Neoclassical economics is an approach to economics focusing on the
determination of goods, outputs, and income distributions in markets
through supply and demand. This determination is often mediated
through a hypothesized maximization of utility by income-constrained
individuals and of profits by firms facing production costs and
employing available information and factors of production, in
accordance with rational choice theory.
Neoclassical economics dominates microeconomics, and together with
Keynesian economics forms the neoclassical synthesis which dominates
mainstream economics today.[better source needed]
Although neoclassical economics has gained widespread acceptance by
contemporary economists, there have been many critiques of
neoclassical economics, often incorporated into newer versions of
1.1 Three central assumptions
3 The marginal revolution
4 Further developments
6 See also
8 External links
The term was originally introduced by
Thorstein Veblen in his 1900
article 'Preconceptions of Economic Science', in which he related
marginalists in the tradition of
Alfred Marshall et al. to those in
the Austrian School.
No attempt will here be made even to pass a verdict on the relative
claims of the recognized two or three main "schools" of theory, beyond
the somewhat obvious finding that, for the purpose in hand, the
so-called Austrian school is scarcely distinguishable from the
neo-classical, unless it be in the different distribution of emphasis.
The divergence between the modernized classical views, on the one
hand, and the historical and Marxist schools, on the other hand, is
wider, so much so, indeed, as to bar out a consideration of the
postulates of the latter under the same head of inquiry with the
former. – Veblen
It was later used by John Hicks, George Stigler, and others to
include the work of Carl Menger, William Stanley Jevons, Léon Walras,
John Bates Clark, and many others. Today it is usually used to
refer to mainstream economics, although it has also been used as an
umbrella term encompassing a number of other schools of thought,
notably excluding institutional economics, various historical schools
of economics, and Marxian economics, in addition to various other
heterodox approaches to economics.
Neoclassical economics is characterized by several assumptions common
to many schools of economic thought. 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.
Three central assumptions
It was expressed by
E. Roy Weintraub that neoclassical economics rests
on three assumptions, although certain branches of neoclassical theory
may have different approaches:
People have rational preferences between outcomes that can be
identified and associated with values.
Individuals maximize utility and firms maximize profits.
People act independently on the basis of full and relevant
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.
William Stanley Jevons
William Stanley Jevons presented "the problem of
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.
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 labor supply
curves and reservation demand.
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 final output to determine equilibrium income and
the income distribution. Factor demand incorporates the
marginal-productivity relationship of that factor in the output
Neoclassical economics emphasizes equilibria, where equilibria are the
solutions of 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,
Economic subjectivism accompanies these emphases.
See also general equilibrium.
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Classical economics, developed in the 18th and 19th centuries,
included a value theory and 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
Adam Smith and David Ricardo.
However, some economists gradually began emphasizing the perceived
value of a good to the consumer. They proposed a theory that the value
of a product was to be explained with differences in utility
(usefulness) to the consumer. (In England, economists tended to
conceptualize utility in keeping with the utilitarianism of Jeremy
Bentham and later of John Stuart Mill.)
The third step from political economy to economics was the
introduction of marginalism and the proposition that economic actors
made decisions based on margins. For example, a person decides to buy
a second sandwich based on how full he or she is 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.
The marginal revolution
The change in economic theory from classical to neoclassical economics
has been called the "marginal revolution", although it has been argued
that the process was slower than the term suggests. It is
frequently dated from William Stanley Jevons's Theory of Political
Economy (1871), Carl Menger's Principles of
Economics (1871), and
Léon Walras's Elements of Pure
Economics (1874–1877). 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
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, Jevons saw his economics as an application and
development of Jeremy Bentham's utilitarianism and never had a fully
developed general equilibrium theory. Menger did not embrace this
hedonic conception, explained diminishing marginal utility in terms of
subjective prioritization of possible uses, and emphasized
disequilibrium and the discrete; further Menger had an objection to
the use of mathematics in economics, while the other two modeled their
theories after 19th century mechanics. Jevons built on the hedonic
conception of Bentham or of Mill, while Walras was more interested in
the interaction of markets than in explaining the individual
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 earlier marginalists went too far in correcting this
imbalance by overemphasizing utility and demand. Marshall thought that
"We might as reasonably dispute whether it is the upper or the under
blade of a pair of scissors that cuts a piece of paper, as whether
value is governed by utility or cost of production".
Marshall explained price 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
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
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
Very long period. Technology, population trends, habits and customs
are not taken as given, but allowed to vary in very long period
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
determinant of price in the very long run.
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 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.
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 curves and the theory of ordinal utility. The
level of mathematical sophistication of neoclassical economics
increased. Paul Samuelson's
Foundations of Economic Analysis
Foundations of Economic Analysis (1947)
contributed to this increase in mathematical modelling.
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. Some
argue that outside political interventions, such as McCarthyism, and
internal ideological bullying played an important role in this rise to
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 Gérard Debreu's Theory of Value
(1959) and in Arrow and Hahn's "General Competitive Analysis" (1971).
