Reviewed by Sep 30, 2020| Updated on
Neoclassical economics is one of the approaches of economics which examines supply and demand as the driving forces for production, pricing, distribution, and consumption of goods.
Neoclassical economists consider consumer’s demand or perception as a critical factor in determining the price of the product. The theory is in contrast to the classical theory, which states production cost to be the critical factor.
Neoclassical economists focus on the customer’s personal satisfaction in evaluating the price of a product. The underlying assumption is that customers will make purchasing decisions after evaluating the utility of a product. Thus, the theory assumes that customers will behave rationally.
In classical economic theory, a product’s price would be derived from the cost of production, such as the cost of materials and labour. However, neoclassical economists assume that customer’s perception about the utility of a product has an impact on the price of the product.
The theory also assumes that the competition for offering valuable products would lead to optimum allocation of resources in an economy. The supply and demand for a product would help create market equilibrium. The theory states that the primary concern of the government should be to create a market equilibrium with growth at complete employment.
The neoclassical theory is criticised on the ground that customers are unlikely to behave rationally in a practical scenario. A customer might be influenced emotionally or might have easy access to credit for high-cost products. Also, there are limits to the potential for growth in the value of a product or sector. Capitalists may not enjoy high profit due to competition.
The theory of neoclassical economics has been blamed for financial crisis arising due to inequalities in global debt. During the 2008 global financial crisis, the belief of neoclassical economists that synthetic financial products had no limit to growth and price ceiling was proven wrong.
During the crisis, the prices of the products crashed, leading to a meltdown of global financial markets. Thus, the neoclassical economic theory may not able to arrive at the optimum price and optimum profit.