Behavioral Finance Lecture 01: Debunking Revealed Preference

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I lecture on Behavioral Finance at the University of Western Sydney this semester, and will record all my lectures and post them on my YouTube Channel ProfSteveKeen. In this first lecture (after the usual preliminaries of explaining assessment and the like to my 85 third year students), I cover the Neoclassical theory of consumer behavior.

As I note to my students, the concept I teach here–Revealed Preference–was taught in 1st year 40 years ago, when I was an fresher undergraduate. But the tuition of Neoclassical economics has been so dumbed down over the years that my 3rd year students hadn’t heard of it before. I expect it’s reserved as punishment for those who undertake an Honors degree these days!

After outlining the theory, I then cover the excellent experimental disproof of the theory by the German economists Reinhard Sippel:

Sippel, R. (1997). “An Experiment on the Pure Theory of Consumer’s Behaviour.” The Economic Journal 107 (444): 1431-1444.

I’m sure that disproving the theory wasn’t Sippel’s original intention. Instead, I suspect that he undertook the experiment to show to his students that their “indifference curves” could be inferred from their purchases, as Samuelson claimed long ago when he dreamed up the concept of Revealed Preference:

Samuelson, P. A. (1938). “A Note on the Pure Theory of Consumer’s Behaviour.” Economica 5 (17): 61-71.

Instead, Sippel found that his experimental subjects violated the “Axioms of Revealed Preference”.

In the first half of the lecture, I cover the axioms of revealed preference, and Sippel’s results:

In the second half, I interpret these results using ideas from computation theory:

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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13 Responses to Behavioral Finance Lecture 01: Debunking Revealed Preference

  1. Steve, do you mind posting the pdf/ppt slides as well? Thanks

  2. Steve Keen says:

    Whoops! Forgot that essential step. I’ll edit the post now.

  3. sj says:

    Mr Keen
    I did study economics at Western University in Campbelltown about ten years ago,I decided to give up I was not happy with the neo cabbage.
    Actually did me a favour I have a far better understanding of the market than most University educated clones.
    Brings me to very important point the financial markets really are a factal and I have prove it.
    If you believe that markets are factal have a critical tipping point you start to see the market as a ecosystem.
    Every eco system has a bush fire once in a while to clean out the carbage and this is done by higher interest rates.
    You leave interest rates too low, cause too much dead wood and brush around.
    You must have pain in a ecosystem to keep it healthy,Mr Keen with respect lower interest rates just another dead branch in the bush.
    Mr Keen have you seen the balance sheets of the big four banks increase their borrowing liabilities by over 30% in the last three years, so I don’t know how you work out the Australain household are de levelaging.
    The evidence is clear by house price increases that households are taking on MORE DEBT.

    Put another dead branch on the fire to keep the high debt plebes happy.
    God help Australain if the elite think lower interest rates will save us, just ask Japan or America.

  4. alainton says:

    Will check this out after breakfast just a note on an excellent article on the ‘expansionary fiscal contraction ‘ idea – i.e. Alberto Alesina – that governments around the world are now experimenting with – that is austerity now will produce prosperity later. http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/8680240/The-Wests-horrible-fiscal-choice.html

    ‘A study by Goran Hjelm from Sweden’s Institute of Economic Research said the formula only really works when countries can let their currencies slide and export their way out of trouble. This is not possible for Spain and Italy within EMU, nor for the combined West at the same time. “We can’t all devalue together and export to Mars,” said Jamie Dannhauser from Lombard Street Research.’

  5. NeilW says:

    @Alainton,

    In that situation they are using the external sector to absorb the unemployment at home caused by a lack of domestic consumption.

    You can see the effects of that with Germany. The peg and lack of transfer payments within the union exacerbates the effects.

    Germany has a chronic lack of domestic consumption that shows up as bankrupt nations in other parts of Europe.

  6. alainton says:

    @Neilw

    I agree, as well as exporting people seeking work in the case of austerity nations such as Latvia, Ireland etc.

    China as well in your scenario, although the comparative advantage of China is rapidly eroding due to oil consumption with last year China having a negative balance of payments – an elementary calculation shows that China cannot continue to have 8% growth for another decade and have positive balance of payments whilst still maintaining its domestic petrol consumption, before then it exhausts its foreign currency reserves buying increasing scarce oil which it is taking a larger and larger global share of. It soon faces an Indonesia style crunch where cost of oil drags down the economy.

  7. mahaish says:

    at some stage in the next 10 to 15 years that loose peg of the chinese is going to get broken me thinks alainton,

    for some of the reasons you have outlined

    that might change the dynamics a bit,

    its going to be interesting , the breaking of the peg, and the ramifications for the communist party and democracy in general in china,

    its quite a debate as to whos currency you would short,

    and i dont buy into this greenback is finished scenario,

    the yanks have a legal framework , however flawed to back the currency,

    the chinese dont,

    you would think re valuation upwards of the yuan would be deflationary for the chinese and very inflationary for the rest of us,

    things couldnt go the other way could it

    should we contemplate currency collapse in china, and hyper inflation for them ,

    as a consequence of the political collapse and turmoil , when the yaun has to come out and play without anybody there to hold its hand.

  8. Derek says:

    Thanks for making your lectures available to the general public. I found this one extremely interesting and I look forward to the next.

  9. alainton says:

    @Mahaish

    Yes quite apart from the short term challenges of a property bubble and local government debt China faces a number of medium term challenges that will get much worse over the next 10 years

    -Reaching limits of water supply
    -Reaching limits of cultivation/food supply
    -Exponentially increasing costs of infrastructure as cities expand to 3rd, 4th fifth ring roads
    -Costs of oil imports
    -Ageing population, but relatively few young people because of population controls, leads to worlds highest projected increase in dependency ratio
    -Increasing wage costs, reducing advantages of low cost manufacturing
    -Ending of the money pump from the US, especially if the US defaults or the dollar devalues
    -With an increasingly open society demands for social expenditure.

    Of course there are many upside risks including Chinas enormous entrepreneurial dynamism, but it is difficult to see how a realistic model of 8%+ growth over 20 years could be constructed. The Chinese government has already knocked it down to 6%.

  10. Ramanan says:

    Re the idea of the government fixing everything (coming from the Neochartalists):

    Page 205 here (Page 218 of the pdf), table 24

    http://www.gao.gov/new.items/d11696.pdf

    says that the RBA used $50 billion of swap lines with the Federal Reserve to ease Australian banks’ funding pressures during the crisis. So the conjecture that government can fix everything is plainly incorrect.

  11. vvadi says:

    Thanks for sharing your lectures. I have just finished watching your first lecture.
    Your analysis on why we can not simulate the demand curve is very similar to Mises analysis in economic calculation problem(http://en.wikipedia.org/wiki/Economic_calculation_problem ).

    Regards

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