Classical economics started of Adam Smith’s the Wealth of Nations in 1776. The central idea of classical theories is on the ability of the market to be self-correcting as well as being the most superior institution in allocating resources. The central assumption of classical theories implied that if all individuals maximize their economic activity. On the other hand, marginal revolution that occurred in Europe in the 19th Century, led by Carl Menger, William Stanley Jevons, and Leon Walras, gave rise to what is known as neoclassical economics. This neoclassical formulation had also been formalized by Alfred Marshall.
However, it was the general equilibrium of Walras that helped solidify the research in economic science as a mathematical and deductive enterprise, the essence of which is still neoclassical and makes up what is currently found in mainstream economics to this day. The classical school investigated two central economic questions that the causes of economic growth and the determinants of the income distribution such as the accumulation and allocation of surplus output, and therefore their emphasis was on production and on the factors that influence the supply of goods.
Unlike its classical school, marginalist school focuses on individual choices, which unavoidably reflect subjective preferences and beliefs, and the allocation of given resources among alternative uses. In other words, Classical theory paid comparatively less attention to choices of individuals whereas marginalist presented more on human welfare. Indeed, the marginalist revolution is a shift in focus from capital accumulation and growth to utility maximization and production efficiency as the aims of economic policy.
This shift from classical to neoclassical economics brought about numerous changes in the way people thought about wealth. Based on their different views on economic issues, their innovations towards economy are different as well. The first different innovation between them is the view of economic growth. Marginalists contributed exogenous innovation relative to the public good features of technological progress dealing with the externalities and increasing marginal returns whereas classicalists does not have many innovations on economic growth. The second different innovations are the ways they use to analyze the economics forces.
Marinalists illustrate the distributive share lends itself to a relatively simple mathematical statement and classicalists based more on historical analysis. The similar innovations of them are they both suggest of free trade union. Veblen critique that marginalists’ economics do not relate to evolutionary science of economics and evolve in the society politically and morally. Some other economists also critique that marginalists have normative bias, instability, relying too heavily on complex mathematical models and its overly unrealistic assumptions.
First of all, they have different innovation towards economic growth. The central innovation explaining economic growth in marginalists’ growth theory is exogenous innovation. In order to exogenous innovation, these theories have to deal with the public good features of technological progress, and the problems this poses with regard to appropriability of innovation. Marginalists assuming that there are important externalities concerned with the development of technical knowledge.
In most cases, these externalities take the form of general technological knowledge which can be used to develop new methods of production and is available to all firms. This externality is closely connected to scale in the aggregate production function increasing returns. Which is, Marginalists analysis makes up much of neoclassical economics and create the popular economic tenet, called “rational decisions are made on the margin. ” Besides, Marginalists created an economic theory of the relation between technological change and economic growth.
Marginalists replace the labor theory of value with the “marginal utility theory of value. ” The marginalists based their explanation of prices on the behavior of consumers in choosing among increments of goods and services, which is, they examined the benefit that a consumer derives from buying an additional unit of something that he already possesses in some quantity. The idea of emphasizing the “marginal” unit proved in the long run to be more significant than the concept of utility alone, because utility measures only the amount of satisfaction derived from a particular economic activity, such as consumption.
In fact, it was the consistent application of marginalism that marked the true dividing line between classical theory and modern economics. The classical economists identified the major economic problem as predicting the effects of changes in the quantity of capital and labor on the rate of growth of national output. The marginal approach, however, focused on the conditions under which these factors tend to be allocated with optimal results among competing uses—optimal in the sense of maximizing consumers’ satisfaction.
However, Classical economic theory does not deal ith the dynamics of growth, but rather with the functioning of markets as resource allocation mechanisms in which demand functions interact with supply functions to determine prices that balance supply and demand, so sustaining market equilibrium. Just as with classical physics, an economy is understood to move according to deterministic laws in which the future is a predictable repetition of the past and the question of innovation does not feature, other than as an unexplained shift in the supply function. Movement into the future proceeds in a regular manner according to the equivalent of natural laws.
The purpose of the movement is to sustain a predictable state of equilibrium specified by the economic laws of supply and demand, the equivalent of natural laws. When one talks about the nature and purpose of the movement of some phenomenon one is talking about teleology as the cause of the movement. Movement that is the repetition of the past with the “”purpose”” of sustaining equilibrium is “”Natural Law Teleology”” (Stacey et al. , 2000). Classical economic thinking about market systems thus assumes Natural Law Teleology.
