Giffen and Veblen Goods Explained: The Two Exceptions to the Law of Demand

Giffen goods and Veblen goods are the two cases usually cited as exceptions to the law of demand. A Giffen good is a strongly inferior staple that takes a large share of a poor household's budget, so the income effect of a price rise outweighs the substitution effect. A Veblen good is a status item whose high price is part of its appeal.

The law of demand and its two forces

The law of demand says that, holding everything else constant, a higher price means a lower quantity demanded. Two forces sit behind it when a price rises.

• The substitution effect. The good is now dearer relative to other goods, so buyers switch away from it. This effect always works against the good whose price rose.
• The income effect. The same money income now buys less, so the buyer is poorer in real terms. Being poorer means buying less of a normal good and more of an inferior good.

For a normal good both effects cut quantity. For an inferior good they pull in opposite directions, and the substitution effect almost always wins. The income effect vs substitution effect guide works through both cases. A Giffen good is the one case where the income effect wins.

What is a Giffen good

A Giffen good is a good whose quantity demanded rises when its own price rises, because a strong income effect overwhelms the substitution effect. It is named after the Scottish economist Robert Giffen, to whom Alfred Marshall credited the idea. Three conditions have to hold together:

1. Strongly inferior. When the household gets poorer, it buys a lot more of the good.

2. Large budget share. A rise in the good's price is a big cut in real income.

3. No cheaper substitute. The household cannot switch down to anything cheaper.

Giffen good worked example

All numbers here are hypothetical. A household spends $50 a week on two foods:

• Potatoes at $1.00 per kg: 30 kg, costing 30 x 1.00 = $30
• Meat at $5.00 per kg: 4 kg, costing 4 x 5.00 = $20

Total spending is 30 + 20 = $50, and potatoes take 30 / 50 = 60% of it. Now potatoes rise to $1.40 per kg, a rise of (1.40 - 1.00) / 1.00 = 40%. The budget stays at $50.

Step 1: Measure the real income loss. The old 30 kg would now cost 30 x 1.40 = $42, which is $12 more than before. The price rise works like a $12 cut in income: the household would need $62 to buy its old basket, so its $50 now buys 50 / 62 = about 81% of it, a loss of about 19% of purchasing power. The $12 shortfall equals 24% of its current budget.

Step 2: Find the substitution effect. Imagine handing the household $12 so it could still afford its old basket, making its budget $62. Potatoes are now dearer relative to meat, so it swaps a little toward meat. Suppose it cuts potatoes by 2 kg, to 28 kg. Those cost 28 x 1.40 = $39.20, leaving 62 - 39.20 = $22.80 for meat, which buys 22.80 / 5.00 = 4.56 kg. The substitution effect is -2 kg.

Step 3: Find the income effect. Now take the $12 back. Suppose that for every $1 of real income lost, this household buys 0.5 kg more potatoes, dropping meat to fill up on cheap calories. The income effect is 0.5 x 12 = +6 kg, taking potatoes from 28 to 34 kg. Those cost 34 x 1.40 = $47.60, leaving 50 - 47.60 = $2.40 for meat, which buys 0.48 kg.

Step 4: Add the two effects. Total effect = -2 + 6 = +4 kg. Potatoes went from 30 kg to 34 kg after a 40% price rise.

With the midpoint method, the percentage change in quantity is (34 - 30) / 32 = 12.5% and the percentage change in price is (1.40 - 1.00) / 1.20 = 33.3%, so price elasticity is 12.5 / 33.3 = +0.375. An ordinary good has a negative sign. You can rerun the numbers in the price elasticity of demand calculator.

Why the budget share matters

Now take a household that buys only 5 kg of potatoes, 10% of its $50 budget, with the same 0.5 kg per $1 inferiority and the same -2 kg substitution effect.

• Real income loss: 5 x 0.40 = $2
• Income effect: 0.5 x 2 = +1 kg
• Total effect: -2 + 1 = -1 kg, from 5 kg down to 4 kg

The price rise barely dents real income, so the substitution effect wins and demand slopes down. That is an ordinary inferior good, the far more common case covered in the normal vs inferior goods guide. The Giffen good vs inferior good comparison lists the differences.

