neoclassical economics

Neoclassical economics is a broad approach that attempts to explain the production, pricing, consumption of goods and services, and income distribution through supply and demand. It integrates the cost-of-production theory from classical economics with the concept of utility maximization and marginalism. Neoclassical economics includes the work of Stanley Jevons, Maria Edgeworth, Leon Walras, Vilfredo Pareto, and other economists.

It emerged in the 1900s. In 1933, imperfect competition models were introduced into neoclassical economics. Some new tools, such as indifference curves and marginal revenue curves, were used. The new tools were instrumental in improving the sophistication of its mathematical approaches, boosting the development of neoclassical economics.

In the 1950s, Keynesian microeconomic theories and neoclassical microeconomic theories were combined. The combination led to the neoclassical synthesis, which has dominated economic reasoning since then.

Assumptions of Neoclassical Economics

There are many branches that use different approaches under neoclassical economics. All of the approaches are based on three central assumptions:

  1. People are rational in making choices between identifiable and value-associated outcomes.
  2. An individual’s purpose is to maximize utility, as a company’s purpose is to maximize profits.
  3. People act independently on perfect (full and relevant) information.

With the fundamental assumptions above, various studies and approaches have been developed. For example, utility maximization can explain the demand for a product or service. The interaction of demand and supply explains the pricing, and thus the distribution of production factors.

FEATURES

There are three axioms which can be found in all neoclassical models and sub-schools and therefore constitute the paradigmatic core of neoclassical economics:-

(1) Methodological individualism:- It implies that processes at the macro level can only be ascribed to the actions of individuals at the micro level. Therefore, all economic phenomena can be described and explained by referring to individual actions. Furthermore this implies that only the individual can be the source of moral values: nobody except the individual knows what is best for the individual. Hence the influence or the setting of values by external institutions such as religion is rejected. This description can on the one hand be interpreted as an ontological fixation on individuals which means that the existence of economic phenomena and structures that cannot be ascribed to the individual (emergence) is rejected. On the other hand, the axiom can be understood methodologically. In this case, the explanation of social phenomena can only take place with reference to the individual. 

(2) Methodological instrumentalism:- The behaviour of actors, according to the second axiom, is a result of fixed preferences or preference bundles. The satisfaction of those preferences generates utility. Individuals continuously strive for the maximization of this utility but are restricted (e.g. due to a budget constraint).

The emphasis on individualism and instrumental rationality leads to the following conception of humans: on the one hand, humans and their preferences are taken as a black box, i.e. as relatively autonomous and independent of external influences; on the other hand, it is assumed that persons act according to an instrumental rationality and aim to reach their goal – i.e. the maximization of utility – as efficiently as possible. While the maximization logic is taken as a universal feature of all human beings, the content of those preferences is variable. Accordingly, individuals may not only strive for the maximization of consumption bundles but also for the achievement of social or ethical preferences.

(3) Methodological equilibration- All in all, decisions and actions at the micro level lead to an overall equilibrium at the macro level. The market itself normally tends towards a state of equilibrium, which is why it is considered to be generally stable. However, this does not mean that the market permanently remains in equilibrium, but that it moves towards a static, stable state in the long run. Nevertheless, it can be concluded from this understanding of the market that neoclassical economics generally assumes that there are general economic laws which exist independently from time and space. The conception of time aims at identifying, comparing and assessing static states rather than at understanding and reconstructing sequences of dynamic processes. Mark Blaug goes even further by arguing that due to the formalistic revolution in the 1950s, the in-part process-oriented analyses of comparative statics were replaced by the definition of an entirely static endpoint.


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