aggregation problem

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1 The conceptual difficulties encountered when an aggregate value is used to represent the total of individual values. Consider an economy with many firms, each of which uses inputs of capital and labour to produce output. Two forms of aggregation problem can arise. First, any attempt to sum the quantities of capital used by individual firms to arrive at an aggregate quantity of capital has to confront the issue posed by different types of capital. For instance, the number of metal presses used by a car manufacturer cannot just be added to the number of computers used by a software developer. Second, even if all firms use the same type of capital, it is generally not possible to aggregate the firms into a single representative firm using the aggregate stock of capital. For this to be possible it has to be the case that one extra unit of aggregate capital produces the same additional output as one extra unit of capital for an individual firm. This is only true if all firms have access to the same constant returns to scale production technology.

2 The erroneous interpretation of observed association between two variables at the aggregate level as evidence of association at the individual level. This is also known as the ecological fallacy.

Subjects: Economics.

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