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Macrofoundations of Micro

July 22nd, 2014

I was very pleased with my post on this topic, making the point that standard microeconomic analysis only works properly on the assumption that the economy is at a full employment equilibrium.

But, it turns out, exactly the same point, using the same title, was made by David Colander 20 years ago

Colander (1993), The Macrofoundations of Micro, Eastern Economic Journal, Vol. 19, No. 4 (Fall, 1993), pp. 447-457

And he wasn’t the first. The term and the idea have a long history, including a contribution by my UQ colleague Bruce Littleboy

The term macrofoundations, I suspect, has been around for a long time. Tracing the term is a paper in itself. Axel Leijonhufvud remembered using it in Leijonhufvud [1981] . I was told that Roman Frydman and Edmund Phelps [1983] used the term and that Hyman Minsky had an unpublished paper from the 1970s with that title; Minsky remembered it, but doubted he could find it and told me that he used the term in a slightly different context. I was also told by Christof Ruhle that a German economist, Karl Zinn, wrote a paper with that title for a Festschrift in 1988, but that it has not been translated into English. I suspect the term has been used many more times because it is such an obvious counterpoint to the microfoundations of macro, and hence to the New Classical call for microfoundations. While he does not use the term explicitly, Bruce Littleboy [1990], in work that relates fundamentalist Keynesian ideas with Clower and Leijonhufvud’s ideas, discusses many of the important issues raised here.

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  1. Ernestine Gross
    July 22nd, 2014 at 18:27 | #1

    I am not familiar with the work done under the heading ‘macrofoundations of micro’. My comment may be therefore off the mark.

    IMHO, arrived at after I worked in general equilibrum theory, microeconomic results (eg consumer choice, production theory) are characterisations of ‘an equilibrium’, assuming it exists. Many of these results rely on a unique equilibrum. Translated to macroeconomic topics, such as ‘unemployment’, ‘an equilibrium’ may entail zero involuntary unemployment (Walras equilibrium) or it may entail positive involuntary unemployment (‘excess supply with its value minimised – eg zero wage) in a Radner equilibrium (which is known as ‘pseudo-equilibrium’). ‘An equilibrium’ in models where markets are incomplete are known to be generically Pareto inefficient (ie involuntary unemployment cannot be ruled out). So, what type of equilibrium is supposed to underly the macroeconomic foundation of microeconomics?

  2. Ikonoclast
    July 22nd, 2014 at 21:24 | #2

    I am only sure that I am sure of nothing anymore: at least in relation to economics. Here are my oblique ramblings.

    A human body in a morgue freezer has an equilibrium state. A living, healthy human body has a homeostatic state. Can a society or socio-economic system ever be said to be in or capable of an equilibrium state?

    In an equilibrium state:

    Conditions are stable within the system
    Net free energy neither enters nor escapes the system

    In a steady state (such as homeostasis);

    Conditions are stable within the system
    Free energy is continuously put into the system
    Over time, the system is maintained in a higher state of order than its surroundings

    But then maybe economists don’t mean by “equilibrium” what physicists and biologists mean by “equilibrium”. If economics has no connection to physics or biology then what is it connected to?

  3. ramit
    July 22nd, 2014 at 22:04 | #3

    This idea, in fact (and not suprisingly), dates back to Keynes’ General Theory. Of course, Keynes does not use the concept of “microfoundations”, but his argument is very close to that. At any rate, it is a fundamentally keynesian idea in its inspiration.

    It appears, however, that this way of thinking is probably reached as follows. In any given industry we have a demand schedule for the product relating the quantities which can be sold to the prices asked; we have a series of supply schedules relating the prices which will be asked for the sale of different quantities on various bases of cost; and these schedules between them lead up to a further schedule which, on the assumption that other costs are unchanged (except as a result of the change in output), gives us the demand schedule for labour in the industry relating the quantity of employment to different levels of wages, the shape of the curve at any point furnishing the elasticity of demand for labour. This conception is then transferred without substantial modification to industry as a whole; and it is supposed, by a parity of reasoning, that we have a demand schedule for labour in industry as a whole relating the quantity of employment to different levels of wages. It is held that it makes no material difference to this argument whether it is in terms of money-wages or of real wages.
    If this is the groundwork of the argument (and, if it is not, I do not know what the groundwork is), surely it is fallacious. For the demand schedules for particular industries can only be constructed on some fixed assumption as to the nature of the demand and supply schedules of other industries and as to the amount of the aggregate effective demand. It is invalid, therefore, to transfer the argument to industry as a whole unless we also transfer our assumption that the aggregate effective demand is fixed. Yet this assumption reduces the argument to an ignoratio elenchi. For, whilst no one would wish to deny the proposition that a reduction in money-wages accompanied by the same aggregate effective demand as before will be associated with an increase in employment, the precise question at issue is whether the reduction in money-wages will or will not be accompanied by the same aggregate effective demand as before measured in money, or, at any rate, by an aggregate effective demand which is not reduced in full proportion to the reduction in money-wages (i.e. which is somewhat greater measured in wage-units). But if the classical theory is not allowed to extend by analogy its conclusions in respect of a particular industry to industry as a whole, it is wholly unable to answer the question what effect on employment a reduction in money-wages will have. For it has no method of analysis wherewith to tackle the problem.

    (Chapter 19)

  4. Tony Lynch
    July 23rd, 2014 at 18:43 | #4

    Damn it, ramit. I’m going back to for a re-read. Keynes always thinks.

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