Home > Uncategorized > Revealed preference theory — much fuss about ‘not very much’

Revealed preference theory — much fuss about ‘not very much’

from Lars Syll

Paul-Samuelson-Pioneer-of-Revealed-Preference-TheoryWe must learn WHY the argument for revealed preference, which deceived Samuelson, is wrong. As per standard positivist ideas, preferences are internal to the heart and unobservable; hence they cannot be used in scientific theories. So Samuelson came up with the idea of using the observable Choices – unobservable preferences are revealed by observable choices … Yet the basic argument is wrong; one cannot eliminate the unobservable preference from economic theories. Understanding this error, which Samuelson failed to do, is the first knot to unravel, in order to clear our minds and hearts of the logical positivist illusions.

Asad Zaman

This blog post made me come to think about an article on revealed preference theory that yours truly wrote twenty-five years ago and got published in History of Political Economy (no. 25, 1993).

Paul Samuelson wrote a kind letter and informed me that he was the one who had recommended it for publication. But although he liked a lot in it, he also wrote a comment — published in the same volume of HOPE — saying:

Between 1938 and 1947, and since then as Pålsson Syll points out, I have been scrupulously careful not to claim for revealed preference theory novelties and advantages it does not merit. But Pålsson Syll’s readers must not believe that it was all redundant fuss about not very much.

awongNotwithstanding Samuelson’s comment, I do still think it basically was much fuss about ‘not very much.’

In 1938 Paul Samuelson offered a replacement for the then accepted theory of utility. The cardinal utility theory was discarded with the following words: “The discrediting of utility as a psychological concept robbed it of its possible virtue as an explanation of human behaviour in other than a circular sense, revealing its emptiness as even a construction” (1938, 61). According to Samuelson, the ordinalist revision of utility theory was, however, not drastic enough. The introduction of the concept of a marginal rate of substitution was considered “an artificial convention in the explanation of price behaviour” (1938, 62). One ought to analyze the consumer’s behaviour without having recourse to the concept of utility at all, since this did not correspond to directly observable phenomena. The old theory was criticized mainly from a methodological point of view, in that it used non-observable concepts and propositions.

The new theory should avoid this and thereby shed “the last vestiges of utility analysis” (1938, 62). Its main feature was a consistency postulate which said: “if an individual selects batch one over batch two, he does not at the same time select two over one” (1938, 65). From this “perfectly clear” postulate and the assumptions of given demand functions and that all income is spent, Samuelson in (1938) and (1938a), could derive all the main results of ordinal utility theory (single-valuedness and homogeneity of degree zero of demand functions, and negative semi-definiteness of the substitution matrix).

In 1948 Samuelson no longer considered his “revealed preference” approach a new theory. It was then seen as a means of revealing consistent preferences and enhancing the acceptability of the ordinary ordinal utility theory by showing how one could construct an individual’s indifference map by purely observing his market behaviour. Samuelson concluded his article by saying that “[t]he whole theory of consumer’s behavior can thus be based upon operationally meaningful foundations in terms of revealed preference” (1948, 251). As has been shown lately, this is true only if we inter alia assume the consumer to be rational and to have unchanging preferences that are complete, asymmetrical, non-satiated, strictly convex, and transitive (or continuous). The theory, originally intended as a substitute for the utility theory, has, as Houthakker clearly notes, “tended to become complementary to the latter” (1950, 159).

Only a couple of years later, Samuelson held the view that he was in a position “to complete the programme begun a dozen years ago of arriving at the full empirical implications for demand behaviour of the most general ordinal utility analysis” (1950, 369). The introduction of Houthakker’s amendment assured integrability, and by that, the theory had according to Samuelson been “brought to a close” (1950, 355). Starting “from a few logical axioms of demand consistency … [one] could derive the whole of the valid utility analysis as corollaries” (1950, 370). Since Samuelson had shown the “complete logical equivalence” of revealed preference theory with the regular “ordinal preference approach,” it follows that “in principle there is nothing to choose between the formulations” (1953, 1). According to Houthakker (1961, 709), the aim of the revealed preference approach is “to formulate equivalent systems of axioms on preferences and on demand functions.”

But if this is all, what has revealed preference theory then achieved? As it turns out, ordinal utility theory and revealed preference theory are – as Wong puts it – “not two different theories; at best, they are two different ways of expressing the same set of ideas” (2006, 118). And with regard to the theoretically solvable problem, we may still concur with Hicks that “there is in practice no direct test of the preference hypothesis” (1956, 58).

Sippel’s experiments showed “a considerable number of violations of the revealed preference axioms” (1997, 1442) and that from a descriptive point of view – as a theory of consumer behaviour – the revealed preference theory was of a very limited value.

Today it seems as though the proponents of revealed preference theory have given up the original 1938-attempt at building a theory on nothing else but observable facts, and settled instead on the 1950-version of establishing “logical equivalences.”

Mas-Collel et al. concludes their presentation of the theory by noting that “for the special case in which choice is defined for all subsets of X [the set of alternatives], a theory based on choice satisfying the weak axiom is completely equivalent to a theory of decision making based on rational preferences” (1995, 14).

When talking of determining people’s preferences through observation, Varian, for example, has “to assume that the preferences will remain unchanged” and adopts “the convention that … the underlying preferences … are known to be strictly convex.” He further postulates that the “consumer is an optimizing consumer.” If we are “willing to add more assumptions about consumer preferences, we get more precise estimates about the shape of indifference curves” (2006, 119-123, author’s italics). Given these assumptions, and that the observed choices satisfy the consistency postulate as amended by Houthakker, one can always construct preferences that “could have generated the observed choices.” This does not, however, prove that the constructed preferences really generated the observed choices, “we can only show that observed behavior is not inconsistent with the statement. We can’t prove that the economic model is correct.”

