Neoclassical economics 21634 224716944 2008-07-10T02:42:08Z ImperfectlyInformed 5106682 fix '''Neoclassical economics''' refers to a general approach in [[economics]] focusing on the determination of prices, outputs, and income [[distribution (economics)|distribution]]s in markets through [[supply and demand]]. These are mediated through a hypothesized maximization of income-constrained [[utility]] by individuals and of cost-constrained [[profits]] of firms employing available information and factors of production.<ref>Antonietta Campus (1987), "marginal economics," ''The [[New Palgrave: A Dictionary of Economics]]'', v. 3, p. 323.</ref> [[Mainstream economics|Mainstream]] [[economics]] is largely neoclassical in its assumptions, at least at the [[microeconomics|microeconomic]] level.<ref name="TomGreen07">{{cite web |url=http://adbusters.org/the_magazine/69/The_Revolution_Will_Begin_with_a_Textbook_Part_Two.html |title=Adbusters : The Magazine - #69 The Big Ideas of 2007 / The Revolution Will Begin with a Textbook (Part Two) |accessdate=2007-06-29 |format= |work=}}</ref> There have been many critiques of neoclassical economics, often incorporated into newer versions of neoclassical theory as human awareness of economic criteria change. Neoclassical economics is often called the [[marginalism|marginalist]] school, although the [[Austrian School]] founded by [[Carl Menger]] is also sometimes called the marginalist school.<ref>Eds. Lysons JS, Cain LP, Williamson SH. (2008). ''Reflections on the Cliometrics Revolution''. Routledge. p 6, quote: "and the "Austrian" marginalist school of Carl Menger"</ref> The term was originally introduced by [[Thorstein Veblen]] in 1900, in his ''Preconceptions of Economic Science''.<ref name=Colander/> It was then used by [[George Stigler]] and [[John Hicks]] broadly to include the work of [[Carl Menger]], [[William Stanley Jevons]], and [[John Bates Clark]].<ref name=Colander>Colander, David. The Death of Neoclassical Economics.</ref> Today it is often used to refer to mainstream economics and the [[Chicago school of economists|Chicago school]], although it has been used as an [[umbrella term]] encompassing a number of mainly defunct [[school of thought|schools of thought]],<ref>Fonseca GL. [http://cepa.newschool.edu/~het/essays/margrev/ncintro.htm Introduction to the Neoclassicals] The New School.</ref> notably excluding [[institutional economics]], various [[historical school of economics|historical schools of economics]], and [[Marxian economics]], in addition to various other [[heterodox economics]]. == Overview == Neoclassical economics is the singular element several schools of thought in [[economics]] address. There is not a complete agreement on what is meant by neoclassical economics, and the result is a wide range of neoclassical approaches to various problem areas and domains -- ranging from neoclassical theories of labor to neoclassical theories of demographic changes. As expressed by [[E. Roy Weintraub]], neoclassical economics rests on three assumptions, although certain branches of neoclassical theory may have different approaches: #People have [[Rational choice theory|rational preferences]] among outcomes that can be identified and associated with a value. #Individuals [[utility maximization|maximize utility]] and firms [[profit maximization|maximize profits]]. #People act independently on the basis of [[information asymmetry|full and relevant information]]. From these three assumptions, neoclassical economists have built a structure to understand the allocation of scarce resources among alternative ends -- in fact understanding such allocation is often considered the definition of economics to neoclassical theorists. Here's how [[William Stanley Jevons]] presented "the problem of Economics". <blockquote>"Given, a certain population, with various needs and powers of production, in possession of certain lands and other sources of material: required, the mode of employing their labour which will maximize the utility of their produce."<ref>[[William Stanley Jevons]] (1879, 2nd ed., p. 289), ''The Theory of Political Economy''. Italics in original.