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On the poverty of microfoundationalist fantasies

from Lars Syll

The microfoundationalist’s fantasy has a powerful hold on macroeconomists. They recognize that an agent-by-agent reconstruction of the economy is not feasible, but they argue that it is something that we could do “in principle,” and that the in-principle claim warrants a particular theoretical strategy. The strategy is to start with the analysis of a single agent and to build up through ever more complex analyses to a whole economy …

The implicit argument in favor of representative-agent models as empirically relevant to aggregate economic data runs something like this: a representative-agent model is not itself an acceptable representation of the whole economy … but it is a first step in a program which step by step will inevitably bring the model closer to the agent-by-agent microeconomic model of the whole economy … I call this argument eschatological justification: it is the claim that there is a plausible in-principle game plan for a reductionist program and that the conclusions of early stages of that program are epistemically warranted by the presumed, but undemonstrated, success of the future implementation of the program in the fullness of time …

Analysis using the representative-agent model employs an analogy between the behavior of a single agent and the agents collectively in a whole economy. For example, the representative-agent is typically endowed with a utility function from precisely the same family as those typically assigned to individual agents in microeconomic analysis. Do we have any good reason to accept the analogy? Microeconomists have long known that the answer is, no.

Exact aggregation requires that utility functions be identical and homothetic … Translated into behavioral terms, it requires that every agent subject to aggregation have the same preferences (you must share the same taste for chocolate with Warren Buffett) and those preferences must be the same except for a scale factor (Warren Buffet with an income of $10 billion per year must consume one million times as much chocolate as Warren Buffet with an income of $10,000 per year). This is not the world that we live in. The Sonnenschein-Mantel-Debreu theorem shows theoretically that, in an idealized general-equilibrium model in which each individual agent has a regularly specified preference function, aggregate excess demand functions inherit only a few of the regularity properties of the underlying individual excess demand functions: continuity, homogeneity of degree zero (i.e., the independence of demand from simple rescalings of all prices), Walras’s law (i.e., the sum of the value of all excess demands is zero), and that demand rises as price falls (i.e., that demand curves ceteris paribus income effects are downward sloping) … These regularity conditions are very weak and put so few restrictions on aggregate relationships that the theorem is sometimes called “the anything goes theorem.”

The importance of the theorem for the representative-agent model is that it cuts off any facile analogy between even empirically well-established individual preferences and preferences that might be assigned to a representative agent to rationalize observed aggregate demand. The theorem establishes that, even in the most favorable case, there is a conceptual chasm between the microeconomic analysis and the macroeconomic analysis. The reasoning of the representative-agent modelers would be analogous to a physicist attempting to model the macro- behavior of a gas by treating it as single, room-size molecule. The theorem demonstrates thatthere is no warrant for the notion that the behavior of the aggregate is just the behavior of the individual writ large: the interactions among the individual agents, even in the most idealized model, shapes in an exceedingly complex way the behavior of the aggregate economy. Not only does the representative-agent model fail to provide an analysis of those interactions, but it seems likely that that they will defy an analysis that insists on starting with the individual, and it is certain that no one knows at this point how to begin to provide an empirically relevant analysis on that basis.

Kevin Hoover

  1. bruceedmonds
    August 1, 2015 at 1:16 pm

    Agent-based simulation — where each economic actor is represented by a different object in the simulation, each with different characteristics and even different decision-making rules, have now repeatedly shown that complex (so called “emergent”) outcomes result from even simple heterogeneous interacting agents (for a recent survey see Squazzoni et al. 2014). Thus there is no argument that the representative agent argument is dead in the water — the simulations provide formal and concrete counter-examples.

    However, agent-based simulations do hold out a partial success of the “reductionist” project, but not in the way envisaged by micro-economics — it would require a detailed attention to how people actually behave at the micro level, including how different people behave in different ways AND in different contexts. Big Data *might* give us enough data to determine this in the future, but at the current stage this is impractical. In any case, the results are likely to give a range of possible outcomes rather than a probabilistic forecast.

    There is a section of economists following this heterogeneous route – Agent-based computational economics (ACE), but unfortunately these researchers carry across many of the toxic assumptions from micro-economics (presumably in an effort to get published, since such simulations do not *need* such assumptions unlike analytic maths). A wider view is provided by the “Social Simulation” community which included simulating economic phenomena, but as a subset of social behaviour (see for example http://jasss.soc.surrey.ac.uk or Edmonds & Meyer 2013)

    Edmonds, B. & Meyer, R. (2013) Simulating Social Complexity – a handbook. Springer.

    Squazzoni, F., Jager, W., Edmonds, B. (2014). Social Simulation in the Social Sciences: A Brief Overview. Social Science Computer Review, 32 (3), pp. 279-294.

  2. August 2, 2015 at 9:30 am

    Kevin Hoover. “it is certain that no one knows at this point how to begin to provide an empirically relevant analysis on that basis.”

    Wrong, Kevin; I do. One has to start with internal differentiation of functions analogous to the use of Cartesian coordinates to partition and then map a spherical surface. Thereafter the techniques of information systems analysis enable one to map the interconnections between the maps of supply and demand functions available in forms such as supermarket information systems.

    Of course no TWO will know how to provide such analysis if they keep on rejecting any offered as impossible. These day, pigs do fly!

  3. Larry Motuz
    August 5, 2015 at 1:48 am

    The wholesale rejection of empiricism in favor of ‘mathematicism’ within mainstream economics is similar to Ptolemy’s construction of the equant to preserve the other axioms on which Greek astronomy was based: geo-centricity and the planets and the sun moving in perfect circles all of the time. Instead of the equant, mainstream economists — and Lars is well outside the mainstream, have created ‘utility’ and ‘indifference’ analysis to explain what, in fact, they cannot observe.

    Representative agents — whether consumers or firms — do not exist. Until that reality is accepted, the entire edifice of economics, both micro and macro, is alike trying to explain the orbits of the sun and planets by reference to the equant, or a ‘measure’ constructed of partial derivatives that are themselves fundamentally construct with reference to equants.

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