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, often incorporated into newer versions of neoclassical theory as circumstances change. The supply and demand model describes how prices vary as a result of a balance between product availability at each price (supply) and the desires of those with purchasing power at each price (demand). ... In philosophy, the word rationality has been used to describe numerous religious and philosophical theories, especially those concerned with truth, reason, and knowledge. ... In economics, utility is a measure of the happiness or satisfaction gained consuming good and services. ... Profit is a positive return made on an investment by an individual or by business operations. ... Buyers bargain for good prices while sellers put forth their best front in Chichicastenango Market, Guatemala. ...

Overview

Neoclassical economics is the grouping of a number of schools of thought in economics. There is not 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. Buyers bargain for good prices while sellers put forth their best front in Chichicastenango Market, Guatemala. ...

As expressed by E. Roy Weintraub, neoclassical economics rests on three assumptions, although certain branches of neoclassical theory may have different approaches: E. Roy Weintraub is a professor of economics at Duke University. ...

1. People have rational preferences among outcomes that can be identified and associated with a value.
2. Individuals maximize utility and firms maximize profits.
3. People act independently on the basis of 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 basic problem of economics: It has been suggested that this article or section be merged with Decision theory. ... This article is about utility in economics and in game theory. ... In economics, profit maximization is the process by which a firm determines the price and output level that returns the greatest profit. ... [William Stanley Jevons] William Stanley Jevons (September 1, 1835 - August 13, 1882), English economist and logician, was born in Liverpool. ...

Given, a certain population, with certain 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.

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 goods, 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 factor supply curves and reservation demand. The theory of the firm consists of a number of economic theories which describe the nature of the firm (company or corporation), including its behaviour and its relationship with the market. ... The supply and demand model describes how prices vary as a result of a balance between product availability at each price (supply) and the desires of those with purchasing power at each price (demand). ... Definitions of consumer goods by Ben Murray New goods acquired by households for their own consumption. ... Supply has a number of meanings: In economics, supply is the aggregate amount of any material good that can be called into being at a certain price point; it one half of the equation of supply and demand. ... Factors of production are resources used in the production of goods and services in economics. ...

Neoclassical economics emphasizes equilibria, where equilibria are the solutions of individual maximization problems. Regularities in economies are explained by methodological individualism, the doctrine that all economic phenomena can be ultimately explained by aggregating over the behavior of individuals. 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. Methodological individualism is a philosophical orientation toward explaining broad society-wide developments as the accumulation of decisions by individuals. ... In common speech, the word individual most often refers to a person, or, by analogy, to any specific object in a group of things. ... Microeconomics (literally, very small economics) is a social science which involves study of the economic distribution of production and income among individual consumers, firms, and industries. ... Economic subjectivism is the theory that value is a feature of the appraiser and not of the thing being valued. ... General Equilbrium (linear) supply and demand curves. ...

Origins of neoclassical economics

Classical economics, developed in the 18th and 19th centuries, 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 and David Ricardo. However, some economists began to say that prices for a product did not always reflect the expected value as indicated by the costs of a product. They proposed a theory that the cost of a product was not expressed in its price, but that this can be explained with differences in "utility." Economists began to explore the way that elements such as supply and demand affected price, and neo-classical economics gradually came into being. Classical economics is a school of economic thought whose major developers include William Petty, Adam Smith, David Ricardo, Thomas Malthus, and John Stuart Mill, and Johann Heinrich von Thünen. ... Adam Smith, FRSE (baptised June 5, 1723 – July 17, 1790) was a Scottish political economist and moral philosopher. ... {{Infobox_Biography subject_name = David Ricardo | image_name = David_ricardo. ...