</ref></blockquote> From the basic assumptions of neoclassical economics comes a wide range of theories about various areas of economic activity. For example, profit maximization lies behind the neoclassical [[theory of the firm]], while the derivation of [[demand]] curves leads to an understanding of [[consumer good]]s, and the [[supply]] curve allows an analysis of the [[factors of production]]. Utility maximization is the source for the neoclassical theory of consumption, the derivation of demand curves for consumer goods, and the derivation of labor supply curves and [[reservation price|reservation demand]]<ref>[[Philip H. Wicksteed]] ''The Common Sense of Political Economy''</ref>. Market [[supply and demand]] are aggregated across firms and individuals. Their interactions determine equilibrium output and price. The market supply and demand for each factor of production is derived analogously to those for market [http://bea.gov/bea/glossary/glossary.cfm?key_word=Final_use&letter=F#Final_use final output] to determine equilibrium income and the income distribution. Factor demand incorporates the [[Production, costs, and pricing|marginal-productivity]] relationship of that factor in the output market. <ref>Christopher Bliss (1987), "distribution theories, neoclassical," ''The New Palgrave: A Dictionary of Economics'', v. 1, pp. 883-886.</ref> <ref>Robert F. Dorfman (1987), "marginal productivity theory," ''The [[New Palgrave: A Dictionary of Economics]]'', v. 3, pp. 323-25.</ref><ref>[[George J. Stigler]] (1941). ''Production and Distribution Theories''(1870-1895). New York: Macmillan.</ref> Neoclassical economics emphasizes equilibria, where equilibria are the solutions of [[agent (economics)|agent]] maximization problems. Regularities in economies are explained by [[methodological individualism]], the position that economic phenomena can be explained by aggregating over the behavior of agents. The emphasis is on [[microeconomics]]. Institutions, which might be considered as prior to and conditioning individual behavior, are de-emphasized. [[Economic subjectivism]] accompanies these emphases. See also [[general equilibrium]]. == Origins ==<!-- This section is linked from [[Labor theory of value]] --> [[Classical economics]], developed in the 18th and 19th centuries, included a [[value theory]] and [[Distribution (economics)|distribution]] theory. The value of a product was thought to depend on the costs involved in producing that product. The explanation of costs in Classical economics was simultaneously an explanation of distribution. A landlord received rent, workers received wages, and a capitalist tenant farmer received profits on their investment. This classic approach included the work of [[Adam Smith]] and [[David Ricardo]]. However, some economists gradually began emphasizing the perceived value of a goods to the consumer. They proposed a theory that the value of a product was to be explained with differences in "utility." This is called [[Utilitarianism]] and is associated with philosopher and economic thinker [[John Stuart Mill]]. The third step from political economy to economics was the introduction of the "marginal theory of value" or [[marginalism]]. Marginal value means that economic actors make decisions based on the "margins". For example, a person decides to buy a second sandwich based on how full they are after the first one, a firm hires a new employee based on the expected increase in profits the employee will bring. This differs from the aggregate decision making of classical political economy in that it explains how vital goods such as water can be cheap, while luxuries can be expensive. Neoclassical economics is conventionally dated from [[William Stanley Jevons]]'s ''Theory of Political Economy'' ([[1871]]), [[Carl Menger]]'s ''Principles of Economics'' (1871), and [[Leon Walras]]'s ''Elements of Pure Economics'' ([[1874]] &ndash; [[1877]]). These three economists have been said to have promulgated the marginal utility revolution, or [[Neoclassical Revolution]]. Historians of economics and economists have debated: * 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<ref>William Jaff&eacute; (1976) "Menger, Jevons, and Walras De-Homogenized", ''Economic Inquiry'', V. 14 (December): 511-525</ref>. 