How Revealing is Revealed Preference?∗

This paper addresses the following two key criticisms of the empirical application of revealed preference theory: When it does not reject, it doesn’t provide precise predictions; and when it does reject, it doesn’t help us characterise the nature of irrationality or the degree/direction of changing tastes. Recent developments in the application of RP theory are shown to have rendered these criticisms unfounded. A powerful test of rationality is available that also provides a natural characterisation of changing tastes. Tight bounds on demand responses and on the welfare costs of relative price and tax changes are also available and are shown to work well in practice. ∗This review paper is based on the results of joint research with Martin Browning and Ian Crawford. I would also like to acknowledge the input of joint research and discussions with Xiaohong Chen, Dennis Kristensen, Rosa Matzkin, and James Powell. This study is part of the program of research of the ESRC Centre for the Microeconomic Analysis of Public Policy at IFS. The financial support of the ESRC and of the Leverhulme Foundation is gratefully acknowledged. The usual disclaimer applies. †Department of Economics, University College London, Gower Street, London, WC1E 6BT, and Institute for Fiscal Studies, [email protected], http://www.ifs.org.uk