NNAMDI AZIKIWE UNIVERSITY, AWKA

DEPARTMENT OF ECONOMICS

ECO 213: MACROECONOMICS

CLASSICAL AND NEOCLASSICAL

ECONOMY: A TERM PAPER
PRESENTATION

GROUP A

25TH FEBRUARY, 2025

 TABLE OF CONTENTS
1. Introduction
o Background of Classical and Neoclassical Economics
o Objectives of the Presentation
2. Definition of Concepts
o Classical Economy
o Neoclassical Economy
o Labor Theory of Value
o Say’s Law
o Laissez-Faire and Free Markets
o Market Equilibrium
o Rational Choice Theory
o Marginal Analysis
3. Content
o Overview of Classical Economics
 Key Assumptions
 Evolutionary Timeline and Key Theorists (Adam Smith, David
Ricardo, Thomas Malthus, John Stuart Mill)
o Overview of Neoclassical Economics
 Key Assumptions
 Evolutionary Timeline and Key Theorists (William Jevons, Carl
Menger, Léon Walras, Alfred Marshall)
o The Evolution of Classical and Neoclassical Economic Thought:
Money, Employment, and Growth Perspectives
o Further Developments and Critiques of Classical and Neoclassical
Economics
o Key Principles and Criticisms
o Real-World Applications of Classical and Neoclassical Economics
o Relevance of Classical and Neoclassical Theories in Modern
Economics
4. Summary
o Key Findings
o Implications of the Theories
5. References
 1. Introduction
Classical and neoclassical economics are two foundational schools of
thought that have significantly influenced economic theory and policy.
Classical economics, emerging in the late 18th century, emphasizes
production, labor, and free markets. In contrast, neoclassical
economics, which was developed in the late 19th century, focuses on
individual decision-making, marginal analysis, and market equilibrium.
This term paper examines the core principles, key theorists,
evolutionary timeline, critiques, and real-world applications of both
classical and neoclassical economics, providing a comprehensive
understanding of their development and impact.
 2. Definition of Concepts

2.1 Classical Economics

Classical economics is an economic framework that advocates for free
markets, minimal government intervention, and the labor theory of
value. Classical economics assumes that markets are self-regulating
primarily through supply-side mechanisms, with minimal role for
demand in determining long-term economic outcomes. Prominent
figures such as Adam Smith and David Ricardo championed these ideas,
emphasizing that free trade enhances domestic productivity and
employment while maintaining stable or growing real wages.
(Source: Investopedia.com)

2.2 Neoclassical Economics

Neoclassical economics emerged as a response to classical theories,
shifting the analytical focus from production and labor to consumer
behavior, price determination, and market equilibrium. It asserts that
individuals make rational choices to maximize utility, and firms aim for
profit maximization. This school of thought introduced mathematical
modeling to analyze economic behaviors, providing a structured
approach to understanding market dynamics.
(Source: Econlib.org)

2.3 Labor Theory of Value

This theory proposes that the value of a good is determined by the
amount of labor required for its production. It suggests that labor,
rather than subjective consumer preference, is the key driver of value.

2.4 Say’s Law

This law by Jean-Baptiste Say asserts that "supply creates its own
demand," meaning that production inherently generates the income
needed to purchase goods and services, ensuring economic stability.

2.5 Laissez-Faire and Free Markets

Advocates for minimal government intervention, emphasizing that free
markets naturally adjust to economic changes, leading to efficient
resource allocation.
2.6 Market Equilibrium
Market equilibrium occurs when the quantity demanded by consumers
equals the quantity supplied by producers, resulting in a stable market
price. This concept is fundamental to neoclassical economics, which
argues that competitive markets naturally move toward equilibrium
through price adjustments. It was formalized by neoclassical
economists Léon Walras and Alfred Marshal.

