Comparison between Neoclassical and Classical Economics

Various paradigm changes and transformations in economic culture are illustrative. The transition from classical economics to neoclassical approaches in the mid-twentieth century resulted in shifts in how people perceived wealth problems (Altman 2015). Both Neoclassical and Classical economics are schools of thinking that use separate approaches to defining various areas of economics. Classical economics was founded by prominent economists such as Adam Smith, John Stuart Mill, and David Ricardo, while neoclassical economics was founded by theorists and writers such as Carl Menger, William Stanley Jevons, and Leon Walras (Samuelson 1978, p.1430). Classical economics tends to be a predecessor of the neoclassical theory, but they both have distinctive approaches in analysing economies. For instance, neoclassical theory stresses on how the exchange of products influences the economy while classical theory evaluates on how the production process of goods and services impacts the economy (Ferguson 1969). Therefore, this essay focuses on comparing and contrasting both classical and neoclassical theories.

The classical and neoclassical economic notions are two different approaches used to explain the concepts of economics (Richter, 2015). Classical economics was utilized as a part of the eighteenth and nineteenth century whereas the neoclassical theory was used towards the mid-twentieth century, which is considered sufficient till today. According to Samuelson (1978), Classical economists believed in a self-regulatory economy that limits government intervention and assumes that the resources expected will be most efficient in meeting individual needs (p. 1417). In contrast to classical theory, neoclassical school of thought works with the hidden hypothesis that people will endeavour to expand utility and business will boost profits.

Classical Economics

The Classical economic theory posits that a self-regulating economy is the most effective and efficient because as needs arise persons will adjust to serving each other’s requirements. Additionally, based on the theory there is no government intervention and individuals allocate limited resources in the most efficient manner to meet their needs (Richter 2015, p.57). In a classical economy, price decisions are made based on the raw materials used to produce, electricity wages, electricity and other costs that have been incurred to produce a finished product. Altman (2015) argues that the classical school highlights production of goods and services as the key focus of economic analysis.

Neoclassical Economics

Neoclassical economics involve economic theories and ideas that are practised in the current world with a fundamental assumption that prices are determined by forces of supply and demand (Altman 2015). In addition to that, there are three basic assumptions that govern neo-classical economics. The theory assumes that individuals are rational in that they act in a manner that brings forth the best personal advantage. Moreover, the theory undertakes that individuals have limited income and; thus, strive to maximise utility. Furthermore, based on the theory organizations have limitations with regard to cost and, hence, use the available resources to maximize profits (Samuelson 1978, p.1427). Finally, neo-classical economics undertakes that persons act independently of one another and can fully access the information necessary for decision making (Richter 2015, p. 58). Different form classical theory, neoclassical economics focuses on how individuals operate within an economy and emphasize the exchange of goods and services as the main focus of economic analysis.

CLASSICAL VERSUS NEOCLASSICAL ECONOMICS

The concept of utility is one of the main difference when comparing neoclassical with classical theories. In the Classical theory, the utility does not focus on the understanding of growth, labour, and value (Bek-Thomsen, Christiansen, and Thorup 2017). Therefore, a classical theory explains more on the equilibrium of the economy depending on the interest wages and function of wages rather than demand and supply. In contrast to classical theory, neoclassical economics focus more on the overall utility of an individual (Richter 2015, p. 57). Additionally, in the neoclassical theory, market forces of demand and supply are the determinants of prices and value of products.

The neoclassical and classical economic theories have different concepts on the values of goods and services. In the classical economics, the cost of producing goods and services is equivalent to its value (Altman 2015). On the other hand, in the neoclassical economics, the function for the supply and demand of a product is similar to its value. Hence, in classical theory, the value of a product is measured by its cost whereas, in the neoclassical school of thought, the value of an item is defined by its utility (Ferguson 1969).

The neoclassical theory emphasizes on the rationality of products different from a classical approach. For instance, in a neoclassical school of thought, economic operators have rational behaviour that guides their selling and purchasing decisions in a manner that firms seek to maximizing profits while consumers try to maximize utility (Altman 2015). This is different in the classical theory whereby there is no enhancement made either at an individual or firm level as indicated by the standard of rationality.

