The demand curve is a lie!

Well… only sometimes. 

Why does a demand curve look the way it does? That is to say, why is it downward sloping? The answer is quite simple – when the price of a good goes up, people buy less of it. This relationship is called the law of demand, and it would seem to apply to the vast majority of goods we are interested in.

There are, however, two exceptions to the law of demand:

Giffen goods

Imagine you’re a family of four and the budget is tight: you have $15. Currently you can only choose from two options for dinner: a steak ($12 each) and a serving of rice ($1 each). At these prices, you opt for a steak and three servings of rice and spend your entire budget. Delicious! 

Overnight, the price of rice triples to $3. You now have two options: one steak and one serving of rice, or five servings of rice.  Now, the choice isn’t so obvious. The steak is delicious, but can one steak and one serving of rice sustain a family of four? You decide to consume five servings of rice, even more than you consumed when it was $1. 

In this setting, rice is an example of a Giffen good: a non-luxury good whose demand increases when its price increases.  

Veblen goods

On the other end of the spectrum is an extremely luxurious good. Think of yachts, jewelry, works of art, and designer clothing. Oftentimes, consumption of these goods yields external value in the form of status and reputation. Yes, you get to ride on the yacht, but you also get to show off that you have a yacht. 

The highest of the high end of these luxuries can violate the law of demand. This occurs when an increase in price heightens the status of that good and so makes that good more desirable. The inverse is also illustrative: when a high-end item becomes cheaper in price, it loses some of its prestige and so people may buy less of it, not more! These goods are called Veblen goods. 

What about you?

Are there any goods you consume that fit into the patterns described above? Can you think of other goods that violate the law of demand that do not fit into the Giffen and Veblen good definitions?