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Chapter 7

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ECON 2201

Chapter 7 – Revealed Preference - How we can use information about a consumers demand to discover information about their preferences, assuming their preferences are stable over the time period that we are observing their behavior Assume that there is a unique demanded bundle and the preferences are strictly convex If (x1, x2) is on the budget line and it is the chosen bundle, then is satisfies the budget constraint with equality (p1x1 + p2x2 = m) - But, say that (y1, y2) is underneath the budget line and it is not chosen, then is just satisfies the budget constraint (p1y1 + p2y2 ≤ m), but it is not the optimal choice ≥ Putting these two together gives you p1x1 + p2x2 p1y1 + p2y2, which tells us that (x1, x2) is directly revealed preferred to (y1, y2). - Basically, the consumer chose X when Y also could’ve been chosen. - If the consumer chooses the best bundle they can afford, then revealed preference implies preference Then, if (y1, y2) is revealed preferred to a bundle (z1, z2), then we can see that (x1, x2) is indirectly implied preferred to (z1, z2) by looking at preference and transitivity You can use assumptions about consumer preferences to “trap” and find an indifference curve - If we assume preferences are convex for bundle Y and Z that are revealed preferred to good X, then we know that all the weighted averages of Y and Z are also preferred to X - If we assume monotonicity, then all the bundles that have more of both goods than X, Y, and Z and any of their weighted averages are also preferred to X
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