A Stochastic Aggregation of Economic Behavior: The Case of Switching Rule in the Adaptive Belief System

The Dixit-Stiglitz aggregation has been established as a conventional technology for analyzing monopolistic competition and product diversity in a micro-founded economic model. However, a simple method for aggregating individual choices cannot be applied to a case in which an economic system relies for its interaction on heterogeneous agents. In this paper, we examine the effects of a stochastic aggregation on group behavior in the adaptive belief system (ABS); our simulation study allows stochastic switching between fundamentalists and chartists for finite number of agents. In particular, agents are allowed to deviate from the behavioral rule, and they are considered irrational. The results show that the stochastic switching has strong influences on price dynamics, especially when the economy is dominated by irrational agents.