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 neoclassical synthesis
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
Main article: Criticisms of neoclassical economics
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 theoretical world in which Pareto
Perhaps the strongest criticism lies in its disregard for the physical
limits of the Earth and its ecosphere which are the physical container
of all human economies. This disregard becomes hot denial by
Neoclassical economists when limits are asserted, since to accept such
limits creates fundamental contradictions with the foundational
presumptions that growth in scale of the human economy forever is both
possible and desirable. The disregard/denial of limits includes both
resources and 'waste sinks,' the capacity to absorb human waste
products and man-made toxins.
The assumption that individuals act rationally may be viewed as
ignoring important aspects of human behavior. Many see the "economic
man" as being quite different from real people. Many economists, even
contemporaries, have criticized this model of economic man. Thorstein
Veblen put it most sardonically.
Neoclassical economics assumes a
person to be,
[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.
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
Problems exist 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 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 ensure that equilibrium is stable and unique are
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. A 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 realism of their assumptions. Mathematical
models also include those in game theory, linear programming, and
econometrics. Some see mathematical models used in contemporary
research in mainstream economics as having transcended neoclassical
economics, while others disagree. Critics of neoclassical
economics are divided into 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
In general, allegedly overly unrealistic assumptions are one of the
most common criticisms towards neoclassical economics. 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
modeling non-rational decision making). Its disregard
for social reality and its alleged role in aiding the elites to widen
the wealth gap and social inequality is also frequently criticized.
Static equilibrium (economics)
^ Antonietta Campus (1987), "marginal economics", The New Palgrave: A
Dictionary of Economics, v. 3, p. 323.
^ Clark, B. (1998). Principles of political economy: A comparative
approach. Westport, Connecticut: Praeger.
^ a b Colander, David; The Death of Neoclassical Economics.
^ Aspromourgos, T. (1986). On the origins of the term
‘neoclassical’. Cambridge Journal of Economics, 10(3), 265–70.
^ Veblen, T. (1900). 'The Preconceptions of Economic Science – III',
The Quarterly Journal of Economics, 14(2), 240–69. (Term on pg.
^ a b
George J. Stigler
George J. Stigler (1941 ). Production and Distribution
Theories. New York: Macmillan. Preview.
^ Fonseca G. L.; “Introduction to the Neoclassicals” Archived
2009-01-12 at the Wayback Machine., The New School.
^ E. Roy Weintraub. (2007). "Neoclassical Economics". The Concise
Encyclopedia Of Economics. Retrieved September 26, 2010, from
William Stanley Jevons
William Stanley Jevons (1879, 2nd ed., p. 289), The Theory of
Political Economy. Italics in original.
Philip H. Wicksteed
Philip H. Wicksteed The Common Sense of Political Economy
^ Christopher Bliss (1987), "distribution theories, neoclassical", The
New Palgrave: A Dictionary of Economics, v. 1, pp. 883–86.
^ Robert F. Dorfman (1987), "marginal productivity theory", The New
Palgrave: A Dictionary of Economics, v. 3, pp. 323–25.
^ C.E. Ferguson (1969). The Neoclassical Theory of Production and
Distribution. Cambridge. ISBN 9780521076296, ch. 1: pp. 1–10
Roger E. Backhouse (2008). "marginal revolution," The New Palgrave
Dictionary of Economics, 2nd Edition. Abstract.
^ a b William Jaffé (1976) "Menger, Jevons, and Walras
De-Homogenized", Economic Inquiry, V. 14 (December): 511–25
^ Philip Mirowski (1989) More Heat than Light:
Economics as Social
Physics, Physics as Nature's Economics, Cambridge University Press.
^ Frederic Lee (2009), A History of Heterodox Economics: Challenging
the mainstream in the twentieth century, London and New York:
^ Olivier Jean Blanchard (1987). "neoclassical synthesis", The New
Palgrave: A Dictionary of Economics, v. 3, pp. 634–36.
^ For example, see
Alfred S. Eichner and
Jan Kregel (Dec. 1975) An
Essay on Post-Keynesian Theory: A New Paradigm in Economics, Journal
of Economic Literature.
Herman E. Daly (1997) Georescu-Roegen versus Solow/Stiglitz,
Thorstein Veblen (1898) Why Is
Economics Not an Evolutionary
Science?, reprinted in The Place of Science in Modern Civilization
(New York, 1919), p. 73.
^ For an argument that the existence of modern corporations is
incompatible with the neoclassical economics, see John Kenneth
Galbraith (1978). The new Industrial State, Third edition, revised,
^ Friedman argued for this in essays III, IV and V in "Essays in
^ For example, David Colander, Richard Holt, and J. Barkley Rosser Jr.
(2004) The changing face of mainstream economics, Review of Political
Economy, V. 16, No. 4: pp. 485–99)
^ For example, Matias Vernengo (2010) Conversation or monologue? On
advising heterodox economists, Journal of Post Keynesian Economics, V.
32, No. 3" pp. 485–99.
^ Jamie Morgan (ed.) (2016) 'What is Neoclassical Economics? Debating
the origins, meaning and significance', Routledge.
Weintraub, E. Roy (2002). "Neoclassical Economics". In David R.
Henderson (ed.). Concise Encyclopedia of
Economics (1st ed.). Library
Economics and Liberty. CS1 maint: Extra text: editors list
(link) OCLC 317650570, 50016270, 163149563
Neoclassical Economics, William King, Drexel University
William Stanley Jevons
Francis Ysidro Edgeworth
John Bates Clark
Guy Laroque (fr)
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