Chapter 7 Flashcards
What is revealed preference?
A theory that infers consumer preferences from observed choices rather than assuming they are known.
What does it mean if bundle is revealed preferred to bundle ?
The consumer chose when was affordable, implying is preferred to .
What assumption is made in revealed preference theory about consumer behavior?
Consumers always choose the best bundle they can afford.
What is direct revealed preference?
When a consumer chooses bundle over bundle , and was affordable.
What is indirect revealed preference?
If is directly preferred to , and is directly preferred to , then is indirectly preferred to .
What does the Weak Axiom of Revealed Preference (WARP) state?
If is directly revealed preferred to , then cannot be directly revealed preferred to .
How do you check if a consumer’s choices violate WARP?
Look for a situation where is chosen over , but at another time, is chosen over .
What does the Strong Axiom of Revealed Preference (SARP) state?
If is revealed preferred to (directly or indirectly), then cannot be revealed preferred to .
What is the key difference between WARP and SARP?
WARP checks direct preferences, while SARP ensures transitivity by also considering indirect preferences.
What does a violation of SARP indicate?
That the consumer’s choices cannot be explained by stable, transitive preferences.
How do you construct a Revealed Preference Table?
List the consumer’s choices at different prices and check if one bundle was affordable but not chosen.
What does a preference cycle indicate?
A violation of SARP, meaning consumer behavior is inconsistent with rational decision-making.
What does recovering preferences mean?
Estimating consumer preferences by analyzing multiple observed choices.
Why is revealed preference theory important in policy-making?
It helps understand how consumers react to taxes, subsidies, and price changes.
What is an index number?
A measure used to compare average consumption or prices over time.
What is a Laspeyres quantity index?
A measure that uses base-period prices to compare quantity changes.
What is a Paasche quantity index?
A measure that uses current-period prices to compare quantity changes.
How does the Paasche index relate to consumer welfare?
If it is greater than 1, the consumer is better off; if less than 1, they are worse off.
What is the Paasche price index?
A price index using current-period quantities as weights.
What is the Laspeyres price index?
A price index using base-period quantities as weights.
How do Social Security payments use revealed preference theory?
They are indexed to price changes to maintain purchasing power.
