4 Neoclassical Economics Assumptions and Specific Criticisms

Neoclassical economics is a school of thought within the social sciences that insists on the innate rationality of consumers, the importance of the profit motive for companies, the need for governments to advocate for market equilibrium, and the influence of utility on prices.

Nineteenth-century theorists like Alfred Marshall, Léon Walras, Carl Menger, Thorstein Veblen, and William Stanley Jevons deserve attribution for turning neoclassical theory into the bedrock of mainstream economics throughout the twentieth century. Some neoclassicists came out of the Austrian school of economics, whereas others followed a more direct line from classical economics itself.

Despite its long history and influence, detractors believe this approach is too abstract and theoretical to describe economic realities. Other critics insist strict adherence to the precepts of neoclassical economics has led to vast levels of income inequality. Still, it remains one of the most influential and oft-cited economic models to this day.

Neoclassical economists build their understanding of the economy around certain core principles. Consider these four essential elements of neoclassical economic theory:

1. 1. Consumers are rational. In the purview of neoclassical economics, consumers methodically evaluate all of their economic choices. The presupposition of this sort of logical economic decision-making is what leads economists of this ilk to believe price derives from the perceived utility of a given good. The Pareto principle—the idea all economic transactions come with tradeoffs—relates to this as well.
2. 2. Firms exist to maximize profits. Neoclassical economists believe companies have a duty to strive for profit maximization. In their view, this leads to an optimization of the political economy as a whole, given the increase of economic activity and competition it portends. Neoclassicists believe this dance between what consumers are willing to pay and what companies hope to make in profits powers economic growth.
3. 3. Market equilibrium is an economic priority. The paramount importance of market equilibrium between supply and demand is one of the essential assumptions of neoclassical economics. This general equilibrium, theoretically, allows for a balanced allocation of resources among all consumers. Neoclassical economists believe a midpoint synthesis of supply and demand is what leads to such a sense of equilibrium.
4. 4. Value derives from perceived utility. The neoclassical theory of value revolves around marginal utility maximization. Economists in this school believe the value of a product derives from what consumers believe its value is, rather than how much it actually cost a company to produce.

The primary difference between neoclassical and classical economics is what each of the two schools of thought believe about how commodities derive their value.

Classical economists believe the cost of production and labor combine as the most formative elements of a given good’s price. By contrast, neoclassical economists think marginal cost—the value perceived by the consumer themselves—is the most important element as to how firms should price their goods.

Still, neoclassical economists drew plenty of inspiration from classical economists like Adam Smith and David Ricardo. In turn, they went on to influence the work of John Maynard Keynes, whose Keynesian economics came to dominate the history of economic thought in the mid-twentieth century.

Neoclassical economics remains popular and mainstream, but its detractors have grown in recent years. Here are four prominent criticisms of the neoclassical approach:

1. 1. Exorbitant trust in human rationality: Behavioral economists believe neoclassicists rely too much on the assumption humans behave rationally at all times. They insist human behavior is often much more emotional, unpredictable, and easily influenced. This undercuts the logical methodology neoclassical economists believe governs every economic transaction.
2. 2. Ideological bias: Critics assert neoclassical economists have pushed their views as self-evident or undeniable when they’re really nothing of the sort. The institutional economic system operates under the guidance of largely neoclassical principles, leading detractors to say this normative approach prevents other economic schools of thought from influencing policy.
3. 3. Overdependence on theory: Certain critics believe neoclassical economic analysis is too mathematical and theoretical, leading it to become detached from the real world. They insist neoclassicists have ignored the failures of the market system, rather than allowing new evidence to reshape their views.
4. 4. Potential contribution to inequality: The emphasis on profit maximization in neoclassical economics leads some to say putting its principles into practice leads to high degrees of wealth inequality. Critics assert this leads to runaway greed among corporations at the expense of the average person.

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