NEOCLASSICAL ECONOMICS

1
NEOCLASSICAL ECONOMICS
Economics The study of how societies use scarce
resources to produce valuable commodities and
distribute them among different people. (Paul
Samuelson Economics) Economy (1530) from
oikonomos, oikonomia (Greek ??????µ???? oikos,
house nemein, to allot, manage Latin
oeconomia) household manager/steward household
management
Economic Sociology The application of the
frames of reference, variables, and explanatory
models of sociology to that complex of activities
concerned with the production, distribution,
exchange, and consumption of scarce goods and
services. (Smelser Swedberg 19943)
Economics is all about how people make choices
sociology is all about how they dont have any
choices to make. (Duesenberry, James. 1960.
Comment on Gary S. Beckers An Economic
Analysis of Fertility. Pp. 231-234 in
Demographic and Economic Change in Developed
Countries. Princeton, NJ Princeton University
Press.
2
Marginal Analysis
Classical economics created by Adam Smith (The
Wealth of Nations, 1776), David Ricardo, John
Stuart Mills stressed the benefits of free
trade, market tendency to equilibrium, and a
labor theory of value. Prices objectively reflect
the amount of labor required to produce goods.
This assumption is the basis of Marxs theory of
capitalist exploitation of workers.
A. Smith
Marginal utility theory dominated neoclassical
economics after 1870. Marginal utilitydf added
subjective satisfaction or benefit that a
consumer derives from an additional unit of
commodity or service. Utility is inverse to
consumption the price a consumer is willing to
pay for additional purchases diminishes due to
satiation.
EX How much are you willing to pay for your first
laptop? How much for a second third hundredth?
3
Individuals Maximize Utility
Neoclassical economists assume methodological
individualism all economic phenomena can be
explained by aggregating over individuals
behaviors. They de-emphasize institutions
rules regulations that predate and condition an
individuals actions. Consumers and producers
are rational actors who seek to maximize
subjective expected utility across a set of goods
and services, making choices within a budget
constraint e.g., what Ns of bananas mangoes
for XX will maximize your SEU?
Alfred Marshall (1890) analyzed commodity prices
and production quantities as the intersection
between supply and demand curves
? Consumer utility maximization explains shifts
in the supply demand curves for consumer goods.
? Producer profit maximization explains the
origin of firms demand curves for factors of
production, and underlies neoclassical economics
theory of the firm.
A. Marshall
4
Factors of Production
Land
Labor
Capital
Firm production function
Technological constraints
Budgetary constraints

Consumer Buyers
Business Buyers
Goods services for sale in the market

5
Firms Maximize Profits
The core neoclassical assumption Firm goal
profit maximization Profit maximization is the
process by which a firm determines the price and
output levels that will return its largest
profit.
Marginal analysis reveals that profit
maximization requires reducing total cost
relative to total revenue Revenue Price of
product X Quantity sold Cost Price of inputs X
Quantity used Profit Revenue Cost
To maximize its profit in a perfectly competitive
market (where all firms are price-takers, not
price-makers), a firm should produce output until
its marginal cost of producing the last unit
exactly equals the equilibirum price in the
market, at which every firm sells all the units
they produce. General equilibria are the
aggregate solutions to individual maximization
problems.
(See next slide)
6
Finding the Maximum Profit
The Market
The Firm


MC
D
AC
S
PE
PE
Q
Q
QPRODUCED
QEQUILIBRIUM
Market price for a good the quantity produced
by all firms is determined at equilibrium by the
intersection between (a) downward sloping
consumer demand curve D and (b) upward sloping
producer supply curve S.
Firm produces the product until its marginal cost
of producing the last unit equals the market
price. Its profit is the difference between
(a) total revenue ( Q x P) minus (b) total
cost ( Q x Average Cost)
7
Market Transactions

