Dominick Salvatore Schaums Outline of Microeconomics, 4th edition Schaums Outline Series 2006

CHAP. 5] ADVANCED TOPICS IN CONSUMER DEMAND THEORY 103
Fig. 5-1
5.2 THE THEORY OF REVEALED PREFERENCE
Up to now we assumed that indifference curves were derived by asking the consumer to choose among
all possible baskets or combinations of commodities. However, consumers often cannot or will not give trustworthy
answers to direct questions on their preferences. According to the theory of revealed preference, a consumer’s
preferences can be inferred (and indifference curve derived) from a sufficient number of observed
choices or purchases in the marketplace, without any need to inquire directly into the individual’s preferences.
For example, if a consumer is observed to purchase basket A rather than basket B, and A is not cheaper than B,
then for this consumer A must be superior to B.
The theory of revealed preference rests on the following assumptions:
(1) The individual’s tastes do not change over the period considered.
(2) There is consistency; that is, if the consumer is observed to prefer basket A to basket B, then this
consumer will never prefer B to A.
(3) There is transitivity; that is, if A is preferred to B and B to C, then A is preferred to C.
(4) Finally, the consumer can be induced to purchase any basket of goods if its price is made sufficiently
attractive.
EXAMPLE 2. Figure 5-2 shows how a consumer’s indifference curve can be derived from revealed preference. Suppose
that the consumer is observed to be at point A on budget line NN (the same as point E on KL in Fig. 5-1). Then, A is preferred
to any point on or below NN. On the other hand, points above and/or to the right of A are superior to A since they involve
more of X and/or Y. Thus, the consumer’s indifference curve must be above NN, except at point A where it is tangent to NN,