Have you been watching with envious eyes as some well-heeled co-worker or neighbor stocks up on luxury goods while you make do with whatever is on special at Target? The Wall Street Journal has an article this morning suggesting that the long luxury binge may finally be moderating: Luxury manufacturers are no longer able to charge whatever the hell they want for their scarce goods.
But that is not the point of this blog post. The point of this blog post is to quibble with this little paragraph from the article:
An economic theory holds that for certain goods, higher prices increase desirability and drive sales, rather than suppress demand as they would for ordinary products. Economists refer to such luxury products as Giffen goods, named for Scottish economist Robert Giffen, who described the phenomenon.
This description is incorrect, at least as I learned it back at the University of Chicago’s graduate school of business, lo these 14 years ago. Though luxury products are what undergraduates usually think of when they learn about Giffen goods, what the writer is describing is actually a Veblen good: a superior good purchased for the purpose of conspicuous consumption. (Since this blog post was written, the Wall Street Journal has changed the story online.)
Birkin bags and Jimmy Choos brand you as the sort of person who has the money and the taste to acquire Birkin bags and Jimmy Choos, and in theory, at least, price increases can actually increase the demand for them, because people who have them are now displaying even more money and taste than they did before the price increase. Normal demand curves slope downward -- which is to say that as the price for an item increases, people generally want to buy it less. But the demand curve for a Veblen good slopes upward.
Giffen goods are also a good for which the demand curve slopes upward. But they’re actually much more interesting than Birkin bags. Here’s one of the rare sightings of a Giffen good in the wild, described by my former employer:
These “Giffen goods” show up in every introductory economics textbook as a freak case when the law of demand fails. Legend describes the Irish potato famine as a possible example: as the price of potatoes rose, people were so poor that they started substituting potatoes, a dietary staple, for meat and other unnecessary luxuries. The Irish consumed more potatoes as a result.
The trouble with this example is that Ireland was having a famine. The rising potato price was almost certainly caused by a supply shortage, making it highly unlikely that people were able to consume more of them. That has not stopped generations of textbook writers from using this particular example. Now, they can finally switch to a case with a bit more proof behind it.
Jensen and Miller look at poor Chinese consumers and demonstrate that they consume more rice or noodles, their staples, as prices go up. The idea is the same as with the proverbial poor Irish. People need a certain amount of calories to survive -- let’s say 1600 per day. You can either get that by consuming rice and perhaps some vegetables alone, or by eating rice, vegetables and a few bites of meat.
But meat is expensive. As the price of rice goes up, these poor Chinese can no longer afford the luxury of cooking meat, yet they still need to get to their 1600 calories. So they eat rice instead, which is still relatively cheap compared to meat. Voila!: Giffen behaviour in action.
The reason Giffen goods are interesting is not status competitions, which people have complained about from time immemorial. The reason Giffen goods are interesting is that you can raise the price of an inferior good -- something that people would rather consume less of as their income rises -- and see people consume more of it. The reason it’s so fascinating is that it’s wildly counterintuitive. Which is also probably why we see so few actual cases of Giffen goods and upward-sloping demand curves appear in the literature.
Incidentally, as far as I can tell, the Wall Street Journal article isn’t even describing an upward-sloping demand curve; the products described in the article seem to be behaving basically normally in response to various changes in demand. But if I’d told you that at the beginning of the post, I wouldn’t have gotten to tell you how fascinating Giffen goods are.
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Megan McArdle at email@example.com.
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