Question

What must be true about the relative magnitudes of substitution and income ratios in order to have a normal good? an inferior good? a Giffen good?

Answer 1

Normal good- In case of normal good price change and quantity demanded are inversely related, it means when price falls of a normal good its quantity demanded increases accordingly and when price increases the quantity demanded for a normal good decreases, so for normal good income effect is positive and substitution effect is negative and both works in same direction to increase the quantity demanded of a normal good when its price falls and decrease in quantity demanded when its price increases.

Bur substitution effect is more powerful than income effect in case of normal goods since consumer spends a very little amount of his income on single commodity.

Inferior good- Inferior goods are the goods for which income effect is negative, it means when price of a good falls its quantity demanded decreases and due to substitution effect its quantity demanded increases since due to substitution effect consumer will buy more of cheaper good whose price has fallen but in this case substitution effect is more powerful than income effect and it outweighs the income effect and resultantly it increases the quantity demanded of a inferior good when its price falls and that's why the consumer faces downward sloping demand curve. So in case of inferior good quantity purchased and its price will have inverse relationship.

Giffen good- Giffen good is the inferior good on which consumer spends large portion of his/her income and due to fall or rise in its price of a Giffen good its demand/quantity purchased follows the same direction, it means when price of any Giffen good falls then its quantity demanded decreases accordingly since due to decrease in the price of Giffen good on which consumer is spending large portion of his income increases consumption of other goods, i.e. meat and when price of Giffen good rises consumer increases its quantity demanded since this good is still cheaper than other costlier good, i.e. meat and in that case income effect is larger than substitution effect and income effect outweighs the substitution effect.