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Heterogeneous Expectations, Market Dynamics, and Social Welfare

  • SaangJoon Baak

    ()

    (International University of Japan)

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    This paper explores the extent to which the lack of rationality of economic agents has affected the economic fluctuations and the social welfare of the U.S. hog market. A group of articles has ascribed the business cycles of the hog market, observed by economists as early as the last century, mainly to a lack of rationality (cobweb expectations) of economic agents. In contrast, others, assuming the full rationality of economic agents, have ascribed them to production lags and external shocks. These two streams of thought are reconciled in this paper by adopting the mechanics of conventional rational-expectations models and assuming heterogeneity in expectations. The dynamic model presented here assumes two types of economic agents. One (rational agent) has rational expectations and the other (boundedly rational agent) has cobweb expectations. The fraction of boundedly rational agents is estimated along with other deep parameters of the model using actual market data. Then, simulation experiments are performed to investigate how the presence of boundedly rational economic agents has affected the volatility of the economic variables and the social welfare of the market. In particular, several sets of artificial data are generated by the model using the estimated parameter values as the fraction of the boundedly rational agents changes from zero to one. Each set of artificial data is related to a certain fraction of boundedly rational agents. Then, the variances of the quantity and price variables are computed using actual and artificial data and compared. Empirical test results indicate that some fraction of economic agents in the U.S. hog market are boundedly rational. According to preliminary simulation experiments, the higher the fraction of boundedly rational agents is, the more volatile the economic variables are. The social welfare will be measured and compared in the same way.

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    Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 1999 with number 222.

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    Date of creation: 01 Mar 1999
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    Handle: RePEc:sce:scecf9:222
    Contact details of provider: Postal: CEF99, Boston College, Department of Economics, Chestnut Hill MA 02467 USA
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    Web page: http://fmwww.bc.edu/CEF99/

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    1. Anderson, Evan W. & McGrattan, Ellen R. & Hansen, Lars Peter & Sargent, Thomas J., 1996. "Mechanics of forming and estimating dynamic linear economies," Handbook of Computational Economics, in: H. M. Amman & D. A. Kendrick & J. Rust (ed.), Handbook of Computational Economics, edition 1, volume 1, chapter 4, pages 171-252 Elsevier.
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    7. Baak, Saang Joon, 1999. "Tests for bounded rationality with a linear dynamic model distorted by heterogeneous expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 23(9-10), pages 1517-1543, September.
    8. repec:att:wimass:9606 is not listed on IDEAS
    9. Lucas, Robert E, Jr & Prescott, Edward C, 1971. "Investment Under Uncertainty," Econometrica, Econometric Society, vol. 39(5), pages 659-81, September.
    10. Brock, William A. & Hommes, Cars H., 1998. "Heterogeneous beliefs and routes to chaos in a simple asset pricing model," Journal of Economic Dynamics and Control, Elsevier, vol. 22(8-9), pages 1235-1274, August.
    11. Evan W. Anderson & Lars Peter Hansen & Ellen R. McGrattan & Thomas J. Sargent, 1995. "On the mechanics of forming and estimating dynamic linear economies," Staff Report 198, Federal Reserve Bank of Minneapolis.
    12. Chavas, Jean-Paul, 1999. "On The Economic Rationality Of Market Participants: The Case Of Expectations In The U.S. Pork Market," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 24(01), July.
    13. Gourieroux, Christian & Holly, Alberto & Monfort, Alain, 1982. "Likelihood Ratio Test, Wald Test, and Kuhn-Tucker Test in Linear Models with Inequality Constraints on the Regression Parameters," Econometrica, Econometric Society, vol. 50(1), pages 63-80, January.
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    15. Nerlove, Marc & Fornari, Ilaria, 1998. "Quasi-rational expectations, an alternative to fully rational expectations: An application to US beef cattle supply," Journal of Econometrics, Elsevier, vol. 83(1-2), pages 129-161.
    16. Hayes, Dermot J. & Schmitz, Andrew, 1987. "Hog Cycles and Countercyclical Production Response," Staff General Research Papers 597, Iowa State University, Department of Economics.
    17. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
    18. McGrattan, Ellen R., 1994. "A note on computing competitive equilibria in linear models," Journal of Economic Dynamics and Control, Elsevier, vol. 18(1), pages 149-160, January.
    19. Chavas, Jean-Paul, 1999. "On Dynamic Arbitrage Pricing and Information: The Case of the US Broiler Sector," European Review of Agricultural Economics, Foundation for the European Review of Agricultural Economics, vol. 26(4), pages 493-510, December.
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