Why Higher Prices Mean Buying Less — Except When They Don't

Split the response to a price rise into the two forces that drive it. The substitution effect pulls you away from the pricier good. The income effect is the feeling of a thinner wallet. Usually the two push the same way. For an inferior good, the income effect pushes back. For a survival staple like rice, it can win, so a higher price means buying more. The formula below adds the two forces. For example, a 10,000-won allowance buys 🍚 rice and 🍌 bananas. When rice gets pricier, bananas look cheap and you switch toward them. At the same time your allowance feels smaller, so you buy less overall. If rice matters too much to cut, you drop the bananas and buy even more rice.

Δx1=SE+IE\Delta x_1 = SE + IE
IE>∣SE∣⇒GiffenIE > |SE| \Rightarrow \text{Giffen}

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Examples & Exercises

A consumer with a lunch budget of 4040 and food 2 fixed at 88 sees food 1 rise from 44 to 66. How much does food 1 fall, and how does the drop split between the substitution and income effects?

A normal good, price 4→64 \to 6 — the two effects hold hands and push together.
Show proof
  1. The old bundle AA splits the budget in half: food 1 55, food 2 2.52.5. At the new price, bundle CC has food 1 down to 4012≈3.33\frac{40}{12} \approx 3.33. The total effect is −1.67-1.67.
  2. To isolate substitution, top up the budget so the old basket stays affordable at new prices: 6×5+8×2.5=506 \times 5 + 8 \times 2.5 = 50. With 5050, bundle BB picks food 1 5012≈4.17\frac{50}{12} \approx 4.17 — the substitution effect is 4.17−5=−0.834.17 - 5 = -0.83.
  3. The rest is the income effect: 3.33−4.17=−0.833.33 - 4.17 = -0.83. For a consumer who likes both foods equally, the two effects split the drop exactly in half. Both negative is the signature of a normal good.

The price of rice rises from 44 to 55, yet one household starts buying more rice — 3030 up to 31.531.5. Is the law of demand broken?

Rice the survival staple, price 4→54 \to 5 — C sits to the RIGHT of A.
Show proof
  1. This household must hit 7070 calories a day. Rice gives 22 calories per unit, meat 11; the budget is 240240 and meat costs 1212. Initially rice 3030 and meat 1010 hit the target exactly.
  2. Dearer rice makes the same calories cost more money — the household is effectively poorer. The only luxury to cut is meat, which falls from 1010 to 6.96.9.
  3. The calorie hole left by the meat must be plugged with rice. The substitution effect is nearly zero, −0.01-0.01 — survival calories have no substitute — while the income effect is +1.58+1.58. Net: +1.57+1.57. Pricier, yet bought more. That is a Giffen good.
  4. This is not the luxury-goods story of "pricier sells better". There, the high price itself creates status value and preferences move; Giffen is made not by taste but by poverty.

1. Intro to Microeconomics