The Law of Demand: Its Function and Mechanism
In the vast and dynamic world of economics, not all goods and services adhere to the traditional law of demand - that demand decreases as price increases. Two exceptions to this rule are Giffen and Veblen goods, each associated with different socio-economic groups and behaviours.
Giffen goods, typically staple foods that form a significant part of consumer budgets, such as rice or bread in low-income households, are a specific case of inferior goods. The paradoxical nature of Giffen goods lies in the fact that their demand increases as the price rises. This anomaly occurs because the negative income effect outweighs the substitution effect. Essentially, when the price of a Giffen good increases, the consumer's overall purchasing power decreases, forcing them to buy more of the inferior good as they cannot afford better substitutes.
On the other hand, Veblen goods are luxury items for the affluent, such as designer bags or luxury jewelry. Contrary to the law of demand, the demand for these goods increases as their price rises. This phenomenon is driven by the perceived exclusivity and status associated with high-priced items. In other words, the higher the price, the more desirable these goods become as status symbols.
While both Giffen and Veblen goods violate the law of demand, it's important to note that the market equilibrium price is determined through the interaction between producers and consumers. This equilibrium price is considered the best price for both parties, taking into account factors such as consumer income, tastes and preferences, prices of related goods (complements or substitutes), and future price expectations.
In addition to these factors, the price also impacts producer profits, as they benefit from selling products at higher prices. For consumers, the price represents the costs they incur to satisfy their needs and wants, affecting their overall satisfaction.
In the realm of economists, the main determining factor in the description of demand for a good is price. However, it's crucial to remember that demand is influenced by a multitude of factors, and not all goods and services conform to the traditional law of demand as seen with Giffen and Veblen goods.
[1] Economics Online. (n.d.). Giffen Goods. Retrieved from https://www.economicsonline.co.uk/economics/giffen-goods.html [2] Investopedia. (2021, March 22). Veblen Good. Retrieved from https://www.investopedia.com/terms/v/veblen-good.asp [3] Khan Academy. (n.d.). Giffen Goods. Retrieved from https://www.khanacademy.org/economics-finance-domain/microeconomics/supply-demand/elasticity/a/giffen-goods [4] Investopedia. (2021, March 22). Inferior Good. Retrieved from https://www.investopedia.com/terms/i/inferiorgood.asp
- In the economy, luxury items such as designer bags or jewelry, popularly known as Veblen goods, challenge the traditional law of supply and demand as their demand increments with an increase in price due to their perceived exclusivity and status.
- Contrastingly, consumer staples like rice or bread in low-income households, termed Giffen goods, defy the conventional law of demand by observing an increase in demand when their price rises because of the negative income effect outweighing the substitution effect.
