PART II - MICROFOUNDATIONS OF MACROECONOMICS

Summary

Arrow was among the first to call for a rigorous microfoundation for the major questions arising in macroeconomics (1967). He was also the first to point out (1959) that when markets are in disequilibrium, agents are in a position to affect their own terms of trade. This point is frequently raised in objection to the fixed price approaches of Bennassy, Dreze, and Malinvaud (for example) as well as the voluminous search theory literature.

It is therefore of real interest to uncover evidence as to whether or not quantities adjust faster than prices. Some evidence that quantity adjustment is faster is given in the paper by Koenig and Nerlove using French and West German industry data.

Modern “rational expectationists” (e.g., Lucas and Sargent) have argued that there is significant doubt as to whether there is any long-term disequilibrium; in particular, they question the existence of involuntary unemployment: Workers, in a variety of contexts, rationally take their chances in the labor market and occasionally lose, that is, are voluntarily (ex ante) unemployed. In response to this view, Kurz presents a model in which the worker does not know his or her own quality, even after the firm discovers it. A low-quality worker is fired and enters the labor market, demanding the same wage as high-quality workers. This situation is both one of involuntary unemployment and is also ex ante rational for the worker.