Luxury & Inferior Goods

Veblen & Giffen Goods

Veblen Goods are types of luxury goods in which the Willingness To Pay (WTP) of Customers increases as the Price increases. Giffen Goods are also goods in which demand will increase with Price, but Giffen Goods are inferior goods and the mechanism causing the increasing WTP is quite different.

Both Veblen and Giffen Goods contradict the Law of Demand as they result in upward-sloping demand curves (the law of demand requires that Quantity sold decreases when Price increases). Furthermore, Mainstream Economics defines WTP as the maximum Price a Customer would pay, and generally requires Price and WTP to be decoupled variables independent of one another.

The Veblen Effect is named after the American economist Thorstein Veblen who first identified conspicuous consumption. It falls within a class of Interaction Effects. These Interaction Effects exist on the periphery of Mainstream Economics as demand for a Product depends upon various interactions with other Customers. For example, a good may become more valuable if other Customers buy it (Network Effects) or a good may become more valuable if other Customers do not buy it (Snob Effect).

The Giffen Effect works differently. Alfred Marshall , in his book Principles of Economics, describes it in this way:

As Mr. Giffen has pointed out, a rise in the price of bread makes so large a drain on the resources of the poorer labouring families and raises the marginal utility of money to them so much that they are forced to curtail their consumption of meat and the more expensive farinaceous foods: and, bread being still the cheapest food which they can get and will take, they consume more, and not less of it.

This Building Blocks example assumes you have already downloaded the open-source KNIME analytics platform and installed the free Market Simulation (Community Edition) plugin. If not, start by returning to Getting Started.

Competitive Story

The supplier for Sprockets enjoys a Monopoly over the Market. But unusually, Customer Willingness To Pay (WTP) for Sprockets increases in proportion to the square of the Price (normally WTP is independent of Price). The supplier of Sprockets wishes to identify the Revenue Maximizing Price as well as the Profit Maximizing Price, but cannot as both Revenue and Profit continues to rise as Price rises.

Setup Market

In this Market, Sprockets are Priced around $1.00 and hence considerably cheaper than in other Markets. This is because the initial WTP Customer Distribution is also a Unit Distribution with Mean = 0.0 and Standard Deviation (SD) = 1.0. The Mean WTP then increases as Price increases.

The Customer Distributions node generates an ascending list of 61 Experimental Prices for Sprockets from $1.00 to $2.20. These Prices are used to calculate the Mean WTP of Customers. A fixed Static Cost of $0.50 is also added to the Product description.

Experimental Prices

61 Experimental Prices are generated between $1.00 and $2.20.

Product WTP

WTP increases with Price such that: Mean WTP = (Price – 1.0) ^ 2

Product List

Each combination of Price and WTP is generated in a list.

Experimental Prices

The WTP Customer Distribution for the Market is re-generated 61 times in a loop – each loop iteration taking a different Price and Mean WTP. Within each loop iteration the Simulate Market node then calculates the Quantity sold, Revenue, and Profit for the given Experimental Price and Mean WTP. The results are kept by the Loop End node for further downstream analysis.

Next Price / WTP

The Group Loop Start node takes the next row as an Input Product Array.

WTP Distribution

Mean WTP [A] is updated but Standard Deviation [B] stays fixed at 1.0.

Sales Results

Each Market Simulation is saved in the loop results.

Upward Demand Curve

All the results from each Experimental Price and Updated WTP loop iteration is collected and prepared for plotting.

Initially Quantity falls as Price increases as the Law of Demand would predict. But this is because WTP is initially not increasing as fast as Price. But soon WTP, being proportional to the square of the Price, will overtake and increase faster than Price. At this point, these Giffen / Veblen Goods defy the Law of Demand and exhibit upward-sloping Demand Curves.

Collect Results

Select the sales results for Sprockets from each loop iteration.

Plot Quantity

The Quantity vs. Price Demand Curve is soon upward-sloping.

Revenue & Profit

The Revenue / Profit Maximization Price is potentially unlimited.