IAI Actuarial Core Principles · Business Economics · Consumer demand and behaviour
Which condition is required for a Giffen good to exist?
A Giffen good must be inferior, and its income effect must be large enough to outweigh the substitution effect. Then a price rise cuts real income so much that consumers buy more of the good, giving an upward-sloping demand curve.
- AThe good is normal and has a strong substitution effect
- BThe good is inferior and its negative income effect outweighs the substitution effectCorrect
- CThe good is a luxury with an income elasticity above one
- DThe good is inferior and its substitution effect outweighs the income effect
- The good has a perfectly inelastic demand curve
Explanation
A Giffen good must be inferior, so that a price rise lowering real income raises consumption. Only when this income effect is larger than the substitution effect does quantity demanded rise with price. Inferiority alone is not sufficient.
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