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<ref>Philip Mirowski (1989) ''More Heat than Light: Economics as Social Physics, Physics as Nature's Economics'', Cambridge University Press</ref>. [[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 theory of value|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. Marshall explained prices by the intersection of supply and demand curves. The introduction of different market "periods" was an important innovation of Marshall's: *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 rent]]s exist in short period equilibrium for fixed factors, and the rate of profit is not equated across sectors. *Long period. The stock of [[capital (economics)|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. == Further developments == An important change in neoclassical economics occurred around 1933. [[Joan Robinson]] and [[Edward H. Chamberlin]], with the near simultaneous publication of their respective books, ''The Economics of Imperfect Competition'' (1933) and ''The Theory of Monopolistic Competition'' (1933), introduced models of [[imperfect competition]]. Theories of [[market form]]s and [[industrial organization]] grew out of this work. They also emphasized certain tools, such as the [[marginal revenue]] curve. Joan Robinson's work on imperfect competition, at least, was a response to certain problems of Marshallian [[partial equilibrium]] theory highlighted by [[Piero Sraffa]]. Anglo-American economists also responded to these problems by turning towards [[general equilibrium]] theory, developed on the European continent by Walras and [[Vilfredo Pareto]]. [[J. R. Hicks]]'s ''[[Value and Capital]]'' (1939) was influential in introducing his English-speaking colleagues to these traditions. He, in turn, was influenced by the [[Austrian School]] economist [[Friedrich Hayek]]'s move to the [[London School of Economics]], where Hicks then studied. These developments were accompanied by the introduction of new tools, such as [[indifference curve]]s and the theory of ordinal [[utility]]. The level of mathematical sophistication of neoclassical economics increased. [[Paul Samuelson]]'s ''[[Foundations of Economic Analysis]]'' (1947) contributed to this increase in [[formal rigor]]. The interwar period in American economics has been argued to have been pluralistic, with neoclassical economics and [[institutional economics|institutionalism]] competing for allegiance. [[Frank Knight]], an early [[Chicago school (economics)|Chicago school]] economist attempted to combine both schools. But this increase in mathematics was accompanied by greater dominance of neoclassical economics in Anglo-American universities after [[World War II]]. Hicks' book, ''[[Value and Capital]]'' had two main parts. The second, which was arguably not immediately influential, presented a model of temporary equilibrium. Hicks was influenced directly by Hayek's notion of intertemporal coordination and paralleled by earlier work by Lindhal. This was part of an abandonment of disaggregated long run models. This trend probably reached its culmination with the [[Arrow-Debreu model]] of intertemporal equilibrium. The Arrow-Debreu model has canonical presentations in Gerard Debreu's ''Theory of Value'' (1959) and in Arrow and Hahn. Many of these developments were against the backdrop of improvements in both [[econometrics]], that is the ability to measure prices and changes in goods and services, as well as their aggregate quantities, and in the creation of [[macroeconomics]], or the study of whole economies. The attempt to combine neo-classical microeconomics and [[Keynesian economics|Keynesian]] macroeconomics would lead to the [[neoclassical synthesis]]<ref> Olivier Jean Blanchard (1987). "neoclassical synthesis," ''The [[New Palgrave: A Dictionary of Economics]]'', v. 3, pp. 634-36.</ref> which has been the dominant paradigm of economic reasoning in English-speaking countries since the 1950s. Hicks and Samuelson were for example instrumental in mainstreaming Keynesian economics. Macroeconomics influenced the neoclassical synthesis from the other direction, undermining foundations of classical economic theory such as [[Say's Law]], and assumptions about [[political economy]] such as the necessity for a hard-money standard. These developments are reflected in neoclassical theory by the search for the occurrence in markets of the equilibrium conditions of [[Pareto optimality]] and self-sustainability. == Criticisms == Neoclassical economics is sometimes criticized for having a [[normative]] bias. In this view, it does not focus on explaining actual economies, but instead on describing a "utopia" in which [[Pareto efficiency|Pareto optimality]] applies. Key assumptions of neoclassical economics which are criticised as unrealistic include: The assumption that individuals act rationally may be viewed as ignoring important aspects of human