Representative agent

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History

The notion of a "representative agent" is a hypothetical construct in economics. Its origins can be traced back to the late 19th century. Francis Edgeworth (1881) used the term "representative particular", while Alfred Marshall (1890) introduced a "representative firm" in his Principles of Economics. However, only after Robert E. Lucas (1976) had published his article about econometric policy evaluation, his famous Lucas critique, representative agents became the dominant macroeconomic approach. Today's representative agent models are characterized by an explicitly stated optimization problem of the representative agent, which can be either a consumer or a producer. The derived individual demand or supply curves are then in turn used for the corresponding aggregate demand or supply curves.

Motivation

Hartley (1997) identifies several motives for their use. They were thought to avoid the Lucas critique, to provide rigorous microfoundations to macroeconomics, and to help build Walrasian general equilibrium models. Lucas (1976) had pointed out that policy recommendations derived from pure macroeconomic relationships neglect subsequent behavioral changes by economic agents. A macroeconomic relationship such as the Phillips curve thus could not be assumed to be stable and may not be exploitable. Representative agent models, on the other hand, go beyond simple aggregate relationships, and macroeconomists assume they know the microeconomic equations from which aggregate supply and demand curves are derived. If a policy change is announced, the representative agent would simply recalculate his optimization problem. Behavioral changes of the representative agent are thus taken into account when formulating macroeconomic policy recommendations.
Since general equilibrium models with many heterogeneous agents are far too complex to solve, the representative agent approach was a simplification that allowed solving for competitive equilibrium allocation.

Critique

Hartley, however, finds none of these three motives convincing. For instance, the equilibria of general equilibrium models with a representative agent are characterized by a complete absence of trade and exchange, which is contradicted by empirical data. Kirman (1992), too, is critical of the representative agent approach in economics. Because representative agent models simply ignore valid aggregation concerns, they usually commit the so-called fallacy of composition. 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 which are capable of dealing with many heterogeneous agents.

Literature

Mauro Gallegati and Alan P. Kirman (1999): Beyond the Representative Agent, Aldershot and Lyme, NH: Edward Elgar, ISBN 1858987032
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 0415146690
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.

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