2.7 Rational Choice Theory

Rational choice theory assumes that individuals make decisions based
on rational calculations to maximize personal benefit. In economic
terms, this means consumers and firms weigh costs and benefits before
making choices, optimizing their utility or profit.
2.8 Marginal Analysis
Marginal analysis examines the additional benefits and costs of an
economic decision. Neoclassical economists use this concept to explain
consumer behavior, pricing strategies, and resource allocation. It helps
determine the optimal level of production or consumption where
marginal benefit equals marginal cost.
 3. Content
The study of economic thought is a continuous evolution of ideas,
shaping our understanding of markets, production, and decision-
making. Classical and neoclassical economics represent two significant
stages in this evolution, each providing unique insights into how
economies function. Classical economics, rooted in the works of Adam
Smith and David Ricardo, emphasizes production, labor, and market
self-regulation. In contrast, neoclassical economics, pioneered by
thinkers like Alfred Marshall and Léon Walras, shifts the focus to
individual decision-making, marginal utility, and market equilibrium.

This section explores the historical development, key theorists,

principles, and criticisms of both schools of thought, providing a
comparative analysis of their contributions and limitations. Through
this discussion, we aim to highlight their relevance in shaping modern
economic policies and real-world applications.

3.1 Overview of Classical Economics

Classical economics emerged in the late 18th and early 19th centuries
as one of the earliest systematic approaches to understanding
economic activity. It was primarily concerned with production, labor,
and the functioning of free markets, advocating for minimal
government intervention. Rooted in the ideas of Adam Smith, David
Ricardo, and John Stuart Mill, this school of thought emphasized
concepts such as the labor theory of value, free trade, and market self-
regulation.

3.1.1 Assumptions of Classical Economics

1. Self-Regulating Markets – Classical economists believe that
markets naturally adjust to imbalances through the forces of
supply and demand, without the need for government
intervention.
2. Say’s Law – This principle states that "supply creates its own
demand," meaning that all goods produced will eventually be sold
because production generates income, which in turn is spent on
other goods and services.
3. Labor Theory of Value – The value of a good is determined by the
amount of labor required to produce it, rather than by consumer
preferences or subjective valuation.
4. Full Employment – Classical economics assumes that in a free
market, all resources, including labor, will be fully utilized in the
long run, as wages and prices adjust to clear any surpluses or
shortages.
5. Minimal Government Intervention – Classical economists
advocate for laissez-faire policies, arguing that government
involvement in economic activities should be limited to protecting
property rights, enforcing contracts, and ensuring national
security.
6. Flexible Wages and Prices – Prices and wages are assumed to be
flexible, allowing the economy to quickly adjust to external shocks
and maintain equilibrium.
7. Rational Economic Agents – Individuals and firms are considered
rational decision-makers who seek to maximize their utility
(consumers) or profits (producers).
8. Long-Run Growth Focus – Classical economists emphasize long-
term economic growth driven by capital accumulation,
 technological progress, and increases in labor productivity.

3.1.2 Evolutionary Timeline and Key Theorists

Classical Economics as a school of thought emerged in the late 18 th
Century, here are some key theorists:
1. Adam Smith (1723–1790): Regarded as the "Father of Economics,"
Smith introduced the concept of the invisible hand, suggesting that
markets self-regulate through individuals' pursuit of self-interest. His
seminal work, “The Wealth of Nations" (1776), laid the foundation for
classical economic thought.
2. David Ricardo (1772–1823): Expanded upon Smith's ideas,
introducing the theory of comparative advantage, which advocates for
international trade based on countries' relative efficiencies. His work
“On the Principles of Political Economy and Taxation” (1817) remains
influential in trade theory.
3. Thomas Malthus (1766–1834): Known for his “Essay on the Principle
of Population” (1798), Malthus posited that population growth could
outpace food production, leading to societal challenges.
4. John Stuart Mill (1806–1873): Contributed to classical economics
with works like “Principles of Political Economy” (1848), discussing
production, distribution, and the role of government in addressing
social inequalities.

3.2 Overview of Neoclassical Economics

Neoclassical economics emerged as a refinement and response to the
limitations of classical economic thought. While Classical economists
focused on production, labor, and macroeconomic factors, neoclassical
economics shifted the emphasis to individual decision-making,
consumer behavior, and market equilibrium. This school of thought
integrates mathematical models and marginal analysis to explain how
individuals and firms make rational choices to maximize utility and
profit.

