Revealed Preference Principle Quiz

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Questions and Answers

What effect does an increase in the interest rate have on the consumption of a lender?

Consumption in the second period increases. (correct)

Consumption in the second period decreases.

Consumption in the first period decreases.

Consumption in the first period increases.

According to WARP, which statement is true regarding a borrower's well-being following an interest rate increase?

Their welfare must definitely increase.

Their welfare must definitely decrease. (correct)

Welfare can remain the same.

Welfare is unaffected by interest rate changes.

How does the budget line change in response to an interest rate adjustment?

It rotates around the endowment point. (correct)

It remains unchanged.

It shifts parallel to the original line.

It becomes steeper but does not intersect the axes.

What remains constant according to the supply and demand interactions for a lender at varying interest rates?

The total endowment of resources. Signup and view all the answers

What is the consequence for a lender when the interest rate decreases?

The lender will still continue as a lender. Signup and view all the answers

What can be inferred about the relationship between x and y if a consumer is a utility maximizer?

x is preferred over y. Signup and view all the answers

What does the principle of revealed preference suggest about the consumer's choice of bundles?

It indicates the consumer prefers one bundle over another based on chosen options. Signup and view all the answers

If y is preferred to z and x is preferred to y, what conclusion can be drawn?

x is preferred to z. Signup and view all the answers

What implication does the convexity of preferences have regarding bundles Y and Z when compared to bundle X?

Mixed combinations of Y and Z are also preferred over X. Signup and view all the answers

What does the budget line represent when evaluating choices made under prices p?

The combination of goods that can be purchased within the income limit. Signup and view all the answers

What is the significance of a rich dataset of choices in understanding consumer preferences?

It enhances understanding of the effects of policy decisions on preferences. Signup and view all the answers

When presented with choices among bundles, what does the concept of indirect revelation imply?

Preferences are indicated by the consumer's actual choices under varying conditions. Signup and view all the answers

Which statement best describes the implications of the choice between bundles under different prices?

Consumer preferences can shift based on the pricing structure. Signup and view all the answers

What does SARP imply about revealed preferences?

If x is revealed to be better than y, then y cannot be better than x. Signup and view all the answers

How does SARP relate to utility maximization?

SARP provides both necessary and sufficient conditions for utility maximization. Signup and view all the answers

What indicates that a dataset is consistent with utility maximization?

SARP must be fulfilled for the dataset. Signup and view all the answers

Which of the following best describes SARP?

It focuses on transitive relationships in revealed preferences. Signup and view all the answers

What happens if stars in parentheses appear in the diagonal cells?

It indicates that SARP is not fulfilled. Signup and view all the answers

What is a potential challenge when testing SARP?

Identifying indirect preferences requires systematic checking. Signup and view all the answers

What does the notation $p1 x1 + p2 x2 \geq p1 y1 + p2 y2$ imply in the context of utility maximization?

The bundle (y1, y2) is not affordable if (x1, x2) is chosen. Signup and view all the answers

Which of these statements is true regarding the examples provided?

Numerous possible chains must be checked for SARP compliance. Signup and view all the answers

Which statement reflects the importance of WARP in the utility maximization model?

WARP is a testable implication of the utility maximization model. Signup and view all the answers

What signifies that WARP is not fulfilled when analyzing price observations?

A star is marked in multiple rows and columns. Signup and view all the answers

What might be inferred from choice bundles being affordable yet yielding contradictory results?

A violation of SARP terms might be occurring. Signup and view all the answers

In the provided table, what do the starred bundles represent?

Bundles that are cheaper than the chosen bundles. Signup and view all the answers

What role does transitivity play in SARP?

SARP implies that transitivity must hold at least indirectly. Signup and view all the answers

What is the slope of the budget line in intertemporal choices?

-(1+i) Signup and view all the answers

Which type of preferences is characterized by an indifference to the timing of consumption?

Perfect substitutes Signup and view all the answers

What does the expression $q1 y1 + q2 y2 \geq q1 x1 + q2 x2$ denote?

Bundle y is affordable when bundle x is chosen. Signup and view all the answers

What implication arises from indirect revelations under SARP?

Indirect revelations can contradict previously direct preferences. Signup and view all the answers

Which scenario demonstrates the fulfillment of WARP?

Choosing different bundles but maintaining consistent affordability. Signup and view all the answers

What does the term 'creditor' refer to in intertemporal consumption choices?

A consumer who chooses a present consumption less than available income Signup and view all the answers

In the context of WARP and utility maximization, the diagonal of the right table in the observations shows what?

The actual expenditures for the chosen bundles. Signup and view all the answers

In the case of Cobb-Douglas preferences, what is optimal concerning consumption across periods?

A mix of consumption between the two periods is optimal Signup and view all the answers

What assumption is particularly relevant in intertemporal consumption problems regarding preferences?

