Background
Revealed preference is a concept used in economics to determine consumers’ preference orders by observing their actual choices rather than through direct inquiry about their tastes and preferences. This methodology relies on the choices made by consumers in response to changes in prices and income levels.
Historical Context
The revealed preference theory was introduced by the American economist Paul Samuelson in the 1938 paper “A Note on the Pure Theory of Consumer’s Behaviour.” It was developed as an alternative to the utility theory, which required making assumptions about the underlying utility functions of consumers.
Definitions and Concepts
Revealed Preference
Revealed preference refers to a method of studying consumer behavior by interpreting their purchasing choices. The theory posits that the decisions individuals make when faced with different sets of commodity bundles can reveal their preference orderings for those bundles.
- Revealed Preference Axiom: If a bundle of goods, A, is chosen over another bundle, B, when both are affordable, then A is revealed to be preferred to B.
- Transitivity: If A is preferred to B, and B to C, then A is revealed preferred to C.
Major Analytical Frameworks
Classical Economics
Classical economics predominantly focused on the production, distribution, and price formation through markets, with less emphasis on consumer behavior modeling to derive preferences.
Neoclassical Economics
Revealed preference theory aligns well with neoclassical economics, which posits that consumers aim to maximize their utility given their budget constraints. The theory eliminates the need for the subjective utility concept by substituting observational data of choice.
Keynesian Economics
Keynesian economics centers around aggregate demand and its impact on economic output and inflation. While consumer preferences are acknowledged, they are typically expressed in terms of macroeconomic aggregates rather than individual choice behavior.
Marxian Economics
Marxian economics critiques capitalist systems and focuses on class struggle and production relations, rather than the granular analysis of individual consumer choice that revealed preference entails.
Institutional Economics
Institutional economics examines the role of institutional structures in shaping economic behavior. Revealed preference may be used to understand how institutions influence consumer choices indirectly.
Behavioral Economics
Behavioral economics studies the effects of psychological, cognitive, emotional, cultural, and social factors on economic decisions. Revealed preference could be critiqued here for assuming rationality, whereas behavioral economics recognizes deviations from the model due to biases and heuristics.
Post-Keynesian Economics
Post-Keynesian economists might employ revealed preferences cautiously, considering the theory’s roots in neoclassical thought. They focus more on complexities in aggregate behavior.
Austrian Economics
Austrian economists might view revealed preference as useful but secondary to their subjective value theory, which emphasizes individual insights and entrepreneurial discovery.
Development Economics
Revealed preference could be used to assess the effect of development policies by evaluating changes in consumer behavior and preference structures as incomes and prices shift in developing economies.
Monetarism
Monetarists, focusing primarily on the regulatory roles of monetary policy, would consider revealed preference mainly regarding how inflation or money supply variations impact consumer choice behavior.
Comparative Analysis
Revealed preference theory provides a ground to infer preference orders without relying on cardinal utility measures. Its reliance on actual choices places it in contrast with utility-maximization models that assume unobservable utility functions. This makes it particularly relevant in the empirical study of economics.
Case Studies
Studies like the examination of consumer choices after economic policy reforms or changes in housing markets could use revealed preference theory to assess shifts in consumer behavior and preferences.
Suggested Books for Further Studies
- “Microeconomic Analysis” by Hal R. Varian
- “Foundations of Economic Analysis” by Paul A. Samuelson
- “The Analysis of Household Surveys: A Microeconometric Approach to Development Policy” by Angus Deaton
Related Terms with Definitions
- Consumer Choice Theory: A branch of microeconomics that studies how consumers make decisions to allocate their resources.
- World Axiom of Revealed Preference (WARP): Refers to a condition necessitating that if a bundle A is chosen over bundle B given some budget constraint, then B should not be chosen over A if A remains affordable.
