Revealed preference theory — an empty tautology

19 Sep, 2021 at 16:12 | Posted in Economics | 3 Comments

timthumbThe 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 empirically nonfalsifiable and of being based on unrestricted universal statements.

The theory is nothing but an empty tautology — and pondering on Reinhard Sippel’s experimental results and Nicholas Georgescu-Roegen’s apt description, a harsh assessment of what the theory accomplishes is inevitable:

analytLack 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.

3 Comments

  1. 》 In essence, hedging by purchasing call options allows you [to] have the best of both worlds, regardless of whether natural gas prices increase or decrease.
    .
    (From https://www.mercatusenergy.com/blog/bid/105354/an-introduction-to-consumer-natural-gas-hedging-part-iv-call-options )
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    Doesn’t finance allow you to bet on A (the price of your bundle rising) and not-A (the price of your consumer bundle falling) at the same time, thus violating the foundational assumption of Samuelson’s that you can only choose A or not-A? Was Samuelson ignorant of finance?
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    》 So how should a theory of consumer behaviour be formulated?
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    Don’t prices become arbitrary unless some kind of revealed preference theory is adopted? If prices are arbitrary, can’t we insure inflation using financial instruments such as inflation swaps, sold at low cost by the Fed if no one else will?

  2. So how should a theory of consumer behaviour be formulated?

    • First of all by being genuinely interested in understanding it. Notice the word ‘behaviour’. That suggests psychologists might be able to tell you something. OK, you might not get clever looking geometric and algebraic gimmickry, but the question is do you really want to understand human and social behaviour? Do you really need to understand that to understand capitalism and the economy?

      My answer would be yes.

      And I say genuinely interested. That means eschewing the neo-classical framework altogether as the monopolistic manner in which economic issues are approached and the disregarding or marginalisation of other forms of social knowledge. You can’t force real world knowledge into the Neo-classical construct without losing it. Neo-classical economics is an Anglo-Saxon construct that and its dominance reflects Anglo Saxon economic and political domination, particularly groups within that community – both good and bad – over the last century and a half, and particularly after 1945. There is very little to suggest this is a superior explanation of capitalism.

      Before you have your answers you need to ask the right questions. Do you we understand consumers? If the answer is no, study consumers and their behaviour first before you posit your Law of Gravity. Cast you net widely, using knowledge accumulated across disciplines. You can have wrong theories as reference points, as long as they are kept to that and don’t dictate the manner in which you go about analysis.


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