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. jacob says:

    I don’t buy the logic of the bread and meat example. If someone is so poor that they only buy bread and meat then raising the price of bread should be equivalent to cutting their income or raising all food prices.

    Shouldn’t a Giffin good apply regardless of income level. Isn’t the distinguishing characteristic that price goes up with all else being equal.

    And by extension would a “middle class” family buy more meat in this example?

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  2. Emmanuel M says:

    Doesn’t petrol follow this quality ? It seems that a Giffen good is a good that competes for budget with higher qualities.

    You have a two products market : petrol and housing. On certain areas (including most european cities), the price of housing goes down as you go farther from downtown. So if you cut on housing, you’ll have to commute longer AND SPEND MORE PETROL.

    If petrol rises, you ‘ll have less disposable income. So you’ll have to cut on housing expenses, therefore moving further away from your job, commuting more and consuming more petrol.

    Aother Giffen good might be banking services. What is named in french “frais de decouvert”. Those are the fees that you bank charges you for financial services (money lending, file processing) when you have a negative account. If the fee gets harsher,you’ll spend more money on them so you will have less money to cover your expenses so you are more likely to go in the negative next month … and spend more on banking fees.

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  3. Jay says:

    Is the motive what establishes a Giffin good, or simply price demand? Does this NYT story from 2006 regarding tuition prices count?

    http://www.nytimes.com/2006/12/12/education/12tuition.html

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  4. Imad Qureshi says:

    This is not even close to convincing. Jensen is ignoring the fact that bread in this case has inelastic demand. Price of bread going up in this case may very well increase the price of meat too because in his two food simple world meat is the closest substitute.
    Let me give you another example. Imagine you are lost in a desert with some water. You estimate you would survive 3 weeks with this water while drinking couple of ounces each day. After two days you run into a man who is lost just like you but has some Pizza. He would trade some of his pizza for your water. To increase the quality of your remaining life you will trade some of your water with his Pizza although now you would die early.

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    • George Gacua Kimani says:

      I agree with you Imad Qureshi , a substitute(a temporary replacement) will as well lead to increase meat price. So should look for alternative though you will die sooner.

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  5. mark says:

    Interestingly enough I was watching a documentary on the history channel about interpols involvement with bringing down the global market of esctasy. It seemed to suggest when the availability and price of the pill went up so did the demand. Of course the narrator and writers of the show may not have known what they were talking about but it caught my attention.

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  6. T Phiri says:

    Your underlying assumption is that this is a two-good market because if there are alternatives close enough to meat, which there are, then the man could still consume the same quantity of bread, less of meat and and add third food x or eliminate meat altogether and just buy food x which is just as tasty or close.

    I see now that the assumption is that this is not a real world scenario.

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  7. ablokussmail@gmail.com says:

    I think that it is obvious that bread is a staple food and more affordable by people compared with fish. Taking this obvious argument to justify the Giffen good is problematic because whatever the prize of staple food people will continue buying them. my suggestion is that the comparison should be based on two things that belongs to the same types of demand. for instance: bread and rice.

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  8. Elías Andrés says:

    When I hear about Giffen goods, I have always thought that expectations of future price increases can push present demand, in a moment when prices have already gone up for a first time.

    It may be because of perceived future scarcity, for instance, or simply because of speculation (in a housing-bubble fashion).

    I am not sure if the inter-temporal dimension is considered within the concept of Giffen good, but I think it is crucial to understanding this particular relationship between prices and quantities demanded.

    As a Venezuelan, I see daily a possible example of a Giffen good: the US dollar sold in the black market. As this “parallel” exchange rate goes up, investors, importers and all the other agents increase their present demand because they expect the US dollar price to continue growing.

    Am I misunderstanding the whole point of Giffen goods?

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