Friday, 24 October 2014


The Preference Revelation Problem

Preference is just another word for "demand" in supply and demand. The aggregate of individual preferences (all our preferences added together) is the total demand. For private goods...our spending (time/money) decisions express our true preferences/demand and our demand shapes the supply. For public goods, because of the free-rider problem, we are compelled to pay taxes. But our current method of paying taxes does not convey our true preferences/values for public goods. 

There are three main ways of trying to discern people's true preferences...stated preference (contingent valuation), revealed preference and demonstrated preference.

Identification key

Identification keys are used by biologists to identify species based on their characteristics. Here's a very basic identification key for the three most common "species" in the preference revelation "genera".

  1. The source discusses the idea that what you say accurately conveys your true preferences/values. Surveys are frequently discussed. Words speak just as loud as actions. See the entry on stated preference
  2. The source discusses predicting...or guessing..."underlying utility functions" or identifying "independently existing functions". Math is frequently used. Samuelson's theory of revealed preference. See the entry on revealed preference
  3. The source does not discuss stated preference and it does not discuss Samuelson's theory. But it does discuss the idea that your choices reveal your true preferences. Actions speak louder than words. See the entry on demonstrated preference


How much public funds should be spent on protecting the environment? That would depend on the demand for environmental protection. Here's how the three different "species" would try and determine the demand... 

  1. Survey people and ask them exactly how much they value environmental protection (stated preference - current system)
  2. Congress guesses/predicts all our preferences (revealed preference - current system)
  3. Taxpayers choose where their taxes go (demonstrated preference - tax choice system)

Each method would produce a different answer. In other words...each method would indicate a different amount of demand. Therefore, each method would supply a different amount of environmental protection. The less accurate a method was...the greater the disparity between supply and demand...the greater the shortage/surplus of environmental protection...the greater the amount of deadweight loss


The vast majority of economists agree that our true preferences/values are required to determine the optimal supply of public goods. Because they understand the basic concept of supply and demand, many economists have spent large amounts of time/energy/effort trying to develop accurate preference revelation mechanisms. The more accurate the mechanism...the more efficient the allocation of public funds would be. 

For example, Caltech scientists even developed a way to try and read your mind in order to try and accurately determine exactly how much you value public goods. 

Nevertheless, the classic solution to the problem of underprovision of public goods has been government funding - through compulsory taxation - and government production of the good or service in question. Although this may substantially alleviate the problem of numerous free-riders that refuse to pay for the benefits they receive, it should be noted that the policy process does not provide any very plausible method for determining what the optimal or best level of provision of a public good actually is. When it is impossible to observe what individuals are willing to give up in order to get the public good, how can policymakers access how urgently they really want more or less of it, given the other possible uses of their money? There is a whole economic literature dealing with the willingness-to-pay methods and contingent valuation techniques to try and divine such preference in the absence of a market price doing so, but even the most optimistic proponents of such devices tend to concede that public goods will still most likely be underprovided or overprovided under government stewardship. - Patricia Kennett, Governance, globalization and public policy

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