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 – 1877). These three economists have been said to have promulgated the marginal utility revolution, or Neoclassical Revolution. Historians of economics and economists have debated: [William Stanley Jevons] William Stanley Jevons (September 1, 1835 - August 13, 1882), English economist and logician, was born in Liverpool. ... 1871 (MDCCCLXXI) was a common year starting on Sunday (see link for calendar). ... Austrian School economist Carl Menger Carl Menger Carl Menger (February 28, 1840 – February 26, 1921) was the founder of the Austrian School of economics. ... Marie-Ésprit-Léon Walras (December 16, 1834 in Évreux, France - January 5, 1910 in Clarens, near Montreux, Switzerland) was a French economist, considered by Joseph Schumpeter as the greatest of all economists. He was a mathematical economist associated with the creation of the general equilibrium theory. ... 1874 (MDCCCLXXIV) was a common year starting on Thursday (see link for calendar). ... 1877 was a common year starting on Monday (see link for calendar). ... In economics, the Neoclassical Revolution was the emergence of marginal theory of value as the central explanation for explaining the origin of value. ...

• 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. In economics, utility is a measure of the happiness or satisfaction gained consuming good and services. ... Jeremy Bentham (IPA: ) (February 15, 1748 – June 6, 1832) was an English gentleman, jurist, philosopher, and legal and social reformer. ... General Equilbrium (linear) supply and demand curves. ...

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. Alfred Marshall Alfred Marshall (July 26, 1842–July 13, 1924), born in Bermondsey, London, England, became one of the most influential economists of his time. ... Classical economics is a school of economic thought whose major developers include William Petty, Adam Smith, David Ricardo, Thomas Malthus, and John Stuart Mill, and Johann Heinrich von Thünen. ... In economics, the cost-of-production theory of value is the belief that the value of an object is decided by the resources that went into making it. ...

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 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. In economics and finance, marginal cost is the change in total cost that arises when the quantity produced (or purchased) changes by one unit. ... Marginal Revenue is the extra revenue that an additional unit of product will bring a firm. ... In economic theory, economic rent is an analytic term employed to distinguish the difference between the income earned by an input or factor of production, and the cost of the factor of production. ... Capital has a number of related meanings in economics, finance and accounting. ...

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 forms and industrial organization grew out of this work. They also emphasized certain tools, such as the marginal revenue curve. Joan Violet Robinson (1903 in Surrey - 1983) was a Keynesian economist who was well known for her knowledge of monetary economics and wide-ranging contributions to economic theory. ... In economic theory, imperfect competition, is the competitive situation in any market where the conditions necessary for perfect competition are not satisfied. ... In economics, the main criteria by which one can distinguish between different market forms are: the number and size of producers and consumers in the market, the type of goods and services being traded, and the degree to which information can flow freely. ... Industrial organization is the field of economics that studies the behavior of firms, the structure of markets and of their interactions. ... Marginal Revenue is the extra revenue that an additional unit of product will bring a firm. ...

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. Definition A partial equilibrium is a special case of the general economic equilibrium, where the clearance on the market of some specific goods is obtained independently from prices and quantities demanded and supplied on other goods markets. ... Piero Sraffa (1898-1983) was an influential economist. ... General Equilbrium (linear) supply and demand curves. ... Vilfredo Federico Damaso Pareto (born July 15, 1848 in Paris, France - died August 19, 1923 in Lausanne, Switzerland) made several important contributions to economics, sociology and moral philosophy, especially in the study of income distribution and in the analysis of individuals choices. ... Sir John Richard Hicks (April 8, 1904 – May 20, 1989) was one of the most important and influential economists of the twentieth century. ... The Austrian School is a school of economic thought that rejects economists overreliance on methods used in natural science for the study of human action, and instead bases its formalism on a logic of action known as praxeology. Alongside this formalism, the school has traditionally advocated an interpretive approach. ... Friedrich Hayek Friedrich August von Hayek (May 8, 1899 in Vienna – March 23, 1992 in Freiburg) was an Austrian economist and political philosopher, noted for his defense of liberal democracy and free-market capitalism against socialist and collectivist thought in the mid-20th century. ... The London School of Economics and Political Science, often referred to as the London School of Economics or simply the LSE, is a specialist university and a constituent college of the federal University of London, located on Houghton Street in Central London, off the Aldwych and next to the Royal...

