Aggregation problem

An aggregate in economics is a summary measure describing a market or economy. The aggregation problem refers to the difficulty of treating an empirical or theoretical aggregate as if it reacted like a less-aggregated measure, say, about behavior of an individual agent as described in general microeconomic theory. Examples of aggregates in micro- and macroeconomics relative to less aggregated counterparts are:

Standard theory uses simple assumptions to derive general, and commonly accepted, results such as the law of demand to explain market behavior. An example is the abstraction of a composite good. It considers the price of one good changing proportionately to the composite good, that is, all other goods. If this assumption is violated and the agents are subject to aggregated utility functions, restrictions on the latter are necessary to yield the law of demand. The aggregation problem emphasizes:

Franklin Fisher notes that this has not dissuaded macroeconomists from continuing to use such concepts.

The aggregate consumer demand curve is the summation of the individual consumer demand curves. The aggregation process preserves only two characteristics of individual consumer preference theory—continuity and homogeneity. Aggregation introduces three additional non-price determinants of demand:

Thus if the population of consumers increases, ceteris paribus the demand curve will shift out; if the proportion of consumers with a strong preference for a good increases, ceteris paribus the demand for that good will change. Finally, if the distribution of income changes in favor of consumers who prefer the good in question, the demand will shift out. It is important to remember that factors that affect individual demand can also affect aggregate demand. However, net effects must be considered.

First, to sum the demand functions without other strong assumptions it must be assumed that they are independent; that is that one consumer's demand decisions are not influenced by the decisions of another consumer. For example, A is asked how many pairs of shoes he would buy at a certain price. A says at that price I would be willing and able to buy two pairs of shoes. B is asked the same question and says four pairs. Questioner goes back to A and says B is willing to buy four pairs of shoes, what do you think about that? A says if B has any interest in those shoes then I have none. Or A, not to be outdone by B, says "then I'll buy five pairs". And on and on. This problem can be eliminated by assuming that the consumers' tastes are fixed in the short run. This assumption can be expressed as assuming that each consumer is an independent idiosyncratic decision maker.

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