Suppose the price of good X, a Giffen good, increases. Which of the following statements are TRUE?
I. The substitution effect of the price increase causes consumers to buy less of good X.
II. The substitution effect of the price increase causes consumers to buy more of good X.
III. The income effect of the price increase causes consumers to buy more of good X.
IV. The income effect of the price increase causes consumers to buy less of good X.

Question

Quizplus · Accepted Answer

For a Giffen good, when the price increases, the substitution effect (I) indeed causes consumers to buy less of it because other goods become relatively cheaper. However, the defining characteristic of a Giffen good is that the income effect (III) is so strong that it outweighs the substitution effect, leading consumers to buy more of the good as it becomes more expensive, due to the good being an inferior good and consuming a large portion of the consumer's income.

Suppose the Price of Good X, a Giffen Good, Increases