Meaning of Preferences
Preference means liking one thing or wants to have a product better than the others. When individual preferences are combined together, then it is known as total demand.
When it is the matter of private goods, then the spending by the public gives the true preference for the private good, but when it is a matter of public good, then true preferences of the good are not being conveyed to the government because of the policy of compulsory taxation by the government.
The central government used to collect information about public goods with the help of the experts appointed by them, but when the government is inefficient in collecting information about public goods as compared to private goods in the market, then this problem is known as the preference revelation problem in economics. Thus, the preference revelation problem is the problem being faced by the government in determining the preferences of individuals.
Types of Preferences
There are three main ways of studying the preferences of individuals.
1. Stated Preference:
This type of preference is also known as contingent valuation. This technique is a survey-based technique for valuing resources of non-market in nature. This type of valuation is for environmental preservation or the impact of toxic substances and contamination on the environment.
These types of non-market resources are useful to the public, and the public also receives various benefits from these non-market resources, but they do not have a price because these resources are not directly sold to the public.
For example, the view of the sunset point is very beautiful, and people benefit from this view, but it is very tough to fix the price of this view. Thus, contingent valuation is a technique based on surveys and is used to measure these kinds of aspects related to non-market resources.
This model of valuing non-market resources was first proposed theoretically by S.V. Cricacy in 1947. The practical application of this model was first made by Davis in 1963 to estimate the value of hunters and also develop an idea about various tourist places.
2. Revealed Preference:
This concept was given by Paul Samuelson, who was an American economist. Revealed preference is an economic theory of consumption behaviour which asserts that the best way to measure consumer preferences is to observe their purchasing behaviour.
This method works on the assumption that consumers used to consider various sets of alternatives before making any purchase decision. This method reveals that one can develop an idea about consumer behaviour from their purchasing habits, taste, style and fashion of the consumer.
This method came into being because the past and present theories were based on the marginal rate of substitution. This method is a type of valuation where the public reveals their preferences according to their choices. This theory predicts individual preferences before spending time and money on something.
This theory also states that the best way to measure consumer behaviour is to keep a watch on their purchasing behaviour. This theory works on the assumption that consumers should consider various kinds of alternatives before making any purchase decision.
The two main methods of revealed preference are:
(a) Travel Cost Method:
This method is most suitable for determining the recreational values related to biodiversity and services of an ecosystem. These are based on the assumption that recreational experiences are associated with a cost.
(b) Hedonic Pricing Method:
In this type of valuation method, one utilizes the information about the implicit demand for the environmental conditions. For example, the value of the house will be affected if it is close to nature. A house will have a handsome price if a nice landscape is seen from the house. So, the valuation pricing procedure will be affected if there is a change in the environmental conditions.
The disadvantage of this type of valuation is that it is time-consuming and expensive in nature.
3. Demonstrated Preference:
This type of preference gives an idea about the choices of the consumer that reveals their true preferences. Demonstrated preference can also be defined as, that the true preferences of an individual can be revealed only after spending time and money on something.
The concept of demonstrated preference simply states that actual choice reveals or demonstrates a man’s preferences and that his preferences are deducible from what he has chosen in action. The choice of tax system comes under the category of demonstrated preference. It is truly said that action speaks louder than words.
For example, a man decides to spend an hour at a movie rather than spending time at a movie, so it can be inferred that spending time was preferred and ranked higher on the value scale.
Problems of Preference Revelation
Preference revelation is an area where studies are being undertaken to ascertain the demand for public goods by consumers. Preference revelation is also called as the preference revelation problem in public choice theory in economics.
This theory says that if policy planners of the government do not have full information and knowledge about individual preferences, then it is possible that public goods can be oversupplied or under-supplied by the government. There are two types of goods in economics: public goods and private goods.
Preference revelation studies the demand for public goods which are non-excludable in nature. This means that people are enjoying various benefits of the public good, but the public good is not contributing to the production function of the economy. The information about public goods and the benefits derived from these public goods is gathered from the public only, and there is a possibility that the common public will not give accurate information about the goods being supplied to them by the government. They can underreport the value of goods being supplied to them in order to avoid taxes. Thus, this problem of undervaluation is also known as the free rider problem in economics.
The government in order to prevent this problem from happening again and again in the economy, goes for compulsory taxation. However, if the government forces the people to pay taxes, then they will not reveal the correct price of the public goods. Therefore, the government will levy too much tax or not enough tax on the public good.
So, the best solution for the preference revelation problem is to implement the tax structure of their choice. If taxpayers are given the chance to choose to pay taxes according to their requirements then they will not hide their preference for public goods and will give correct information about their prices.
The preference revelation problem in economics is the problem that governments face in determining the preferences of individuals. Individual preferences can be determined by survey or by revealed preference. The information which is collected from revealed preference is considered to be the ideal information, and it is considered to be less biased and error-free as compared to other sources.
