Economics is divided into two sections, micro (focusing on individuals) and macro (focusing on the whole economy). However in universities the emphasis is heavily on micro to the extent that macro is often seen as simply micro on a larger scale. This is fundamentally wrong and ignores several points.
This focus ignores the fact that the best option for the individual is not always the best option for society as a whole. This may seem an obvious point but it is one often ignored by neo-classical economists. Rather they proclaim that if each individual does what is best in their own interest then society as a whole will benefit. A couple of examples show why this is not the case.
This current recession is a main example. Individuals being greedy did not benefit society, rather it led to a massive housing bubble followed by a financial and economic collapse. Each individual responded to it in a rational way, but this led to a negative outcome for the economy. Each individual aimed to balance their finances by spending less, which is a perfectly logical and rational idea. However if everyone in the economy does this then we end up in recession. This is because one person’s spending is another person’s income. You may decide to save money by not going to the cinema. However if enough people do this then the cinema closing resulting in unemployment. An economy can quickly fall into a downward spiral. These unemployed cinema workers now do not have enough money to spend at your business, reducing your income, leading to more spending cuts and more unemployment.
This is why the recession is lasting so long. We cannot get out of the recession until spending increases. However businesses will not increase investment until consumers start spending as it is pointless to expand if no one is willing to buy your extra products. While this is rational from a micro point of view, it leads to a continuation of a recession in the macro view. Likewise consumers are reducing spending in the face of wage cuts, job losses, tax rises etc. Likewise this makes sense from their point of view and works if only they do it, but if everyone cuts spending then the economy declines. That is why austerity will not work. This means that the aggregate of rational decisions leads to an irrational solution, strange as that may sound.
An economy in recession clearly shows why we cannot base macroeconomics on microeconomics foundations. Mainly because microeconomics cannot explain how recessions happen in the first place. There is no such thing as unemployment, only people choosing not to work. During the Great Depression economists could not explain the paradox of mass unemployment of people willing to work but forced to go hungry. This was contrast with the vast amount of machinery left idle and factories abandoned, while consumers suffered from a lack of basic goods and even food. This paradox drove some to embrace Communism. While this won’t happen this time, there still will be (and needs to be) a revolution in economics. We need to put macro over micro.