WARP&SARP (2) Notes PDF

Revealed Preference Analysis
Weak and the Strong Axioms of

Revealed Preference
Revealed Preference Analysis
• Suppose we observe the demands (consumption
choices) that a consumer makes for different
budgets. This reveals information about the
consumer’s preferences. We can use this
information to ...
Test the behavioral hypothesis that a consumer
chooses the most preferred bundle from those
available.
Discover the consumer’s preference relation.
Assumptions on Preferences
• Preferences
• do not change while the choice data are gathered.
• are strictly convex.
• are monotonic.
• Together, convexity and monotonicity imply that
the most preferred affordable bundle is unique.
Assumptions on Preferences
x2
If preferences are convex and
monotonic (i.e. well-behaved)
then the most preferred
x2* affordable bundle is unique.
x1* x1
Direct Preference Revelation
• Suppose that the bundle x* is chosen when the
bundle y is affordable. Then x* is revealed directly
as preferred to y (otherwise y would have been
chosen).
The chosen bundle x* is
x2 revealed directly as preferred
to the bundles y and z.
p
x* x*x*
D
y
y z x*x*
p
z
D
x1
Indirect Preference Revelation
• Suppose x is revealed directly preferred to y, and y
is revealed directly preferred to z. Then, by
transitivity, x is revealed indirectly as preferred to
z. Write this as x z
I
x y y z x z
D D I
x2
z is not affordable when x* is chosen.
x*
x1
x2
x* is not affordable when y* is chosen.
x*
y*
z
x1
x2
x*
y*
z
x1
x2
So x* and z cannot be compared
x* directly.
y*
z
x1
x2
x* directly.
But x*x* y*
p
y* D
z
x1
x2
x* directly.
But x*x* y*
p
y* D
z and y*
p z
D
x1
x2
x* directly. p
But x* D y*
y*
and y* z
p
z D
p
so x* I z.
x1
Two Axioms of Revealed
Preference
• To apply revealed preference analysis, choices must
satisfy two criteria -- the Weak and the Strong
Axioms of Revealed Preference.
The Weak Axiom of Revealed
Preference (WARP)
• If the bundle x is revealed directly as preferred to
the bundle y then it is never the case that y is
revealed directly as preferred to x; i.e.
x
p y not (y
p x).
D D
Preference (WARP)
• Choice data which violate the WARP are inconsistent
with economic rationality.
• The WARP is a necessary condition for applying
economic rationality to explain observed choices.
Preference (WARP)
• What choice data violate the WARP?
Preference (WARP)
x2
y
x
x1
Preference (WARP)
x2
x is chosen when y is available
so x y.
p
D
y
x
x1
Preference (WARP)
x2
x is chosen when y is available
so x y.
p
D
y is chosen when x is available

so y x.
p
D
y
x
x1
Preference (WARP)
x2
x is chosen when y is available so x y.
p
D
y is chosen when x is available so y p x.
D
These statements are inconsistent
with each other.
y
x
x1
Checking if Data Violate the WARP
• A consumer makes the following choices:
• At prices (p1,p2)=($2,$2) the choice was (x1,x2) = (10,1).
• At (p1,p2)=($2,$1) the choice was (x1,x2) = (5,5).
• At (p1,p2)=($1,$2) the choice was (x1,x2) = (5,4).
• Is the WARP violated by these data?
At prices (p1,p2)=($2,$2) the choice was (x1,x2) = (10,1).
At (p1,p2)=($2,$1) the choice was (x1,x2) = (5,5).
Choices
(10, 1) (5, 5) (5, 4)
Prices
($2, $2) $22 $20 $18
($2, $1) $21 $15 $14
($1, $2) $12 $15 $13

Choices
(10, 1) (5, 5) (5, 4)
Prices
($2, $2) $22 $20 $18
($2, $1) $21 $15 $14
($1, $2) $12 $15 $13
Red numbers are costs of chosen bundles (as much as wealth)

Choices
(10, 1) (5, 5) (5, 4)
Prices
($2, $2) $22 $20 $18
($2, $1) $21 $15 $14
($1, $2) $12 $15 $13
Red numbers are costs of chosen bundles (as much as wealth

Circles surround affordable bundles that were not chosen
Choices
(10, 1) (5, 5) (5, 4)
Prices
($2, $2) $22 $20 $18
($2, $1) $21 $15 $14
($1, $2) $12 $15 $13

Choices
(10, 1) (5, 5) (5, 4)
Prices
($2, $2) $22 $20 $18
($2, $1) $21 $15 $14
($1, $2) $12 $15 $13

