Difference between classical & neoclassical economics

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Difference between classical & neoclassical economics
Neoclassical economics evolved from classical economics. (Economic crisis image by Denis Ivatin from Fotolia.com)

Economic history is marked by many revolutions and paradigm shifts. In the early 20th century, the shift from classical to neoclassical economics brought about numerous changes in the way people thought about wealth. The main intellectual shift ushered in by neoclassical economics was the idea of value as a function of perception, a sharp departure from the classical theory of value as cost of production. Many of the differences between classical and neoclassical economics can be attributed to this shift.

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Utility

The main difference between classical and neoclassical economics lies in the concept of utility. In classical economics, utility is conspicuously absent in theories of value, labour and growth. In the classical school, equilibrium was a function of wages and interest wages rather than supply and demand. By contrast, utility is given a very high priority in the neoclassical school. Also in the neoclassical school, economic equilibrium is a function of supply and demand across all markets, with the supply and demand of all goods functions of their utility and scarcity.

Value

The classical and neoclassical theories of value are very different. In the classical school, the value of a good is equivalent to the cost of producing it. In the neoclassical school, the value of a good is a function of the demand for it and the supply of it. Therefore, in classical economics, value is an inherent property; in neoclassical economics, value is a perceived property. In classical economics, value is cost; in neoclassical economics, value is utility.

Profit

The classical and neoclassical schools of economics both place value on profit but in distinctly different ways. In classical economics, profit is a payment to a capitalist for performing a socially useful function. This definition circumvents the apparent problem of classical value theory: If value equals cost, then where do profits come from? Neoclassical economists define profit in a much simpler way. To neoclassical economists, profit is simply a surplus of earnings over expenses. If the supply and demand for a good results in a higher price than that of the labour and capital that went into producing the good, then the good and its components simply have different equilibrium prices.

Rationality

Rationality is emphasised in neoclassical economics but not in classical economics. In neoclassical economics, individual agents have rational preferences that guide their purchasing and selling behaviour: Individuals seek to maximise utility, and firms seek to maximise profits. In classical economics, no distinction is made between firm and individual according to the principle of "rationality. In classical economics, the profits that accrue to firms are the same as wages that accrue to workers, economic benefits brought on by the invisible hand of the free market.

Equilibrium

Classical and neoclassical definitions of equilibrium are fundamentally different. In classical economics, equilibrium occurs when savings are equal to investment. In neoclassical economics, equilibrium occurs at the intersection point of the supply and demand curves or, in macroeconomics, aggregate supply and aggregate demand curves. This is one of the most fundamental differences between classical and neoclassical economics because the two concepts of equilibrium are based on entirely different components.

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