General Equilibrium and Disequilibrium and the Microeconomic Foundations of Macroeconomics

The elementary theory of consumer and producer behaviour under competitive conditions, and the resulting elementary supply/demand model of the partial equilibrium of a single market are the foundations on which the models of general (economy-wide) Walrasian equilibrium are built. By 1960 a rigorous development of such models, in the context of what has become known as the Arrow-Debreu economy, had taken place. As economy-wide models, these can claim to be macroeconomic; and yet their clear specification of the behaviour of individual agents (consumers and firms) which leads to the macroeconomic outcome, gives them a microfoundation. However, at that time they presented a dilemma to economic theory, since most of the central features of interest to macroeconomists (including e.g. money, expectations, involuntary unemployment) are missing from these Walrasian, Arrow-Debreu models. On the other hand, the then popular macroeconomics built on aggregate demand/supply analysis, IS-LM analysis and the Phillips curve trade-off between output and inflation clearly involved money, expectations, etc., and thus did not rest on the Walrasian, Arrow-Debreu base; the appropriate microeconomic foundation for this macroeconomics was not clear. From then on it is possible to identify a number of themes in the literature aimed at providing a microfoundation for macroeconomics. The objective of this chapter is to introduce the reader to some of the important surviving themes from this literature.