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Revealed preference

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Pioneered by American economist Paul Samuelson (1915- ), revealed preference theory is a method by which it is possible to discern the best possible option on the basis of consumer behaviour. Essentially, this means that the preferences of consumers can be revealed by their purchasing habits. Revealed preference theory came about because the theories of consumer demand were based on a diminishing marginal rate of substitution. This diminishing MRS is based on the assumption that consumers make consumption decisions based on their intent to maximize their utility. While utility maximization was not a controversial assumption, the underlying utility functions could not be measured with great certainty. Revealed preference theory was a means to reconcile demand theory by creating a means to define utility functions by observing behavior.

Theory

If a person chooses a certain bundle of goods (ex. 2 apples, 3 bananas) while another bundle of goods is affordable (ex. 3 apples, 2 bananas), then we say that the first bundle is revealed preferred to the second. It is then assumed that the first bundle of goods is always preferred to the second. This means that if the consumer ever purchases the second bundle of goods then it is assumed that the first bundle is unaffordable. This implies that preferences are transitive. In other words if we have bundles A, B, C, ...., Z, and A is revealed preferred to B which is revealed preferred to C and so on then it is concluded that A is revealed preferred to C through Z. With this theory economists can chart indifference curves which adhere to already developed models of consumer theory.
The Weak Axiom of Revealed Preference

More formally, let pA be the price of apples and pB be the price of bananas, and let the amount of money available be m=5. If pA =1 and pB=1, and if the bundle (2,3) is chosen, it is said that that the bundle (2,3) is revealed preferred to (3,2), as the latter bundle could have been chosen as well at the given prices.

The Weak Axiom of Revealed Preference (WARP) is often invoked in consumer theory. It relates to the case that the optimal choice of a consumption bundle is, for any price system, unique, and it postulates for different bundles A and B the following: If A is revealed preferred to B, it is not the case that B is revealed preferred to A. In other words: The weak axiom of revealed preference rules out that, in cases where A and B are available, sometimes A is chosen, and sometimes B. If A is chosen in one of these cases, B can never be chosen.

References

  • Nicholson, W. (2005) Microeconomics, Thomson, Southwestern.
  • Varian, H. (1992) Microeconomic Analysis, Third edition, New York: Norton, Section 8.7
  • Samuelson, P. (1938). A Note on the Pure Theory of Consumers' Behaviour. Economica 5:61-71.

External links



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