Question

3. A Giffen good is a good whose demand rises as its price rises. Graphically show that it is possible for good 2 to be a Giffen good even with convex, monotone preferences. To get full credit on this problem you must do the following things: (a) (5 points) Correctly show the shift in the budget set when the price of good 2 rises b) (5 points) Correctly maximize utility with indifference curves both before and after the price change (c) (10 points) Clearly show that good 2 is a Giffen good

labelling all axes, slopes, intercepts, etc. thank you very much

Answer 1

a) A Giffen good is a good for which demand increases as the price increases, and falls when the price decreases. A Giffen good has an upward-sloping demand curve, which is contrary to the fundamental law of demand A Giffen good is typically an inferior product that does not have easily available substitutes, as a result of which the income effect dominates the substitution effect.

C)An example offered of a Giffen good is that of the Irish potato famine of 1845-49. During the famine, as the price of potatoes rose, impoverished consumers had little money left for more nutritious but expensive food items like meat (the income effect). So even though they would have preferred to buy more meat and fewer potatoes (the substitution effect), the lack of money led them to buy more potatoes and less meat.