Chapter 9 The Revealed Preference Approach to Demand

Abstract

The standard approach in measuring demand responses and consumer preferences assumes particular parametric models for the consumer preferences and demand functions, and subsequently fits these models to observed data. In principle, the estimated demand models can then be used (i) to test consistency of the data with the theory of consumer behavior, (ii) to infer consumer preferences, and (iii) to predict the consumer's response to, say, new prices following a policy reform. This chapter focuses on an alternative, nonparametric approach. More specifically, we review methods that tackle the earlier issues by merely starting from a minimal set of so-called revealed preference axioms. In contrast to the standard approach, this revealed preference approach avoids the use of parametric models for preferences or demand. The structure of the chapter is as follows. First, we introduce the basic concepts of the revealed preference approach to model consumer demand. Next, we consider issues like goodness-of-fit, power, and measurement error, which are important in the context of empirical applications. Finally, we review a number of interesting extensions of the revealed preference approach, which deal with characteristics models, habit-formation, and the collective model.