EconomistAn economist is an expert in the social science of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy...
s use the term
representative agent to refer to the typical decision-maker of a certain type (for example, the typical consumer, or the typical firm).
More technically, an
economic modelIn economics, a model is a theoretical construct that represents economic processes by a set of variables and a set of logical and/or quantitative relationships between them. The economic model is a simplified framework designed to illustrate complex processes, often but not always using...
is said to have a representative agent if all
agentsIn economics, an agent is an actor and decision maker in a model. Typically, every agent makes decisions by solving a well or ill defined optimization/choice problem. The term agent can also be seen as equivalent to player in game theory....
of the same type are identical. Also, economists sometimes say a model has a representative agent when agents differ, but act in such a way that the sum of their choices is mathematically equivalent to the decision of one individual or many identical individuals.
EconomistAn economist is an expert in the social science of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy...
s use the term
representative agent to refer to the typical decision-maker of a certain type (for example, the typical consumer, or the typical firm).
More technically, an
economic modelIn economics, a model is a theoretical construct that represents economic processes by a set of variables and a set of logical and/or quantitative relationships between them. The economic model is a simplified framework designed to illustrate complex processes, often but not always using...
is said to have a representative agent if all
agentsIn economics, an agent is an actor and decision maker in a model. Typically, every agent makes decisions by solving a well or ill defined optimization/choice problem. The term agent can also be seen as equivalent to player in game theory....
of the same type are identical. Also, economists sometimes say a model has a representative agent when agents differ, but act in such a way that the sum of their choices is mathematically equivalent to the decision of one individual or many identical individuals. A model that contains many different agents whose choices cannot be aggregated in this way is called a
heterogeneous agent model.
The notion of the representative agent can be traced back to the late 19th century. Francis Edgeworth (1881) used the term "representative particular", while
Alfred MarshallAlfred Marshall was an English economist and one of the most influential economists of his time, being one of the founders of neoclassical economics...
(1890) introduced a "representative firm" in his
Principles of Economics. However, after
Robert Lucas, Jr.'s critiqueThe Lucas critique, named for Robert Lucas′ work on macroeconomic policymaking, says that it is naïve to try to predict the effects of a change in economic policy entirely on the basis of relationships observed in historical data, especially highly aggregated historical data.The basic idea...
of econometric policy evaluation spurred the development of
microfoundationsIn economics, the term microfoundations refers to the microeconomic analysis of the behavior of individual agents such as households or firms that underpins a macroeconomic theory....
for macroeconomics, the notion of the representative agent became more prominent and more controversial. Many
macroeconomic modelsA macroeconomic model is a model or framework designed to describe the operation and activity in the economy of a country or a region. These models are usually designed to examine the dynamics of aggregate quantities such as the total amount of goods and services produced, total income earned, the...
today are characterized by an explicitly stated
optimizationOptimization or optimality may refer to:Relating to improving performance:* Optimization , the process of finding function extrema to solve problems...
problem of the representative
agentIn economics, an agent is an actor and decision maker in a model. Typically, every agent makes decisions by solving a well or ill defined optimization/choice problem. The term agent can also be seen as equivalent to player in game theory....
, which may be either a consumer or a producer (or, frequently, both types of representative agents are present). The derived individual demand or supply curves are then used as the corresponding aggregate demand or supply curves.
Motivation
When economists analyze the behavior of a representative agent, this is because it is usually simpler to refer to one 'typical' decision maker instead of simultaneously analyzing many different decisions. Of course, economists must abandon the representative agent assumption when differences between individuals are central to the question at hand. For example, a macroeconomist might analyze the impact of a rise of oil prices on a typical 'representative' consumer; but an analysis of health insurance would probably require a heterogeneous agent model (since health insurance, by definition, is a transfer of money from relatively healthy people to others with illnesses requiring expensive care).
Hartley (1997) discusses the reasons for the prominence of representative agent modelling in contemporary macroeconomics. The
Lucas critiqueThe Lucas critique, named for Robert Lucas′ work on macroeconomic policymaking, says that it is naïve to try to predict the effects of a change in economic policy entirely on the basis of relationships observed in historical data, especially highly aggregated historical data.The basic idea...
