Macroeconomics with microeconomic foundations

Nowadays more and more macroeconomic theories are developed based on microeconomic foundations; such changes are different from the most traditional macroeconomics study, which starts from an overall picture. Such method has its advantages as well as disadvantages.

I would like to start with the advantages. Of course, the economic performance is the summary of individuals’ activities within the economy. When the population is large enough, it is more likely to see individuals have an average or a most common pattern in their activities. Using these patterns and accumulating them can form a model to picture the economy with more realistic factors in the models. Therefore, such macroeconomics models are more likely to be closer to the reality. Secondly, the work of collecting all information about the economy is not possible, the microeconomics models usually require much smaller samples. If we are able to collect data from a reasonable sample, we can build a microeconomic model and aggregate this model to build a macroeconomic model. So using this method can make modelling easier. Thirdly, such method makes more logic sense. The performance of an economy is contributed by all the individuals within the economy; therefore, considering individuals when modelling the economy makes more sense compared with modelling macroeconomics theories without taking into account of individuals.

However, such method has its disadvantages. Firstly, the models developed by such method may not be homogeneous across different economies. As recognising the cultural and geographical differences, individuals from different economies behave differently, this leads to different economies have different average individual patterns, thus the models are not homogeneous. Secondly, macroeconomics does not only consider individuals, but also considers firms and banks as well. The behaviours of firms and banks are not like individuals, especially when many of them are globalised organisations. Modelling these companies and banks in the economy is extremely complicated. Often over-complicated models can collapse. Thirdly, over-simplified individual models can deliver very inaccurate macroeconomic models, as the small errors made by over-simplified individual models accumulate and create significant errors in the models.

Therefore, build macroeconomics models based on microeconomics foundations has its pros and cons, so researchers have to be careful when using such method.