Revealed Preferences

Question 1

What is the main feature of the chosen bundle?

Answer 1

It satisfies the budget constraint exactly

Question 2

What is the main feature of the alternative bundle?

Answer 2

It can lie inside, on or outside the budget constraint

Question 3

What is the Weak axiom of revealed preference (WARP)?

Answer 3

It cannot be that we choose a bundle over the alternative (which we can afford) at one set of prices and then when prices change we choose the alternative when we could have afforded the original bundle

Question 4

What is the Strong axiom of revealed preferences (SARP)?

Answer 4

If (x1’,x2’) is directly or indirectly revealed preferred to (x1’‘,x2’’), and the two bundles are not the same, then it cannot be that (x1’‘,x2’’) is directly or indirectly revealed preferred to (x1’,x2’).

Question 5

How do we deduce that there is an increase in welfare with the Laspeyres or Paasche index?

Answer 5

If the consumer chooses the new bundle when they could’ve afforded the original, then they’re better off now

Question 6

What is the compensating variation (cv)?

Answer 6

The amount income would have to change to make the consumer just as well off as before the price change

Question 7

How do you calculate the compensating variation?

Answer 7

• Find the original optimal consumption bundle and its corresponding overall utility
• Find the new optimal consumption bundle and sub into objective function
• Equate the resulting objective function to the original overall utility and solve for M
• Find the difference between the two M’s

Question 8

What is the equivalent variation?

Answer 8

How much income would have to change before the price change to leave him as well off as he would be after the price change

Question 9

How do you calculate the equivalent variation?

Answer 9

• Find the new optimal bundle and its respective overall utility
• Sub the original bundle into objective function and equate to new utility then solve for M

Question 10

Explain the theory of revealed preference

Answer 10

We assume preferences are unchanged and we observe behaviour under different prices and/or income. The idea is that we are using observed behaviour to infer something about individuals preferences

Question 11

In price indices, what do the letters t and b represent?

Answer 11

• b represents the base year

- t represents the next year