A grouping of a number of schools of thought in economics. Neoclassical economics is conventionally dated from William Stanley Jevons' 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. 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.
In particular, Walras was more interested in the interaction of markets than in explaining the individual pysche 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.
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.
Marshall explained prices by the intersection of supply and demand curves. The introduction of different market "periods" was an important innovation in Marshall:
- 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.
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. R. Hicks' Value and Capital (1939) was influential in introducing his English-speaking colleagues to these traditions. He, in turn, was influenced by Freidrich 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 (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 institutialism 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.
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 1960s saw a major debate, the Cambridge Capital Controversy, about the validity of neoclassical economics, with an emphasis on the theory of 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. Some think the Sonnenschein-Mantel-Debreu results put paid to these attempts.
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".
The above historical survey highlights only some meanders in a broad stream of economics. Any attempt to summarize the essence of neoclassical economics is bound to be contentiousness. In particular, the vision, problem domains, and concerns of neoclassical economists vary among neoclassical economists. Nevertheless, the remainder of this article attempts to present some such attempts.
Neoclassical economists, especially Lionel Robbins, define economics as the study of the allocation of scarce resources among alternative ends. Here's how Jevons presented the economic problem:
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.
Neoclassical economics emphasizes equilibria, where equilibria are the solutions of individual maximization problems. Regularities in economies are explaned by methodological individualism, the doctrine that all economic phenonema 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.
Neoclassical theories often revolve around utility and profit maximization. Profit maximization lies behind the neoclassical theory of the firm, the derivation of supply curves for consumer goods, and the derivation of demand curves for 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. In fact, economic man has been sometimes jokingly named Max U.
Many economists 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 more influential. 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.
Normative bias. Not about explaining actual economies, but describing a realistic utopia in which Pareto optimality obtains.
Copying of 19th century mechanics.
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