This video explains how revealed preference theory works. We’ll learn how to use both the Weak and Strong Axioms of Revealed Preference, in order to derive a utility function from consumer behaviour.
Revealed preference theory is attributable to Paul Samuelson, who developed the concept in his article “Consumption Theory in Terms of Revealed Preference”, in 1948. Consumer theory depends on the existence of preferences, which materialise into utility functions. These utility functions are maximised by consumers subject to a budget restraint. The issue is that it is difficult to accept that individuals really have a definite mathematical formula in mind when choosing between different options. What revealed preference theory does is work backwards to assume that we can deduce these utility functions from consumer behaviour. Analysing these choices leads us backwards to a set of preferences that influences the choices they make. It therefore allows economists to study consumer behaviour empirically.
There are two main axioms to the theory, both based on completeness and transitivity: the Weak Axiom of Revealed Preference and the Strong Axiom of Revealed Preference, which adds transitivity.
If we compare bundles of goods, we can map out all a consumer’s choices. In theory, we can track this backwards to actually build utility functions if we have access to unlimited data. Without actually having to do this, we can aggregate consumer data to reveal general truths about a certain population’s preferences.
Learn more by reading the dictionary entry.