By introducing concepts such as marginal utility, opportunity cost, and

market equilibrium, Neoclassical economics provides a more structured
approach to analyzing how prices and resources are allocated in an
economy. Its core principles continue to influence modern economic
theories, guiding policies on market efficiency, competition, and
consumer behavior.

3.2.1 Assumptions of Neoclassical Economics:

1. Rational Decision-Making: Individuals and firms are assumed to
act rationally, making decisions that maximize their utility (for
consumers) or profit (for producers).
2. Marginal Analysis: Economic decisions are made based on
marginal analysis, meaning individuals and firms evaluate the
additional costs and benefits of their choices.
3. Market Equilibrium: Markets are assumed to be self-correcting,
adjusting through the interaction of supply and demand to reach
equilibrium where resources are allocated efficiently.
4. Perfect Competition: Many neoclassical models assume a market
structure where numerous buyers and sellers exist, preventing
any single entity from influencing prices.
5. Complete Information: Economic agents are assumed to have full
knowledge of prices, goods, and market conditions, allowing them
 to make optimal decisions.
6. Utility and Profit Maximization: Consumers seek to maximize their
satisfaction (utility), while firms aim to maximize their profits by
minimizing costs and optimizing production.
7. Diminishing Marginal Utility and Returns: The additional
satisfaction gained from consuming an extra unit of a good
decreases over time, and similarly, the additional output from
increasing production factors eventually declines.

3.2.2 Evolutionary Timeline and Key Theorists

Neoclassical Economics as a school of thought emerged in the late 19 th
Century, here are some key theorists:
1. William Stanley Jevons (1835–1882): Introduced the theory of
marginal utility in “The Theory of Political Economy” (1871),
emphasizing the importance of additional satisfaction gained from
consuming one more unit of a good.
2. Carl Menger (1840–1921): Founder of the Austrian School of
Economics, Menger's “Principles of Economics” (1871) focused on
the subjective theory of value, arguing that value is determined by
individual preferences.
3. Léon Walras (1834–1910): Developed the general equilibrium
theory, illustrating how markets reach equilibrium through the
interaction of supply and demand across multiple markets
simultaneously.
4. Alfred Marshall (1842–1924): Synthesized classical and neoclassical
thoughts in “Principles of Economics” (1890), introducing concepts
like price elasticity and the supply-demand framework still used
today.
The Evolution of Classical and Neoclassical Economic Thought: Money,
Employment, and Growth Perspectives

Quantity Theory of Money

The Quantity Theory of Money states that money supply directly affects price
levels:

MV = PQ

where:

• M = Money supply

• V = Velocity of money

• P = Price level

• Q = Output (real GDP)

Classical View
• Classical economists (like David Hume and Irving Fisher) believed
money is neutral—increasing money supply only affects prices, not real output.

• Policy Implication: The government should not interfere with money

supply because markets self-correct.

Neoclassical View
• Neoclassical economists refined this by introducing expectations and
monetary neutrality in the long run.

• Monetarists (Milton Friedman) later extended QTM, arguing that

money supply affects real output in the short run but only prices in the long run.
 • Policy Implication: Central banks should control inflation by
managing money supply.

Classical Theory of Employment

The Classical Theory of Employment (from Adam Smith & Say’s Law) states that
markets always clear, meaning there is no long-term unemployment.

• Wages adjust to ensure full employment—if unemployment exists,

wages fall until jobs are restored.

Classical View (Say’s Law):

• “Supply creates its own demand” → No need for government
intervention.

• Unemployment is voluntary because people choose not to work at

lower wages.

Neoclassical View:
• Agrees with classical theory but adds marginal productivity theory—
wages depend on worker productivity.

• Market failures (sticky wages, imperfect competition) can cause

short-term unemployment, but long-run equilibrium restores full employment.

