Revealed preference theory
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The document presents the revealed preference theory, introduced by Paul A. Samuelson in 1938, which analyzes consumer preferences based on market behavior rather than utility analysis. It outlines key assumptions about consumer choices between two commodities, explains the theory’s implications for consumer behavior, and discusses its merits and demerits. While the theory is seen as more realistic and scientific, it is criticized for its limited application and failure to account for the income and substitution effects.
Revealed preference theory
- 2. The revealed preference approach is quite distinct from the two approaches. Alfred Marshall who built up the theory of demand on the basis of the marginal utility analysis. J.R. Hicks who reconstructed the theory of consumer’s behaviour on the basis of the indifference curve analysis. THE YOUNG INDIAN ECONOMISTS REVEALED PREFERENCE THEORY
- 3. REVEALED PREFERENCE THEORY The revealed preference approach has been propounded by the American Economists, Prof. Paul A. Samuelson in his article “Consumption Theory In Terms Of Revealed Preference” in 1938. This theory relies on the market behaviour of the consumer to know about his preferences with regard to the various combinations for the two reactions and responses of the consumer. THE YOUNG INDIAN ECONOMISTS
- 4. ASSUMPTIONS The consumer has only two combinations of commodities The income of the consumer, prices of the two commodities are constant during the period of analysis The tastes of the consumer are given and remain unchanged during the period of analysis The consumer should choose only one combination of the commodities in a given price-income situation Based on observed facts and ordinal utility analysis THE YOUNG INDIAN ECONOMISTS
- 5. ASSUMPTIONS A consumer can be persuaded to buy more of a commodity if its price is subjected to substantial cut The choice of the consumer reveals his preference and market behaviour of the consumer Consistency states strong ordering preference hypothesis of Samuelson Transitivity states that no two observations of choice behaviour can conflict with regard to an individual consumer’s preferences. THE YOUNG INDIAN ECONOMISTS
- 6. EXPLANATION OF THE THEORY When a consumer purchases some commodities either because, he likes them more than other cheaper than other commodities There are two combinations of commodities; X and Y Consumer buys combination of X and not combination of Y Assuming that both the commodities are equally same cost and are equally good If the consumer buys X combination rather than Y commodity, because he like X combination better and revealed preference took place The price line PL reflects the income-price situation for the consumer THE YOUNG INDIAN ECONOMISTS
- 7. EXPLANATION OF THE THEORY The consumer can choose any combination lying on the price line i.e. C, A, B; below and to the left of the price line G, E, D, F The consumer can purchase any combination within the triangle known as Consumer’s Choice Triangle These are all alternative combinations and the consumer is free to choose any one of them The combinations lying on the price line is equally costly The combinations lying below the price line i.e. Consumer’s Choice Triangle is inferior zone The combinations lying above the price line is superior zone The gap between preferred zone and inferior zone is said to be ignorance zone.
- 8. REVEALED PREFERENCE THEORY THE YOUNG INDIAN ECONOMISTS
- 9. REVEALED PREFERENCE THEORY MERITS OF REVEALED PREFERENCE THEORY More realistic More scientific More consistent Based on fewer assumptions DEMERITS OF REVEALED PREFERENCE THEORY Ruled out the possibility of indifference in the behaviour of the consumer Fails to bring distinction between the income effect and the substitution effect of a price change Deals only with the individual demand curve Takes into account only that consumer whose market behaviour is governed strictly by the current market conditions
- 10. CONCLUSION Prof. Samuelson’s revealed preference theory is really an improvement upon the indifference curve analysis It has more implications for welfare economics The method of actual observation makes it superior to other demand theories The revealed preference theory is restrictive. “In Samuelson’s revealed preference theory what is gained is rigour and methodology is lost in the narrowness of the scope of its application”. THE YOUNG INDIAN ECONOMISTS
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