Within market systems, classical economic theory conceived of people in a particular way, namely, as rational individuals. These rational individuals (economic man) were thought of as operating in a calculating way in markets driven by the laws of supply and demand. Each rational individual calculated the predicted economic consequences of every action as determined by the laws of the market, choosing those actions that maximized their individual utilities. Individuals were assumed to act as profit and utility maximizers and, because they behaved in this way, markets functioned efficiently to optimize resource allocation.
Stacey et al. (2000) refer to this way of thinking as “”Rationalist Teleology””. This is a way of thinking about movement as being caused by the rational choices of autonomous individuals in order to achieve their chosen goals. The second innovations is that the illustration of the mathematics. Suppose that the production function which is, the relationship between all hypothetical combinations of land, labor, and capital on the one hand and total output on the other. The equation is given as Q = f (L,K) in which Q stands for total output, L for the amount of labor employed, and K for the stock of capital goods.
Land is subsumed under capital, to keep things as simple as possible. According to the marginal productivity theory, the wage rate is equal to the partial derivative of the production function, or Q/L. The total wage bill is (Q/L) L. The distributive share of wages equals (L/Q) (Q/L). In the same way the share of capital equals (K/Q) (Q/K). Thus the distribution of the national income among labor and capital is fully determined by three sets of data: the amount of capital, the amount of labor, and the production function.
On closer inspection the magnitude (L/Q) (Q/L), which can also be written (Q/Q)/ (L/L), reflects the percentage increase in production resulting from the addition of 1 percent to the amount of labor employed. This magnitude is called the elasticity of production with respect to labor. In the same way the share of capital equals the elasticity of production with respect to capital. Distributive shares are, in this view, uniquely determined by technical data. In classical economics tradition, historical analysis is called for and mathematical models and statistical investigations are of limited usefulness.
The classical economists have made consistent efforts to explain the rise of the capitalist mode of production in terms of historical analysis. They from the beginning have sensed that it was the essence of capitalist production to generate an accumulating surplus, and that the manner of this accumulation was crucially related to the character of the newly emerging social relations of capitalist society. The classical theory of value would be limited to the goods and services that were typical products of competitive capitalism.
They regarded the explanation of this historical phenomenon as their primary task. The third innovation of marginalists ’theory is that proposing trade union with limit as little as possible. Marginalists’ trade theory is based upon the assumption that states act to maximize their aggregate economic utility. This leads to the conclusion that maximum global welfare and Pareto optimality are achieved under free trade. While particular countries might better their situations through protectionism, economic theory has generally looked askance at such policies.
Neoclassical theory recognizes that trade regulations can be used to correct domestic distortions and to promote infant industries, but these are exceptions or temporary departures from policy conclusions that lead logically to the support of free trade. Marginalists’ theory demonstrates that the greater the degree of openness in the international trading system, the greater the level of aggregate economic income. Imply that all states regardless of their size or relative level of development. The static economic benefits of openness are, however, enerally inversely related to size. Trade gives small states relatively more welfare benefits than it gives large ones. Empirically, small states have higher ratios of trade to national product. They do not have the generous factor endowments or potential for national economies of scale that are enjoyed by larger particularly continental states. The impact of openness on social stability runs in the opposite direction. Greater openness exposes the domestic economy to the exigencies of the world market.
That implies a higher level of factor movements than in a closed economy, because domestic production patterns must adjust to changes in international prices. Social instability is thereby increased, since there is friction in moving factors, particularly labor, from one sector to another. The impact will be stronger in small states than in large, and in relatively less developed than in more developed ones. Large states are less involved in the international economy: a smaller percentage of their total factor endowment is affected by the international market at any given level of openness.
This shows exactly that the marginalists care more about the human welfare whereas the classicalists care more about wealth. The classical and neoclassical schools of economic theory have emphasized the advantages of free trade policies and the disadvantages of protectionism for the improvement of popular living standards and the promotion of overall rates of economic growth. The basic conclusion of classicalist and marginalists economic theory is that the advantages of free international trade represent basically only a special case of the advantages of the free market system in general.
Although moving toward free trade may represent very real financial losses for the small minority of companies with the political influence to get themselves protected from foreign competition, these losses are normally much more than counterbalanced by the gains to the great majority of the population. Free trade leaves the country’s consumers free to seek out the best bargains they can find by not arbitrarily restricting their ability to choose foreign suppliers when they offer a better deal than their domestic competitors in terms of price and/or quality. This enhances competition and breaks down local monopolies.
