Neoclassical economics is a broad theory that focuses on supply and demand as the driving forces behind the production, pricing, and consumption of goods and services. It emerged in around 1900 to compete with the earlier theories of classical economics. One of the key early assumptions of neoclassical economics is that utility to consumers, not the cost of production, is the most important factor in determining the value of a product or service.
Neoclassical economics theories underlie modern-day economics, along with the tenets of Keynesian economics.
The term neoclassical economics was coined in 1900. Neoclassical economists believe that a consumer’s first concern is to maximize personal satisfaction. Therefore, they make purchasing decisions based on their evaluations of the utility of a product or service. This theory coincides with rational behavior theory, which states that people act rationally when making economic decisions.
Further, neoclassical economics stipulates that a product or service often has value above and beyond its production costs. While classical economic theory assumes that a product’s value derives from the cost of materials plus the cost of labor, neoclassical economists say that consumer perceptions of the value of a product affect its price and demand.
Finally, this economic theory states that competition leads to an efficient allocation of resources within an economy. The forces of supply and demand create market equilibrium.
In contrast to Keynesian economics, the neoclassical school states that savings determine investment. It concludes that equilibrium in the market and growth at full employment should be the primary economic priorities of government.