Economic Growth & Development

Both classical and neoclassical economics have different views on long-term
economic growth.
Classical Growth Theory (Malthus, Ricardo, Smith)

• Economic growth is limited by resource constraints (e.g., land in

agriculture).

• Diminishing returns to capital and labor slow down long-term

growth.

• Policy Implication: Government should not interfere, but growth is

limited by natural constraints.

Neoclassical Growth Theory (Solow Model)

• Technology & capital accumulation drive long-term growth, not just
labor and land.

• Unlike classical views, growth is not limited—innovation and

investment can sustain growth.

• Policy Implication: Governments should invest in human capital &

innovation to drive growth.

3.3 Further Developments and Critiques of Classical and

Neoclassical Economics
Many 20th Century economists criticized the Classical and Neoclassical
schools of thoughts, a few of them are:
1. John Maynard Keynes (1883–1946): Challenged classical and
neoclassical assumptions with “The General Theory of
Employment, Interest, and Money” (1936), advocating for active
government intervention during economic downturns.
 2. Thorstein Veblen (1857–1929): Critiqued neoclassical economics,
emphasizing the role of social and institutional factors in
economic behavior. Coined the term "conspicuous consumption."
3. Joseph Stiglitz (b. 1943): Highlighted issues of information
asymmetry and market failures, arguing that markets do not
always lead to efficient outcomes without appropriate regulation.
4. Amartya Sen (b. 1933): Criticized neoclassical assumptions about
rationality and welfare, introducing the capability approach to
measure economic development.

3.4 Key Principles and Criticisms of the Classical and

Neoclassical Economics
3.4.1 Classical Economics
 Labor Theory of Value: Proposes that the value of a good is
determined by the labor required for its production.
Criticism: Struggles to explain price variations and the value of
non-labor-intensive goods.

 Self-Regulating Markets: Suggests that free markets naturally

adjust to equilibrium without government intervention.
Criticism: Overlooks potential market failures and the need for
regulatory oversight.

Keynesian Critique of Classical Economics

One of the most significant critiques of classical economics came
 from John Maynard Keynes in the 20th century. Keynes
challenged classical assumptions, particularly the idea that
markets are self-regulating and that full employment is always
achieved in the long run.
o Failure to Explain Economic Crises and Recessions – Classical
economists assumed that Say’s Law (supply creates its own
demand) would prevent prolonged economic downturns.
However, Keynes argued that demand, not just supply, drives
economic activity. The Great Depression (1929–1939)
demonstrated that classical policies failed to restore full
employment.
o Wage and Price Rigidity – Classical theory assumes wages and
prices are flexible, but Keynes argued they are often sticky due
to contracts and regulations, preventing markets from
adjusting quickly.
o Need for Government Intervention – Classical economists
believed government intervention distorts markets, but Keynes
countered that active government spending (fiscal policy) is
necessary to stimulate demand and prevent unemployment.

3.4.2 Neoclassical Economics

 Marginal Analysis: Focuses on decision-making based on
additional costs and benefits.
Criticism: Assumes rational behavior and perfect information,
which may not reflect real-world complexities.
 Market Equilibrium: Posits that markets tend toward equilibrium
where supply equals demand.
Criticism: May not account for persistent imbalances and the
dynamic nature of markets.

Behavioral Economics Critique of Neoclassical Assumptions

Neoclassical economics assumes that individuals and firms are
rational decision-makers who maximize utility and profits.
However, behavioral economists argue that real-world decision-
making is often irrational and influenced by psychological and
cognitive biases.
o Irrational Consumer Behavior – Neoclassical models assume
rational choice theory, where consumers make logical decisions
based on complete information. However, behavioral
economists like Daniel Kahneman and Amos Tversky showed
that people often make irrational choices due to biases and
heuristics.
Example: Loss aversion – People fear losses more than they
value gains, leading to decisions that may not be economically
optimal.
o Imperfect Information and Decision-Making – Neoclassical
models assume that individuals have perfect information, but
behavioral economics shows that most decisions are made
under uncertainty and bounded rationality (limited ability to
process information).
Example: Herd behavior – Investors in financial markets often
follow the crowd rather than acting on fundamental economic
 principles, contributing to bubbles and crashes.
o Emotional and Social Influences on Markets – Unlike the self-
correcting markets assumed in neoclassical theory, behavioral
economists argue that social, emotional, and psychological
factors shape economic outcomes.
Example: Overconfidence bias – Many investors believe they
can predict market movements, leading to excessive risk-taking
and financial instability.

