The term methodological individualism was coined by the Austrian economist and historian Joseph Schumpeter, who also, incidentally, coined the term creative destruction, in reference to the "gales of innovation" which freedom of exchange unleashes.
Methodological individualism is another way of saying individualistic method.
Both terms denote “a principle of explanation, in which the individual human being serves as the basic and most fundamental unit of analysis in the social sciences."
A social system is a system of individual relationships.
All actions are performed by individuals.
The individualistic method — or methodological individualism, if you prefer — does not, however, claim that only individual human beings are real and that social phenomena do not exist. It holds, rather, that each individual human being is alone able to think, feel, and act.
Methodological individualism rests upon the principle that the relevant object of political and ethical inquiry are the individual human beings in question, as distinguished from a society, race, class, sex, or any other group. Quoting Karl Popper:
“Social phenomena] should always be understood as resulting from the decisions, actions, attitudes, etc. of human individuals, and we should never be satisfied by an explanation in terms of so-called 'collectives' (states, nations, races, etc.).”
The reason this principle is so critical to ground in the facts which give rise to it (and to thereafter deeply defend) is this: any other view of humanity — which is to say, any view that doesn’t recognize the individual as the proper standard by which societies are gauged and maintained — results in command and control: other humans, purveyors of force, seizing control over other individual human lives.
Individualism has always been mischaracterized by critics, most of whom to this day charge it with treating individuals as "a hermetically sealed atom" — atomistic, is their word for it — isolated, shut off, cut off, uninfluenced by others. This exact mischaracterization underpins J.K. Galbraith's ersatz demonstration in his influential book, from 1958, The Affluent Society. Galbraith’s arguments are to this day deployed routinely, unmodified — despite the thorough debunkings a number of Galbraith’s fellow economists and philosophers have given to his arguments. As Friedrich Hayek famously explained it in his devastating critique of The Affluent Society:
Professor Galbraith's argument could be easily employed, without any change of the essential terms, to demonstrate the worthlessness of literature or any other form of art. Surely an individual's want for literature is not original with himself in the sense that he would experience it if literature were not produced. Does this then mean that the production of literature cannot be defended as satisfying a want because it is only the production which provokes the demand? (Friedrich A. Hayek, "The Non Sequitur of the 'Dependence Effect,'" in Friedrich A. Hayek, Studies in Philosophy, Politics, and Economics, University of Chicago Press, 1967).
Economic theory is not built or based upon the unintelligible notion that each individual person arrives at her or his values in a vortex — some metaphysically impossible place sealed-off from all other human action and interaction — and the fact that this is how critics characterize individualism tells you how little they themselves understand the term. Human choices do not occur in a vacuum. Of course individuals learn from one another — especially in a free society: learn from, influence, build upon, reciprocate, and so on — and we do so as individual humans acting voluntarily. This is good, and it is healthy.
This does not, as J.K. Galbraith proposes, invalidate individual choice, neither does it make values “artificial and illegitimate.” On the contrary, in fact, it makes choice and values possible. Because valuing is a choice.