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Consumer Surplus when Preferences are Intransitive: Analysis and Interpretation
John Fountain
Abstract
The theoretical validity of consumer surplus analysis at the level of the individual agent is shown to be independent of the assumption that individual preferences are transitive. With or without transitive preferences, consumer surplus can be calculated as an appropriate area to the left of compensated demand functions. Without transitive preferences consumer surplus cannot be interpreted as a money index of utility change nor does it have an exact willingness to pay interpretation; rather it must be interpreted as a hypothetical compensation payment. Without transitive preferences the measurement of consumer surplus using ordinary demand functions to approximate compensated demand functions must rely on a heuristic rule to the effect that the "inconsistency effect" of a price change is small since full duality between ordinary and compensated demand functions does not (generally) hold.
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