Exceptions to the Law of Demand?
Recall that the law of demand states that there is an inverse relationship between the price of a good
and the quantity of the good demanded, CetPar. However, in the situations described below, this law
does not always hold
Veblen Goods
Veblen goods are goods whose demand curve is upward sloping due to
ostentation (defined as a pretentious display of wealth) or a belief that a
lower prestige good means lower quality. Note that the characteristics of
Veblen goods (ostentation and “quality illusion”) have more to do with the
characteristics of the buyer than of the goods themselves. Veblen goods are
named after Thorstein Veblen (right), who explained this phenomenon in
his book, The Theory of the Leisure Class in 1899. They are alternatively
known as ‘ostentatious goods’, or ‘conspicuous consumption’ goods. In such
a demand curve there is a positive (direct) relationship between price and
quantity demanded, as shown in the figure below.
Note that at the lower range of prices, below the
so-called “snob value status” line, the demand
curve for a Veblen good behaves as a demand
curve for a normal good (@ higher prices, less
quantities of the good are demanded). At some
point however, ostentation or “quality illusion”
sets is and quantity demanded increases with
respect to price increases.
In the case of Veblen goods, a consumer derives
more utility (satisfaction) from the desire to
impress other people than from the consumption
of the good itself. As price increases, the good
becomes more attractive because the consumer
associates possession of the good with increased social status. Therefore quantity demanded increases
as price increases, while quantity demanded falls as price falls. Examples of Veblen goods may include
diamonds, mink coats and luxury cars.
Consumers displaying this kind of behavior are more likely to be higher income individuals purchasing
items in the luxury goods market. The upward sloping demand curve is likely to be an individual demand
curve (recall that earlier I stated that these goods really have more to do with the nature of the
consumer rather than the nature of the good), or a demand for a group of high income consumers. It is
far less likely to be a market demand curve that includes all consumers, as the market demand curve is
the sum of all individual demands, and therefore also includes the demand of lower income individuals
whose behavior is consistent the law of demand. In fact, the existence of an upward-sloping market
demand curve has never been established by economists for any type of good.
Giffen Goods
Recall that demand shows the relationship between the price of a good and the quantity of the good
demanded, CetPar. As we know, any price change produces a change in the quantity demanded, shown
as a movement along a demand curve. We also know that the total effect of a price change on quantity
demanded can be broken down into two separate effects: the substitution effect and the income effect,
with the total effect of a price change being the sum of the two effects.

The substitution effect. Say there is a price decreases; the consumer substitutes more of the
now less expensive good for other similar products that have become relatively more expensive.
The result is that the quantity of the good demanded increases. There is always an inverse
relationship between price and quantity demanded as a result of the substitution effect: as price
increases, quantity demanded falls; as price decreases, quantity demanded increases.

The income effect. Consider again a price decrease; a fall in the price of a good means that the
consumer’s real income (or purchasing power) has increased! Consider the following simple
example. Say you have $12 and you want to buy some pencils. When the price is $4 per pack,
you can buy 3 packs. Suppose that the price of pencil packs falls to $3 per pack. You can now
buy 4 packs. The sum of money at your disposal ($12) has not changed, and yet the ‘purchasing
power’ of $12, or what your money can buy, has increased as a result of the fall in the price of
pencil packs. “Real income’ is the same as ‘purchasing power’: it increases as prices fall, and it
decreases as prices rise. There will be two possible impacts on how much of the good will be
demanded, depending on whether it is a normal good or an inferior good:
o
If the good is a normal good, as real income increases, quantity demanded of the good
increases. In this case, the income effect gives rise to an inverse relationship between
price and quantity demanded; as price falls, quantity demanded increases,
o
If the good is an inferior good, as real income increases, quantity demanded of the good
falls. The income effect now gives rise to a direct relationship between price and
quantity demanded; as price falls, quantity demanded falls.
When a good is a normal good, the income effect and the substitution effect reinforce one another:
both lead to an inverse relationship between price and quantity demanded, and this results in the
standard, downward-sloping demand curve, indicating that the law of demand holds.
If on the other hand a good is inferior, there are two possibilities:

If the income effect is smaller than the substitution effect, there results a downward-sloping
demand curve so that the law of demand holds; the good is inferior, but not Giffen.

If the income effect is greater than the substitution effect, there results an upward-sloping
demand curve; the law of demand does NOT hold and the good is a Giffen good.
A Giffen good is a kind of inferior good whose demand curve is upward-sloping because the income
effect of a price change is greater than the substitution effect. Giffen goods are named after Sir Robert
Giffen, a Scottish economist, who was given credit for the idea by the great English economist, Alfred
Marshall.
These relationships will become
clearer if you carefully study the
figure at the right. (Note that
upward-pointing arrows signify an
increase, and downward-pointing
arrows signify a decrease.) We
know that a normal demand curve
– that is a demand curve for either
a normal good or an inferior good
- slopes downward to the right. A
Giffen good’s demand curve would
slope UPWARD to the right, just
like a supply curve!
Price ↓
Substitution
Quantity
Effect
demanded ↑
Income
Effect
Income
Effect- Normal
Good
Real
income
For an inferior good,
↑
Income
Effect- Inferior
Good
Giffen goods are very rare; in fact
some economists claim they may
if income effect ˂ substitution effect, the
not even exist at all. They were
good is NOT Giffen,
named after Sir Robert Giffen, a
Quantity
19th century economist who
if income effect ˃ substitution effect, the
observed increased consumption
good IS Giffen.
demanded
of bread by lower income people
as the price of bread increased (he
was examining data from the Paris during the French Revolution). Giffen’s explanation was that as the
price of bread increased, poor people’s real income fell. As bread consumption made up a large
percentage of household expenditures, an increase in the price of bread could make a perceptible
difference in household’s real incomes. Bread was an inferior good (meat was preferable), therefore a
fall in real income led to an increase in the demand for bread. The income effect was larger than the
substitution effect, and thus the overall effect of the increase in the price of bread was to increase bread
consumption.
↓
The Role of Expectations
If the price of a good falls, and the consumer expects it to fall further, she or he may postpone purchases
(especially if the purchases would represent a large-“ish” percentage of that person’s income, like an
automobile or a house, for example) for the future when the price will be lower, and therefore quantity
demanded can fall; this results in a positive relationship between price and quantity demanded. If the
price of a good increases and the consumer expects it to increase further, she or he may increase the
quantity demanded in the present to take advantage of the current lower price. Once again there may
be a resultant positive relationship between price and quantity demanded.
Questions:
1. What are Veblen goods and how might they violate the law of demand?
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2. (a) Explain the substitution effect of a price change; what does it tell us about the relationship
between the price of a good and quantity demanded?
(b) Explain the income effect of a price change; what does it tell us about the price of a good and
the quantity demanded in the case of (i) normal goods, and (ii) inferior goods?
(c) How can we use the concepts to explain the possibility of an upward-sloping demand curve
in the case of Giffen goods?
(d) When does an inferior good NOT violate the law of demand?
(e) Do you think that most inferior goods are Giffen or nor Giffen goods? Explain.
(a)______________________________________________________________________________
(b)______________________________________________________________________________
(c)______________________________________________________________________________
(d)______________________________________________________________________________
(e)______________________________________________________________________________
3. How can expectations lead to an upward-sloping demand curve?
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