Question

Select all that applies:

	a.	Ordinary goods could be normal or inferior.
	b.	Giffen goods could be ordinary or normal.
	c.	Normal goods must be ordinary.
	d.	Inferior goods must be Giffen.
	e.	If income and substitution effects work in the opposite direction, then the good must be ordinary.
	f.	If income and substitution effects work in the opposite direction, and the substitution effect is stronger, then the good must be Giffen.

Answer 1

a) Ordinary goods could be normal or inferior. This is true. Ordinary good is a good which creates an increased demand due to a fall in price or creates a decreased demand due to rise in price. Since substitution effect is always negative, an ordinary good good could be normal good since both substitution and income effect are negative and the total price effect is also negative. Similarly, it could be an inferior good if the greater substitution effect is combined with smaller positive income effect and the total price effect is negative.

b) Giffen goods could be ordinary or normal. This does not apply or this is not true. Giffen goods are those goods which show positive relationship between price and quantity demanded which means that as price increases the demand for these goods will also increase. The income effect in this case exceeds the negative substitution effect. Ordinary goods on the other hand or normal goods have inverse relationship between price and quantity demanded.

c) Normal goods must be ordinary. This statement is true. In the case of normal goods. both the substitution and the income effects are negative which yield a negative price effect which show inverse relationship between price and quantity demanded.

d) Inferior goods must be giffen. This is not true. All giffen goods are necessarily inferior because inorder to be giffen good price effect must be positive but price effect will be positive only when income effect is positive and it is greater than negative substitution effect. However, positive income effect implies that when price of a good decreases and real income increases the quantity demanded will reduce which implies that commodity is inferior. Therefore, all giffen goods are inferior but all inferior goods are nor giffen.

e) This is not true. If substitution and income effect work in opposite directions, then the good can be either an inferior good or a giffen good depending on the magnitude of the both effects. If negative substitution effect outweighs positive income effect, then it is an inferior good and if positive income effect outweighs the negative substitution effect, then it is a giffen good.

f) This is not true. If substitution and income effect work in opposite directions and substitution effect is stronger, then the good is an inferior good and not a giffen good.