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The Representative Household Assumption Requires sustainable Heterogeneity in Dynamic Models

Harashima, Taiji (2014): The Representative Household Assumption Requires sustainable Heterogeneity in Dynamic Models.

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Abstract

The assumption of the representative household defined as the average of all households is impossible in dynamic models if households are heterogeneous in their time preference rates because, as is well known, the most patient household eventually prevails. Because time preference rates are unquestionably heterogeneous across economies and time periods, macroeconomics studies using the representative household assumption in dynamic models are fallacious. I present an alternative definition of the representative household based on the concept of sustainable heterogeneity. By this definition, use of the representative household assumption becomes possible in dynamic models.

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