behavior. Many see the "[[Homo economicus|economic man]]" as being demonstrably different from a real man on the real earth. The assumption of [[rational expectations]] which has been introduced in some more modern neo-classical models (sometimes also called [[new classical]]) can also be criticized on the grounds of realism. Large corporations might perhaps come closer to the neoclassical ideal of profit maximization, but this is not necessarily viewed as desirable if this comes at the expense of neglect of wider social issues. The response to this is that neoclassical economics is descriptive and not normative. It addresses such problems with concepts of private versus social utility. Problems with making the neoclassical [[general equilibrium]] theory compatible with an economy that develops over time and includes capital goods. This was explored in a major debate in the 1960s—the "[[Cambridge capital controversy]]"—about the validity of neoclassical economics, with an emphasis on the [[economic growth]], [[capital (economics)|capital]], aggregate theory, and the [[marginal productivity theory]] of distribution. There were also internal attempts by neoclassical economists to extend the Arrow-Debreu model to disequilibrium investigations of stability and uniqueness. However a result known as the Sonnenschein-Mantel-Debreu theorem suggests that the assumptions that must be made to insure that the equilibrium is stable and unique are quite restrictive. In the opinion of some, these developments have found fatal weaknesses in neoclassical economics. Economists, however, have continued to use highly mathematical models, and many equate neoclassical economics with economics, unqualified. Mathematical models include those in [[game theory]], [[linear programming]], and [[econometrics]], many of which might be considered non-neoclassical. So economists often refer to what has evolved out of neoclassical economics as "mainstream economics". Critics of neoclassical economics are divided in those who think that highly mathematical method is inherently wrong and those who think that mathematical method is potentially good even if contemporary methods have problems. The basic theory of a downward sloping aggregate demand curve is criticized for its allegedly strong assumptions. In general, allegedly overly unrealistic assumptions are one of the most common criticisms towards neoclassical economics. For example, many theories assume perfect knowledge for market actors and the most common theory of finance markets assumes that debts are always paid back and that any actor can raise as much loan as he wants at any given point of time. The basic theory of production in neoclassical economics is criticized for incorrect assumptions about the rationales of producers. According to the theory, increasing production costs are the reason for producers not to produce over a certain amount. Some empirical counter arguments claim that most producers are not making their production decisions in the light of increasing production costs. For example they often may have additional capacity that could be taken into use, if producing more was desirable. Often at individual levels, variables such as supply and demand, which are independent, are (allegedly wrongly) assumed to be independent also at aggregate level. This criticism has been applied to many central theories of neoclassical economics. The critique of the assumption of [[rationality]] is not confined to social theorists and ecologists. Many economists, even contemporaries, have criticized this vision of economic man. [[Thorstein Veblen]] put it most sardonically. Neoclassical economics assumes a person to be, <blockquote>"a lightning calculator of pleasures and pains, who oscillates like a homogeneous globule of desire of happiness under the impulse of stimuli that shift about the area, but leave him intact."<ref>[[Thorstein Veblen]] (1898) ''Why Is Economics Not an Evolutionary Science?'', reprinted in The Place of Science in Modern Civilization (New York, 1919), p. 73.