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Neoclassical Economics

Neoclassical Economics

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Published by Etjih Tasriah
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Published by: Etjih Tasriah on Jan 02, 2012
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The Library of Economics and Liberty logo The Concise Encyclopedia of Economics * Search Site<../searchsite.html> Search Card Catalog <../searchcc.html> Search a Book <../search.html> **Home* <../../index.html> *Books* <../classics.html> *Encyclopedia* <../CEE.html> *?**Articles:* <../CEETitles.html> By Title <../CEETitles.html> By Author <../CEEAuthors.html> ByCategory <../CEECategory.html> *Biographies* <../CEEBiographies.html> *Index* *Cite thispage* *Articles* <../forum.html> *Topics* <../list.html> *Data* <../data.html> *Links*<../links.html> *Quote* of the Day *Register* for /Econlib News/ <../register.html> *About* theEconlib Website <../About.html> *FAQ* and Help <../help.html> Neoclassical Economics by E.Roy Weintraub Economists publicly disagree with each other so often that they are easy targetsfor standup comedians. Yet noneconomists may not realize that the disagreements are mostlyover the details?the way in which the big picture is to be focused on the small screen. When itcomes to broad economic theory, most economists agree. President Richard Nixon, defendingdeficit spending against the conservative charge that it was "Keynesian," is reported to havereplied, "We're all Keynesians now." In fact, what he should have said is "We're all neoclassicalsnow, even the Keynesians," because what is taught to students, what is mainstream economicstoday, is neoclassical economics. By the middle of the nineteenth century, English-speakingeconomists generally shared a perspective on value theory and distribution theory. The value of abushel of corn, for example, was thought to depend on the costs involved in producing thatbushel. The output or product of an economy was thought to be divided or distributed among thedifferent social groups in accord with the costs borne by those groups in producing the output.This, roughly, was the "Classical Theory" developed by Adam Smith , David Ricardo , ThomasRobert Malthus , John Stuart Mill , and Karl Marx . But there were difficulties in this approach.Chief among them was that prices in the market did not necessarily reflect the "value" so defined,for people were often willing to pay more than an object was "worth." The classical "substance"theories of value, which took value to be a property inherent in an object, gradually gave way to aperspective in which value was associated with the relationship between the object and the personobtaining the object. Several economists in different places at about the same time (the 1870sand 1880s) began to base value on the relationship between costs of production and "subjectiveelements," later called "supply" and "demand." This came to be known as the Marginal Revolutionin economics, and the overarching theory that developed from these ideas came to be calledneoclassical economics. (The first to use the term "neoclassical economics" seems to have beenthe American economist Thorstein Veblen .) The framework of neoclassical economics is easilysummarized. Buyers attempt to maximize their gains from getting goods, and they do this byincreasing their purchases of a good until what they gain from an extra unit is just balanced bywhat they have to give up to obtain it. In this way they maximize "utility"?the satisfactionassociated with the consumption of goods and services. Likewise, individuals provide labor tofirms that wish to employ them, by balancing the gains from offering the marginal unit of theirservices (the wage they would receive) with the disutility of labor itself?the loss of leisure.Individuals make choices at the margin. This results in a theory of demand for goods, and supplyof productive factors. Similarly, producers attempt to produce units of a good so that the cost of producing the incremental or marginal unit is just balanced by the revenue it generates. In thisway they maximize profits. Firms also hire employees up to the point that the cost of theadditional hire is just balanced by the value of output that the additional employee would produce.The neoclassical vision thus involves economic "agents," be they households or firms, optimizing(doing as well as they can), subject to all relevant constraints. Value is linked to unlimited desiresand wants colliding with constraints, or scarcity. The tensions, the decision problems, are workedout in markets. Prices are the signals that tell households and firms whether their conflictingdesires can be reconciled. At some price of cars, for example, I want to buy a new car. At thatsame price others may also want to buy cars. But manufacturers may not want to produce asmany cars as we all want. Our frustration may lead us to "bid up" the price of cars, eliminatingsome potential buyers and encouraging some marginal producers. As the price changes, theimbalance between buy orders and sell orders is reduced. This is how optimization underconstraint and market interdependence lead to an economic equilibrium. This is the neoclassicalvision. Neoclassical economics is what is called a metatheory. That is, it is a set of implicit rules orunderstandings for constructing satisfactory economic theories. It is a scientific research program