Market equilibrium is another factor that is viewed differently between the two schools of thoughts. According to Ferguson (1969), market equilibrium refers to the point where the market clears; the demand for products equals to its supply. Equilibrium in classical economics happens when the ratio of saving tends to be equivalent to the ratio of investment. In the neoclassical theory, market equilibrium happens at the convergence in aggregate demands and supply curves (Bek-Thomsen, Christiansen, and Thorup 2017, p.11). This is a standout amongst the most central contrasts amongst neoclassical and classical financial aspects since the two ideas of equilibrium depend on completely extraordinary components.

History is a significant factor that provides a distinctive difference between the two theories. Classical economics grounds its analysis in history, specially the history of the culture or nation of which a certain economic system is involved (Richter 2015, p. 68). Moreover, history gives an idea of how this economy extended and contracted before, which can then be utilised to attempt to foresee how it may grow and contract later on. On the other hand, neoclassical approach grounds its analysis in mathematical models that are not grounded in history (Ferguson 1969). Therefore, these models give an idea of how an individual economic actor may act in response to change in events.

Value analysis depicts the difference between classical and neoclassical theories in defining the value of goods and services. The classical theory concentrates on economic systems and the ways in which these systems were produced, hence, it focuses on the inherent value of products and services (Richter 2015, p. 58). Based on this approach, goods and services are valued to be substantial regardless of their producers and consumers. On the other hand, neoclassical economics focus on individuals within economic systems and the variable value of goods and services. Different from classical economics, neo-classical approach values goods to be worth something depending upon who produces them, who consumes them and how they are used.

Based on the analysis above, neo-classical economics gives the most satisfactory vision because it reflects ideas that are practised in the current world with a fundamental assumption that prices are determined by forces of supply and demand. Additionally, the three assumptions explained above attached to this theory is more realistic to the present world. Moreover, the classical economic theory fails to give a satisfactory vision because it is rooted in the concept of a laissez-faire economic market that is ideal. Bek-Thomsen et al. explain that a laissez-fair is a free--market that requires little to no government intervention and allows persons to act according to their own self-interest regarding economic decisions (2017, p.10). This is different in the present world because, to create Pareto optimality and protect both consumers and producers, there needs to be a government intervention. Without government intervention, producers can take advantage of consumers or even laborers.

Neo-classical economics gives the most satisfactory vision of a perfect market that exists in our daily activities. In a classical economy, price decisions are made based on the raw materials used to produce a finished product. Due to the growing of increase in the perfect market in the world, prices are no longer determined by the cost of inputs; instead, by the forces of demand and supply including prices, availability of close substitutes, seasons and so many other factors (Richter 2015, p.58). Additionally, the classical economy’s theory on equilibrium does not reflect the reality of present days because equilibrium is not attained when the rate of saving tends to be equivalent to the ratio of investment; instead, it is attained when the demand for products equals to its supply. This is the reason why classical economics was mainly applicable as a part of the eighteenth and nineteenth century whereas the neoclassical theory was used towards the mid-twentieth century, which is considered sufficient till today (Altman 2015).

Conclusion

In conclusion, both classical and neo- classical theories are applicable in the economic analysis. The main difference is that classical approach believes in a self-regulatory mechanism where there is little or no government intervention in an economic system and give individuals freedom to act according to their self-interest regarding economic decisions (Samuelson 1978, p.415). In contrary to that, neo classical economics is based on three strong assumptions that reflect the current economic systems where the exchange of goods and services is determined by market forces (Altman 2015). This makes neo-classical the most satisfactory methodology in analyzing economic systems.

References

Altman, M. (2015). Handbook of contemporary behavioral economics: foundations and developments. Routledge.

Bek-Thomsen, J., Christiansen, C. O., Jacobsen, S. G., and Thorup, M. (2017). Introduction in History of Economic Rationalities (pp. 1-12). Springer International Publishing.

Ferguson, C.E. (1969). The Neoclassical Theory of Production and Distribution. Cambridge.

Richter, R. (2015). New economic sociology and new institutional economics: In Essays on New Institutional Economics (pp. 51-75). Springer International Publishing.

Samuelson, P. A. (1978). The Canonical Classical Model of Political Economy. Journal of Economic Literature, V. 16: pp. 1415–34