</ref></blockquote> [[Herbert Simon]]'s theory of [[bounded rationality]] has probably been the most influential of the [[Heterodox economics|heterodox]] approaches. Is economic man a first approximation to a more realistic psychology, an approach only valid in some sphere of human lives, or a general methodological principle for economics? Early neoclassical economists often leaned toward the first two approaches, but the latter has become prevalent. Neoclassical economics is also often seen as relying too heavily on complex mathematical models, such as those used in [[general equilibrium]] theory, without enough regard to whether these actually describe the real economy. Many see an attempt to model a system as complex as a modern economy by a mathematical model as unrealistic and doomed to failure. Famous answer to this criticism is [[Milton Friedman]]'s claim that theories should be judged by their ability to predict events rather than by the realisticity of their assumptions. Naturally, critics claim that neoclassical economics (as well as other branches of economics) has not been very good at predicting events. Critics of neoclassical models accuse it of copying of 19th century mechanics and the "clockwork" model of society which seems to justify elite privileges as arising "naturally" from the social order based on economic competitions. This is echoed by modern critics in the [[anti-globalization movement]] who often blame the neoclassical theory, as it has been applied by the [[IMF]] in particular, for inequities in global debt and trade relations. They assert it ignores the complexity of nature and of human creativity, and seeks mechanical ideas like equilibrium: <blockquote>"And in Poinset's ''Elements de Statique''..., which was a textbook on the theory of mechanics bristling with systems of simultaneous equations to represent, among other things, the mechanical equilibrium of the solar system, Walras found a pattern for representing the catallactic equilibrium of the market system." (William Jaffe)</blockquote> The [[neo-Marxism|neo-Marxists]] [[Michael Hardt]] and [[Antonio Negri]] criticize neoclassical economics and its rejection of Keynesian regulation on philosophical grounds: they assert that neoclassical economics incorrectly posits money as ''[[a priori]]'' ("monetary [[Aristotle|Aristotelianism]]"), even though it is a regulatory instrument.<ref>[[Michael Hardt]] and [[Antonio Negri]] (2005). ''[[Multitude: War and Democracy in the Age of Empire]]''. Hamish Hamilton.</ref> It is fair to say that many (but not all) of these criticisms can only be directed towards a subset of the neoclassical models (for example, there are many neoclassical models where unregulated markets fail to achieve Pareto-optimality and there has recently been an increased interest in modelling bounded rationality). ==References== {{reflist}} == See also == Aspects of [[Economics]]: * [[Aggregation problem]] * [[Distribution (economics)|Distribution theory]] * [[Homo economicus]] (economic man) * [[Rational choice theory]] * [[Utility]] * ''[[Value and Capital]]'' * ''[[Foundations of Economic Analysis]]'' * A broad critique of Neoclassical economics has been put forward in the book ''Debunking Economics'' by [[Steve Keen]] Other theories of economics and variations on Neoclassical theory: * [[Economic liberalism]] * [[Classical economics]] * [[Keynesian economics]] * [[Monetarism]] [[Heterodox economics]]: * [[Feminist economics]] * [[Behavioral economics]] * [[Austrian School]] of economics * [[Bounded rationality]] and [[Behavioral finance]] * [[Biophysical economics]] * [[Ecological economics]] * [[Evolutionary economics]] * [[Institutionalist Political Economics]] ==External links== * [http://www.econlib.org/library/Enc/NeoclassicalEconomics.html Neoclassical economics] from the Concise Library of Economics * [http://william-king.www.drexel.edu/top/prin/txt/Neoch/Eco111s1.html Introduction to neoclassical economics] at Drexel * [http://www.paecon.net/PAEReview/issue38/ArnspergerVaroufakis38.htm What Is Neoclassical Economics] at Post-Autistic Economics Review *[http://www.rationalitycontroversy.org/ Rationality Controversy and Economic Theory] from www.rationalitycontroversy.org/ {{Neoclassical economists}} {{ History of economic thought}} [[Category:Economic theories]] [[de:Neoklassische Theorie]] [[et:Neoklassikaline koolkond]] [[es:Escuela neoclásica (economía)]] [[eo:Neoklasika ekonomika skolo]] [[fr:École néoclassique]] [[ko:신고전파 경제학]] [[it:Economia neoclassica]] [[he:כלכלה נאו-קלסית]] [[hu:Neoklasszikus közgazdaságtan]] [[ja:新古典派経済学]] [[no:Nyklassisk økonomi]] [[pt:Economia neoclássica]] [[simple:Neoclassical economics]] [[sk:Neoklasická ekonómia]] [[sr:Неокласична политичка економија]] [[fi:Uusklassinen taloustiede]] [[sv:Neoklassisk nationalekonomi]] [[zh:新古典主义经济学]]