Page 77 - DECO401_MICROECONOMIC_THEORY_ENGLISH

Microeconomic Theory

Notes
2. Inferior Goods – The inferior goods apart from Giffen’s goods are those on which
(i) Income Effect is negative.
(ii) The negative income effect is less powerful than substitution effect, so the price effect is negative.
(iii) The demand of theory applies on it.
The superior negative income effect reflects the demand of product X due to it price falls from OL to OK. This is
the meaning of Giffen’s Paradox. In summary, the price falls of Giffen product creates the substitution effect
and it boosts the consumption of product but the income effect not only works on opposite direction but also
more powerful than substitution effect. Due to this the price effect creates the less demand of product. In this
situation the demand curve would be positive.

4.24 Possible Combinations of Income and Substitution Effects

Below is the summary of possible combination of income and substitution effect:

Table 6: Income and Substitution Effect in Case of Normal, Inferior and Giffen Goods
Nature of Goods Income Substitution Effect Total Effect
Effect
1. Normal Goods Positive Negative Theory of Demand does not apply
2. Inferior goods which Negative Negative Theory of Demand is applied because
are not Giffen’s goods substitution effect is more powerful
than negative income effect.
3. Giffen’s goods Negative Negative Theory of Demand does not apply
because negative income effect is more
powerful than substitution effect.

4.25 The Slutsky’s Approach

Figure 4.29 represents the separation of income effect and substitution effect.

Fig. 4.29

Y Price Effect = OM OL = LM

A

S IC
1
IC
2
Q
Oranges T R

IC

O X
LN BM S C
Apples

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