8/2/20 Economics

REVEALED PREFERENCE
THEORY
 What is Revealed Preference?
Revealed preference, a theory offered by American economist Paul Anthony
Samuelson in 1938, states that consumer behavior, if their income and the item's
price are held constant, is the best indicator of their preferences.

Revealed preference theory works on the assumption that consumers are

rational.

Three primary axioms of revealed preference are WARP, SARP, and GARP.

 Understanding Revealed Preference

For a long time, consumer behavior, most notably consumer choice, had been
understood through the concept of utility. In economics, utility refers to how
much satisfaction or pleasure consumers get from the purchase of a product,
service, or experienced event. However, utility is incredibly difficult to quantify in
undeniable terms, and by the beginning of the 20th Century, economists were
complaining about the widespread reliance on utility. Replacement theories were
considered, but all were similarly criticized, until Samuelson's "Revealed
Preference Theory," which posited that consumer behavior was not based on
utility, but on observable behavior that relied on a small number of relatively
uncontested assumptions.

Revealed preference is an economic theory regarding an individual's consumption

patterns, which asserts that the best way to measure consumer preferences is to
observe their purchasing behavior. Revealed preference theory works on the
assumption that consumers are rational. In other words, they will have

By Inaam Ullah Baloch

8/2/20 Economics

considered a set of alternatives before making a purchasing decision that is best

for them. Thus, given that a consumer chooses one option out of the set, this
option must be the preferred option.

Revealed preference theory allows room for the preferred option to change
depending upon price and budgetary constraints. By examining the preferred
preference at each point of constraint, a schedule can be created of a given
population's preferred items under a varied schedule of pricing and budget
constraints. The theory states that given a consumer's budget, they will select the
same bundle of goods (the "preferred" bundle) as long as that bundle remains
affordable. It is only if the preferential bundle becomes unaffordable that they
will switch to a less expensive, less desirable bundle of goods.

The original intention of revealed preference theory was to expand upon the
theory of marginal utility, coined by Jeremy Bentham. Utility, or enjoyment from a
good, is very hard to quantify, so Samuelson set about looking for a way to do so.
Since then, revealed preference theory has been expanded upon by a number of
economists and remains a major theory of consumption behavior. The theory is
especially useful in providing a method for analyzing consumer choice empirically.

 Three Axioms of Revealed Preference

As economists developed the revealed preference theory, they identified three
primary axioms of revealed preference—the weak axiom, the strong axiom, and
the generalized axiom.

By Inaam Ullah Baloch

8/2/20 Economics

 Weak Axiom of Revealed Preference (WARP): This axiom states that given
incomes and prices, if one product or service is purchased instead of
another, then, as consumers, we will always make the same choice. The
weak axiom also states that if we buy one particular product, then we will
never buy a different product or brand unless it is cheaper, offers increased
convenience, or is of better quality (i.e. unless it provides more benefits). As
consumers, we will buy what we prefer and our choices will be consistent,
so suggests the weak axiom.
 Strong Axiom of Revealed Preference (SARP): This axiom states that in a
world where there are only two goods from which to choose, a two-
dimensional world, the strong and weak actions are shown to be
equivalent.
 Generalized Axiom of Revealed Preference (GARP): This axiom covers the
case when, for a given level of income and or price, we get the same level
of benefit from more than one consumption bundle. In other words, this
axiom accounts for when no unique bundle that maximizes utility exists.

 Example of Revealed Preference

As an example of the relationships expounded upon in revealed preference
theory, consider consumer X that purchases a pound of grapes. It is assumed
under revealed preference theory that consumer X prefers that pound of grapes
above all other items that cost the same, or are cheaper than, that pound of
grapes. Since consumer X prefers that pound of grapes over all other items they
can afford, they will only purchase something other than that pound of grapes if
the pound of grapes becomes unaffordable. If the pound of grapes becomes
unaffordable, consumer X will then move on to a less preferable substitute item.

 Criticisms of Revealed Preference Theory

The revealed preference theory fails to analysis consumer’s behaviour in choices
involving risk or uncertainty. If there are three situations, A, B, and C, the

By Inaam Ullah Baloch

8/2/20 Economics

consumer prefers A to В and С to A. Out of these, A is certain but chances of

occurring В or С are 50-50. In such a situation, the consumer s preference for С
over A cannot be said to be based on his observed market behaviour.

THE END

By Inaam Ullah Baloch