MCom I Semester Managerial Economics Theory Revealed Preference Study Material Notes

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MCom I Semester Managerial Economics Theory Revealed Preference Study Material Notes

MCom I Semester Managerial Economics Theory Revealed Preference Study Material Notes: Revealed Preference Theory Assumptionso fo Revealed Preference Theory Explanation of Revealed Preference Theory Criticism of Revealed Preference Theory Importance of Revealed Preference Theory ( Most Important Notes for MCom Examinations )

Study Material Notes
Study Material Notes

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THEORY OF REVEALED PREFERENCE

REVEALED PREFERENCE THEORY: AN INTRODUCTION

Prof. Marshall propounded cardinal approach of utility analysis. Prof. Hicks and Prof. Allen propounded ordinal approach of utility analysis. Both the approaches present only the psychological analysis of behaviour of consumers. Prof. Samuelson criticised both of these approaches and propounded revealed preference theory for the study of behaviour of consumers. This theory is based on observed market behaviour of consumers. It presents behaviouristic analysis of the demand of consumers.

ASSUMPTIONS OF REVEALED PREFERENCE THEORY

Theory of revealed preference is based on certain assumptions. Therefore, these assumptions must be clearly understood to have a better understanding of this theory. These assumptions are as under :

(1) Constant Income, Taste and Fashion. It assumes that there is no change in the income, taste, habit, fashion, etc. during the course of consumption.

(2) Choice Reveals Preference. Most important assumption of revealed preference theory is that a consumer has a certain preference and his choice reveals this preference. Thus, a consumer reveals his preference. This is why this theory is named as theory of revealed preference.

(3) Consistent Behaviour of Consumer. It assumes that the behaviour of consumer remains constant. Normally, there is no inconsistency in his behaviour. Example: There are two commodities : A and B. Consumer prefers A. It assumes that he will always prefer A, even in different conditions.

(4) Transitivity in the Behaviour of Consumer. It assumes that a consumer is capable in maintaining harmonious adjustment among alternative combinations also. He maintains consistency in his behaviour even in such a case. Example: There are three commodities : A, B and C. Consumer prefers A in comparison to B and B in comparison to C. In this case, he will prefer A in comparison to C also.

(5) Rational Behaviour of Consumer. It assumes that a consumer is rational and takes all his decisions in a rational manner. He always prefers more useful combinations.

(6) A Fall in Price Increases Demand. It assumes that a consumer can be motivated to purchase more quantity of a commodity if offered at a lower price. Thus, a fall in price implies an increase in demand.

EXPLANATION OF REVEALED PREFERENCE THEORY

Theory of revealed preference is based on a common experience of life. We find that there are many alternatives before a consumer out of which he selects a particular alternative. A question arises in this regard; why did he select this particular alternatives ? Prof. Samuelson stated that there may be two causes for it:

(i) That particular alternative is more useful than others, or

(ii) That particular alternative is cheaper than others.

Thus, a consumer chooses a particular alternative and his choice reveals his preference. It may be called his revealed preference.

Explanation with the Help of Diagram :

This diagram represents that X and Y are two commodities. Pl is the price line of consumer which presents price-income position of the consumer. On this price line, the consumer can combination chooses the combination ‘A’ which implies that he will purchase OM quantity of commodity X and ON quantity of commodity Y.

 

It reveals that the consumer has preferred combination ‘A’ in comparision to B, C, D, E, F, G and H combinations. The consumer will never like to prefer the combinations D, E and F because they are inferior. Similarly, he can never afford the combinations G and H because they are above his price-income line.

CRITICISMS OF REVEALED PREFERENCE THEORY

Though the theory of revealed preference presents a more practical analysis of the behaviour of consumer, yet it is not free from criticisms. Important criticism of this theory are as follows:

(1) Ignorance of Indifference. Theory of revealed preference ignores the indifference of a consumer. It explains that a consumer can always choose the best alternative and is never indifferent to alternative combinations. Practical experience of life establishes that a consumer is generally indifferent to a number of alternatives and combinations.

(2) Ignorance of Substitution Effect. An important criticism of this theory is that it ignores the effect of substitutes on the behaviour of consumer Thus, this theory ignores Giffin’s paradox also.

(3) Imagination of an Ideal Consumer. This theory assumes not only a rational consumer but an ideal consumer also. It assumes that the behaviour of a consumer is affected only by the present market conditions and economic factors. It ignores all the non-economic factors affecting the behaviour of a consumer.

(4) Ignorance of the Object of Welfare. Theory of revealed preference ignores the aspect of welfare of consumers. It presents only the economic aspects of utility analysis.

(5) Ignorance of Negative Income Elasticity. Theory of revealed preference considers only the positive income elasticity. It ignores negative income elasticity which is a common experience of life.

(6) Suitable Only for Individual Consumers. Theory of revealed preference is suitable for the study of behaviour of individual consumers and not for the study of a market or economy as a whole.

Though there are many criticisms of the theory of revealed preference, yet it does not make the theory impractical. The fact is that this theory presents a new approach to the study of behaviour of consumers.

IMPORTANCE OF REVEALED PREFERENCE THEORY

(1) More Practical. Theory of revealed preference is based on the observed behaviour of consumers. It is based on the real and practical observations of their behaviour. Therefore, it is said to be more practical than cardinal and ordinal approaches.

(2) Helpful in Constructing Demand Curve. Prof. Samuelson has used this theory in constructing a practical demand schedule and curve.

(3) Helpful in Constructing Index Number. The preference is helpful in constructing index numbers. The ideal index number of Fisher is based on this theory.

(4) Basis of Welfare Economics. Since the preference is based on the consistency and transitivity of the behaviour of consumers, it is of great help in welfare economics. It presents a more practical view of maximising the welfare of consumers.

 

 

 

 

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