Giffen goods are those commodities whose demand goes up with the rise in price. If the price goes down the demand for the commodity also decreases. This is opposite to what the law of demand states.
Normally the rise in price of a commodity results in decrease in the demand. The first instance was found by Sir Robert Giffen in the consumer buying habits of labor class in Victorian era England. The story is about the laborers buying more bread when the price increased, and less bread when the price of bread decreased. This was unusual. On closer inspection Sir Robert Giffen found out that laborers were buying meat when the price of bread went down. However when the price of bread went up they did not have enough money to buy meat, and bought more bread instead.
Sir Robert Giffen made an observation that rise in price of bread consumed almost all of money of the laborers. So they were forced to forgo the expensive meat and bought more bread instead. Here bread was the primary food for the laborers and they could not do without it.
This is unique situation listed as exception to the law of demand. There are very few examples can be found in the modern world. There are certain pre-requisites for the paradox to occur. They are:
- The commodity must be categorized as Inferior – The price elasticity of inferior goods is less than zero. If the income level of the consumer increases he is likely to stop using the “inferior good”, and go for better options. If the income level remains the same the demand of such goods is quite stable.
- Lack of substitutes – For the Giffen paradox to occur the commodity in question should be unique with no close substitutes.
- Constitute a large chunk of income – The expense on the commodity should be a considerately large percentage of the income.