Question

What is the revealed preference theory?

Short answer

Answer: Revealed preference theory, developed by Paul Samuelson, is an economic concept that helps identify a consumer's preferences through the observation of their choices made under varying budget constraints and prices. It postulates that a consumer's preferences can be revealed based on the choices they make. For example, consider a consumer who has to choose between apples and bananas with the same prices and within their budget. If the consumer consistently buys more apples, it implies they prefer apples over bananas. Their choice of purchasing more apples reveals their preference, even if the prices change later. This theory allows economists to analyze and understand consumer behavior by examining the choices they make in different situations.

Step-by-step solution

Definition of Revealed Preference Theory

Revealed preference theory is an economic theory developed by Paul Samuelson to determine a consumer's preferences through the observation of their choices made under varying budget constraints and prices. It assumes that, in a given situation, preferences can be revealed by the choices a consumer makes. If a consumer consistently chooses one option over another, it implies that they prefer the chosen option.

Example of Revealed Preference Theory

Consider a consumer with a fixed budget who needs to choose between two goods, apples and bananas. Suppose the prices of apples and bananas are the same, and the consumer chooses to buy more apples than bananas. Their choice of buying more apples over bananas reveals a preference for apples. If the prices change and the consumer still chooses to buy more apples, this reinforces their preference for apples over bananas.

In Summary

Revealed preference theory allows economists to deduce a consumer's preferences by observing their choices in the face of different budget constraints and prices. The choices they make reveal their preferences for certain goods over others, which can be used to analyze and understand consumer behavior.