building" is all about the ability to motivate customers to willingly pay more.

jw

I am not sure that water is a griffin good... in a history channel program I recall the description of the rise and fall of the bottled water industry at the turn of the century. At its peak, 1905, a bottle ruffly equivalent to 750 ml was approximately $25 in todays dollars. If that is true we have a way to go on water to reclaim its old high. I was under the impression that illegal addictive drugs were griffin goods. And how is vodka and tequila not considered griffin goods?

Mark

I have to say that I am impressed that someone found a Giffen good. That it is a staple food does not suprise me. However, I wonder what makes wheat and rice in China different from other staple foods in poor areas. Is it Chinese urbanization? Is it a tight international market? How long a period of time does the data cover?

AaronS

I think a stock or commodity can be a type of "Giffen good," at least for period of time. For example, as the price of a stock or commodity rises, sometimes demand for it increases, because people think that there is money to be made.

And this can go on for some time--witness the price of gold. There's no shortage of gold that I know of--it's just the old, "if oil goes up, gold goes up" routine. More and more people, afraid of missing the boat, buy in, and the price keeps going up.

A Giffen good? I don't know, maybe.

HS

This seems easy to any high-end (woman) shopper: go look at Hermes purses as one example. No one wants the $2000 purse but everyone wants the $16k purse. There are more examples: Louis Vuitton bags, Lanvin shoes, Dior dresses. All of these high-end products have lesser priced products but the high-end shopper does not want the cheaper product (made by the same manufacturer) -- s/he wants only the pricier product merely because it is pricier. May not make sense but sure looks good.

Matt

@Mark:

Imagine bread costs $1 for 1000 calories and meat costs $1 for 100 calories. Then suppose you have $3/day to spend on food. (This is all incredibly oversimplified, but the idea is that there is a unit cost for bread. You can't buy just one piece, but rather you need to buy a loaf.)

You can live off of 2,100 calories, spending the $3 on 2 parts bread and 1 part meat.

Then, the price of bread goes up to $1.35 for 1000 calories. Perhaps a bread competitor decides to fill a void by offering a $1/800 calorie alternative.

Now you could spend $2.70 on the original bread, leaving you starving but with $.30 left over and no food options, or you can spend all $3 on bread, get 2400 calories and survive on the Giffen Good.

Scott

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.

Josh

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?

Jakob

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.

Jonathan Rees

What about tuition at Bennington?

frankenduf

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

Andrew

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.