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Consumption externalities and upward-sloping demand.

Article Excerpt
Abstract

The law of demand states that individual demand curves are negatively sloped. To date, the Giffen Paradox represents the only analytically valid exception to the law under standard assumptions. This article shows that if consumption externalities exist, it is possible for the individual's demand curve to slope upward. In particular, the condition under which demand becomes upward-sloping can be delineated in terms of measures of elasticity of demand. (JEL D11, D62)

Introduction

The Giffen Paradox [Stigler, 1947] contradicts the classic law of demand [Mill, 1909], that individual demand curves are negatively sloped. To date, this represents the only analytically valid exception to the law under the assumptions of the standard theory. Under the standard theory of demand, the individual is assumed to consume pure private goods, in the sense that the benefits are entirely used up in consuming the good, so that consumption by one individual precludes any direct utility gains or losses to other individuals. Empirically, however, many cases exist under which the consumption of private goods yields externalities, especially those of a negative nature. Prominent examples include car trips, public park visits, public transportation, housing, and internet surfing: consuming each of these private goods generates externalities in various forms of environmental pollution and congestion. If the analysis is generalized to include private goods conferring externalities, richer properties follow for the individual's demand functions. As will be shown, if consumption externalities exist, it would be possible for the individual's demand curve to slope upward. Plott...

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