These developments were accompanied by the introduction of new tools, such as indifference curves 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. An indifference curve is a graph showing combinations of goods for which a consumer is indifferent, that is, it has no preference for one combination versus another, as they render the same level of satisfaction for the consumer. ... In economics, utility is a measure of the happiness or satisfaction gained consuming good and services. ... For the medical term see rigor (medicine) Rigour (American English: rigor) has a number of meanings in relation to intellectual life and discourse. ...

The interwar period in American economics has been argued to have been pluralistic, with neoclassical economics and institutionalism competing for allegiance. Frank Knight, an early 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. see New institutionalism see historical institutionalism see Institutionalism in political parties Category: ... Frank Hyneman Knight (November 7, 1885 - April 15, 1972) was an important economist in the first half of the twentieth century. ... The Chicago School of Economics is a school of thought in economics; it refers to the style of economics practiced at and disseminated from the University of Chicago after 1946. ... Combatants Allies: Poland, British Commonwealth, France/Free France, Soviet Union, United States, China, and others Axis Powers: Germany, Italy, Japan, and others Casualties Military dead: 17 million Civilian dead: 33 million Total dead: 50 million Military dead: 8 million Civilian dead: 4 million Total dead: 12 million World War II...

Hicks' book 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. The Arrow-Debreu model is the central model in the General (Economic) Equilibrium Theory and often used as a general reference for other microeconomic models. ...

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 macroeconomics would lead to the neo-classical synthesis which has been the dominant paradigm of economic reasoning in English speaking countries since the 1950's. Hicks and Arrow were for example essential in the development of Keynesian economics. Econometrics literally means economic measurement. It is a combination of mathematical economics, statistics, economic statistics and economic theory. ... Macroeconomics is the economics sub-field of study that considers aggregate behavior, and the study of the sum of individual economic decisions. ...

Macroeconomics influenced the neo-classical 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 neo-classical theory by the search for the occurrence in markets of the equilibrium conditions of pareto optimality and self-sustainability. In economics, Say’s Law or Say’s Law of Markets is a principle attributed to French businessman and economist Jean-Baptiste Say (1767-1832) stating that there can be no demand without supply. ... Political economy was the original term for the study of production, the acts of buying and selling, and their relationships to laws, customs and government. ...

Criticisms of neoclassical economics

Neoclassical economics is sometimes criticised 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 optimality obtains. Key assumptions of neoclassical economics which are widely criticised as unrealistic include: Pareto efficiency, or Pareto optimality, is a central theory in economics with broad applications in game theory, engineering and the social sciences. ...

• The focus on individuals in the economy may obscure analysis of wider long term issues, such as whether the economic system is desirable and stable on a finite planet of limited natural capital.
• The assumption that individuals act rationally may be viewed as ignoring important aspects of human behavior. Many see the "economic man" as being demonstrably different to a real man on the real earth. Large corporations might perhaps come closer to the neoclassical ideal of profit maximisation, but this is not necessarily viewed as desirable if this comes at the expense of a "locust-like" neglect of wider social issues. But they are not human, and are increasingly criticized for not being human. The assumption of rational expectations which has been introduced in some more modern neo-classical models (sometimes also called new classical) may also be strongly criticised on the grounds of realism.
• 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, 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". An economic system is a mechanism which deals with the production, distribution and consumption of goods and services in a particular society. ... Natural capital is a metaphor for the mineral, plant, and animal formations of the Earths biosphere when viewed as a means of production of oxygen, water filter, erosion preventer, or provider of other natural services. ... Rational expectations is a theory in economics originally proposed by John F. Muth (1961). ... It has been suggested that this article or section be merged with Neoclassical economics. ... General Equilbrium (linear) supply and demand curves. ... The capital controversy refers to a debate in economics concerning the nature and role of capital goods (or means of production) that occurred during the 1960s, largely between economists such as Joan Robinson and Piero Sraffa at the University of Cambridge in England and economists such as Paul Samuelson and... Accumulated GDP growth for various countries. ... Capital has a number of related meanings in economics, finance and accounting. ... Game theory is a branch of applied mathematics that studies strategic situations where players choose different actions in an attempt to maximize their returns. ... In mathematics, linear programming (LP) problems are optimization problems in which the objective function and the constraints are all linear. ... Econometrics literally means economic measurement. It is a combination of mathematical economics, statistics, economic statistics and economic theory. ...

