Giffen goods are those commodities, the demand of which falls as the price of such goods falls. The demand for these goods has a positive slope, which means more is demanded, when the price is higher and less is demanded when the price is lower. Derivation of demand curve for a Giffen commodity is explained below.
In Fig. 5.34, commodity ‘X’ is assumed to be Giffen commodity. In this figure, the consumer is at equilibrium at point E1, where the initial budget line AB, is tangent to the indifference curve IC1. At this equilibrium, the consumer purchases OX, quantity of the commodity ‘X’ at price OA/OB1.
When the price of commodity ‘X’ falls, the new budget line AB2 is to the right of original budget line AB1. The new equilibrium point is E1 Since commodity ‘X’ is a Giffen commodity, the demand for this commodity falls to OX2 and the new equilibrium point E2 is to the left of the original equilibrium E1.
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The price of commodity ‘X’ in this situation is OA/OB2. When the price of commodity ‘X’ falls further, the new budget line AB3 becomes tangent to the indifference curve IC3 at point E3. At this equilibrium point, the demand of the consumer for commodity ‘X’ falls to OX3. The price consumption curve (PCC) for the Giffen commodity ‘X’ is obtained by joining the successive equilibrium points E1, E2 and E3. This PCC is found to be backward bending.
With the above information from PCC, demand curve for the Giffen commodity can be drawn in the lower panel of the diagram. It may be seen that the demand curve of a Giffen commodity has a positive slope, which indicates that the quantity demanded falls (from OX1 to OX2 to OX3), as the price decreases (from OA/OB1 to OA/OB2 to OA/OB3).
In other words, the quantity demanded varies directly with the changes in price. This case is an exception to the general law of demand.