Revealed preference theory, in economics, a theory, introduced by the American economist Paul Samuelson in 1938, that holds that consumers’ preferences can be revealed by what they purchase under different circumstances, particularly under different income and price circumstances. The theory entails that if a consumer purchases a specific bundle of goods, then that bundle is “revealed preferred,” given constant income and prices, to any other bundle that the consumer could afford. By varying income or prices or both, an observer can infer a representative model of the consumer’s preferences.
Much of the explanation for consumer behavior, particularly consumer choice, is rooted in the concept of utility developed by the English philosopher and economist Jeremy Bentham. Utility represents want (or desire) satisfaction, which implies that it is subjective, individualized, and difficult to quantify. By the early 20th century, substantial problems with the use of the concept had been identified, and many proposed theoretical replacements struggled with the same critiques. As a result, Samuelson offered what became known as revealed preference theory in an attempt to build a theory of consumer behavior that was not based on utility. He argued that his new approach was based on observable behavior and that it relied on a minimal number of relatively uncontroversial assumptions.
As revealed preference theory developed, three primary axioms were identified: the weak, strong, and generalized axioms of revealed preference.
1. weak axiom
The weak axiom indicates that, at given prices and incomes, if one good is purchased rather than another, then the consumer will always make the same choice. Less abstractly, the weak axiom argues that if a consumer purchases one particular type of good, then the consumer will never purchase a different brand or good unless it provides more benefit—by being less expensive, having better quality, or providing increased convenience. Even more directly, the weak axiom indicates that consumers will purchase what they prefer and will make consistent choices.
2. strong axio
The strong axiom essentially generalizes the weak axiom to cover multiple goods and rules out certain inconsistent chains of choices. In a two-dimensional world (a world with only two goods between which consumers choose), the weak and strong axioms can be shown to be equivalent. While the strong axiom characterizes the implications of utility maximization (see expected utility), it does not address all the implications—namely, there may not be a unique maximum.
3. generalized axiom
The generalized axiom covers the case when, for a given price level and income, more than one consumption bundle satisfies the same level of benefit. Expressed in utility terms, the generalized axiom accounts for circumstances where there is no unique bundle that maximizes utility.
Suppose that an individual, facing the budget constraint given by line l1 in Figure , chooses market basket A. Let’s compare A to baskets B and D. Because the individual could have purchased basket B (and all baskets below line l1 ) and did not, we say that A is preferred to B.
It might seem at first glance that we cannot make a direct comparison between baskets A and D because D is not on l1 . But suppose the relative prices of food and clothing change, so that the new budget line is l2 and the individual then chooses market basket B. Because D lies on budget line l2 and was not chosen, B is preferred to D (and to all baskets below line l2 ). Because A is preferred to B and B is preferred to D, we conclude that A is preferred to D.Furthermore, note in Figure that basket A is preferred to all of the baskets that appear in the green-shaded areas. However, because food and clothing are “goods” rather than “bads,” all baskets that lie in the pink-shaded area in the rectangle above and to the right of A are preferred to A. Thus, the indifference curve passing through A must lie in the unshaded area.
Given more information about choices when prices and income levels vary, we can get a better fix on the shape of the indifference curve.
Suppose that facing line l3 (which was chosen to pass through A), the individual chooses market basket E. Because E was chosen even though A was equally expensive (it lies on the same budget line), E is preferred to A, as are all points in the rectangle above and to the right of E. Now suppose that facing line l4 (which passes through A), the individual chooses market basket G. Because G was chosen and A was not, G is preferred to A, as are all market baskets above and to the right of G.
We can go further by making use of the assumption that indifference curves are convex. In that case, because E is preferred to A, all market baskets above and to the right of line AE in Figure must be preferred to A. Otherwise, the indifference curve passing through A would have to pass through a point above and to the right of AE and then fall below the line at E—in which case the indifference curve would not be convex. By a similar argument, all points on AG or above are also preferred to A. Therefore, the indifference curve must lie within the unshaded area. The revealed preference approach is valuable as a means of checking whether individual choices are consistent with the assumptions of consumer theory.
CHARACTERISTICS OF REVEALED PREFERENCE THEORY
The two most-distinguishing characteristics of revealed preference theory are as follows:
(1) It offers a theoretical framework for explaining consumer behavior predicated on little more than the assumption that consumers are rational, that they will make choices which advance their own purposes most efficiently
(2) It provides necessary and sufficient conditions, which can be empirically tested, for observed choices to be consistent with utility maximization.
Criticisms of Revealed Preference Theory
Some economists say that revealed preference theory makes too many assumptions. For instance, how can we be sure that consumer’s preferences remain constant over time? Isn’t it possible that an action at a specific point in time reveals part of a consumer’s preference scale just at that time? For example, if just an orange and an apple were available for purchase, and the consumer chooses an apple, then we can definitely say that the apple is revealed preferred to the orange.
There is no proof to back up the assumption that a preference remains unchanged from one point in time to another. In the real world, there are lots of alternative choices. It is impossible to determine what product or set of products or behavioral options were turned down in preference to buying an apple.