Choices Chosen
(10, 1) (5, 5) (5, 4) (10, 1) (5, 5) (5, 4)
Prices ↓
($2, $2) $22 $20 $18 (10,1) D D
($2, $1) $21 $15 $14 (5, 5) D
($1, $2) $12 $15 $13 (5 ,4) D

Choices Chosen
(10, 1) (5, 5) (5, 4) (10, 1) (5, 5) (5, 4)
Prices ↓
($2, $2) $22 $20 $18 (10,1) D D
($2, $1) $21 $15 $14 (5, 5) D
($1, $2) $12 $15 $13 (5 ,4) D

Chosen
(10,1) is directly revealed ↓
(10, 1) (5, 5) (5, 4)
preferred to (5,4),
but (5,4) is directly revealed (10,1) D D
preferred to (10,1),
(5, 5) D
WARP is (5 ,4) D
violated by the data
x2
(5,4) (10,1)
p
D
(10,1) (5,4)
p
D
x1
The Strong Axiom of Revealed
Preference (SARP)
• If the bundle x is revealed (directly or indirectly) as
preferred to the bundle y and x  y, then it is never
the case that the y is revealed (directly or
indirectly) as preferred to x; i.e.
p
x y or x y
p
D I
not ( y x or y x ).
p p
D I
Preference
• What choice data would satisfy the WARP but
violate the SARP?
Preference
• Consider the following data:
A: (p1,p2,p3) = (1,3,10) & (x1,x2,x3) = (3,1,4)
B: (p1,p2,p3) = (4,3,6) & (x1,x2,x3) = (2,5,3)
C: (p1,p2,p3) = (1,1,5) & (x1,x2,x3) = (4,4,3)

Preference
Choice
A: ($1,$3,$10) A B C
Prices
(3,1,4).
A $46 $47 $46
B: ($4,$3,$6)
(2,5,3).
B $39 $41 $46
C: ($1,$1,$5)
(4,4,3). C $24 $22 $23
Preference
A: ($1,$3,$10), (3,1,4)
B: ($4,$3,$6), (2,5,3)
C: ($1,$1,$5), (4,4,3)
In situation A, bundle A is
directly revealed preferred to Chosen
A B C
bundle C; A C. ↓
D
In situation B, bundle B is A $46 $47 $46
directly revealed preferred to
bundle A; B A. B $39 $41 $46
D
In situation C, bundle C is C $24 $22 $23

directly revealed preferred to
bundle B; C B.
D
Preference
A: ($1,$3,$10), (3,1,4)
B: ($4,$3,$6), (2,5,3)
C: ($1,$1,$5), (4,4,3)
Chosen Chosen
A B C A B C
↓ ↓
A $46 $47 $46 A D
B $39 $41 $46 B D
C $24 $22 $23 C D
The data do not violate the WARP.

Preference
A: ($1,$3,$10), (3,1,4)
B: ($4,$3,$6), (2,5,3)
C: ($1,$1,$5), (4,4,3)
We have that Chosen

A B C
↓
A C, B A and C B
D D D A D
violates transitivity
B D
C D
violates SARP
The data do not violate the WARP, but

violates SARP
Preference
• That the observed choice data satisfy the SARP is a
condition necessary and sufficient for there to be a
well-behaved preference relation that “rationalizes”
the data

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Revealed Preference Analysis

Weak and the Strong Axioms of

y is chosen when x is available

($2, $1) $21 $15 $14

($1, $2) $12 $15 $13

($2, $1) $21 $15 $14

($1, $2) $12 $15 $13

Red numbers are costs of chosen bundles (as much as wealth)

($2, $1) $21 $15 $14

($1, $2) $12 $15 $13

Red numbers are costs of chosen bundles (as much as wealth

($2, $1) $21 $15 $14

($1, $2) $12 $15 $13

Red numbers are costs of chosen bundles (as much as wealth

($2, $1) $21 $15 $14

($1, $2) $12 $15 $13

Red numbers are costs of chosen bundles (as much as wealth

($2, $1) $21 $15 $14 (5, 5) D

($1, $2) $12 $15 $13 (5 ,4) D

Red numbers are costs of chosen bundles (as much as wealth

($2, $1) $21 $15 $14 (5, 5) D

($1, $2) $12 $15 $13 (5 ,4) D

Red numbers are costs of chosen bundles (as much as wealth

A: (p1,p2,p3) = (1,3,10) & (x1,x2,x3) = (3,1,4)

B: (p1,p2,p3) = (4,3,6) & (x1,x2,x3) = (2,5,3)

C: (p1,p2,p3) = (1,1,5) & (x1,x2,x3) = (4,4,3)

In situation C, bundle C is C $24 $22 $23

B $39 $41 $46 B D

C $24 $22 $23 C D

The data do not violate the WARP.

We have that Chosen

The data do not violate the WARP, but

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