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:

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.

Herbert Simon's theory of bounded rationality has probably been the most influential of the 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 appoaches, but the latter has become prevalent. Herbert Alexander Simon (June 15, 1916 – February 9, 2001) was a researcher in the fields of cognitive psychology, computer science, public administration, economics and philosophy (sometimes described as a polymath). ... Many models of human behavior in the social sciences assume that humans can be reasonably approximated or described as rational entities, especially as conceived by rational choice theory. ...

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. General Equilbrium (linear) supply and demand curves. ...

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 competititions. 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: Anti-WEF grafiti in Lausanne. ... The flag of the International Monetary Fund (IMF) The International Monetary Fund (IMF) is the international organization entrusted with overseeing the global financial system by monitoring foreign exchange rates and balance of payments, as well as offering technical and financial assistance when asked. ...

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)

See also

Aspects of Economics: Buyers bargain for good prices while sellers put forth their best front in Chichicastenango Market, Guatemala. ...

• Homo economicus
• Rational choice theory
• Slutsky conditions
• Utility

Other theories of economics and variations on neoclassical theory: Homo economicus, or Economic man, is the concept in some economic theories of man as both rational and It is a term used for an approximation or model of Homo sapiens that acts to obtain the highest possible well-being for himself given available information about opportunities and other constraints... It has been suggested that this article or section be merged with Decision theory. ... In economics, utility is a measure of the happiness or satisfaction gained consuming good and services. ...

• Classical Economics
• Keynesian economics
• Monetarism

Heterodox economics: Classical economics is a school of economic thought whose major developers include William Petty, Adam Smith, David Ricardo, Thomas Malthus, and John Stuart Mill, and Johann Heinrich von Thünen. ... Keynesian economics (pronounced ), also called Keynesianism, is an economic theory based on the ideas of an English economist, John Maynard Keynes, as put forward in his book The General Theory of Employment, Interest and Money, published in 1936 in response to the Great Depression of the 1930s. ... Monetarism is a set of views concerning the determination of national income and monetary economics. ... Heterodox economics refers to schools of economic thought which do not conform to the dominant paradigm of neoclassical economics. ...

• Behavioral economics
• Austrian School of economics
• Bounded rationality and Behavioral finance
• Biophysical economics
• Ecological economics

Nobel Prize in Economics winner Daniel Kahneman, was an important figure in the development of behavioral finance and economics and continues to write extensively in the field. ... The Austrian School is a school of economic thought that rejects economists overreliance on methods used in natural science for the study of human action, and instead bases its formalism on a logic of action known as praxeology. Alongside this formalism, the school has traditionally advocated an interpretive approach. ... Many models of human behavior in the social sciences assume that humans can be reasonably approximated or described as rational entities, especially as conceived by rational choice theory. ... Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel winner Daniel Kahneman, was an important figure in the development of behavioral finance and economics and continues to write extensively in the field. ... Biophysical economics is a system of economic thought based not on money but on laws of energy and material transformations and empirical assessments of these and their relation to money. ... Ecological economics is a branch of economics that addresses the interdependence and co-evolution between human economies and natural ecosystems. ...

External links

• Neoclassical economics from the Concise Library of Economics
• Introduction to neoclassical economics at Drexel