LAUSR

Abstract Heterogeneous agent (HA) and representative agent (RA) models often give very different answers to important economic questions, even when studying the same phenomenon with the otherwise identical assumptions. There are a variety of reasons why HA and RA models may differ. This paper provides a formula that can be used to decompose the different response functions of HA and RA models into six major “mechanical” categories. Because solving HA models is costly, researchers using this formula are better able to predict when an HA model is unlikely to improve upon an RA model, and defend their use of an RA model without first solving the HA model. Moreover, when two models do diverge, this paper provides a framework for understanding mechanically why they diverged.