Free trade also enhances the profitability of many other local industries by enabling them to shop around for better deals in purchasing their supplies of raw materials and other capital goods and thus helping them to reduce their costs of production. In the most general terms, free trade makes possible a progressive extension of the area within which specialization and the division of labor takes place according to the principle of comparative advantage, producing gains from trade in overall productivity and economic efficiency that result in higher average living standards both at home and abroad.
Veblen’s criticism took two forms; one was scientific had to do with the requirements of a properly evolutionary science of economics; the other was political and moral had to do with the direction in which he thought society should evolve. First economics in his view was still largely pre-Darwinian in that it used utilitarian theory as its criterion of choice and clung to an outmoded hedonistic psychology; it was teleological in that it unrealistically postulated certain processes such as equilibrium as normal and taxonomic insofar as it is substituted classification for causal explanation.
It erred, methodologically, in using deduction to draw conclusion from unrealistic axioms. The static bias exhibited by neoclassicism made it seem unlikely to Veblen that it could develop into an evolutionary economics capable of explaining cumulative change in terms of casual sequence. Veblen’s criticism of marginalists also focused on its neglect of the original of consumer tastes and preferences, its use of marginalist explanations of income distribution and, implicitly, with the static role it assigned to the state.
In his view, neoclassical simply took consumption patterns for granted without inquiry into the origins of consumer values. They ignored the emulatory nature of much consumption and, the role of advertising and salesmanship in whetting consumer appetites. Marginal productivity theory claimed to explain the distribution of income without explaining how the factors of production, such as land, labor and capital, came to be owned as they were; acquisition was thus identified with production.
Although he was not explicit about the role the state should play in the economy and doubted how much deliberative change could be achieved through collective action, he implied that the adaptive processes of the of the community to a changing environment might require the state to perform other than the static, limited roleassigned to it by the neoclassicists. Thus Veblen had negative attitutions toward classical liberalism and the powerful strains of it deposited in neoclassical economics.
He found them both wanting on scientific and moral grounds, and since they were the conventional wisdom among economists, it is not surprising he remained a marginal figure in his own profession. The other economists critique that marginalists have a normative bias. First, some economists think that large corporations might perhaps come closer to the neoclassical ideal of profit maximization, but this is not necessarily viewed as desirable if this comes at the expense of neglect of wider social issues.
The response to this is that neoclassical economics is descriptive and not normative. It addresses such problems with concepts of private versus social utility. Second, some of the economists consider general equilibrium theory compatible with an economy that develops over time and includes capital goods is a problem. This was explored in a major debate in the 1960s—the “Cambridge capital controversy”—about the validity of neoclassical economics, with an emphasis on the economic growth, capital, aggregate theory, and the marginal productivity theory of distribution.
There were also internal attempts by neoclassical economists to extend the Arrow-Debreu model to disequilibrium investigations of stability and uniqueness. However a result known as the Sonnenschein-Mantel-Debreu theorem suggests that the assumptions that must be made to ensure that the equilibrium is stable and unique are quite restrictive. Neoclassical economics is also often seen as relying too heavily on complex mathematical models, such as those used in general equilibrium theory, without enough regard to whether these actually describe the real economy.
Many see an attempt to model a system as complex as a modern economy by a mathematical model as unrealistic and doomed to failure. Famous answer to this criticism is Milton Friedman’s claim that theories should be judged by their ability to predict events rather than by the realism of their assumptions. Mathematical models also include those in game theory, linear programming, and econometrics.
The assumptions of rational expectations are also one of the most common criticisms towards marginalists’ economics because of its overly unrealistic assumptions, there are many neoclassical models where unregulated markets fail to achieve Pareto-optimality and there has recently been an increased interest in modeling non-rational decision making. Recently empirical evidence has indicated that markets produce the types of learning assumed in the traditional neoclassical Economics only under very limited ideal conditions – which are rarely met in real-life – namely perfect competition and free information.
To conclude, both marginalists and classicalists’ school contribute a lot of innovations towards economy, marginalists’ exogenous innovation relative to the public good features of technological progress dealing with the externalities and increasing marginal returns bring the new concept of economic growth. On the other hand, the illustration of mathematical statement and historical analysis provide a convenience way to analyze economiy. Although different economists have criticized on marginalists’ school, the innovations of these two school cannot not be ignored.