Kreps holds a similar view, pointing to the fact that revealed preference theory is “consistent with the standard preference-based theory of consumer behavior” (1990, 30).

The theory of consumer behavior 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 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 unfalsifiable and of being based on unrestricted universal statements.

As Kornai (1971, 133) remarked, “the theory is empty, tautological. The theory reduces to the statement that in period t the decision-maker chooses what he prefers … The task is to explain why he chose precisely this alternative rather than another one.” Further, pondering Amartya Sen’s verdict of the revealed preference theory as essentially underestimating “the fact that man is a social animal and his choices are not rigidly bound to his own preferences only” (1982, 66) and Georgescu-Roegen’s (1966, 192-3) apt description, a harsh assessment of what the theory accomplished should come as no surprise:

georgescu1Lack 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.

  1. C-R D
    September 5, 2017 at 3:55 pm

    “Yet the basic argument is wrong; one cannot eliminate the unobservable preference from economic theories”. It is this argument that is wrong.

    Consumer preference is in ordinal space. Ordinal space is observable in a set of reals that is isomorphically related to that ordinal space.Since the relevant mapping is a bijection, what can not be eliminated is its monotonicity; this is probably due to the fact that the set of preference does not have a minimum element. For more, please visit the references below.

    https ://mpra.ub.uni-muenchen.de/id/eprint/80408

    https://mpra.ub.uni-muenchen.de/id/eprint/78716

  2. September 5, 2017 at 6:09 pm

    So much unnecessary theorising.

    Back in 1879, Henry George began his analysis with two assumptions of human behaviour. (The fewer scientific assumptions the better.)

    “Men’s desires are unlimited.”

    “Man seeks to satisfy his desires with the least exertion.”

    No attempt to penetrate the consciousness to find conclusions that cannot be anything else but suspect. No attempt to set out what those desires may be, though survival is likely to be at the top, or close to the top. (If it isn’t, the subject is not likely to be long part of our enquiry!)

    The first assumption suggests there can be no such thing as unemployment. If we all worked 24-hours each day, we would be unable to satisfy unlimited desires.

    Why is this important? Because we can turn our attention to why people are unemployed even though there are unlimited desires that need satisfying. We might seriously look for an answer instead of slapping more and more financial palliatives onto an ever more (unnecessarily) complicated economy.

    The second assumption is self-evident. People don’t want jobs, yet our political-economic structure concentrates on jobs, jobs, jobs. We want the rewards of work – the more the better but with the least exertion.

    So, instead of supplying “jobs”, perhaps we should be finding out why people can’t find jobs. The answer may be surprising.

    Harry Pollard

  3. Norman L. Roth
    September 5, 2017 at 7:10 pm

    Sept. 05, 2017
    This commentary is addressed mainly to Mr. Lars Syll. BUT, All others welcome too..

    When it comes to the debunking of Paul Samuelson’s “Revealed Preference theory”, nothing beats Stanley Wong’s {with Philip Mirowski’s support} FOUNDATION’S OF PAUL SAMUELSON’S REVEALED PREFERENCE THEORY, 1978: Published by Routledge & Regan Paul.. Revised edition published by Routledge in 2006. Notice Mr. Wong’s send.
    up of Samuelson’s pompously titled “FOUNDATIONS of ECONOMIC ANALYSIS” in the title. of M. Wong’s own very RIGHT book {pun intended}.

    A far different {“faith-based”} approach to assaulting Samuelson’s “masterpiece” of tautology and the neglect of the sequence of real time ,is revealed by advocates of “Islamic Economics & Finance”. They skewer Samuelson’s application of “Logical Positivism” by denouncing REVEALED PREFERENCE as anti-Islamic: Because “It rejects the unseen”.. While Islam demands “faith in the unseen”…. Hmmmm ? For a thorough treatment of the natural history of Consumer’s and Consumption, I recommend reading Chapter 2 of TELOS & TECHNOS: i.e…TELOS & THE CURRENT CONCEPTION of the STANDARD of LIFE. Which treats human nature’s zest for the enjoyment of “the better things in life” with respect, rather than sanctimonious denunciation or bizarre ranting about “commodity fetiishism”.. See page 90 of 197 page edition of TELOS & TECHNOS. Obviously Marx hated the very idea of human beings freely choosing the goods & services they wanted according to their own value loadings.
    This chapter also reveals the attitudes of much deeper & less embittered thinkers than Samuelson or Marx, on the notion of “consumer insatiability” Including John Ramsey McCulloch {believer in its “automaticity”}}, John Kenneth Galbraith {Up-date of Savanarolla & Marx combined ?},Thorstein Veblen {not quite a believer}, Alfred Marshall {non-believer}.
    Savanarolla, who believed in it as mortal sin which had to be curtailed. Unfortunately, I was remiss in my failure to mention Elizabeth Hoyt and her classic 1944 article about the role of the GESTALT in Consumer economics. The idea of the CURRENT CONCEPTION of the STANDARD of LIFE as a complex historical process of accumulation & decummulation is incompatible with the shallow anti-historical idea of “consumer insatiability”.. What is there about the whole subject of consumer behavior that attracts even more cranky vituperation & conspiratorial polemics than even Money and Banking ?.

    Thank you for your patience.

    Please GOOGLE: {1} Norman L. Roth {2} Norman L. Roth, Curent Conception of the Standard of Life {3} Norman L. Roth, Technological Time {4} Norman L. Roth, Origins of Markets {5} Norman L. Roth, Economics

  1. No trackbacks yet.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s