Convexity of preferences Signup and view all the answers

If two bundles are affordable in the context of WARP but do not reflect the same choice, what does this indicate?

There is a violation of consumer rationality. Signup and view all the answers

What can be concluded if data points contradict the implications of WARP?

The model of utility maximization may not apply. Signup and view all the answers

If a consumer chooses consumption $c_1$ greater than their initial income $m_1$, how are they classified?

Borrower Signup and view all the answers

Which statement correctly describes the relationship between consumption bundles $(c_1, c_2)$ under perfect complements?

Both quantities must be consumed in equal amounts Signup and view all the answers

How can WARP be utilized in assessing data sets?

It serves as a framework for checking consistency in choices. Signup and view all the answers

What does m2 represent in the context of the intertemporal budget constraint?

Future consumption value Signup and view all the answers

Which statement about the impact of interest rates on consumption choices is correct?

Higher interest rates reduce future consumption incentives Signup and view all the answers

What does the term 'indifference curve' represent in intertemporal choices?

Different combinations of consumption yielding the same utility Signup and view all the answers

Study Notes

The Principle of Revealed Preference

Consumers are utility maximizers, they make choices that maximize their utility, and revealed preference is a principle that allows us to deduce their preferences based on their choices.
If a consumer selects bundle x instead of another bundle y that is also affordable, it is assumed x is weakly preferred to y.
If the consumer x is strictly better than y when choosing bundle x, then it is directly revealed preferred.
Indirect revealed preference can occur when there are multiple bundles, x, y, and z. If y is preferred to z and x is preferred to y, we know that x is indirectly preferred to z.

Learning about Preferences

The more data we have on a person's choices, the more we can learn about their preferences.
The text illustrates how we can learn about bundles y and z and their preferences compared to bundle x. It uses the concept of convexity in preferences to show that any combination of y and z are better than x.
We can deduce that y is not directly preferred to x if y was not affordable when choosing bundle x.
If y was affordable when choosing x, then x is directly preferred to y.

Testing WARP

WARP (Weak Axiom of Revealed Preference) is a testable implication of the utility maximization model.
The text uses a table to demonstrate how we can apply WARP to a set of observed choices.
If we have three bundles chosen at three sets of prices, we can calculate the cost of those bundles at each set of prices.
We can test WARP by marking bundles that are cheaper than the chosen bundle, then looking for contradictions.
If there are contradictions, where a bundle is affordable in two situations, but not chosen in both, then WARP is not satisfied.
When WARP is contradicted, it means that the observed choices are inconsistent with the assumption of rational utility maximization.

The Strong Axiom of Revealed Preference (SARP)

SARP is an extension of WARP that includes indirect revealed preferences.
SARP states that if a bundle x is revealed preferred to y, either directly or indirectly, then y can't also be revealed preferred to x.
SARP is a necessary condition for utility maximization, meaning that if utility maximization holds, SARP must also hold.
SARP is also a sufficient condition for utility maximization. This means if SARP is satisfied, then utility maximization must hold.

Testing SARP

The text provides another table for demonstrating SARP, with three choices and their corresponding costs.
When testing SARP, we need to consider all possible indirect revealed preferences.
If we find that a bundle y is revealed preferred to a bundle x both directly and indirectly, then SARP is not satisfied.
This contradiction would indicate that the choices are not consistent with utility maximization

Intertemporal Decisions

Intertemporal decisions involve making choices between consuming goods in different periods.
The text introduces the concept of the intertemporal budget constraint, where it's possible to borrow by consuming more in the current period and less in the future period.
Consumption smoothing is the idea that people prefer a smoother flow of consumption over time.
Perfect substitutes in consumption mean the consumer is indifferent between consuming a good now or later.
Perfect complements mean the consumer wants the same amount of consumption in each period.
Cobb-Douglas preferences imply a balanced mix of consumption over time.

Comparative Statics using WARP

The text uses WARP to analyze how changes in the interest rate affect consumption decisions.
A consumer who chooses to consume more than their current income is called a borrower, and a consumer who chooses to consume less is a lender.
The text uses a graphical representation to show how the budget constraint rotates around the endowment point when the interest rate changes.
WARP tells us that a lender will continue to be a lender after an interest rate increase.
However, WARP does not permit us to conclude whether a lender will borrow after a decrease in interest rates.
Regarding a borrower, WARP cannot tell us anything about their behavior.

Additional Notes

The text discusses how we can use WARP to analyze the impact of changes in prices or income on consumption decisions.
Revealed preference provides a way to understand consumer choices without having to directly observe their preferences. This makes it a useful tool for economists.
The text emphasizes the importance of having a rich dataset of choices in order to learn more about a consumer's preferences.

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Description

Test your understanding of the revealed preference principle, which is essential for analyzing consumer choice behavior. This quiz will cover direct and indirect revealed preferences, as well as how we can learn about consumer preferences through their choices.