Neoclassical economic theory: unrealistic assumptions and market failures

¶ … Economics: Criticism of the Neoclassical Theory

For a long time, the neoclassical economic theory has dominated the field of economics; both in teaching and in practice, in the United States. Neoclassical economics basically describes various approaches that outline how supply and demand in the markets is influenced by income distributions, prices, and outputs. More specifically, the neoclassic economic theory postulates that the needs and rights of consumers do not have any bearing on a consumer's preference between two goods. According to Wolff and Resnick, consumer's wants and abilities are the main determinants of behaviors related to supply and demand, which will ultimately influence the price set (59). Therefore, according to this theory steady rate of economic growth is only achieved by the proper utilization of three major driving forces: capital, labor, and economics. It also stresses on the accumulation of capital and savings as major contributors to economic growth. However, the neoclassical theory has been widely criticized for describing ideologies that do not actually exist in the real world. Some people opine that Pareto optimality is only applicable in neoclassical models and that actual economies cannot function on unrealistic assumptions. In agreement with this opinion, this text seeks to prove that this ability of the neoclassical theory to demonstrate how exactly the market is able to yield optimal and effective different prices for commodities, capital and labor, is rarely appropriate.

Criticisms of the neoclassical theory

Neoclassical economics is primarily concerned with the efficient allocation of resources in a given economy. According to Henning, it purports that it is the rationality of the individual that will eventually influence how they plan to maximize their utility (3). However, this assumption that individuals are able to act in a rational way is false particularly because individuals are guided more by their emotional impulses. Therefore, to assume that consumers in a market will act rationally, which will influence the prices that are set by the market, is wrong. In fact, this assumption ignores the fact that human beings can be influenced by other events, which is often the case. Moreover, prices cannot be optimal because rational behavior may be merely emotional and may not result in material benefit. Majority of other assumptions that are critical to the neoclassical theory, such as non-satiation, are also not easy to understand (Wolff and Resnick, 65).

The idea of effective and optimal prices is also biased. Sraffa argues that the output in a given economy is not related to the household demand; rather it is only used in the determination of the equilibrium prices (Salvadori and Gehrke, 141). It is important to note that fluctuations in price do not go hand in with demand. The neoclassical theory does not also explain in detail how the market, given the numerous factors that influence its competition, will be able to determine the optimal price. Some critics also argue that its notion of Pareto optimality only exists in a nonexistent world, particularly because the interaction between prices and the quantities of commodities is rather complex. Neoclassical economists are not in a position to explain the process in which the output and the relative prices act upon one another, and it is false of them to assume that absolute price levels and demand are independent.

In line with unrealistic assumptions, the models that are used by neoclassical theorists also raise some concerns. The major economic participants in the market do not have an environment where they can achieve optimality. Majority of the models used in the neoclassical theory, therefore, tend to borrow from mathematical models without considering the present economy (Wolff and Resnick, 148). In most of these models, optimality is also not achieved. It is rather hard to measure different elements that are the driving factors in competitive markets given the dynamic nature of the modern economy, and the models do not also accurately communicate the limitations and weaknesses. Some of the geometric diagrams that are used by neoclassical models point towards essentialism mainly in their analysis of various causes and effects of economic relationships (Wolff and Resnick, 148). Henning also states that these models give explanations of the value and price changes of a commodity but fail to equate the real price change to the nominal price (5). Such are the assumptions that make this approach unsuitable for describing actual economies, and cast doubt on the efficiencies of prices set for commodities in the market, capital and labor.

Conclusion