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. Daniel says:

    The article talks about looking for Giffen goods amoung necessities like the bread/meat example. I would look for a Giffen good in frivilous luxury items.

    1.Diamonds – The more they cost, the more people buy them in order to show off. Are diamonds disqualified because the supply is manipulated by a cartel? In that case…

    2.Handbags – Not the practical ones that most of our wives and girlfriends own. I’m talking about the latest high fashion accessory by the top designer seen on the arms of Hollywood stars. These things are not popular because they do a better job helping the owner carry around her makeup. They are popular because they are expensive and the more expensive they are, the more people want to buy them.

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  2. Rob says:

    Years ago my fraternity ran a fireworks stand to raise money for a charitable cause. There were three “fountains” that were identical in wholesale price and, presumably, quality. The wrappers were all different colors. We would pick one color and charge $.25 more for it. We always sold more of the more expensive color even though the quality was the same. Is that what we are discussing here?

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  3. David Heigham says:

    To my surprise, I think that I have a case of a Giffen good in my household.

    We have two automobiles. One has a diesel engine and one a gasoline engine. Driving the one with the diesel engine is – marginally – a less comfortable experience than driving the one with the gasoline engine. I.e., diesel is for us an inferior good.

    Oil prices have risen in general. However diesel prices have riden more sharply than gasoline prices. We drive about the same aggregate distance, but choose to use the diesel vehicle more often than before because the greater distance per unit of fuel achieved with diesel means that using the diesel car minmizes our total travel expenditure.

    For us, therefore diesel fuel is a Giffen good, at least relative to gasoline, at least over this band of relative prices, at least until we change automobiles.

    As to when you can get away with marketing something as a Veblen good, look at “When do Higher Prices Increase Demand?” , Thomas Morwitz and Lodish, January 2004.

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  4. Alexandre says:

    Just another thing to point out here, is that a Giffen good is necessarily an inferior good (when income increases, demand declines) with another requisite: the income effect is bigger than the substitution effect.

    In the text example it means that the decrease in purchase power (resulting from the increase in bread prices) offsets the willingness to swap toward meat consumption resulting from the change in relative prices.

    I guess part 2/3 will explain this in a friendlier way.

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  5. Doug B says:

    This seems to me to be a clearer example: I have $50 per week to spend on dinner. 6 days/week I eat McDonald’s at $5 per meal, so that on the 7th day, I can treat myself to a better meal (e.g., TGIFriday’s?) for $20. For sake of simplicity, say these are my only 2 choices for food.

    If McDonald’s raises their prices so that my dinner now costs $7, I would then have to eat at McDonald’s all 7 days of the week, because I would no longer have enough money to eat one nicer meal. (Feeling sort of queasy just thinking about it…)

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  6. Jeff says:

    Mark -

    Really? For the love.

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  7. kip says:

    Well this is anecdotal, but Joel Spolsky (owner of a software company in NYC) has said that the single biggest thing he did to boost sales of their software was to raise the price. He attributes it to people believing “you get what you pay for.” I can’t seem to find the article on his blog where he said this though, but he does give one example in another post I found:

    The only reason we assumed that the demand curve is downward sloping is that we assumed things like “if Freddy is willing to buy a pair of sneakers for $130, he is certainly willing to buy those same sneakers for $20.” Right? Ha! Not if Freddy is an American teenager! American teenagers would not be caught dead in $20 sneakers. It’s, like, um, the death penalty? if you are wearing sneakers? that only cost $20 a pair? in school?

    That’s from the very end of this post: http://www.joelonsoftware.com/articles/CamelsandRubberDuckies.html

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  8. janpi says:

    I was under the impression that illegal addictive drugs were griffin goods. In Italy we have the first food in the world but isn’t more expensive and haven’t more colories

    http://www.radioboville.blogspot.com

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