Neoclassical economics

Neoclassical economics refers to a general approach (a "metatheory") to economics based on supply and demand which depends on individuals (or any economic agent) operating rationally, each seeking to maximize their individual utility or profit by making choices based on available information. Mainstream economics is largely neoclassical in its assumptions. There have been many critiques of neoclassical economics, both from within orthodox economics, and from outside of it, and often these critiques have been incorporated into new versions of neoclassical theory.

Origins of neoclassical economics

Classical economics, developed in the middle of the 19th century, focused on value theory and distribution theory. The value of a product was thought to depend on the costs involved in producing that product. Goods were distributed in an economy, it was assumed, in the same way that costs were distributed -- thus, a landlord would receive more goods than a tenant farmer because the landlord bore most of the cost. This classic approach included the work of Adam Smith, David Ricardo, and Karl Marx.

Related Topics:
Classical economics - Adam Smith - David Ricardo - Karl Marx

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The problem with this approach was that prices for a product did not always reflect the expected value as indicated by the costs of a product. Clearly, something was wrong with the perspective that the price of a product was inherent in its manufacture. Economists began to explore the way that elements such as supply and demand effected price, and neo-classical economics gradually came into being.

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Neoclassical economics is conventionally dated from William Stanley Jevons' Theory of Political Economy (1871), Carl Menger's Principles of Economics (1871), and Leon Walras's Elements of Pure Economics (1874 – 1877). These three economists have been said to have promulgated the marginal utility revolution, or Neoclassical Revolution. Historians of economics and economists have debated

Related Topics:
William Stanley Jevons - 1871 - Carl Menger - Leon Walras - 1874 - 1877 - Neoclassical Revolution

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• Whether utility or marginalism was more essential to this revolution (whether the noun or the adjective in the phrase "marginal utility" is more important)
• Whether there was a revolutionary change of thought or merely a gradual development and change of emphasis from their predecessors
• Whether grouping these economists together disguises differences more important than their similarities.

In particular, Walras was more interested in the interaction of markets than in explaining the individual psyche through a hedonistic psychology. Jevons saw his economics as an application and development of Jeremy Bentham's utilitarianism and never had a fully developed general equilibrium theory. Menger emphasized disequilibrium and the discrete. Menger had a philosophical objection to the use of mathematics in economics, while the other two modeled their theories after 19th century mechanics.

Related Topics:
Jeremy Bentham - General equilibrium

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Alfred Marshall's textbook, Principles of Economics (1890), was the dominant textbook in England a generation later. Marshall's influence extended elsewhere; Italians would compliment Maffeo Pantaleoni by calling him the "Marshall of Italy". Marshall thought classical economics attempted to explain prices by the cost of production. He asserted that the neoclassicals went too far in correcting this imbalance by overemphasizing utility and demand. Marshall thought the question of whether supply or demand was more important was analogous to the pointless question of which blade of a scissors did the cutting.

Related Topics:
Alfred Marshall - Maffeo Pantaleoni - Classical economics - Cost of production

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Marshall explained prices by the intersection of supply and demand curves. The introduction of different market "periods" was an important innovation of Marshall's:

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• Market period. The goods produced for sale on the market are taken as given data, e.g. in a fish market. Prices quickly adjust to clear markets.
• Short period. Industrial capacity is taken as given. The level of output, the level of employment, the inputs of raw materials, and prices fluctuate to equate marginal cost and marginal revenue, where profits are maximized. Economic rents exist in short period equilibrium for fixed factors, and the rate of profit is not equated across sectors.
• Long period. The stock of capital goods, such as factories and machines, is not taken as given. Profit-maximizing equilibria determine both industrial capacity and the level at which it is operated.
• Very long period. Technology, population trends, habits and customs are not taken as given, but allowed to vary in very long period models.

Marshall took supply and demand as stable functions and extended supply and demand explanations of prices to all runs. He argued supply was easier to vary in longer runs, and thus became a more important determinate of price in the very long run.

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