Neoclassical economics

Neo-classical economics has been the dominant approach in economics since the end of WWII. Prior to WWII, institutional economics enjoyed a wide following as an alternative economic methodology. Neo-classical economics is distinguished by the use of optimal decision making to model and theorize about economic activity. Decisions represent some maxima or minima of an agent's objective function subject to some constraint. Profit and utility maximization are just two variants of this approach. Neo-classical economics is often known as micro-economics or price-theory. There are, however, other forms of mico-economics and price-theory. These denotations reflect the hegemony of neo-classical economics in academia. Currently, the terrian of neo-classical economics is being challenged from many directions. Behavioral, evolutionary, experimental, computational, institutional, neo-institutional, Post-Keynesian (i.e., Keynesian), Austrian, Marxist, feminist, and Sraffian economics all, to varying degrees, represent challenges to the neo-classical paradigm.

The Neoclassical Economic Model (which I will refer to as classical economics, mostly throughout) has been the dominant model since Adam Smith wrote Wealth of Nations and got the ball rolling on hands-off economics. The concept is that the market works itself out on its own. The fixing is done by the price system, which is possible for providing full employment. If unemployment were to occur, automatic adjustment within the price system would bring the economy back to full employment.

The classical model runs on three assumptions:

• All markets clear instantly
• No money illusion
• Complete crowding out on investment

All Markets Clear Instantly
This means that market changes happen instantly. This theory goes on the thought that if the oil supply changes, the price and demand will immediately change to equilibrium.

No Money Illusion
Money illusion basically means that inflation doesn't exist. If your income goes up 3% over the past year, you feel like you're getting more money. However, if inflation went up 5%, then your spending power has gone down.

Complete Crowing Out On Investment Lets create a simple economy that makes only pencils. p is the total number of pencils, c is the amount of consumption by the private sector, while g is the amount of consumption by the government.

p = c + g

Crowding out means that if the consumption is maxed out, and government consumption increases, private consumption must decrease to keep the equation equal.

The model also assumes perfect competition, which we all know isn't always true. Because of the above assumptions, there are many arguments against the classical model, the most notable and popular is the Keynesian model. However, a lot of governments still follow a version of the classical model since conservative governments believe in hands off economics.