Revealed preference

Revealed preference theory, pioneered by economist Paul Anthony Samuelson in 1938, is the method of analyzing choices offered by individuals, mostly used for comparing a influence of policies on consumer behavior. Revealed preference models assume that the preferences of consumers can be revealed by their purchasing habits.

Revealed preference picture arose because existing theories of consumer demand were based on a diminishing marginal rate of substitution MRS. This diminishing MRS relied on the precondition that consumers pretend consumption decisions to maximise their utility. While utility maximisation was not a controversial assumption, the underlying return functions could not be measured with great certainty. Revealed preference idea was a means to reconcile demand theory by introducing utility functions by observing behaviour.

Therefore, revealed preference is a way to infer the preferences of individuals given the observed choices. It contrasts with attempts to directly degree preferences or utility, for example through stated preferences. Taking economics to be an empirical subject, there is the issue that one cannot observe preferences. In other words, according to advocates of revealed preference theory "It is not what you say, this is the what you score that reveals what you want."

Motivation

Revealed preference theory tries to understand the preferences of a consumer among bundles of goods, given their budget constraint. For instance, whether a consumer buys bundle of goods A over bundle of goods B, where both bundles of goods are affordable, this is the revealed that they directly prefer A over B. It is assumed that the consumer's preferences areover the observed time period, i.e. the consumer will not reverse their relative preferences regarding A & B.

As a concrete example, if a grown-up chooses two apples & three bananas over an affordable alternative three apples and two bananas, then the number one bundle is considered revealed preferred to the second. It is assumed that the number one bundle of goods is always preferred to the second, and that the consumer purchases thebundle of goods only if the first bundle becomes unaffordable.