I discuss what we mean by microfoundations of macroeconomic models. This is effectively where we use our microeconomic assumptions and results, and aggregate these to give macroeconomic results.
The idea of micro founding has been around for quite some time, but it gained a lot of attention when Lucas published his famous critique in 1976. He repeated the concerns of previous economists in a more concise way, while publishing at the time of stagflation in many major economies. This time saw policymakers fail to understand that increasing inflation does not necessarily imply a decrease in unemployment, as was believed to be the case due to the famous Phillip's curve. In fact, this relationship is only that: a relationship. when we try to exploit this relationship, it breaks down due to individuals adapting their expectations about future inflation, causing the curve to shift.
This meant that a new movement formed. Economists began to focus on the merits of using our microeconomic assumptions and building up to an aggregate model. This meant that we had internal consistency in the models; macro models logically developed from our micro models, as lots of individuals make up the macro economy. We then have macro results based on individual optimisation problems, which change when policy changes.
There are a couple of issues with this. Firstly, our micro models tend to make very strict assumptions about individual economic agents. We assume a certain utility function and budget constraint, with with we conduct a constrained optimisation problem. However, all individuals do not have constraints of this form, and perhaps no one does at all. When we aggregate a set of unrealistic assumptions, we often see results that are not present in the actual data. On top of this, the behaviour of groups does not always equal the behaviour of individuals within those groups.
Building models in this way thus has its benefits and its challenges, but each individual model has its own merits and can be critiqued and improved. Eventually we would hope to end up with something that allows us to analyse the economy in a meaningful way.
Subscribe for more videos looking at games of chance, tutorials, and everything to do with the industry. Put suggestions for video ideas in the comments section below and any feedback offered would be greatly appreciated.
My videos are intended for educational and entertainment purposes. I try to credit the relevant parties for any work that I refer to in my videos (for example, citing relevant academic papers). If you believe a video does not observe good academic practice, please do not hesitate to contact me by email at everythingbetting@gmail.com
21 сен 2024
