Joan Robinson and the inadequacies of revealed preference theory

17 October, 2017 at 19:13 | Posted in Economics | 6 Comments

We are told nowadays that since utility cannot be measured it is not an operational concept, and that ‘revealed preference’ should be put in its place. Observable market behaviour will show what an individual chooses …

joanIt is just not true that market behaviour can reveal preferences. It is not only that the experiment of offering an individual alternative bundles of goods, or changing his income just to see what he will buy, could never be carried out in practice. The objection is logical, not only practical …

We can observe the reaction of an individual to two different sets of prices only at two different times. How can we tell what part of the difference in his purchases is due to the difference in prices and what part to the change in his preferences that has taken place meanwhile? There is certainly no presumption that his character has not changed, for soap and whisky are not the only goods whose use affects tastes. Practically everything develops either an inertia of habit or a desire for change.

We have got one equation for two unknowns. Unless we can get some independent evidence about preferences the experiment is no good. But it was the experiment that we were supposed to rely on to observe the preferences.

As so often, Robinson hits the nail on the head.

The very raison d’être for developing revealed preference theory in the 1930’s and 1940’s was to be able to ascertain people’s preferences by observation of their actual behaviour on markets and not having to make unobservable psychological assumptions or rely on any utility concepts. This turned out to be impossible. Samuelson et consortes had to assume unchanging preferences, which, of course, was in blatant contradiction to the attempt of building a consumer and demand theory without non-observational concepts. Preferences are only revealed from market behaviour when specific theoretical constraining assumptions are made. Without making those assumptions there are no valid inferences​ to make from observing people’s choices on a market.

But still, ​a lot of mainstream economists consider the approach offered by revealed preference theory a great progress. As people like Robinson, Georgescu-Roegen, and Kornai have shown, this is, however, nothing but an illusion. Revealed preference theory does not live up to what it claims to offer. As part of the economist’s​ tool-kit, ​it is of extremely limited use.

If we want to be able to explain the behaviour and choices people make, we have to know​ something about people’s beliefs, preferences, uncertainties​, and understandings. Revealed preference​ theory does not provide us with any support whatsoever in accomplishing that.

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6 Comments

  1. The problem as I see it is that real world markets don’t care much for my tastes. Stores treat me as superfluous. In a world of r > g, firms can make more from pure investing. Derivatives and swaps and other “special purpose vehicles” multiply the price value of any underlying real assets. I think Mary Mellor says it best in Money for the People (I’ve probably quoted this here before … ):

    “The primary aim of the capitalist market economy is not the provision of essential goods and services for the people, but the investment of money and labor in activities that provide even more money (i.e., profit) for the owners of capital.”

    Provision just enough for your neoliberal walled garden, and amass money-as-points via games such as flipping houses to each other, and you don’t need more customers. You can passive-aggressively exclude all your non-friends from markets by pricing them out, while enforcing constraints on social spending by government. The budget constraint is required for government but the private sector often deals with insolvency by keeping its funding liquidity rolling over. “Liquidity kills you quick”, solvency can be reckoned with another day. But for government, budgets must balance, so that private markets capriciously control my access to vast persistent surplus …

    • All this is way off Robinson’s point, of course, but good soap box fair. 🙂 Although, your point about your tastes supports the notion that standard neoclassical economics has little to say about the real world.
      .
      Swapping assets at ever increasing prices is an illusory wealth creation game. Wealth creation entails increasing real output. However, someone has to have the income to buy that output. Squeezing the “lower orders”, paradoxically, works against this. One day, the “upper echelons” will wake up to this fact.
      .
      Quantitative easing failed because it, essentially, fostered swapping deckchairs on the Titanic.

      • Why must real output increase?

        I hear ads on the radio for weight loss, and marvel at the health problems we’ve created for ourselves through oversupply. But the factory farm owners, the truckers, the restauranteers, the doctors, the weight loss clinic makes money keeping ppl ignorant and GDP increases so markets are working efficiently!

        “Quantitative easing failed because it, essentially, fostered swapping deckchairs on the Titanic.”

        The Titanic is risen, housing prices are inflating because shadow banking is back in full swing with better insurance mechanisms. Mehrling defines shadow banking as money market funding of capital market lending. I would say that shadow banking multiplies price values of derivative assets internally, and funds loans with that internally-created money as well. Housing inflation is driven more by money supplied out of thin air by the private world financial sector than by rising incomes.

        • “Why must real output increase?”

          If, say, property prices rise in general and I have a property portfolio and I am a high income earner and I don’t need to increase my consumption, then what have I gained? If I sell one property to buy an other, I gain nothing.

          • I’ll quote Sister Simone again. She said she gave a speech to CEOs; she asked if they really needed their millions in compensation to put food on the table. One responded: No, Sister Simone, we don’t need the money to live. We want to make more than the other guy.

            You gain points in a neoliberal game with rigged rules arbitrarily set and changed at will by a powerful select few.

            Quoting Mary Mellor, again, from http://www.greattransition.org/publication/money-for-the-people

            “The primary aim of the capitalist market economy is not the provision of essential goods and services for the people, but the investment of money and labor in activities that provide even more money (i.e., profit) for the owners of capital.”

            Since r > g, capital becomes its own labor, and you have gained stature among neoliberal peers by amassing more assets. He who dies with the most toys and/or biggest bank account wins …

  2. “As so often, Robinson hits the nail on the head.”

    Absolutely. And the profession still does not do any serious reflection. I also advise people not to hold their breath with this Rethinking Macroeconomics conference. The outcome will be that we need more frictions in rational choice models.


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