What is Revealed Preference Revealed Preference

Revealed preference is an economic theory of consumption behavior which asserts that the best way to measure consumer preferences is to observe their purchasing behavior. Revealed preference theory works on the assumption that consumers have considered a set of alternatives before making a purchasing decision. Thus, given that a consumer chooses one option out of the set, this option must be the preferred option. The theory allows room for the preferred option to change depending upon price and budgetary constraints. By examining the preferred preference at each point of constraint, a schedule can be created of a given population's preferred items under a varied schedule of pricing and budget constraints.

BREAKING DOWN Revealed Preference

Revealed preference theory was introduced by Paul Samuelson in 1938. Its original intention was to expand upon the theory of marginal utility coined by Jeremy Bentham. Utility, or enjoyment from a good, is very hard to quantify so Samuelson set about looking for a way to do so. Since then it has expanded upon by a number of economists and remains a major theory of consumption behavior. The theory is especially useful in providing a method for analyzing consumer choice empirically.

The theory states that given a consumer's budget, they will select the same bundle of goods (the "preferred" bundle) as long as that bundle remains affordable. It is only if the preferential bundle becomes unaffordable that they will switch to a less expensive, less desirable bundle of goods.

Example of Revealed Preference

For example, if consumer X purchases a pound of grapes, it is assumed under revealed preference theory that consumer X prefers that pound of grapes above all other items that cost the same, or are cheaper than, that pound of grapes. Since consumer X prefers that pound of grapes over all other items they can afford, they will only purchase something other than that pound of grapes if the pound of grapes becomes unaffordable. If the pound of grapes becomes unaffordable, consumer X will then move on to a less preferable substitute item.