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!

Leave A Comment

Comments are moderated and generally will be posted if they are on-topic and not abusive.

 

COMMENTS: 67

View All Comments »
  1. Seth Roberts says:

    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).

    Thumb up 0 Thumb down 0
  2. Mike says:

    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?

    Thumb up 0 Thumb down 0
  3. Ryan says:

    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…

    Thumb up 0 Thumb down 0
  4. Christopher says:

    Aren’t there many examples of products being re-branded as luxury items (requiring an increase- sometimes large- in price)… and successfully selling more?

    There has to be some sort of designer purse that was, say, selling for $10. Then the manufacturer (through demand or as a marketing gimmick) raises the price to $100 and sells more.

    Thumb up 0 Thumb down 0
  5. LBM says:

    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?

    Thumb up 0 Thumb down 0
  6. Jurgen says:

    I’m not an economist and didn’t know about Giffen goods until I read this blog post but I did already understand the concept.
    I think you get Giffen goods whenever a customer is incapable of determining the quality of a good by looking at it.
    My favorite example of this is locks. Only an expert can tell from the outside whether a given lock would be susceptible to lock picking, normal consumers can’t. In the absence of this knowledge the consumer falls back to a basic quality assumption: You get what you pay for. The belief that products that are expensive are of high quality (which is based on the assumption that high quality would be expensive to produce and therefore require a higher price). Other products where I would expect the same effect are clothes, alcohol, prostitution and jewelry.

    Thumb up 0 Thumb down 0
  7. SBG says:

    In my introductory mico class, we were given the example of tennis lessons. An instructor wouldn’t get customers when he charged $15.00 per hour, but would get plenty when he charged $50.00 per hour. Buyers thought that such a low price was probably a sign of poor quality.

    Thumb up 0 Thumb down 0
  8. David says:

    I’m not an economist, either. However, pretty much everyone on this blog seems to be confused about the definition of what a giffen good is. The key element is that the product in question has to be an “inferior good” not a “normal good”. It is true that for certain luxury items (eg. Liquor in bars) people may buy more if the prices are raised, however, it is also true that people will buy more luxury items as their income rises. This is the definition of a “normal good”. As income increases more of the good is demanded. An inferior good is where the opposite occurs. As income rises people will begin to substitute other products for that inferior good. So, in the this blog, bread is an inferior good, because as income increases meat becomes more desirable and bread becomes less. If the supply and demand curves are correct then people will buy less of an “inferior good” if the prices are increased. The key here is that if bread is such an important part of the diet then people will be forced to buy more of the good even though the prices have been increased because they can no longer afford to substitute it with anything else.

    Thumb up 0 Thumb down 0