Question

What is the difference between normal goods and inferior goods? A giffen good is one that has an upward sloping demand curve -- as price increases so does quantity demanded. Is a Giffen good always a inferior good? Why or why not? Can you give an example?

Answer 1

Normal goods are those goods for which demand increases with the increase in income. Whereas for inferior goods demand decreases with increase in income. The income effect for normal good is always positive and the income effect for inferior good is always negative.

Giffen goods are goods whose demand falls as price of the good falls and increases as the price of the good increases. that is to say that the law of demand which establishes an inverse relationship between the price and quantity demanded does not hold for giffen goods. When the price of a good changes, effect on its quantity demanded would be a cumulative result of income effect and substitution effect.

For an inferior good both the income effect and substitution effect are negative but negative substitution effect outweighs negative income effect. Therefore the price effect is negative. However, if the income effect is more stronger than the substitution effect, then then the price effect will be positive which is the case of a giffen good. This means that a giffen good must be an inferior good but all inferior goods are not giffen.   

For example. imagine an inferior good being a low nutrition diet. As the income increases people consume less of this type of diet because they may interested to consume more of high nutrition diet. If we consider the substitution effect of this type of good, the substitution effect is always negative. So if the price of low diet food goes up, the substitution effect will dictate that the people will buy more of high nutrition food because that good has become relatively cheaper. However if the income effect is stronger than the substitution effect then the demand of the low nutrition good will increase. then this goods is treated as giffen good although it is inferior in nature.