Define income and substitution effects. The income effect is the urge to buy more items based on a higher income and fewer items based on a lower income. Income can be increased either by lower prices or a raise at one's job. The substitution effect is the urge to buy an alternate product when one product's price increases. If apples increase in price and oranges are now cheaper than apples, the substitution effect holds that a consumer will buy oranges instead of apples.
Characterize normal and inferior goods. A normal good is one in which demand increases as price decreases. Examples include your favorite type of soda, soup or tickets to a baseball game. In general, you will purchase more of these things if prices decrease. Inferior goods are those that you buy less of as income increases. Noodle soup is an example. As college students earn more money after graduation, they are less likely to subsist on noodle soup.
Identify Giffen goods. A Giffen good is a special type of inferior good. Economists at Harvard use the example of rice in China. When Chinese rice decreases in price, so does the demand for it. Economists believe this is because as Chinese have more money to spend due to cheaper rice, instead of stocking up on more rice they choose to buy other items such as meat, which is more expensive but also more nutritious.
Draw demand curves for Giffen and inferior goods. On each graph, make the X-axis the increasing demand of a product and the Y-axis the increasing income of the individual. For your Giffen graph, plot points at which demand rises with income. Draw a curve through your points on each graph. Use the graphs and definitions of Giffen and inferior goods to note how and why they are different.
Draw the axis for two different graphs. Each graph must have a vertical X-axis and a horizontal Y-axis. Label each X-axis "Demand" and each Y-axis "Income" Write "0" at the origin of each graph. Choose your own scale for each axis, making sure the numbers increase the further away you get from the origin. Each of your graphs will have increasing demand and increasing income for its axes. Label one graph "Giffen" and the other "Inferior."
Plot your Giffen graph. On the graph labeled "Giffen," make your plot points show increasing income with increasing demand. Draw a line through your points. You will create a demand curve that extends upward, left to right from the origin.
Plot your inferior goods graph. Plot points at which demand decreases as income increases. This means you will have a curve that extends downward from left to right from the top of your graph.
Review the definitions of effects and goods in conjunction with the graphs. Note both the visual differences and theoretical differences.