Definition of index number and giffen good

Q. Define index number and giffen good (May 2011)

Index number (May’11): In economics and finance, an index is a statistical measure of changes in a representative group of individual data points. These data may be derived from any number of sources, including company performance, prices, productivity, and employment. An index number is an economic data figure reflecting price or quantity compared with a standard or base value. The base usually equals 100 and the index number is usually expressed as 100 times the ratio to the base value. For example, if a commodity costs twice as much in 1970 as it did in 1960, its index number would be 200 relative to 1960. Index numbers are used especially to compare business activity, the cost of living, and employment. They enable economists to reduce unwieldy business data into easily understood terms.

Giffen good (May’11): In economics and consumer theory, a Giffen good is one which people paradoxically consume more of as the price rises, violating the law of demand. In normal situations, as the price of a goodrises, the substitution effect causes consumers to purchase less of it and more of substitute goods. In the Giffen good situation, the income effect dominates, leading people to buy more of the good, even as its price rises. Evidence for the existence of Giffen goods is limited, but microeconomic mathematical models explain how such a thing could exist. Giffen goods are named after Scottish economist Sir Robert Giffen, to whom Alfred Marshall attributed this idea in his book Principles of Economics. Giffen first proposed the paradox from his observations of the purchasing habits of the Victorian era poor.

An example At this point, the consumer’s entire budget is taken up by the giffen good, so any price increase now will result in a decrease of the amount of good the consumer is able to buy.  Thus, we will have our typical downward sloping demand curve.