User:Xerographica/Preference revelation

Preference is just another word for "demand"...as 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

Example

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.

Importance

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.

There's plenty of scholarly material on the subject. If you're interested in this subject...then demonstrate your preference by reading these reliable sources, sharing any other relevant, reliable sources that you might find...and making constructive edits to the relevant entries.

Passages

Individuals express preferences about changes in the state of the world virtually every moment of the day. The medium through which they do this is the market place. A vote for something is revealed by the decision to purchase a good or service. A vote against, or an expression of indifference, is revealed by the absence of a decision to purchase. Thus the market place provides a very powerful indicator of preferences. - David Pearce, Dominic Moran, Dan Biller, Handbook of Biodiversity Valuation

Thus, Waldfogel’s study provides at least suggestive evidence of the difficulty new paternalists will face in crafting wise policies. The basic problem is that paternalist policymakers need a baseline of “true” preferences to satisfy, but the knowledge of such preferences is very hard to access. That individuals sometimes have difficulty determining their own preferences does not mean outsiders will do any better; they can also do worse. - Mario J. Rizzo, Douglas Glen Whitman, The Knowledge Problem of New Paternalism

Consumers fare better [at identifying their own preferences] than all types of givers except significant others and possibly grandparents...it seems unlikely that an alternative chooser would do better than friends, siblings, and parents, all of whom have substantial amounts of information about the ultimate consumer's preferences. - Joel Waldfogel, Does Consumer Irrationality Trump Consumer Sovereignty?

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

Whereas the income received for providing a private good conveys information about the demand for that good, taxes collected under the threat of coercion say little about the demand for a public good or service. Payment of taxes indicates only that taxpayers prefer paying taxes to going to jail. Little or no information is revealed about user preferences for goods procured with tax-supported expenditures. As a consequence, the organization of collective consumption units will need to create alternative mechanisms to prices for articulating and aggregating demands into collective choices reflecting individuals' preferences for a quantity and/or quality of public goods or services. - Vincent Ostrom, Elinor Ostrom, Public Goods and Public Choices

Jay Lund's chapter explores the informational problems implied in finding the best way to allocate water resources. In this respect, the main advantage of water trading is that its effectiveness does not require having in advance detailed information on the value of water on any place and for any alternative use. Engaging in trade is a voluntary decision, thus the market is itself a preference revelation mechanism. No particular prior information on people's preferences is then required in advance for trading to find mutually beneficial deals. By definition, when a transaction takes place, the maximum willingess to pay of those buying water is higher than the minimum compensation required by the sellers of water property rights and the deal improves the welfare of those engaged in it. Allowing for water trading thus reduces the information burden of water authorities as they do not need detailed information beyond that required to reach a decision on the overall constraints on the water use in the entire economy. - Carlos Mario Gomez, Incentives and prices in water trading

General-fund financing is analogous to a market situation where the individual is forced to purchase a bundle of goods, with the mix among the various components determined independently of his own preferences. The specific tie-in sale is similar to general-fund financing, that is, nonearmarking. - James M. Buchanan

Thus while Samuelson is technically on safe ground in his solution of the public goods problem, the assumptions required make the solution useless for policy purposes. But a reliance on aggregation through consultation, as Wicksell wants, offers a guarantee neither of theoretical efficacy nor of practical usefulness. Some of the debates and doubts about the states role in the economy that erupted in the 1960s and 1970s arose from these twin problems. - Meghnad Desai, Providing Global Public Goods

Wicksell (1882) was the first to focus on this failure of preference revelation, suggesting that it could be overcome in democratic societies, where voters can support politicians whose tax and spending policies meet their wishes. With mandatory acceptance of political outcomes, consumers have an incentive to reveal their preferences, suggesting an efficient provision of public goods. - Richard Musgrave, Peggy Musgrave, Providing Global Public Goods

If the individual is to spend his money for private and public uses so that his satisfication is maximized, he will obviously pay nothing whatsover for public purposes (at least if we disregard fees and similar charges). Whether he pays much or little will affect the scope of public services so slightly, that for all practical purposes he himself will not notice it at all. Of course, if everyone were to do the same, the State will soon cease to function. The utility and the marginal utility of public services (Mazzola's public goods) for the individual thus depend in the highest degree on how much the others contribute, but hardly on how much he himself contributes….Equality between the marginal utility of public goods and their price cannot, therefore, be established by the single individual, but must be secured by consultation between him and all other individuals of their delegates. - Knut Wicksell

