The representative agent — providing pseudo-microfoundations for macro models

3 August, 2016 at 19:00 | Posted in Economics | Leave a comment

fubar1Suppose that the aggregate choice of society does coincide with that of the representative individual, both before and after that change. This reflects a pious hope, but at least with this heroic assumption we should be able to use the model to make policy recommendations. Since the economy’s behavior is properly represented by one individual, it might seem that we merely have to ask, which of the two possible outcomes, that before the change or that after, does the representative agent prefer?

However, this reasoning contains a fatal flaw. It is possible that the
representative individual prefers situation a to situation b, whilst all the
individuals that are “represented” strictly prefer b to a. Even though
the representative individual makes the same choices as the aggregate choices
of the individuals in the economy, the preferences of that agent may be
completely at variance with theirs! …

Thus to infer society’s preferences from those of the representative individual,
and to use these to make policy choices, is illegitimate …

It should be clear by now that the assumption of a representative individual
is far from innocent; it is the fiction by which macroeconomists can justify
equilibrium analysis and provide pseudo-microfoundations. I refer to these as
pseudo-foundations, since the very restrictions placed on the behavior of the
aggregate system are those which are obtained in the individual case and, as we
have seen, there is no formal justification for this. Thus, when the conclusions
of such a model are tested with empirical data (not a particularly frequent
occurrence) and should they, by chance, be rejected, this may simply reflect the
fact that the assumption that the economy could be represented by a single
individual was erroneous.

Alan Kirman

Yours truly is extremely fond of economists like Alan Kirman. With razor-sharp intellects they immediately go for the essentials. They have no time for bullshit. And neither should we.

New Classical, Real Business Cycles, Dynamic Stochastic General Equilibrium (DSGE) and ‘New Keynesian’ macroeconomics with their microfounded macromodels are bad substitutes for real macroeconomic analysis. Opting for cloned representative agents that are all essentially identical is of course not a real solution to the fallacy of composition that the Sonnenschein-Mantel-Debreu theorem points to. Representative agent models are rather an evasion whereby issues of distribution, coordination, heterogeneity — everything that really defines macroeconomics — are swept under the rug.

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