Revealed Preferences

Question 1

How can we find Revealed Preferences?

Answer 1

• Consumption patterns can be revealed by observing demand choices consumers make
• This can be used to discover preference relations for consumers

Question 2

What are some preference assumptions?

Answer 2

• Preferences do not change when data is gathered
• Preferences are strictly convex
• Preferences are monotonic
• Monotonicity and convexity imply that the most preferred affordable bundle is unique

Question 3

What is the Direct Preference Revelation?

Answer 3

• X* is directly revealed preferred (DRP) to y if X* is chosen when y is affordable
• p1x1+p2x2 ≥ p1y1+p2y2

Question 4

What is Indirect Preference Revelation?

Answer 4

• X is indirectly revealed preferred (IRP) to z if x>y and y>z

Question 5

Name the two Axioms of Revealed Preferences

Answer 5

• Strong Axiom of Revealed Preferences (SARP)
• Weak Axiom of Revealed Preferences (WARP)

Question 6

What is the WARP?

Answer 6

• If bundle x is DRP to y, y will never be directly preferred to x
• There is no transitivity and no multiple bundles
• WARP is necessary to economic rationality and integral to explaining observed choices

Question 7

What is the SARP?

Answer 7

• If bundle x is DRP/IRP to y, y will never be directly preferred to x
• Transitivity and multiple bundles are present
• SARP is necessary to preferences to be ‘well-behaved’

Question 8

What are index numbers? How can they be used?

Answer 8

• Over time, prices change
• This means that indices are used to compare price/quantity in a base period and a current period
• Takes a ratio of expenditures