Microeconomic Foundations of Macroeconomics

Economic theory can be divided into microeconomics and macroeconomics. The neoclassical theory of microeconomics has been much influenced by the theory of classical mechanics in physics. In the latter theory, a system which consists of a number of particles can be fully described by specifying mass, position, and velocity of each single particle. Similarly, microeconomic theory tries, as we saw in preceding chapters, to describe the behavior of an economy by specifying the behavior of each single consumer and the input–output activity of each single firm. There is, however, an alternative approach in physics. Consider the behavior of the gas contained in a balloon. The gas consists of different molecules and the behavior of these molecules like the collisions among them obeys the laws of classical mechanics. If we know the position, velocity and mass of each of these molecules, therefore, we can describe, at least in principle, the behavior of the gas. From the more practical point of view, however, it is much more important to measure the balloon’s volume, its pressure, its temperature, etc., to describe the behavior of the gas. For example, it can be described by the universal gas equation, pV = NRT, where p denotes pressure, V volume, N the number of mols, R the universal gas constant, and T the absolute temperature.