The Interesting Lies Of Samuelson: How We Naively Believed The Case Of Giffen Goods – OpEd

By Ali Hashemifara

You have probably heard of the widely believed myth that Napoleon was very short. Evidence proved after his death, however, that he had a completely normal height. Historians, interestingly, have mentioned that this narrative could have spread so thoroughly due to British painters drawing him short almost in a sarcastic way. Myths such as this, however irrelevant, do not alter the truth. Some myths, however, are so powerful that they make truth appear like a myth. This is the case of “Giffen goods”—goods that are demanded more when their prices rise. Many believe that there can be some special, so-called Giffen goods that can exclusively have an upward-sloping demand curve. Historically, mathematically, and economically, this is impossible.

Turning to its historical inaccuracy, a Giffen good does not have a real-world example. Giffen goods first appeared in Alfred Marshall’s Principles in 1895, in which he mentions very briefly that, in the latter half of the nineteenth century, the consumption of wheat goods such as bread in Britain was not reduced while their prices were bid up. He suggests that because bread is an overwhelmingly inferior good and due to the hoarding behavior of the poor masses, they would buy more of it even as its price increased. Thus, an upward-sloping demand curve.

He goes on to attribute the discovery of such a phenomenon to Giffen and regards this type of good as the only exception to the Law of Demand. This is not, however, the source of the Giffen good’s eminence. It is only in 1964 that in his book Economics, Paul Samuelson again mentions the Giffen good after almost half a century, with reference to a completely different occurrence—the Great Famine in Ireland:

When the 1845 Irish famine greatly raised the price of potatoes, families who consumed a lot of potatoes merely because they were too poor to consume much meat might have ended up consuming more rather than less of the high-P[rice] potatoes.

He then goes on to say that this observation has been made by Francis Giffen who was an American economist. He does not cite the source of such a statement. It was only in a later edition of his book that he changed the name Francis to Sir Robert, with no comments or footnotes explaining the reason. Having earned a very good readership, the Giffen good found its way gradually to economic analyses and textbooks.

Historical Issues

Let us now critically assess this scenario. Sir Robert Giffen—to whom all references find their way—was a Scottish economist born in 1837 who spent his early years in Glasgow and his later years in London, working as an editorial assistant to Walter Bagehot at The Economist. The Great Famine of Ireland occurred from 1845-1849, due to a fungus blight that, in those years, reduced the potato crop to less than 50 percent and caused the price of potatoes to increase.

Accordingly, at the time the famine started, Giffen was only an eight-year-old child who, of course, could not understand the demand schedule or price elasticity. He did not even live in Ireland at the time famine began as he stayed in Glasgow until 1862. Marshall himself—born in 1842—was only a toddler by then. How could, therefore, a Scottish man living in London have told Marshall about his childhood observations of changes in demand behavior of the Irish masses while being in another country? Even ignoring these facts, if the Great Famine of Ireland really caused prices of potatoes and demand for potatoes to rise simultaneously, why did Giffen not report such an odd anomaly in his books and articles himself?

My argument might be attacked by saying that Marshall gave an example of wheat goods, not potatoes, that showed characteristics of an upward-sloping demand curve. But there is no conclusive evidence that the very incremental rise in the demand for wheat goods was at all due to their price increases in the 1850s.

Mathematical Issues

Turning now to its mathematical impossibility, the model of Giffen goods refutes its own main assumptions. In the 1845-1849 famine, the supply of potatoes must have been perfectly inelastic, meaning that if the price of potatoes rose, their quantity supplied could not change. This must be the case because the farmers could certainly not increase their crops even if it seemed profitable to do so, as the blight simply did not let them produce more.

The only case for the demand curve to be upward-sloping could therefore be if the demand curve were below the supply curve above the equilibrium. This means that, if the price of potatoes rises over the equilibrium—which was the case in 1845—there will be a shortage as supply will be less than demand. The price of potatoes therefore will rise again to deter the shortage and get the market back to equilibrium. As price rises, however, this shortage will only increase. Prices must rise again. Shortage occurs and this process continues until the price of potatoes reaches infinity, which is impossible in reality. Additionally, if we think about it differently and state that the reduction in supply of potatoes can be modeled through a shift of the supply curve to the left—with an upward-sloping demand curve—the price of potatoes can only fall! This is precisely the opposite of what happened in Ireland. Prices went up, not down, as quantity supplied diminished.

Economic Issues

Finally, turning to the economic flaws of the Giffen goods hypothesis, a distinction should be made between the notional and effective demand. The notional demand is essentially the willingness of one to buy a good or service he desires to have, regardless of whether he can actually buy it or not. The effective demand, on the other hand, refers to both willingness and ability of one to purchase what he desires. The supply-demand model compiled by Marshall himself is based on the effective demand statistics, not notional. If I like to buy a Porsche car but cannot pay for it, it is obvious that my demand for Porsche products will not be counted in the demand schedule.

Both Marshall and Samuelson seem to have overlooked this simple yet important detail in their Giffen good propositions. The demand for those potatoes could not have really risen if there were fewer potatoes available in Ireland. Even if we assume that the Irish people wanted to buy more potatoes as their price rose, they simply were not able to do so. There were fewer potatoes than before as the blight had destroyed previously available crops. Therefore, even assuming that the notional demand for potatoes increased, effective demand for potatoes could certainly not increase and so the demand curve cannot be upward-sloping. Indeed, the population of Ireland fell by over one million during 1841-1851, suggesting that those who could not buy potatoes starved and died. If you are suspiciously thinking that demand could rise because Ireland could import potatoes, keep in mind that this blight had also spread in Europe and so Ireland did not import potatoes from neighboring countries, although it imported American corn as a substitute to potatoes for mere subsistence.

Correlation and Causation

Last but not least, we should be able to differentiate between correlation and causation. If the price and the demand of a good increase, it would be premature if we instantly put forward a theory that claims a price increase causes an increase in demand. There are various reasons why the demand for something might increase, including a change in the expected future prices, price of related goods, population or even the weather. The change in demand could be due to changes in exogenous variables like the ones mentioned above, and can have nothing to do with endogenous variables, that is, price and quantity. If a researcher observes many serial killers eating ice cream before they kill a person, he cannot seriously propose that eating ice cream encourages murder attempts.

In closing, as mentioned in my opening lines, myths such as Napoleon’s height can be treated as jokes harmlessly. This is not the same as teaching economics myths. After Paul Samuelson’s interesting lies about Giffen goods, all textbooks repeated the same information with no critical re-assessment of the fallacies stated so baselessly as facts. The New Keynesian economics taught at universities must be at least reviewed for potential flaws like this. After all, for better or worse, the demand curve can only be downward-sloping.

• About the author: Ali Hashemifara is an economics student at the University of Reading. He has previously written pieces for Durham University’s Economics Society and Oxford University’s Cutting Takes. He can be contacted at a.hashemifara@student.reading.ac.uk. 
• Source: This article was published at the Mises Institute