What is Neoclassical Economics?

Neoclassical Economics argues that, as the consumers goal is utility maximization and the organizations goal is profit maximization, the customer is ultimately in control of market forces such as price and demand. 

The theory relates the supply and demand to an individuals rationality and ability to maximize utility. It applies mathematical equations to analyze different aspects of economics.

NeoClassical Perscpective

The neoclassical perspective on macroeconomics holds that, in the long run, the economy will fluctuate around its potential GDP and its natural rate of unemployment. 

Building Blocks of Neoclassical Economics

Two building blocks of neoclassical economics: 

(1) potential GDP determines the economy's the size and 

(2) wages and prices will adjust in a flexible manner so that the economy will adjust back to its potential GDP level of output. 

Policy Implication of Neoclassical Economics

The key policy implication is that the government should focus more on long-term growth and on controlling inflation than on worrying about recession or cyclical unemployment. 

This focus on long-run growth rather than the short-run fluctuations in the business cycle means that neoclassical economics is more useful for long-run macroeconomic analysis and Keynesian economics is more useful for analyzing the macroeconomic short run. 

The History of Neoclassical Economic Theory

The Neoclassical economics has its root in the works of: 

• Adam Smith (1723-90) and David Ricardo (1772-1823). 
• The theory was refined by Alfred Marshall (1842-1924), Vilfredo Pareto (1848-1923), John Clark (1847-1938), and Irving Fisher (1867-1947) during 19th and 20th century. 
• The term Neoclassical economics was coined in 1900. 

Today, the mainstream economics is dominated by the Neoclassical synthesis formed by the Neoclassical economics together with Keynesian economics. 

Neoclassical Economics vs Classical Economics

The Neoclassical theory assumes the consumers often perceive a product as being more valuable than the cost of production and the perceived value depends on the utility of the product and it affects the demand of the product. 

In contrary, classical economics calculates the value of a product as the cost of material plus the cost of labor. The neoclassical thought refutes this idea of product cost. 

The Neoclassical economists argue, the consumers want to maximize their personal satisfaction and thus they make informed decisions based on the evaluation utility of a product. This is similar to the rational behavior theory which argues that people rationally make economic decisions. 

This theory also states that competition leads to an efficient allocation of resources within an economy. It says the market equilibrium between supply and demand is established by this resource allocation. 

The critics of the neoclassical economic theory argue the neoclassical economics is based on unrealistic assumptions that are far from the real situations. It assumes all parties behave rationally while taking an economic decision, but this assumption does not consider the susceptibility of human nature to other forces. 

The decision of a consumer is not free, and they may make irrational choices due to other forces. 

The neoclassical theory holds that matters like labor law will improve naturally as a result of the economic condition. This argument is vehemently criticized by many economists who believe this theory leads to inequalities in global debt and trade relations. 

The neoclassical theory states, there is no upper limit for a capitalist's profit-making. As the value of the product depends on the perception of the consumers, the capitalists can exploit this to make money. The selling price minus the cost of the production is called the economic surplus.

Related Topics

• Supply-Side Economics
• Say's Law
• Laffer Curve
• Neo-Classical Economics
• New Keynesian Economics
• Classical Economics
• Supply-Side Economics
• Keynesian Economics
• Keynes' Law
• Keynesian Analysis
• Demand Side Theory
• Market Forces
• Aggregate demand
  
• Aggregate Demand Curve (and shifts)
• Aggregate supply
• Aggregate Supply Curve (and Shifts)
• Aggregate Demand / Aggregate Supply Models
• Potential GDP
• Aggregate Supply and Demand Equilibrium
• Aggregate Supply and Aggregate Demand in Macroeconomics and Microeconomics
• Input-Output Model
• Stagflation
• Growth and Recessions in the Aggregate Demand - Aggregate Supply Model
• Unemployment in the Aggregate Demand - Aggregate Supply Model
• Inflation in the Aggregate Demand - Aggregate Supply Model
• Keynesian, Intermediate, and Neoclassical Zones