Question

Based on substitution and income effects, distinguish individual demand curves for inferior and Giffen goods due to price reduction a good.

Answer 1

Inferior good's demand decreases with increase in income of the consumer. In case of inferior good the income effect works in opposite direction to the substitution effect. In case of reduction of price of inferior good the negative income effect will lessen the quantity purchased while the substitution effect will increase the quantity purchased.This means that with fall in the price of a good the substitution effect ie the consumer will buy more of the good whose price has fallen,will be more than the negative income effect.A fall in the price of good X will increase quantity purchased of good X but the income effect is negative.Thus in the case of inferior good having weak income effect the demand curve will be downward sloping.

But there are certain inferior goods the negative income effect of which are more than the substitution effect ie quantity purchased will change directly with price.Such goods are called giffen goods . So giffen goods are inferior goods and consumer purchases ,less of the good when price falls and more when price rises. A fall in the price of giffen good increases the purchasing power of the poor people that they will reduce the consumption of the good.So large income effect will be more than the substitution effect.Since the negative income effect is more than the substitution effect the net effect is the fall in the quantity purchased as a result of the fall in the price.So the demand curve of the giffen good will slope upward.