What is Revealed Preference Theory?
Revealed preference, a theory introduced by American economist Paul Anthony Samuelson in 1938, posits that consumer behavior, if income and item prices are held constant, serves as the best indicator of their preferences.
Key Takeaways
- Revealed preference theory suggests that consumer behavior, fixed income, and item prices reflect preferences.
- Assumes that consumers act rationally when making purchasing decisions.
- Includes three primary axioms: WARP, SARP, and GARP.
Understanding Revealed Preference
Historically, consumer behavior and choice were understood through the concept of utility, which represents the satisfaction or pleasure obtained from consuming a product or service. Quantifying utility, however, was complex and often seen as speculative. In the 20th century, economists criticized the heavy reliance on utility conceptions, leading to Samuelson’s development of the Revealed Preference Theory. This theory redefined consumer behavior analysis by focusing on observable actions and minimal assumptions.
Revealed preference asserts that observing individuals’ purchasing patterns is the best way to gauge their preferences. The theory assumes rationality in consumers, meaning they consider various alternatives before selecting the option that best meets their needs. Therefore, if an individual chooses one option from several, it indicates that this option is preferred.
The theory also accounts for changes in behavior due to price and budget fluctuations. By tracking these preferences across different price and budget constraints, it’s possible to create a consumption schedule for a population. According to the theory, a consumers’ chosen bundle of goods remains constant if affordable. Preferences only shift when the original bundle becomes unaffordable.
The Expansion and Utility of Revealed Preference Theory
The Revealed Preference Theory aimed to build upon Jeremy Bentham’s marginal utility theory, which quantifies the enjoyment derived from goods. Samuelson’s framework provided an empirical method to analyze consumer choice. Over time, numerous economists have expanded this theory, solidifying its place as a major tool in consumption behavior analysis.
Three Axioms of Revealed Preference Theory
Economists have identified three axioms of revealed preference:
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Weak Axiom of Revealed Preference (WARP): This principle states that given consistent income and prices, if one product is preferred and purchased over another, consumers will consistently make similar choices unless the alternative becomes relatively more convenient, cheaper, or superior in quality.
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Strong Axiom of Revealed Preference (SARP): SARP generalizes WARP by considering multiple goods. It asserts that preferences observed in two-dimensional choices extend equivalently to more complex, multi-dimensional scenarios.
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Generalized Axiom of Revealed Preference (GARP): This principle accounts for situations where multiple bundles provide the same level of utility, recognizing the preference for available bundles even when no single choice maximizes utility alone.
Example of Revealed Preference Theory
Consider a consumer, X, who chooses to buy a pound of grapes. According to revealed preference theory, X prefers these grapes over all equally priced or cheaper items. X will continue to purchase grapes as long as they remain affordable. If grapes become too expensive, X will switch to a less preferable option.
Criticisms of Revealed Preference Theory
Critics argue that revealed preference theory makes several assumptions, notably assuming constant consumer preferences over time. This assumption overlooks the possibility that preferences can change. For example, choosing an apple over an orange at one point doesn’t ensure an unchanged preference at another time.
Moreover, real-world scenarios often present numerous choices, complicating the judgment of what products were bypassed in favor of the chosen item.
Related Terms: Marginal Utility, Rational Choice Theory, Behavioral Economics, Utility Maximization, Indifference Curve.
References
- Brown University, Orlando Bravo Center for Economic Research. “A Rationalization of the Weak Axiom of Revealed Preference”.
- Princeton University Press. “1 Revealed Preference”, Page 8.
