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Foundations of Contemporary Revealed Preference Theory

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Abstract

This paper examines methodological issues raised by revealed preference theory in economics: particularly contemporary revealed preference theory. The paper has three goals. First, to make the case that revealed preference theory is a broad research program in choice theory—not a single theory—and understanding this diversity is essential to any methodological analysis of the program. Second, to explore some of the existing criticisms of revealed preference theory in a way that emphasizes how the effectiveness of the critique depends on the particular version of revealed preference under consideration. Finally, three additional criticisms are presented that are aimed specifically at contemporary revealed preference theory.

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Notes

  1. [Box 38] Paul Samuelson Papers, David M. Rubenstein Rare Book and Manuscript Library, Duke University.

  2. Throughout this paper the term rational choice will be used for the general theoretical framework and particular choice theories—such as OUT or expected utility theory—will be viewed as particular instantiations of that general theoretical framework.

  3. There exists a more abstract set-theoretic version of RPT (Arrow 1959), but the discussion here will focus exclusively on RPT as a theory of consumer choice.

  4. See the consumer choice chapter of any advanced microeconomics textbook, for example Mas-Colell et al. (1995).

  5. See Hands (2006) and (2011) for detailed discussion of the integrability literature of this period.

  6. By Wong (2006) and others.

  7. It is always "a" utility function, not "the" utility function, since any monotonic transformation of a utility function generates the same demand functions (i.e. if U(x) is a utility function that would generate a particular set of demand functions, then V(x) = F[U(x)] with F′ > 0 would generate the same demands).

  8. This literature is discussed in detail in Varian (2006); Moscati and Tubaro (2011) survey some of the GARP-based empirical literature, while Moscati (2007) provides the most complete historical discussion of empirical work on revealed preference theory prior to 1970.

  9. One interesting philosophical question not explored here is the justification of the extension of the patterns revealed in the initial (observed) choice set XD onto the wider set X. It seems that some sort of robustness analysis would be required and it is not clear exactly where that would come from within CRPT (see Woodward (2000, 2006) for a general discussion of robustness and Kuorikoski et al. (2010) for a discussion of economics).

  10. Defenders of CRPT often say all of "standard economics," but they cannot possibly mean it. I am assuming they mean "choice theory" and not literally everything that goes on in economic science.

  11. This implies that TRPT satisfies OUT's context independence condition while ERPT, and thus CRPT, does not. See Hausman (2012, pp. 16–7) for a discussion of the meaning and importance of the context independence assumption in OUT.

  12. As Samuelson and his co-authors put it: "Why is this assumption peculiar? Because the demand functions … are market demand functions, not individual demand functions. ‘Rationality’ cannot be required of market demand functions because a changes in prices normally change the distribution of income. With a changed income distribution, different ‘preferences’ will be revealed. In other words, Wald really assumed that there is essentially only one rational consumer" (Dorfman et al. 1958, p. 368). Also see Samuelson (1955, pp. 499–500).

  13. Hausman (2008, 2012) makes a distinction between "actual" choice and "hypothetical" choice within RPT. This is an important distinction for some debates, but it is not essential to the argument here.

  14. It should be noted that in his most recent book (Hausman 2012), Hausman makes additional arguments about the failures of RPT, such as its inability to support game-theoretic reasoning. These arguments may be contested by defenders of CRPT, but the point is that he has expanded his critique of RPT in recent work.

  15. Dhongde and Pattanaik (2010) provide a detailed survey of the various criticisms of rational choice theory that Sen has raised over the years.

  16. Such argument have become quite popular in the recent literature in behavioral economics (see Kahneman 2003; Kahneman and Tversky 2000; Knetsch 1992; Thaler 1980; Tversky and Kahneman 1991and host of others).

  17. Bhattacharyya et al. (2011) provide a new, and more general, formulation for Sen's menu-dependence arguments, but end up supporting his basic position.

  18. See Hausman and McPherson (2006) or Hausman (2012) for a detailed discussion of welfare economics and its relationship to OUT.

  19. Gul and Pesendorfer do as well, but their discussion of this notion or normative economics is difficult to sort our from their discussion of welfare economics, so I will focus primarily on Binmore.

  20. Although this is not the only interpretation of Friedman's essay. See Mäki (2009) for a recent discussion of the literature.

  21. It should be noted that it may be possible to combine elements of CRPT with causal mechanisms other than traditional (mental state) preferences: i.e. a RPT theory based on ERPT that offers causal explanations of economic behavior (i.e. is not merely instrumental), but where folk-psychological preferences are not the relevant causes. This seems to be an aspect of Binmore's approach.

  22. At this point it should be noted that this entire paper has proceeded along without recognizing a significant elephant in the room. The elephant in the room is the work of Ross (2000, 2005, 2008, 2011 and elsewhere) and it is the most philosophically sophisticated defense of CRPT. Ross offers a realist-based defense of CRPT against some of the criticisms that have been raised in this paper, although he also admits that many of the defenders of CRPT, particularly Gul and Pesendorfer, are often confused (or at least overly rhetorical and isolationist) and do little to clarify the CRPT position (Ross 2011). The reason that Ross' arguments are not discussed here is simply that his position involves many deeply interconnected philosophical and scientific moving parts and any summary compact enough to be included here would not do it justice. It requires a separate investigation. Ross starts from Daniel Dennett's intentional stance, but a realist (not instrumentalist) interpretation of Dennett's position: the literature on "real patterns" (Dennett 1991; Ross 1995). It is committed to a particular version of realism—"structural realism" – but ontic structural realism (Ladyman 1998; Ross and Spurrett 2007), not the epistemic structural realism of John Worrall (1989). And finally, but significantly, it employs resources from the rapidly growing literature on neuroeconomics—the relationship between economics and neuroscience—particularly the work of Paul Glimcher (2003).

  23. Daniel McFadden's remark captures this nicely: "The work has both fascinated and dismayed economists: it has been like watching master carpenters construct the scaffold for your hanging" (McFadden 1999, p. 79).

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Acknowledgments

D. Wade Hands would like to thank Jonathan Andreas, Don Ross, and two anonymous referees for comments on an early draft of this paper. Errors, omissions, and remaining confusions are of course solely the author’s responsibility. Partial support was provided by the Institute for New Economic Thinking Grant IN01100003.

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    D. Wade Hands

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Hands, D.W. Foundations of Contemporary Revealed Preference Theory. Erkenn 78, 1081–1108 (2013). https://doi.org/10.1007/s10670-012-9395-2

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