4.5 Revealed Preference

We have seen that we can predict a consumer’s purchasing behavior if we know that person’s preferences. We can also do the opposite: We can infer a consumer’s preferences by observing the consumer’s buying behavior. If we observe a consumer’s choice at many different prices and income levels, we can derive the consumer’s indifference curves using the theory of revealed preference (Samuelson, 1947). We can also use this theory to demonstrate the substitution effect. Economists can use this approach to estimate demand curves merely by observing the choices consumers make over time.

Recovering Preferences

The basic assumption of the theory of revealed preference is that a consumer chooses bundles to maximize utility subject ...

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