Representative Agent - Motivation

Motivation

When economists study a representative agent, this is because it is usually simpler to consider 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 some analyses of auctions involve heterogeneous agent models because competing potential buyers can value the good differently.

Hartley (1997) discusses the reasons for the prominence of representative agent modelling in contemporary macroeconomics. The Lucas critique (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 microfounded models of this kind. However, this was technically more difficult than earlier modelling strategies. Therefore, almost all the earliest general equilibrium macroeconomic models 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.