The Morgenbesser retort and revealed preference theory

7 Oct, 2017 at 16:47 | Posted in Economics | 1 Comment

counter The experiment reported here was designed to reflect the fact that revealed preference theory is concerned with hypothetical choices rather than actual choices over time. In contrast to earlier experimental studies, the possibility that the different choices are made under different preference patterns can almost be ruled out. We find a considerable number of violations of the revealed preference axioms, which contradicts the neoclassical theory of the consumer maximising utility subject to a given budget constraint. We should therefore pay closer attention to the limits of this theory as a description of how people actually behave, i.e. as a positive theory of consumer behaviour. Recognising these limits, we economists should perhaps be a little more modest in our ‘imperialist ambitions’ of explaining non-market behaviour by economic principles.

Reinhard Sippel 

Sippel’s experiment showed considerable violations of the revealed preference axioms and that from a descriptive point of view — as a theory of consumer behaviour — the revealed preference theory was of a very limited value.

The neoclassical theory of consumer behaviour has been developed in great part as an attempt to justify the idea of a downward-sloping demand curve. What forerunners like e.g. Cournot (1838) and Cassel (1899) did was merely to assert this law of demand. The utility theorists tried to deduce it from axioms and postulates on individuals’ economic behaviour. Revealed preference theory — in the hands of Paul Samuelson and Hendrik Houthakker — tried to build a new theory and to put it in operational terms but ended up with just giving a theory logically equivalent to the old one. As such it also shares its shortcomings of being based on unrestricted universal statements.

an Lack of precise definition should not … disturb us in moral sciences, but improper concepts constructed by attributing to man faculties which he actually does not possess, should. And utility is such an improper concept … [P]erhaps, because of this impasse … some economists consider the approach offered by the theory of choice as a great progress … This is simply an illusion ​because even though the postulates of the theory of choice do not use the terms ‘utility’ or ‘satisfaction’, their discussion and acceptance require that they should be translated into the other vocabulary … A good illustration of the above point is offered by the ingenious theory of the consumer constructed by Samuelson.

Demanding consistency in a theory that builds on an ad hoc constancy assumption of human behaviour doesn’t take us very far in understanding real-world human behaviour. Not taking account of institutional and cognitive factors constantly changing our behaviour is simply bad science.

One could, of course, choose to simply treat revealed preference theory as a purely deducible syntactic scientific theory consisting of a set of uninterpreted sentences. If so, the theory is arguably ‘true’ — but, of course, from an economic point of view, also totally empty and uninteresting!  A social science theory that does not make claims about the world we live in is nothing but irrelevant pseudo-science. Arguing that revealed preference theory is nothing but a set of definitions, defining what is considered to be rational, is empty axiomatics without any connection to the real world, and therefore — besides its possible heuristic values — totally uninteresting for social scientists. Definitions and axioms are not up to empirical testing, simply because you cannot test empirical claims that have not been made.

But most social scientists find this approach to exclude the complexities of reality unacceptable. A ‘conventionalist’ approach — reducing all theoretical hypotheses to a set of axioms or ‘postulates’  — may ‘save’ a theory, but only at the price of giving up the search for truth or, even, the possibility of asserting anything about the real world. Among economists, revealed preference theory has always been more than a set of definitions and axioms. It’s a theoretical hypothesis asserting things about (parts of) the real-world system we live in.

What Sippel managed to do was to show that as such a hypothesis, revealed preference theory was no good. Its basic assumptions were shown not only to be unjustified, but actually false. His experiment was a decisive counterexample showing that the universal claims for revealed preference theory are false.

And how do mainstream economists react when confronted with this monumental absence of empirical fit of revealed preference theory? Well, they do as they always have done – they use one of their four pet strategies for immunizing their models and theories to the facts:

♦ Treat the model as an axiomatic system, making all its claims into tautologies – “true” by the meaning of propositional connectives.

♦ Use unspecified auxiliary ceteris paribus assumptions, giving all claims put forward in the model unlimited ‘alibis.’

♦ Limit the application of the model to restricted areas where the assumptions/hypotheses/axioms are met.

♦ Leave the application of the model open, making it impossible to falsify/refute the model by facts.

Sounds great, doesn’t it? Well, the problem is, of course, that ‘saving’ theories and models by these kinds of immunizing ‘conventionalist tricks’ or strategies are totally unacceptable from a scientific point of view. Equivocation between interpreting models as empirically empty and purely deductive-axiomatic analytical systems, or, respectively, as models with explicit empirical aspirations is unwarranted and highly questionable. Models and theories that are compatible with everything, or come with unspecified domains of application, are worthless from a scientific point of view.

But, of course, no discussion of counterexamples is complete without a mention of Morgenbesser’s retort. So here it is:

morgenbesser

1 Comment

  1. If revealed preference theory is unprovable, doesn’t it follow that prices cannot be proved efficient? If prices cannot be proven efficient, doesn’t that make the efficient market hypothesis very shaky and not something to base public policy on? In particular if market prices are arbitrary and market allocations are not efficient, why should we strive to maximize GDP and fear inflation? We should use public policy to explore the idea that the more you know, the less you need. We should implement full indexation of the economy and convert prices to units of real income purchasing power so that unexpected, unwanted, even runaway nominal inflation disappears. If the basic assumptions of the efficient market hypothesis are flawed, why do we still talk of “price signals”? Public policy should override price signals when they result in gross inequality, and deprivation as in Venezuela. The Fed could easily open an unlimited currency swap line with Greece, or Venezuela, as it has with the ECB. Only market fundamentalist public policy prevents us …


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