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Original Title: Lecture Revealed Preference A

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Ichiro Obara

UCLA

Obara (UCLA)

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L ++

L ,t +

= 1, ..., T

from a consumer.

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Here we take a very dierent approach to choice behavior. We start with some axioms on choice behavior, not on preference. Consider the following properties. x t is revealed preferred to x s if p t x s p t x t . x t is strictly revealed preferred to x s if p t x s < p t x t .

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Here is one well-known axiom.

For any x t , x s D, if x t is revealed preferred to x s and x t = x s , then x s is not revealed preferred to x t .

WARP

x

t

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For any p t(n) , x t(n) , n = 1, ..., N D, if x t(n) is revealed preferred to x t(n+1) for n = 1, ..., N 1, then x t(N) is not strictly revealed preferred to x t(1) .

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What is the use of axioms such as these? They may have a normative value. If you think that they are reasonable, you may apply their implications in your decision making. They may have a descriptive value. We may like to use it to...

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check if the data is consistent with some preference or a particular class of preferences,

2 3

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If a consumers choice is based on his or her preference, then the following must be the case.

u(x t ) u(x s ) if x t is revealed preferred to x s , and u(x t ) > u(x s ) if x t is strictly revealed preferred to x s and u is locally nonsatiated. u(x t ) > u(x s ) if x t is revealed preferred to x s , x t = x s and u is strictly quasi-concave.

So GARP or WARP may be necessary for such consumers. Then (in principle) they can be used to check if the assumption of utility maximization is contradicted by the data.

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Is the converse true? Can we regard a consumer as a utility maximizer when these axioms are satised?

Rationalizable Data

A nite data set D is rationalized by a utility function u : u(x t ) u(x) for all x B(p t , p t x t ) and t = 1, ..., T . More precisely, the question is: can we nd a utility function that rationalizes the data when the data satises the above axioms?

L +

if

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Example. Consider three price-commodity bundle pairs given by p 1 = (1, 1, 2), p 2 = (2, 1, 1), p 3 = (1, 2, 1 + e), x 1 = (1, 0, 0), x 2 = (0, 1, 0), x 3 = (0, 0, 1). This satises WARP, but violates GARP. Thus there is no (locally nonsatiated) utility function that rationalizes it.

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This example suggests that...

GARP

WARP Rationalizable Data

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But it turns out that the right picture is the following.

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Theorem (Afriat)

The following statements are equivalent.

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A nite data set D satises GARP. A nite data set D can be rationalized by a continuous, concave, and strongly monotone utility function.

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Some intuition: Whether a consumers indierent curve is a red curve or a blue curve cannot be detected by two data points.

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Some intuition: Whether a consumers indierent curve is a red curve or a blue curve cannot be detected by two data points.

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Proof of 2 3. It can be shown that U t , t > 0, t = 1, ..., T such that for all i, j, U j U i + i p i (x j x i ). Dene u by u(x) := min U t + t p t (x x t ) .

t

L +

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Remark. There is a natural interpretation of the inequality that appears in the beginning of the proof. Suppose that a consumer maximizes a concave utility function u. Then for any x i , x j D, u(x j ) u(x i ) + Du(x i ) x j x i The inequality is obtained if Du(x i ) = i p i (we will see this formula soon).

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Remark One way to interpret Afriats theorem is that, if GARP is satised, then we can treat the consumer as if he or she is maximizing a (well-behaved) utility function. So we may expect that all the implications of utility maximization apply to this consumers demand behavior.

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