Giffen good on a demand graph

Put the price of potatoes on the vertical axis and kilograms per week on the horizontal axis. Plot 30 kg at $1.00 and 34 kg at $1.40. The line joining them slopes upward. Nothing shifted: tastes and money income stayed the same, so the extra potatoes are a movement along one demand curve.

The upward stretch is limited. At $1.70 per kg, the whole $50 budget buys only 50 / 1.70 = about 29.4 kg, fewer than the 34 kg bought at $1.40. Somewhere between $1.40 and $1.70, quantity demanded has to turn back down. A Giffen demand curve slopes upward only over a narrow range of prices.

What is a Veblen good

A Veblen good is a luxury whose demand rises as its price rises, because the high price signals status. Many economists read the Veblen case as a demand shift, not a movement along one curve (see below). The idea comes from the economist Thorstein Veblen, who coined the phrase "conspicuous consumption" for spending meant to display wealth.

The mechanism has nothing to do with budgets. Buyers are usually well off and the item is a small share of their spending, so the income effect is tiny. What changes is the product in the buyer's eyes. A watch that costs more says more about its owner.

Veblen good worked example

Hypothetical numbers again. A watchmaker sells 400 watches a month at $1,500, for revenue of 400 x 1,500 = $600,000. It raises the price to $2,000, and sales rise to 460 a month, for revenue of 460 x 2,000 = $920,000.

• Percentage change in quantity (midpoint) = 60 / 430 = 13.95%
• Percentage change in price (midpoint) = 500 / 1,750 = 28.57%
• Measured arc elasticity across the two observed points = 13.95 / 28.57 = +0.49

Price and sales rose together. If the higher price shifted demand, this number links two different demand curves and is not a true price elasticity of demand. At $4,000, sales fall to 200, and revenue drops to 200 x 4,000 = $800,000. The status effect has a ceiling, and past it the usual downward slope returns.

Is a Veblen demand curve really upward sloping?

A common reading treats the Veblen case as a series of demand shifts. The law of demand holds tastes constant. When a higher price changes what the watch signals, tastes have changed, and the demand curve shifts right. Joining the points from several shifted curves traces a line that slopes up, so under the strict "other things equal" reading the law of demand survives. In the Giffen case tastes never change, and the upward slope is a movement along one curve.

Giffen vs Veblen vs normal vs inferior goods

The substitution effect of a price rise cuts quantity in all four columns. The Giffen good vs Veblen good comparison puts the two exceptions on one page.

Why Giffen and Veblen goods are rare

Giffen goods need three conditions at once. Most inferior goods take a small budget share, as the 5 kg household showed, and most households have something cheaper to switch to. Even when all three conditions hold, the upward slope covers a narrow price range, and better-off buyers still have downward-sloping demand, which pulls the market curve back down.

Veblen goods need a visible price. The signal works only if other people know roughly what the item cost. Ask whether the buyer would still pay more if nobody could ever learn the price. If yes, it is not a Veblen effect. Most luxuries are luxuries by income, with an income elasticity above 1, and their demand still slopes down, as the income elasticity of demand guide explains.

Some cases only look like exceptions. When demand increases, price and quantity both rise along the supply curve. That is a demand shift, not an upward-sloping demand curve, a distinction the law of demand guide covers.

Giffen and Veblen goods on the AP Micro exam

Giffen and Veblen goods go beyond the AP Microeconomics course. The course covers the law of demand, and the income and substitution effects behind it, in topic 2.1, Demand. See the AP Micro 2.1 topic page, the consumer choice module, and the supply and demand sandbox to practice shifts versus movements along a curve.

See it move

Make it move

Supply and demand at equilibrium, drawn by the interactive graph. Tap it to drag the curves, open the full version, or put it on your own site free, or turn it into a five-minute class activity.

Common mistakes:

• Calling every inferior good a Giffen good. An inferior good's demand curve still slopes down.
• Swapping the mechanisms. Giffen is about real income on a tight budget. Veblen is about status.
• Saying the substitution effect reverses. It was -2 kg in the example. The income effect is what changes.
• Reading a demand shift as an upward-sloping demand curve. Check whether something other than the good's own price changed.