• Economics claims that the market, through its
  pricing mechanism, is the most efficient means to
  coordinate all buy-sell transactions.
• Producers and consumers are rational actors,
  assumed to have perfect information about market
  prices at the time of exchange.
• Actors abilties to calculate their utility and
  profit maxima are equal (no information
  asymmetries). Participation in market
  transactions doesnt run a risk of opportunistic
  behavior (self-seeking with guile).
• Therefore, no transaction costs need occur
• Search costs
• Negotiation costs
• Organizational costs
• Monitoring costs
• Opportunity costs

8
The Firm as Black Box
Neoclassical economists did not theorize about
what goes on inside firms. Organizationally, the
production function is an undifferentiated
black box that mysteriously transforms factors of
production into products services for sale on
the market.
OUTPUTS
INPUTS
Using the firms production function, a single
owner/manager decides what how much will be
produced, subject to its budget constraint.
Neoclassical theory of the firm ignores the
differing interests, resources, and actions of
entrepreneurial owners, boards of directors,
shareholders, managers, employees, communities,
governments, and numerous other firm
stakeholders.
9
Criticisms of Neoclassical Economics
Neoclassical economics is often criticized for
not explaining actual economies, instead
describing a normative Pareto-optimal Utopia"
Over-Reaching Claims (a.k.a. economic
imperialism) The economic approach is a
comprehensive one that is applicable to all human
behavior all human behavior can be viewed as
involving participants who maximize their utility
from a stable set of preferences and accumulate
an optimal amount of information. (Gary
S. Becker 1976 The Economic Approach to Human
Behavior).

• Unrealistic Assumptions -- Do these principles
  reflect a real world?
• People orgs are rational, risk-neutral,
  self-interested utility maximizers
• Humans possess perfect information (certainty)
  about prices qualities
• Production, profit, efficiency, are the only
  important economic values
• Markets are perfectly competitive (participants
  are price-takers, not -makers)
• Economies can use unlimited planetary
  resources, no externalities (pollution)
• Simplification to obtain (mathematical) rigor
  is analytically worthwhile

10
Economic Sociology as Alternative
Economic sociology in its classical era
emphasized institutional analysis
Economic sociology is the study of economic
institutions. (Joseph Schumpeter. 1954. History
of Economic Analysis). Finally there are the
economic institutions institutions relating to
the production of wealth (serfdom, tenant
farming, corporate organization, production in
factories, in mills, at home, and so on),
institutions relating to exchange (commercial
organization, markets, stock exchanges, and so
on), institutions relating to distribution (rent,
interest, salaries, and so on). They form the
subject matter of economic sociology. (Emile
Durkheim. 1909. L'Année Sociologique.)
Central concepts in economic sociologys current
era are social embeddedness and the social
construction of economic institutions
THREE THEORETICAL PILLARS of ECON SOC ? Networks
embeddedness of interpersonal
interorganizational relations ? Organizations
resource dependence, neoinstitutionalism, pop.
ecology, ? Culture beliefs, ideologies,
taken-for-granted assumptions
11
Readings Discussion Quex
1. How valid are Becker Coleman claims that
utility-maximizing principles can explain all
forms of social behavior, not just economic
activities? 2. By going beyond narrow
self-interest to include other motives (guilt,
affection), has Becker diluted neoclassical econ
models rigor power? 3. How can social
structure action perspectives enrich economics?
Or is Fine right economics colonization of
social sciences is inevitable? 4. Why does
Granovetter call embeddedness the opposite of
atomization? Does this structural approach to
economic life make econ soc distinct from
economics? Or can econ soc deal only with
nonrational left-overs? 5. Is Swedbergs
theoretical tripod sufficient for developing econ
soc as an intellectually powerful
institutionalized theory group? Dont
middle-range theories lack the unifying power
achieved by neoclassical economics? 6. What does
Zafirovski see as relation between econ soc
economics? Why does he argue that rational
choice model is unable to bridge the gap? 7.
Beckert argues that refuting maximization alone
cant create a truly sociological theory of
economics. How could uncertainty about outcomes
become the foundation of an alternative to
neoclassical economics?