New Classical economists. Why do New Classical economists believe that economic policy is ineffective?

Essay , 2016 , 8 Pages

Economics - Macro-economics, general

The neoclassical school has two founding members WS Jevons and L. Walras, who wrote their key projects in the 1870s. The difference made by the neoclassical school in relation to the classical school is that it uses the principles of utilitarianism of the human nature in the sphere of economy. The man is a rational person looking for the maximum satisfaction of his/her needs, for getting the maximum utility by directing his/her actions towards the increase of his/her pleasure and the reduction of his/her pain. Thus, for the neo-classical economists, the consumer seeks the combination of goods that maximizes the utility derived from consumption and the producer seeks to maximize profits, while each individual chooses the combination of work and leisure that maximizes his/her satisfaction. Also, they argue that the value of goods results from the satisfaction they provide and not from the work they incorporate as the classical economists believed.

From the text:
- the market failure to achieve efficiency and justice;
- imperfect competition;
- equality of power;
- external consequences

Table of contents

Introduction

The market failure to achieve efficiency and justice and the theoretical justification for state intervention

Imperfect competition

Why are monopolies / oligopolies considered to result in a loss of social welfare?

Equality of power

Market failures

External consequences

Conclusion

Reference List

Introduction

The neoclassical school has two founding members WS Jevons and L. Walras, who wrote their key projects in the 1870s. The difference made by the neoclassical school in relation to the classical school is that it uses the principles of utilitarianism of the human nature in the sphere of economy (Barr 1998). The man is a rational person looking for the maximum satisfaction of his/her needs, i.e. getting the maximum utility by directing his/her actions towards the increase of his/her pleasure and the reduction of his/her pain. Thus, for the neo-classical economists, the consumer seeks the combination of goods that maximizes the utility derived from consumption and the producer seeks to maximize profits, while each individual chooses the combination of work and leisure that maximizes his/her satisfaction. Also, they argue that the value of goods results from the satisfaction they provide and not from the work they incorporate as the classical economists believed (Le Grand et al. 1992).

For the largest part of his life, Jevons was liberal and reacted severely to the social legislation in England that was adopted that time and to the progressive income tax. Only at the end of his life, he became more modest, defending social housing for the poor, the arrangements for health and workplace safety, the enhancement of public education, the public health system, the reduction of child labour and the protection of working women (Gough 1979). However, he was opposed to the trade unions. In contrast, Walras believed that where competition is not appropriate, the Government has to intervene (goods of public interest, natural monopolies), while he was seeking a prescription of an effective and equitable distribution of income.

The organization in a systematic theory, called "economic prosperity" of the neoclassical economists, views to maximize social welfare and the reasons that justify state intervention in the economy is due, mainly to the contribution of three economists: V. Pareto (optimal allocation), A. Pigou (externalities) and P. Samuelson (public goods). It can be said in brief that the neoclassical economists accept and recommend state intervention only in cases of market failure (Stiglitz 1988). They believe that state intervention is a necessary second-best option (second best), over the first option which is the fully competitive market. The reasons that according to the neo-classical economists state intervention is justified in general, applies and in the case of social policy. So the neoclassical theory of welfare provides concepts and arguments that will help to explain why and how the state should intervene in the various fields of social policy (Barr 1998).

The neoclassical economic theory of welfare boils down to two fundamental theorems. First, in conditions of perfect competition, the markets lead to optimal allocation of resources, i.e. to the one that secures maximum efficiency. Excellent distribution is the one that has the following quality: there is no redeployment of resources to improve one's position, but at the same time it is not detrimental to someone else. The allocation of resources having the above uality are called effective by Pareto or excellent by Pareto (Gough 1979). Second, if the distribution of income in a competitive economy is not desirable, this is not due to the market but to the initial distribution of wealth. So, it is not required by the state to replace or correct the market mechanism. It just needs to redistribute the wealth and leave the rest to the competitive market. This theorem gives the major reasons for confidence in the market mechanism regarding the optimal allocation of resources and the equal distribution of the product.

For the neoclassical economists, the cause that the perfect competitive market leads to a Pareto optimal resource allocation is the system of values shaped by the forces of supply and demand. The prices act as incentives or disincentives that drive people and business in decisions aiming to maximize their own benefit as a whole but also seeking to maximize social welfare. However, most modern neoclassical economists (Coase 1984) – apart from the extreme liberals - have abandoned the idea that real economic competition can lead to perfection. Instead, they identify the flaws and weaknesses in the markets, many of which are inherent. In these circumstances, the market system leads to a serious deviation from the goal of maximizing efficiency and social prosperity. This deviation can be corrected with government intervention.

The market failure to achieve efficiency and justice and the theoretical justification for state intervention

But what if the real economic competition cannot reach the perfect and many of the imperfections and market failures are inherent? In this case, the neoclassical economic theory of welfare justifies state intervention as a second best option following the one of the perfect competition, which is the first choice.

The economy according to Pareto is efficient only when it meets the following four conditions: perfect competition, lack of market failures, perfect markets and perfect information. When these do not apply, state intervention can improve resource allocation and hence the efficiency of the economy (Barr 1998).

The neoclassical economic theory of welfare accepts that government intervention may be justified for reasons of correcting the uneven distribution of income and wealth in the case of social assets.

Imperfect competition

The prevalence of perfect competition in the market implies that people first receive the prices from the market, and secondly that they have equal power. People accepting the values of the market means that there is freedom of entry and exit from an industry, and that it has a large number of businesses and consumers, of which no one can influence individually or collectively the prices (Eggertson 1990). Equality of power implies that individual differences (other than income) do not mean unequal access to employment, means of production, consumption, and unequal bargaining power.

Prices in the market. The rapid prevalence of monopolies in 1880 and afterwards into all the countries of the developed capitalism forced neoclassical economists to recognise that in many areas, there is no competition among a large number of businesses, since one company or some large companies share among them the product market.

Why are monopolies / oligopolies considered to result in a loss of social welfare?

Because they limit the produced quantity to achieve a higher price for their product. In the case of oligopolies this is done with an agreement. The limitation of the quantity produced in relation to the socially desirable results in resource allocation, which does not correspond to consumer preferences of individuals, and thus it is not excellent by Pareto.

In the case of monopolies, government intervention usually takes the form of regulation (e.g., imposing a price ceiling) price subsidies or public production, while in the case of oligopolies takes the form of legislation against the trusts and control of companies’ mergers.

Equality of power

For the neoclassical economists, the inequality of force derives from the discrimination against certain individuals or groups, while income differences do not lead according to their opinion to inequality of power therefore they are fully legitimised. The discriminations can be faced by the state through various arrangements. Legislation on health and safety at work, like the one against race and gender discrimination are examples of state intervention towards correcting the inequality of power. However, the elimination of power inequality is not possible only through legislative interventions, since some of its forms are inherent in the capitalist system (e.g. between wages and capital), while others are based on other overarching social power relations (gender, race, etc.) (Grand et al 1992). The elimination of the phenomenon of unequal power requires radical social changes (Coase 1990).

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• Course: Economics
• Author: Fotini Mastroianni (Author)
• Publication Year: 2016
• Pages: 8
• Catalog Number: V351391
• ISBN (eBook): 9783668380127
• ISBN (Book): 9783668380134
• Language: English
• Tags: equality of power, market, neoclassical school, W.S. Jevons, L. Walras, classical economists