Neoclassical Economics: Definition, Theory & Model

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  • 0:01 Definition of…
  • 0:27 The Theory
  • 1:46 Assumptions of the…
  • 2:20 History of…
  • 3:18 The Neoclassical…
  • 3:59 Lesson Summary
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Lesson Transcript
Instructor: Jennifer Francis

Jennifer has a Masters Degree in Business Administration and pursuing a Doctoral degree. She has 14 years of experience as a classroom teacher, and several years in both retail and manufacturing.

This lesson discusses neoclassical economics, its history, tenets, and assumptions as well as its application to today's global economics. After reviewing, complete the short quiz to test your understanding.

Definition of Neoclassical Economics

Neoclassical economics is a theory that focuses on how the perception of efficacy or usefulness of products affects market forces: supply and demand. It suggests that because the consumer's goal is utility maximization, or customer satisfaction, and that the organization's goal is profit maximization, the customer is ultimately in control of market forces such as price and demand.

The Theory

One of the most important tenets of the neoclassical theory is that consumers often perceive a product as being more valuable than the cost of production, thus affecting demand for the product.

Did you know that the semi-precious gemstone agate is one of the most common minerals on earth? Yes, it can be found in all 50 of the United States and may even be in your own back yard! Jewelry designers cut and polish the agate and then sell it in finished jewelry for hundreds or thousands of dollars (depending on the name of the designer), and customers willingly buy them. The importance of adornment increases the demand for the jewelry, which increases its price (as demand exceeds supply), even though the cost of production may be minuscule by comparison.

Another tenet of neoclassical theory is that economic choices are often made based on the likelihood that an economic option will turn out to be lucrative or valuable in the future. Think of the environmental scare of global warming and ozone depletion. The way we live our everyday lives is contributing to the problem, so would it not make sense to invest now in making bicycles or breeding horses or even creating energy efficient jet packs? Perhaps government policies should dictate that automobile manufacturers only make fuel efficient, green cars with caps on the allowable amount of emissions.

Assumptions of Neoclassical Theory

The following are the basic assumptions of the neoclassical theory:

  • Decisions on economic issues are always made rationally, based on full information on the usefulness of the product or service
  • Consumers compare goods and then make the purchase decision based on the perceived utility
  • The customer's main objective is to capitalize on the satisfaction afforded by the use of the product
  • The main aim of companies is to maximize profits
  • Market equilibrium is achieved only when both the customer and the company achieve their respective goals.

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