Rational expectations equilibria of economies with local interactions

Abstract We consider general economies in which rational agents interact locally. The local aspect of the interactions is designed to represent in a simple abstract way social interactions, that is, socioeconomic environments in which markets do not mediate all of agents’ choices, which might be in part determined, for instance, by family, peer group, or ethnic group effects. We study static as well as dynamic infinite horizon economies; we allow for economies with incomplete information, and we consider jointly global and local interactions, to integrate e.g., global externalities and markets with peer and group effects. We provide conditions under which such economies have rational expectations equilibria. We illustrate the effects of local interactions when agents are rational by studying in detail the equilibrium properties of a simple economy with quadratic preferences which captures, in turn, local preferences for conformity, habit persistence, and preferences for status or adherence to aggregate norms of behavior.

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