Can a Representative-Agent Model Represent a Heterogeneous-Agent Economy?

Sungbae An (), Yongsung Chang () and Kim, Sun-Bin ()
Additional contact information
Sungbae An: Singapore Management University, http://www.mysmu.edu/faculty/sungbae/
Kim, Sun-Bin: Korea University, http://econ.korea.ac.kr/new2/prof/prof.php?profid=sbkim06

No 542, RCER Working Papers from University of Rochester - Center for Economic Research (RCER)

Abstract: Accounting for observed fluctuations in aggregate employment, consumption, and real wage using the optimality conditions of a representative household often requires preferences that are incompatible with economic priors (e.g., Mankiw, Rotemberg, and Summers 1985). This discrepancy between the equilibrium model and the aggregate data is often viewed as evidence of the failure of labor-market clearing. We argue that such a conclusion is premature. We construct a model economy where all prices are flexible and all markets clear at all times but household decisions are not readily aggregated because of incomplete capital markets and the indivisible nature of the labor supply. We demonstrate that if we were to explain the model-generated aggregate time series using decisions of a fictitious" stand-in household, such a household is likely to have a non-concave or unstable utility. Our analysis suggests that the representative-agent model often fails to represent an equilibrium outcome of a heterogeneous-agent economy.

Keywords: Representative-agent model; Aggregation; Heterogeneity; Incomplete Markets; Indivisible Labor; GMM Estimation (search for similar items in EconPapers)
JEL-codes: E24 E32 J21 J22 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-bec, nep-dge, nep-mac and nep-sea
Date: Written

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Related works:
Working Paper: Can a Representative Agent Model Represent a Heterogeneous Agent Economy? (2007)
Journal Article: Can a Representative-Agent Model Represent a Heterogeneous-Agent Economy (2009)
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