Demand Defying: When More Means More

The law of demand is a fundamental principle in economics, stating that the quantity of a good or service demanded is inversely proportional to its price. In other words, as the price of a product rises, the quantity demanded falls, and vice versa. This is based on the concept of diminishing marginal utility, where consumers first satisfy their most urgent needs with a product, then use it for lower-valued ends. The law of demand is used to determine demand elasticity, which measures the influence of price changes on the quantity demanded.

However, there are exceptions to the law of demand, such as Giffen goods and Veblen goods, which exhibit a positive relationship between price and demand. Giffen goods are inferior goods that constitute a large portion of a consumer's income, while Veblen goods are luxury items that signal economic and social status.

Giffen goods: Demand increases as price increases

Giffen goods are a rare exception to the law of demand, which states that the quantity purchased varies inversely with price. Giffen goods are low-income, non-luxury products that exhibit an upward-sloping demand curve, meaning that demand increases as the price increases. This is contrary to the fundamental laws of demand, which create a downward-sloping demand curve.

The concept of Giffen goods was first proposed by Scottish economist Sir Robert Giffen in the late 1800s and was later popularised by Alfred Marshall in his 1890 book, "Principles of Economics". Giffen goods are typically essential items with few close substitutes, and demand is heavily influenced by income pressures. As the price of a Giffen good increases, consumers may be unable to afford superior substitute goods, and therefore, they consume more of the Giffen good. This results in an increase in demand as the price rises.

To be classified as a Giffen good, the product must meet three necessary conditions:

• The good must be an inferior good.
• There must be a lack of close substitute goods.
• The good must constitute a substantial percentage of the buyer's income, but not so much that none of the associated normal goods are consumed.

Examples of Giffen goods include staple foods such as bread, rice, and wheat. These goods are typically essentials, and consumers may be forced to buy more of them as the price increases due to a lack of affordable substitutes. Giffen goods can also be found in other contexts, such as the stock market, where widespread interest tends to increase during periods of rising stock prices.

In summary, Giffen goods are a unique phenomenon in economics, where demand increases as price increases. This unusual behaviour is a result of the interaction between the income effect and the substitution effect, and it highlights the complex nature of consumer behaviour in certain market conditions.

Veblen goods: Luxury goods that gain value and demand as prices rise

Veblen goods are a type of luxury good that gains value and demand as prices rise, seemingly contradicting the law of demand. Named after American economist Thorstein Veblen, who first identified "conspicuous consumption" as a mode of status-seeking, Veblen goods are often sought by affluent consumers who value their utility as status symbols.

The demand for Veblen goods increases with price due to their exclusivity and appeal. If the price of a coveted luxury item rises, it may become more attractive to those for whom status is important, as it is now even further out of reach for the average consumer. Conversely, if the price of such an item is lowered, its reduced exclusivity may result in a decline in demand, as it could be shunned by status-conscious consumers and remain too expensive for the mass market.

Examples of Veblen goods include designer clothing, luxury cars, yachts, expensive jewellery, and high-end watches. These goods are typically well-made, exclusive, and have a very strong brand identity synonymous with luxury. They are generally targeted at affluent individuals and are far more likely to be sold in upscale boutiques than in common department stores.

The existence of Veblen goods can be explained by several concepts:

• Pecuniary emulation or pecuniary success, which leads to invidious comparison or invidious distinction.
• Relative consumption trap.
• The inverse relationship between one's well-being and another's income.
• The suppression of explicit attempts to emphasise social status differences.

The theory of Veblen goods has had a significant impact on marketing and advertising, with multiple studies considering Veblen goods as a tool to develop and maintain strong relationships with consumers. However, concerns have been raised about the wastefulness of Veblen goods, as well as their potential negative social and financial consequences, such as the conspicuous demonstration of unequal wealth distribution and possible changes to optimal tax formulas.

