Revealed preference

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Revealed preference theory, pioneered by American economist Paul Samuelson, is a

method by which it is possible to discern the best possible option on the basis of consumer
behavior. 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 (MRS). 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.

Contents
[hide]

• 1 Theory
o 1.1 The Weak Axiom of Revealed Preference
o 1.2 The Strong Axiom of Revealed Preference
• 2 Criticism
• 3 See also
• 4 References

• 5 External links

[edit] 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.

[edit] The Weak Axiom of Revealed Preference

The Weak Axiom of Revealed Preference (WARP) is a characteristic on the choice behavior
of an economic agent. For example, if an individual chooses A out of a set of options
including B, they should never choose B when faced with a choice of a different set of
options which also includes A and B. More formally, if A is ever chosen when B is available,
then there can be no set containing both alternatives from which B is chosen and A is not.
These two definitions however do not state the same necessary restrictions to satisfy WARP.
The former prohibits ever choosing B after A was once chosen over B. The latter (and weaker
rectriction) only requires to choose A as well, if B were to be chosen out of several choices.

This characteristic can be stated as a characteristic of Walrasian demand functions as seen in

the following example. 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. More formally, assume a consumer has a demand
function x such that they choose bundles x(p,w) and x(p',w') when faced with price-wealth
situations (p,w) and (p',w') respectively. If p·x(p',w') ≤ w then the consumer chooses x(p,w)
even when x(p',w') was available under prices p at wealth w, so x(p,w) must be preferred to
x(p',w').

[edit] The Strong Axiom of Revealed Preference

The Strong Axiom of Revealed Preference (SARP) is an expansion of the concept of WARP.
A choice behavior that satisfies WARP can form circles. That is if A is preferred to B and B
to C then under WARP it is possible that C is preferred to A. SARP makes this behavior
impossible, as it is the same as WARP plus the requirement that circles are not possible. (in
two dimensions WARP=SARP)

[edit] Criticism
Stanley Wong [1] argues that revealed preference theory is a failed research program.
According to Wong, Samuelson's 1938 presented revealed preference theory as an alternative
theory to utility theory, while in 1950, Samuelson took the demonstrated equivalence of the
two theories as a vindication for his position, rather than as a refutation.

If there exist only an apple and an orange, and an orange is picked, then one can definitely
say that an orange is revealed preferred to an apple. In the real world, when it is observed that
a consumer purchased an orange, it is impossible to say what good or set of goods or
behavioral options were discarded in preference of purchasing an orange. In this sense,
preference is not revealed at all in the sense of ordinal utility. [1][2][3][dead link] One of the
critics of the revealed preference theory states that "Instead of replacing 'metaphysical' terms
such as 'desire' and 'purpose'" they "used it to legitimize them by giving them operational
definitions." Thus in psychology, as in economics, the initial, quite radical operationalist
ideas eventually came to serve as little more than a "reassurance fetish" (Koch 1992, 275) for
mainstream methodological practice." [4]

[edit] See also

• Conjoint analysis
• Hedonic regression
• Travel cost analysis
• Contingent valuation or stated preference methods

[edit] References
 1. ^ Stanley Wong, Foundations of Paul Samuelson's Revealed Preference Theory: A
Study by the Method of Rational Reconstruction, Routledge (1978)

• Nicholson, W. (2005) Microeconomics, Thomson, Southwestern.

• Mas-Colell, A.; Whinston, M.D.; Green, J.R. (1995) "Microeconomic Theory", First
Edition, New York: Oxford University Press, New York
• Samuelson, P. (1938). A Note on the Pure Theory of Consumers' Behaviour.
Economica 5:61-71.
• Varian, H. (1992) Microeconomic Analysis, Third edition, New York: Norton, Section
8.7

[edit] External links

• Revealed Preference, review by Hal R. Varian, 2005, prepared for Samuelsonian
Economics and the 21st Century.
• Lecture Notes in Microeconomic Theory, book by Ariel Rubinstein, 2005.

Retrieved from "http://en.wikipedia.org/wiki/Revealed_preference"

Categories: Consumer theory
Hidden categories: All articles with dead external links | Articles with dead external links
from October 2009

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