Stochastic Macro-equilibrium and A Microfoundation for the Keynesian Economics

In place of the standard search equilibrium, this paper presents an alternative concept of stochastic macro-equilibrium based on the principle of statistical physics. This concept of equilibrium is motivated by unspecifiable differences of economic agents and the presence of all kinds of micro shocks in the macroeconomy. Our model mimics the empirically observed distribution of labor productivity. The distribution of productivity resulting from the matchings of workers and firms depends crucially on aggregate demand. When aggregate demand rises, more workers are employed by firms with higher productivity while at the same time, the unemployment rate declines. The effect of the reservation wage on unemployment also depends on aggregate demand. The model provides a micro-foundation for Keynes' principle of effective demand.