economic theory Economics () is the social science that studies the production, distribution, and consumption of goods and services. Economics focuses on the behaviour and interactions of economic agents and how economies work. Microeconomics analyzes ...

and

econometrics Econometrics is the application of statistical methods to economic data in order to give empirical content to economic relationships. M. Hashem Pesaran (1987). "Econometrics," '' The New Palgrave: A Dictionary of Economics'', v. 2, p. 8 p. 8 ...

, the term heterogeneity refers to differences across the units being studied. For example, a

macroeconomic model A macroeconomic model is an analytical tool designed to describe the operation of the problems of economy of a country or a region. These models are usually designed to examine the comparative statics and dynamics of aggregate quantities such a ...

in which consumers are assumed to differ from one another is said to have heterogeneous agents.

Unobserved heterogeneity in econometrics

, statistical inferences may be erroneous if, in addition to the observed variables under study, there exist other relevant variables that are unobserved, but correlated with the observed variables; dependent and independent variables .M. Arellano (2003),
Panel Data Econometrics
', Chapter 2, 'Unobserved heterogeneity', pp. 7-31. Oxford University Press. Methods for obtaining valid statistical inferences in the presence of unobserved heterogeneity include the instrumental variables method;

multilevel model Multilevel models (also known as hierarchical linear models, linear mixed-effect model, mixed models, nested data models, random coefficient, random-effects models, random parameter models, or split-plot designs) are statistical models of parame ...

s, including

fixed effects In statistics, a fixed effects model is a statistical model in which the model parameters are fixed or non-random quantities. This is in contrast to random effects models and mixed models in which all or some of the model parameters are random va ...

and

random effects In statistics, a random effects model, also called a variance components model, is a statistical model where the model parameters are random variables. It is a kind of hierarchical linear model, which assumes that the data being analysed are ...

models; and the

Heckman correction The Heckman correction is a statistical technique to correct bias from non-randomly selected samples or otherwise incidentally truncated dependent variables, a pervasive issue in quantitative social sciences when using observational data. Concep ...

for selection bias.

Economic models with heterogeneous agents

{{Further, Agent-based computational economics, Dynamic stochastic general equilibrium

Economic model In economics, a model is a theoretical construct representing economic processes by a set of variables and a set of logical and/or quantitative relationships between them. The economic model is a simplified, often mathematical, framework desi ...

s are often formulated by means of a representative agent. Depending on the application, individual agents can be aggregated to or represented by a single agent. For example, individual demand can be aggregated to market demand if and only if individual preferences are of the Gorman polar form (or equivalently satisfy linear and parallel Engel curves). Under this condition, even heterogeneous preferences can be represented by a single aggregate agent simply by summing over individual demand to market demand. However, some questions in economic theory cannot be accurately addressed without considering differences across agents, requiring a heterogeneous agent model. How to solve a heterogeneous agent model depends on the assumptions that are made about the expectations of the agents in the model. Broadly speaking, models with heterogeneous agents fall into the category of

agent-based computational economics Agent-based computational economics (ACE) is the area of computational economics that studies economic processes, including whole economies, as dynamic systems of interacting agents. As such, it falls in the paradigm of complex adaptive systems. ...

(ACE) if the agents have

adaptive expectations In economics, adaptive expectations is a hypothesized process by which people form their expectations about what will happen in the future based on what has happened in the past. For example, if people want to create an expectation of the inflatio ...

, or into the category of

dynamic stochastic general equilibrium Dynamic stochastic general equilibrium modeling (abbreviated as DSGE, or DGE, or sometimes SDGE) is a macroeconomic method which is often employed by monetary and fiscal authorities for policy analysis, explaining historical time-series data, as we ...

(DSGE) if the agents have

rational expectations In economics, "rational expectations" are model-consistent expectations, in that agents inside the model are assumed to "know the model" and on average take the model's predictions as valid. Rational expectations ensure internal consistency i ...

. DSGE models with heterogeneneous agents are especially difficult to solve, and have only recently become a widespread topic of research; most early DSGE research instead focused on representative agent models.

Methods for solving DSGE models with heterogeneous agents

*Heathcote, Storesletten and Violante ( AEJ Macro 2009) make convenient functional form assumptions that allow for some dimensions of heterogeneity but nonetheless maintain an analytical solution for the general equilibrium. * Krusell and Smith ( JPE 1998) permit an arbitrary distribution of wealth but assume all prices and equilibrium variables are approximately functions of the mean or of a few other statistics of that distribution. *Algan, Allais, and den Haan (2009) approximate the distribution by a parameterized distributional form at all times. *Reiter ( JEDC 2009) and Mertens and Judd (mimeo 2011) develop perturbation methods for approximating the dynamics of the distribution under arbitrary distributional forms.

References

Computational economics Economic methodology

Unobserved heterogeneity in econometrics

Economic models with heterogeneous agents

Methods for solving DSGE models with heterogeneous agents

See also

References