Consumer Demand and Revealed Preference

Consumer Theory

Economics is frequently described as the study of the allocation of scarce resources. This is a very broad description, and it can be interpreted at both an individual and a societal level. In order to understand how resources are allocated at a social level, we first need to know how an individual will select from possible allocations of the resources available to him or to her. There are innumerable examples of these choices, such as purchases of goods or services, the allocation of income between present and future consumption, or the allocation of time between work and leisure. Many of these choices have common elements. Each has a constrained set of possible alternative choices (e.g., income is limited, and there are only 24 hours in a day). For each of these choices there is a rate of exchange between the alternatives. Relative prices of goods and services determine the tradeoffs or rates of exchange between the consumption alternatives; the interest rate determines the rate of exchange between present and future consumption; and the wage rate determines the rate of exchange between work (and hence consumption) and leisure. The economic theory of consumer choice abstracts away from particulars in order to develop models that can be used to analyze a range of choice problems. Once the general model is developed, it can be applied to a wide range of specific choice problems.

Objectives and Organization

The objective of this topic is to describe the economic model of choice, preferences, and demand. The materials are designed to cover a range of backgrounds and interests, from introductory to advanced undergraduate or even beginning graduate microeconomics. The sections with more difficult materials can be skipped without a loss of continuity. Each section below is marked as beginning (B), intermediate (I), or advanced (A).

Contents:

1. The Consumer's Budget
2. Choices and Preferences
    a. Choice Example
    b. Preferences
    c. Derived Properties of Preferences
    d. Example of Inconsistent Choices
    e. Representation of Preferences by a Utility Function
    f. Examples of Consistent Choices
3. Revealed Preference (WARP, SARP, and GARP)
4. Demand