(1976) pointed out that policy recommendations based on observed past macroeconomic relationships may neglect subsequent behavioral changes by economic agents, which, when added up, would change the macroeconomic relationships themselves. He argued that this problem would be avoided in models that explicitly described the decision-making situation of the individual agent. In such a model, an economist could analyze a policy change by recalculating the decision problem of each agent under the new policy, then aggregating these decisions to calculate the macroeconomic effects of the change.
Lucas' influential argument convinced many macroeconomists to build
microfoundedIn economics, the term microfoundations refers to the microeconomic analysis of the behavior of individual agents such as households or firms that underpins a macroeconomic theory....
models of this kind. However, this was technically more difficult than earlier modelling strategies. Therefore, almost all the earliest
general equilibrium macroeconomic modelsDynamic stochastic general equilibrium modeling is a branch of applied general equilibrium theory that is increasingly influential in contemporary macroeconomics...
were simplified by assuming that consumers and/or firms could be described as a representative agent. General equilibrium models with many heterogeneous agents are much more complex, and are therefore still a relatively new field of economic research.
Critique
Hartley, however, finds these reasons for representative agent modelling unconvincing. Kirman (1992), too, is critical of the representative agent approach in economics. Because representative agent models simply ignore valid aggregation concerns, they sometimes commit the so-called
fallacy of compositionA fallacy of composition arises when one infers that something is true of the whole from the fact that it is true of some part of the whole...
. He provides an example in which the representative agent disagrees with all individuals in the economy. Policy recommendations to improve the welfare of the representative agent would be illegitimate in this case. Kirman concludes that the reduction of a group of heterogeneous agents to a representative agent is not just an analytical convenience, but it is "
both unjustified and leads to conclusions which are usually misleading and often wrong." In his view, the representative agent "
deserves a decent burial, as an approach to economic analysis that is not only primitive, but fundamentally erroneous."
A possible alternative to the representative agent approach to economics could be
agent-based simulation models Agent-based Computational Economics is the computational study of economic processes modeled as dynamic systems of interacting agents.-Overview:...
which are capable of dealing with many heterogeneous agents. Another alternative is to construct
dynamic stochastic general equilibriumDynamic stochastic general equilibrium modeling is a branch of applied general equilibrium theory that is increasingly influential in contemporary macroeconomics...
models with heterogeneous agents, which is difficult, but is becoming more common (Ríos-Rull, 1995).
Literature
- Mauro Gallegati and Alan P. Kirman (1999): Beyond the Representative Agent, Aldershot and Lyme, NH: Edward Elgar, ISBN 1-85898-703-2
- James E. Hartley (1996): 'Retrospectives: The origins of the representative agent', Journal of Economic Perspectives 10: 169-177.
- James E. Hartley (1997): The Representative Agent in Macroeconomics. London, New York: Routledge, ISBN 0-415-14669-0
- Alan P. Kirman (1992): 'Whom or what does the representative individual represent?' Journal of Economic Perspectives 6: 117-136.
- Lucas, Robert E. (1976): 'Econometric policy evaluation: A critique', in K. Brunner and A. H. Meltzer (eds.) The Phillips Curve and Labor Markets, Vol. 1 of Carnegie-Rochester Conference Series on Public Policy, pp. 19-46, Amsterdam: North-Holland.
- Ríos-Rull, José-Víctor (1995): 'Models with heterogeneous agents', Chapter 4 in T. Cooley (ed.) Frontiers of Business Cycle Theory, Princeton University Press.
See also
- Agent (economics)
In economics, an agent is an actor and decision maker in a model. Typically, every agent makes decisions by solving a well or ill defined optimization/choice problem. The term agent can also be seen as equivalent to player in game theory....
- Homo economicus
Homo economicus, or Economic human, is the concept in some economic theories of humans as rational and broadly self-interested actors who have the ability to make judgments towards their subjectively defined ends.- History of the term :...
- Aggregate demand
In macroeconomics, aggregate demand is the total demand for final goods and services in the economy at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a...
- Aggregation problem
An aggregate in economics is a summary measure describing a market or economy. The aggregation problem refers to the difficulty of treating an empirical or theoretical aggregate as if it reacted like a less-aggregated measure, say, about behavior of an individual agent as described in general...