Revealed preference information is being obtained from centralized structures of the government, but the information gathered by the government-making bodies can prove to be costly and time-consuming, so these bodies often use survey information, but such information is less accurate from the information gathered from other sources.
When central bodies of the government obtain information, they often process that the information collected by them is less efficient due to a lack of appropriate expert opinion, and too much political interference in the working of centralized structures also detracts from the ability of the government to find out the optimal solution of the preference revelation problem.
Markets are used to gather information in a more efficient manner than the central structures of the government. Thus, the relative inefficiency of the government in gathering information about individual preferences is called as preference revelation problem in economics.
Read More in: Theory of Public Finance
- Public Finance: Meaning, Nature & Scope
- Role of Government in Economy
- Role of Government in Mixed Economy: Public & Private Sector
- Role of Government under Cooperation and Competition
- Role of Government in Economic Development and Planning
- Concept of Public Goods, Private Goods, and Merit Goods
- Concept of Market Failure and Functions of Government
- Market Failure and Functions of Government: Decreasing Costs
- Market Failure and Functions of Government: Externalities
- Market Failure and Functions of Government: Public Goods
- Future Market: Meaning, Role & Uncertainty
- Concept of Information Asymmetry
- Theory of Second Best: Concept & Explanation
- Problem of Allocation of Resources: Public & Private Mechanisms
- Preferences: Meaning, Types & Problems of Preference Revelation
- Preference Aggregation & Its Mechanism
- Voting Systems, Direct Democracy, Representative Democracy, Leviathan Hypothesis & Arrow’s Impossibility Theorem
- Economic Theory of Democracy: Concept & Explanation
- Politico Eco Bureaucracy: Concept & Explanation
- Rent-Seeking and Directly Unproductive Profit-Seeking Activities
- Rationale for Public Goods: Concept & Explanation
- Benefit Theory or Voluntary Exchange Theory
- Lindahl Model: Concept, Equilibrium & Limitations
- Bowen Model: Concept, Advantages & Limitations
- Samuelson’s Model of Public Expenditure
- Musgrave’s Model of Public Expenditures
- Demand Revealing Schemes for Public Goods
- Vickery-Clarke-Groves Mechanism
- Groves-Ledyard Mechanism
- Tiebout Model: Concept, Assumptions Equilibrium & Simple Tiebout Model
- Theory of Club Goods
- Keynesian Principles of Stabilization Policy
- Difference Between Keynesian Economic Thought and Others
- Role of Expectations and Uncertainty in Formulating Stabilization Policy
- Intertemporal Markets Efficiency & Failure
- Liquidity Preference Theory
- Diamond-Dybvig Banking Model
- Preference Shocks, Adverse Selection & Central Bank
- Equilibrium Deposit Contract
- Social Goods and Its Effect on Stabilization Policy
- Effect of Infrastructural Facilities on Stabilization Policy
- Effect of Distributional Inequality on Stabilization Policy
- Effect of Regional Imbalances on Stabilization Policy
- Wagner’s Law of Increasing State Activities: Explanation, Graph & Criticism
- Peacock-Wiseman Hypothesis: Explanation, Graph & Criticism
- Public Expenditure: Concept, Objectives, & Public vs Private Expenditure
- Pure Theory of Public Expenditure
- Structure & Growth of Public Expenditure in India
- Trends, Lessons & Priorities in Public Expenditure in India
- Social Cost-Benefit Analysis: Project Evaluation, Estimation of Costs & Discount Rate
- Performance Based Budgeting and Zero Based Budgeting
- Theories of Tax Incidence: Concentration Theory, Diffusion Theory & Modern Theory
- Tax System and Its Principles
- Equity Principle and Efficiency Principle of Taxation: Meaning, Explanation & Examples
- Ability to Pay and Benefits Received Principle of Taxation
- Theory of Optimal Taxation: Excess Burden & Distortions of Taxation
- Deadweight Loss of Taxation: Causes, Measurement & Example
- Concept of Equity & Efficiency in Economics
- Trade-Off Between Equity and Efficiency: Meaning & Example
- Theory of Measurement of Dead Weight Loss
- Double Taxation: Meaning, Desirability, Forms & Solution
- Solution to Problem of Double Taxation: Intra-Country & International
- Double Taxation Avoidance Agreement (DTAA) and Indian Policy
- Classical View on Public Debt
- Compensatory Aspect of Public Debt Policy
- Public Debt or Borrowings: Concept, Need, Sources & Types
- Concept of Public Debt or Public Borrowings
- Need for Public Debt or Public Borrowing
- Sources of Public Debt
- Classification of Public Debt
- Burden of Public Debt: Meaning, Types & Explanation
- Debt Through Created Money or Deficit Financing
- Public Debt (Public Borrowings) and Inflation (Price Level)
- Crowding Out of Private Investment and Activity
- Principle of Public Debt Management and Debt Repayment