Question

Axion of Revealed Preference

a) define the phrases "revealed preferred" and "principle of rationality"

b) Over a three-year period, an individual exhibits the following consumption behavior:

price of X price of Y X Y

yr1 3 3 7 4  

yr2 4 2 6 6

yr3 . 5 2 5 6 .  

Is this behavior consistent with principle of rationality? Why or why not?

Answer 1

a) "Revealed Preferred" theory was introduced by American economist Paul Samuelson. It was mentioned in one of his articles “Consumption Theory in Terms of Revealed Preference”. Its original intention was to expand upon the theory of marginal utility. It is a method of analyzing choices made by individuals, mostly used for comparing the influence of policies on consumer behaviour.

Karl R. Popper introduced "principle of rationality”. The principle of rational acceptance can be described as a set of guidelines to help determine if it is reasonable to accept a given statement. This can be used when you can't really test out the truthfulness of a statement on your own. It's a way of making a judgment call, even though you cannot access evidence. The 'principle of rationality' is the assumption that people try to reach their goals. Both the reconstruction of the 'logic of the situation' and the application of the 'principle of rationality' constitute an important method of understanding in all social sciences.

b) According to revealed preference axiom, a person is rational if at the given level of income and price, a person can afford two bundles A & B and he is choosing A over B, he will never choose B over A, if both bundles are available at different income and price level.

As per table given below,

	Price of X	Price of Y	X	Y
Year 1	3	3	7	4
Year 2	4	2	6	6
Year 3	5	2	5	6

If we assume that consumer is choosing X over Y, irrespective of price change, the behaviour should be consistent in all 3 years. However in third year he is choosing Y over X.

If we assume that consumer is choosing Y over X, irrespective of price change, the behaviour should be consistent in all 3 years. However in the first year itself, he is choosing X over Y.

Considering above two examples we can say that the behaviour is not consistent as per principle of rationality.