In this article we will discuss about the merits and demerits of Revealed Preference Theory.
(i) It does not involve any psychological introspective information about the behaviour of the consumer. Rather, it presents a behaviouristic analysis based on observed consumer behaviour in the market. This approach has helped, according to Samuelson, to divest the theory of demand of the “last vestiges” of the psychological analysis.
Thus the revealed preference hypothesis is more realistic, objective and scientific than the earlier demand theorems.
(ii) It avoids the “continuity” assumption of the utility and indifference curve approaches. An indifference curve is a continuous curve on which the consumer can have any combination of the two goods. Samuelson believes that there is discontinuity because the consumer can have only one combination.
(iii) The Hicksian demand analysis is based on the assumption that the consumer always behaves rationally to maximise his satisfaction from a given income. Samuelson’s demand theorem is superior because it completely dispenses with the assumption that the consumer always maximises his satisfaction, and makes no use of the dubious hypothesis like the Law of Diminishing Marginal Utility of the Marshallian analysis or the Law of Diminishing Marginal Rate of Substitution of the Hicksian approach.
(iv) In the first stage of Samuelson’s demand theorem the ‘over compensation effect’ is more realistic as an explanation of consumer behaviour than the Hicksian substitution effect. It permits the consumer to shift to a higher price-income situation in case of rise in the price of X and vice versa. It is an improvement over Hicks “compensating variation”.
(v) Similarly, the second stage of the Samuelsonian Theorem explains the Hicksian income effect in a much simpler way. Hicks himself admits the superiority of Samuelson’s theory when he writes that as a clear alternative to the indifference technique its presentation is the newest and important contribution of Samuelson to the theory of demand.
(vi) This theory provides the basis for welfare economics in terms of observable behaviour based on consistent choice.