Basic necessities: Demand remains constant despite price changes

Basic necessities are goods that people need regardless of the price. Demand for these goods remains constant even if the price increases. This is because these goods are essential and people cannot do without them. Therefore, demand for basic necessities is relatively inelastic.

The law of demand states that there is an inverse relationship between the price of a good and the quantity demanded. In other words, as the price of a good increases, the quantity demanded will decrease, and vice versa. This law is based on the concept of diminishing marginal utility, which means that consumers will first satisfy their most urgent needs with the first unit of an economic good they purchase. Each additional unit of the good is then used for a less valued need.

However, basic necessities are an exception to the law of demand. The demand for these goods remains constant despite price changes because they are essential and people need them regardless of the cost. Examples of basic necessities include food, shelter, and medicine.

The demand for basic necessities is relatively inelastic, which means that it is less responsive to changes in price. This is because people rely on these goods for their everyday needs and cannot easily do without them. As a result, even if the price of basic necessities increases, the demand for them will remain relatively stable.

The inelastic demand for basic necessities can have important implications for businesses and policymakers. For businesses, it means that they can set higher prices for these goods without significantly affecting demand. For policymakers, it means that changes in the price of basic necessities can have a significant impact on consumers, as these goods are essential and people will continue to purchase them regardless of the cost.

Income effect: Demand changes as a result of purchasing power changes

The income effect is a change in the demand for a good or service due to a change in a consumer's purchasing power, which is, in turn, due to a change in their real income. It is part of consumer choice theory, which relates preferences to consumption expenditures and consumer demand curves. The income effect describes how an increase in income can change the quantity of goods that consumers will demand.

The income effect predicts that as one's income grows, people will begin to demand more goods (and vice-versa). This is reflected in microeconomics via an upward shift in the downward-sloping demand curve. This effect, however, can vary depending on the availability of substitutes and the good's elasticity of demand.

For so-called normal goods, as income rises, so does the demand for them. Normal goods are defined as having a positive income elasticity of demand coefficient, but less than one. This means that a decrease in the relative price of the good will result in an increase in quantity demanded because the good is now cheaper than substitute goods, and because the lower price means that consumers have a greater total purchasing power and can increase their overall consumption.

Inferior goods, on the other hand, may see their demand fall as income increases. An example of such an inferior good could be store-brand items: as people become wealthier, they may opt for more expensive name brands instead. Inferior goods are goods for which demand declines as consumers' real incomes rise, or rises as incomes fall. This occurs when a good has more costly substitutes that see an increase in demand as the economy improves. For inferior goods, the income elasticity of demand is negative, and the income and substitution effects work in opposite directions.

The income effect is important for everyday consumers because it relates to what and how much they can afford to buy. It also relates to the economy as a whole. When legislatures pass new laws that impact household income or taxes, they often look at how the income effect will play out and what this will do to the economy.

Substitution effect: Demand changes due to the relative price of substitute goods

The substitution effect is a key concept in microeconomics that helps explain the behaviour of the demand curve. It refers to the change in demand for a good resulting from a change in the relative price of the good compared to its substitute goods. In other words, when the price of a good increases, consumers may shift their consumption to relatively cheaper substitute goods, causing the demand for the original good to decrease.

For example, if the price of coffee decreases, some consumers who previously bought tea might switch to coffee because it is now a more affordable option. Similarly, an increase in the price of beef may lead to consumers eating more chicken. The substitution effect is strongest for products that are close substitutes.

The substitution effect can be contrasted with the income effect, which refers to the change in the quantity demanded of a good or service resulting from a change in the consumer's real income or purchasing power. When the price of a good falls, the consumer's real income increases, leading to an increase in demand. Conversely, when prices rise, real income decreases, resulting in reduced demand.

The income effect and substitution effect often work together to explain why the quantity demanded of a good changes when its price changes. For normal goods, both effects typically lead to an increase in quantity demanded when prices fall and a decrease when prices rise. However, for inferior goods, the income and substitution effects can work in opposite directions.

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