Chapter 4. Heterogeneous Agents in the Macroeconomy: Reduced-Heterogeneity Representations

This chapter surveys heterogeneous agent models with rational expectations that deliver a finite number of heterogeneous agents as an equilibrium outcomes. Instead of having a distribution with infinite support to follow, this class of models endogenously generates a finite number of agents as an equilibrium outcome. As a consequence, many of the additional tools and techniques developed in the DSGE literature with a representative agent can easily be imported in this class of models, allowing these models to be brought to the data with advanced econometric techniques. No-trade, small-heterogeneity and truncation methods are presented. The derivation of optimal policies is presented in these environments. Finally, the chapter discusses the relation with other heterogeneous agent models that don't rely on rational expectations, namely agent-based models.