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Unit-4: Ordinal Utility Theory: Indifference Curve Approach

has positive correlation. In other words, the theory of demand is not applied on Giffen’s Notes
products.
The theory of demand is not applied when negative
income effect is dominating on net effect. The difference The substitution effect for Giffen’s product tells
between income effect and substitution effect in terms that cheap product can be bought in more quantity,
of Giffen’s product can be described as follows– but in this situation it is so negative that it fails the
substitution effect. So, a product can be bought in
Figure 4.28 represents the income effect and less amount even if its price is low.
substitution effect of Giffen’s product.

Fig. 4.28

Y Price Effect = KL
Substitution Effect = LR
A Income Effect = – RK
Q 3
T
Commodity Y Q 1 Q IC 2

2
IC
1
O X
KL RB T C
Commodity X

In Fig. 4.28, AB is initial budget line and IC is initial indifference curve. The equilibrium point for
1
consumer is Q where he demands OL units of Giffen’s product X. The budget line goes right to AC if
1
the price falls for product and the new equilibrium point for consumer is Q . We know that there is net
3
effect of movement from Q to Q . We can get substitution effect by drawing a line TT with parallel line
3
1
AC and which touches point Q of indifference curve IC and it is equal to LR. If price falls for product
1
2
X, it is cheaper than product Y, so the consumption quantity of product X will always increase by LR.
By this figure it represents that income effect is negative and it is equal to (–RK).
It is clear that (–RK) > (RL). The difference is –KL.
Net Effect or Income Effect = –KL
Substitution Effect = LR
Income Effect = (–) RK

The Difference Between Inferior Product and Giffen’s Product
1. Giffen’s Product– Giffen products are those inferior products on which consumer spends more parts of his income.
For it
(i) Income Effect is always negative. So if the real income of consumer rises then he demands less for the Giffen’s
products.
(ii) Negative income effect is more powerful than substitution effect. So the net effect or price effect is always
positive. It means if the price of product X rises then it is more demandable.
(iii) The theory of demand is not applied on Giffen’s products.

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