3.5 Real-World Applications of Classical and Neoclassical

Economics

3.5.1 Classical Economics

- Industrial Revolution: The laissez-faire policies influenced economic
expansion but also led to income inequality.
- Free Trade Policies: Many modern international trade agreements
are based on Ricardo’s theory of comparative advantage.

3.5.2 Neoclassical Economics

- Modern Market Structures: Used to analyze consumer choice and
market efficiency in various industries.
- Government Policies: Influences policies on taxation, subsidies, and
social welfare to optimize economic performance.
 3.6 Relevance of Classical and Neoclassical Theories in
Modern Economics
Despite their historical origins, classical and neoclassical economic
theories remain highly relevant in shaping modern economic thought,
policies, and market structures.

1. Influence on Economic Policies

Classical Economics: The principles of free markets, limited government
intervention, and comparative advantage continue to guide trade
policies, deregulation, and globalization. Many modern economies
emphasize market-driven growth, drawing from Adam Smith’s and
David Ricardo’s ideas.
Neoclassical Economics: Used in policy-making to understand consumer
behavior, taxation effects, and market efficiency. Governments apply
neoclassical principles in designing fiscal and monetary policies to
optimize economic performance.
2. Impact on Market Structures and Competition
Classical Perspective: The idea of self-regulating markets is reflected in
today’s emphasis on competition laws and anti-monopoly regulations.
Neoclassical Perspective: The concept of perfect competition and price
mechanisms helps businesses and policymakers assess market
efficiency and pricing strategies.
3. Macroeconomic and Microeconomic Applications
Classical Economics: Ideas such as Say’s Law influence supply-side
economic policies, advocating for production incentives and
investment-driven growth.
Neoclassical Economics: Marginal analysis and rational choice theory
play a crucial role in microeconomic modeling, helping firms determine
production levels, pricing, and resource allocation.
4. Financial and Investment Strategies
Classical View: The long-run growth theories inform modern
investment and capital accumulation strategies.
Neoclassical View: The efficient market hypothesis and consumer
preference modeling guide financial markets, stock valuation, and risk
management.
5. Development of Behavioral and Institutional Economics
While classical and neoclassical theories assume rational decision-
making, modern behavioral economics challenges these ideas by
integrating psychological insights into economic behavior. However,
many economic models today still build upon the foundational
principles established by these theories.

5. Summary
The evolution from classical to neoclassical economics marks a
significant shift in economic thought, transitioning from a focus on
production and labor to an emphasis on individual choice and market
dynamics. While both schools have profoundly influenced economic
policies and frameworks, they are not without criticisms. Classical
economics' assumptions about self-regulating markets and the labor
theory of value have been challenged for oversimplifying complex
economic phenomena. Neoclassical economics, with its reliance on
assumptions of rational behavior and market equilibrium, faces
critiques for not adequately addressing real-world imperfections and
inequalities. Understanding these theories' historical contexts, key
contributors, and inherent limitations provides a comprehensive
perspective on their significance in economic thought and
policymaking.

References

Smith, A. (1776). “The Wealth of Nations.”

Ricardo, D. (1817). “On the Principles of Political Economy and
Taxation.”
 Malthus, T. (1798). “An Essay on the Principle of Population.”
Marshall, A. (1890). “Principles of Economics.”
Keynes, J. M. (1936). “The General Theory of Employment, Interest, and
Money.”
Stiglitz, J. (2001). “Information and the Change in the Paradigm in
Economics.”
Sen, A. (1999). “Development as Freedom.”
Veblen, T. (1899). “The Theory of the Leisure Class.”
Econlib.org
Investopedia.com
Tutor2u.net

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