Microeconomic Thinking and Macroeconomic Models

Microeconomics is the study of how households and firms make decisions and
how these decisionmakers interact in the marketplace.A central principle of microeconomics
is that households and firms optimize—they do the best they can
for themselves given their objectives and the constraints they face. In microeconomic
models, households choose their purchases to maximize their level of satisfaction,
which economists call utility, and firms make production decisions to
maximize their profits.
Because economy-wide events arise from the interaction of many households
and many firms, macroeconomics and microeconomics are inextricably linked.
When we study the economy as a whole,we must consider the decisions of individual
economic actors. For example, to understand what determines total consumer
spending, we must think about a family deciding how much to spend
today and how much to save for the future.To understand what determines total
investment spending, we must think about a firm deciding whether to build a
new factory. Because aggregate variables are the sum of the variables describing
many individual decisions, macroeconomic theory rests on a microeconomic
foundation.
Although microeconomic decisions always underlie economic models, in
many models the optimizing behavior of households and firms is implicit rather
than explicit.The model of the pizza market we discussed earlier is an example.
Households’ decisions about how much pizza to buy underlie the demand for
pizza, and pizzerias’ decisions about how much pizza to produce underlie the
supply of pizza. Presumably, households make their decisions to maximize utility,
and pizzerias make their decisions to maximize profit.Yet the model did not
focus on these microeconomic decisions; it left them in the background. Similarly,
in much of macroeconomics, the optimizing behavior of households and
firms is left implicit.