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Microeconomic Theory

Notes negative income effect. So the demand increases if the price falls and the demand theory occurs on
inferior goods too. In other words,
Price Effect = OS – OQ = QS
Substitution Effect = QT
Income Effect = (–ST)
So QS (Price Effect) = QT (Subs Effect) + (–ST) Income Effect = QT – ST

Self Assessment

State whether the following statements are True/False:
8. Every consumer wants to get maximum satisfaction with his limited income.
9. The slope of indifference curve generally occurs downward from right to left.
10. The recognition of indifference curve analysis is dropping of marginal rate.
11. The sloping of downward of indifference curve happens due to dropping of marginal rate.
12. Substitution Effect is always positive.

4.22 Giffen’s Paradox

In the early 19th century in Britain, Sir Francis Giffen discovered an exception by studying the
behaviour of labour in pricing of wheat and quantity of bread, which is called Giffen’s Paradox. This
paradox explains that the inferior food which is a main food item for poor and on which they spend a
big part of his income (like Bread in 19th century Britain and currently corn in Rajasthan), on which
(i) the Income Effect of Price Effect is positive, (ii) the positive Income Effect is more powerful than
Substitution Effect and hence the theory of demand is
not applied on it. These products are called Giffen’s Giffen Paradox gives the idea where the theory of
product. In other words, Giffen products are those demand applies. The sloping of Giffen Products is
products which get less demand if price falls and from downward to upward. This represents that if
get more demand if price rises. Thus Giffen products the price falls, the demand of product is also low
are those inferior products where the theory of and there is low demand of product if price gets its
maximum level.
demand is not applied means the demand is less if
price is less and vice versa.

4.23 Income and Substitution Effects in Case of Giffen Goods

The substitution effect is always positive for all products like general or inferior as per Giffen. The
meaning of positive substitution effect is if the product X gets cheaper then product X will be bought
more than product Y means there is substitution for product X by product Y.
Income effect is positive for inferior goods. The positive Income Effect means the real income of
consumer increases if the price falls for product, so he demands less for that product.
However, the rise of real income of consumer helps to try more to the substitution product of good quality.
Since the income effect is negative for inferior product but it is not important that it is more powerful than
substitution product, so the Net Effect or Price Effect is affected more by substitution effect. In this case,
the theory of demand is applied if there is negative income effect. But in terms of Giffen’s products–
(a) Income Effect is negative and
(b) The negative income effect is more powerful than substitution effect. So Net Effect or Price
Effect is affected by negative income effect. This means that the price of product and demand

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