What is Neoclassical Economics?

Developed in the late 19th century, neoclassical economics is an approach to economics that focuses on supply and demand. In contrast with previous theories, neoclassical economics sees economics as the study of allocating resources among competing uses or ends. It is differentiated from other economic philosophies by the fundamental assumptions that it makes about economics and economic behavior. The school of neoclassical economics assumes individuals make rational decisions among competing outcomes, that firms seek to maximize profits while individuals maximize satisfaction or happiness, and that individuals act independently and possess complete, relevant information. Collectively, the theories that are based on these assumptions explain the allocation of scarce resources among competing ends and comprise neoclassical economics.

Value and price are used by neoclassical economists to explain the workings of supply and demand. In the neoclassical view, individuals have unlimited wants that collide with scarcity. The decisions that individuals and firms must make as they seek to maximize either satisfaction or profits are worked out in the market by the actions of supply and demand to assign value. In neoclassical economics, the value of a good is the satisfaction it brings to the individual. Price is the mechanism that determines how and if the conflicting wants of firms and individuals can be reconciled.

For example, an individual might want to buy a car at a certain price. Others also might want to buy the same car at the same price. Regardless, manufacturers might be unwilling or unable to produce as many cars as the consumers want at that price. Consumer frustration begins to bid up the price of cars until some potential buyers eliminate themselves from the market by deciding that the satisfaction they would obtain from owning the car at a higher price does not justify the cost to them. The value of the car to the buyer declines as the price changes. Through the elimination of buyers by changes in price and value, demand and supply are brought into agreement.

Since its inception as the successor to the 18th century theory of classical economics, neoclassical economics has had a profound impact on economic thought. Its emphasis on mathematics and models as the basis of economic theory has been fundamental to the formation of modern economies. Today, much of what is being taught in college courses on microeconomics and macroeconomics is derived from neoclassical economic analysis. Neoclassical economics has become the most widely taught theory of economics.