Lecture 8 Ch4-2012VerDPost

# Lecture 8 Ch4-2012VerDPost - Revealed Preference Thus far...

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Revealed Preference 1 Thus far with the theory of consumer choice, we have asked the following question: Given preferences (indifference curves) and given a budget constraint, can we infer what the optimal choice basket will be? Learning Outcome: Using the theory of revealed preference , you will learn when you can reverse the direction of the inference. Given observations on baskets the consumer chooses under different budget constraints: 1) Can we infer a preference ordering on the baskets the consumer has chosen? 2) Can we infer whether a consumer is behaving irrationally (i.e., with intransitive preferences)? 3) Can we predict the baskets a consumer might choose with a new budget constraint? Northwestern University ɣ Economics 310-1 ɣ Microeconomic Theory ɣ Professors Ron Braeutigam and Jim Hornsten

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Drawing Inferences 2 If the consumer chooses basket A when B costs just as much, we know A is weakly preferred to B… ( A B) . If the consumer chooses basket C when C costs more than D, we know C is strongly preferred to D… ( C D) . Key Assumption: Consumer preferences (the underlying indifference map) do not change between observations. Northwestern University ɣ Economics 310-1 ɣ Microeconomic Theory ɣ Professors Ron Braeutigam and Jim Hornsten
Revealed Preference: An “Easy” Example 3 x y A BL1 BL2 B In all of the examples to follow, assume: Given budget line BL1, the consumer selects basket A. Given budget line BL2, the consumer selects basket B. For each good, more is better. Example 1: Can we infer how the consumer ranks baskets A and B? Northwestern University ɣ Economics 310-1 ɣ Microeconomic Theory ɣ Professors Ron Braeutigam and Jim Hornsten Under BL1 both baskets were affordable. A lies to the NE of B. Thus, we can infer that A B Under BL2, basket B was affordable. A was not affordable. Thus, just by looking at choices available with BL2, we can’t rank A and B

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Revealed Preference: A Little Harder 4 x y A BL1 BL2 B As before, assume: Given budget line BL1, the consumer selects basket A. Given budget line BL2, the consumer selects basket B. For each good, more is better. Example 2: Can we infer how the consumer ranks baskets A and B? Northwestern University ɣ Economics 310-1 ɣ Microeconomic Theory ɣ Professors
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## This note was uploaded on 02/16/2012 for the course ECON 310-1 taught by Professor Schulz during the Winter '08 term at Northwestern.

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Lecture 8 Ch4-2012VerDPost - Revealed Preference Thus far...

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