Revealed Preference

Revealed preference theory holds that consumers' preferences can be revealed by what they purchase under different circumstances, particularly under different income and price circumstances. The concept argues 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 and/or prices, 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 Jeremy Bentham's concept of utility. Utility represents wantsatisfaction, which implies that it is subjective, individualized, and difficult to quantify. By the early 20th century, substantial problems with the use of utility had been identified, and many of the theoretical replacements of the concept either struggled with the same critiques (often because they retained too much of the heritage of utility) or suffered from being essentially unmeasurable and untestable. In 1938, Paul Samuelson noted that there seemed little reason to believe in the dominant theories of the time other than the fact that the concepts led “to the type of demand functions in the market which seem plausible.” 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 precepts that were observable and relied on a very minimal number of assumptions that many would argue were relatively uncontroversial.

As revealed preference theory has developed, three primary axioms have been developed: the weak, strong, and generalized axioms of revealed preference. The weak axiom indicates that at given prices and incomes, if one good is purchased rather than another, then the consumer will always make that same choice. Less abstractly, the weak axiom argues that if a consumer purchases one particular type of good, then the consumer would 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.

Although relatively simple, the weak axiom provides strong rationality properties that economics requires, including downward sloping demand curves and the dependence of consumption on relative prices. These properties can be developed without resorting to the types of strong assumptions required by utilitybased or indifference curve analysis, such as diminishing marginal rates of substitution.

The strong axiom essentially generalizes the weak axiom to cover multiple goods and rules out certain [Page 1829]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. Later research built on the revealed preference framework and demonstrated that indifference curves and utility functions can be developed from observations of behavior, even though revealed preference theory explicitly rejects these precepts as a starting point for explaining behavior. As a result, a number of the analytical tools and concepts regarding consumer choice could be preserved, albeit with a stronger theoretical base.

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