We shall now show below that, even though the recommendations of the benefit principle maximize social welfare, it is not possible for the government to implement them. This is due to what we call the problem of 'preference revelation.' This problem consists in the fact that even though individuals want the government to produce the optimum quantity of G, G*, which maximizes social welfare, they are unlikely to communicate this information to the government. - Ghosh & Ghosh, Economics Of The Public Sector

But the Samuelson condition involves individual marginal rates of substitution. In order for the set of Pareto-optimal allocations to be known, it is necessary for each consumer to tell the government what his marginal rate of substitution is. But it may be in an individual's interest to give false information about his utility function. This is what has become known as the preference revelation problem. - John McMillan, The Free-Rider Problem: A Survey

Determining the efficient level of public goods requires knowing consumer preferences. That knowledge is often assumed as given in theoretical models of optimal provision, but obtaining it is a major challenge when it comes to actual policy. - Richard Musgrave, Peggy Musgrave, Providing Global Public Goods

During the decade of the 1970s, one new method appeared after another to solve the heretofore seemingly insoluble problem of inducing people to reveal their preferences for public good honestly. - Dennis C. Mueller, Public Choice: An Introduction

The large theoretical literature on incentive-compatible demand revelation was inspired in part by attempts to design preference revelation mechanisms for public goods which would avoid free riding and result in the optimal decentralized provision of public goods. The incentive-compatible demand revelation devices (ICDRDs) proposed by theorists create situations in which it is in the person's selfish interest to choose to reveal his or her true preferences for a good. - Robert Mitchell, Richard Carson, Using Surveys to Value Public Goods

One set of solutions assumes the existence of a government and concentrates on the problem of how the government can persuade consumers to reveal their utility functions honestly. - John McMillan, The Free-Rider Problem: A Survey

The demand-revealing process is the subject of much current research in public economics. It involves designing a special tax structure under which individuals cannot do better than correctly reveal their demands for the public good. Each individual pays a tax (or receives a subsidy) equal to the net loss (gain) in consumers' surplus that his public-good demand imposes on all the other individuals. - John McMillan, The Free-Rider Problem: A Survey

In his seminal analyses of public goods, Samuelson concluded that strategic bias implied that there was ‘an inherent political difficulty of ever getting men to reveal their tastes so as to attain the definable optimum’. This view led to widespread acceptance by economists for some time that true demand for public goods could not be determined. - C.D. Throsby, Glenn A. Withers, Strategic bias and demand for public goods

Expositions of welfare economics typically assume that the analyst possesses knowledge that is in no one’s capacity to possess. A well-intentioned administrator of a corrective state would face a vexing problem because the knowledge he would need to act responsibly and effectively does not exist in any one place, but rather is divided and dispersed among market participants. Such an administrator would seek to achieve patterns of resource utilization that would reflect trades that people would have made had they been able to do so, but by assumption were prevented from making because transaction costs were too high in various ways. A corrective state that would be guided by the principles and formulations of welfare economics would be a state whose duties would exceed its cognitive capacities. - Richard Wagner

See also

• Benefit principle
• Dollar voting
• Opportunity cost
• Public choice
• Public economics
• Rational ignorance

References

• Meghnad Desai - Public Goods: A Historical Perspective
• Richard Musgrave, Peggy Musgrave - Providing Global Public Goods
• Bernd Hansjürgens - The influence of Knut Wicksell on Richard Musgrave and James Buchanan
• Alain Maricano - Why markets do not fail. Buchanan on voluntary cooperation and externalities.
• Douglas Ginsburg, Joshua Wright - Behavioral Law and Economics: Its Origins, Fatal Flaws, and Implications for Liberty
• John McMillan - The Free-Rider Problem: A Survev
• C.D. Throsby, Glenn A. Withers - Strategic bias and demand for public goods
• Daniel M. Hausman - Revealed preference, belief, and game theory
• David Bradford, Gregory Hildebrandt - Observable Preferences for Public Goods
• Marcel K. Richter - Revealed Preference Theory
• Dennis C. Mueller - Public Choice: An Introduction
• Robert Mitchell, Richard Carson - Using Surveys to Value Public Goods