that generates economic theories. Its fundamental assumptions are not open to discussion in thatthey define the shared understandings of those who call themselves neoclassical economists, oreconomists without any adjective. Those fundamental assumptions include the following: 1.People have rational preferences among outcomes. 2. Individuals maximize utility and firmsmaximize profits. 3. People act independently on the basis of full and relevant information.Theories based on, or guided by, these assumptions are neoclassical theories. Thus, we can speakof a neoclassical theory of profits, or employment, or growth, or money. We can createneoclassical production relationships between inputs and outputs, or neoclassical theories of marriage and divorce and the spacing of births. Consider layoffs, for example. A theory whichassumes that a firm's layoff decisions are based on a balance between the benefits of laying off anadditional worker and the costs associated with that action will be a neoclassical theory. A theorythat explains the layoff decision by the changing tastes of managers for employees with particularcharacteristics will not be a neoclassical theory. What can be contrasted to neoclassicaleconomics? Some have argued that there are several schools of thought in present-dayeconomics. They identify (neo-)Marxian economics , (neo-)Austrian economics , post-Keynesianeconomics , or (neo-)institutional economics as alternative metatheoretical frameworks forconstructing economic theories. To be sure, societies and journals promulgate the ideasassociated with these perspectives. Some of these schools have had insights that neoclassicaleconomists have learned from; the Austrian insights on entrepreneurship are one example. But tothe extent these schools reject the core building blocks of neoclassical economics?as Austriansreject optimization, for example?they are regarded by mainstream neoclassical economists asdefenders of lost causes or as kooks, misguided critics, and antiscientific oddballs. The status of non-neoclassical economists in the economics departments in English-speaking universities issimilar to that of flat-earthers in geography departments: it is safer to voice such opinions afterone has tenure, if at all. One specific attempt to discredit neoclassical economics developed fromBritish economist Joan Robinson and her colleagues and students at Cambridge in the late fiftiesand early sixties. The so-called Two Cambridges Capital Controversy was ostensibly about theimplications, and limitations, of Paul Samuelson and Robert Solow's aggregating "capital" andtreating the aggregate as an input in a production function. However, this controversy really wasrooted in a clash of visions about what would constitute an "acceptable" theory of the distributionof income. What became the post-Keynesian position was that the distribution of income was"best" explained by power differences among workers and capitalists, while the neoclassicalexplanation was developed from a market theory of factor prices. Eventually the controversy wasnot so much settled as laid aside, as neoclassical economics became mainstream economics. Howdid such an orthodoxy come to prevail? In brief, the success of neoclassical economics isconnected to the "scientificization" or "mathematization" of economics in the twentieth century. Itis important to recognize that a number of the early Marginalists, economists like William StanleyJevons and F. Y. Edgeworth in England, Leon Walras in Lausanne, and Irving Fisher in the UnitedStates, wanted to legitimize economics among the scholarly disciplines. The times were optimisticabout a future linked to the successes of technology. Progress would be assured in a society thatused the best scientific knowledge. Social goals would be attainable if scientific principles couldorganize social agendas. Scientific socialism and scientific management were phrases that flowedeasily from the pens of social theorists. Neoclassical economics conceptualized the agents,households and firms, as rational actors. Agents were modeled as optimizers who were led to"better" outcomes. The resulting equilibrium was "best" in the sense that any other allocation of goods and services would leave someone worse off. Thus, the social system in the neoclassicalvision was free of unresolvable conflict. The very term "social system" is a measure of the successof neoclassical economics, for the idea of a system, with its interacting components, its variablesand parameters and constraints, is the language of mid-nineteenth-century physics. This field of rational mechanics was the model for the neoclassical framework. Agents were like atoms; utilitywas like energy; utility maximization was like the minimization of potential energy, and so forth.In this way was the rhetoric of successful science linked to the neoclassical theory, and in this wayeconomics became linked to science itself. Whether this linkage was planned by the earlyMarginalists , or rather was a feature of the public success of science itself, is less important thanthe implications of that linkage. For once neoclassical economics was associated with scientific

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