Introduction

In the following pages I give my understanding of general-equilibrium economics and complexity economics (i.e., agent-based modeling). The two are spiritual siblings, because they are based on ground-up modeling via many heterogeneous agents. I argue that the difference between them is that general equilibrium (GE) involves supply equaling demand across many interdependent markets, or, in other words, a multidimensional fixed point of doing and expecting. This framework is a prerequisite for complete rationality. By contrast, agent-based modeling (ABM) drops simultaneous equations and replaces rational utility maximization with behavioral rules. The advantage is that, freed from the computational burden of solving simultaneous equations, ABM can operate in much higher dimensions and include realistic levels of detail that are unimaginable in equilibrium models. The downside is that one can never be sure that, as the economy evolves into new situations, the assumed behavioral rules won’t become unrealistically irrational.

My suggestion is to treat GE and ABM as complementary. Economists should solve stylized GE models to find out what rational behavior is. Once rational behavior is understood, it can be mimicked or approximated by behavioral rules in a much richer ABM model. Conversely, one can check that an ABM model is compatible with full rationality by building a simpler GE model and seeing if similar features appear. Of course, some ABM models are designed to display features that emerge only in a world of boundedly rational agents.

I describe four ongoing research projects in which I began with a GE-style model and then tried to enrich it (with others) into an ABM model. These are mortgage prepayment models, models of monies and inflation, models of booms and busts with collateral, and models of housing.

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