Neoclassical Economics

There has been a twentieth century school of economic thought that has been enormously influential especially in microeconomics. This school of thought is called "neoclassical economics."

Neoclassical economists share the following points in common.

Neoclassical economists, define economics as "The study that considers human behavior as a relation between scarce means and alternative ends."
Almost all neoclassical economists are positive economists.
Neoclassical economists believe that free markets usually bring about an efficient allocation of resources.
Conversely, efficient allocation is the important thing about free markets.

Assumptions

Another thing neoclassical economists share is some assumptions that they make as a starting point. Many other economists accept those assumptions as well, but there is also some controversy about them. Nevertheless, they will be basic assumptions for this class as well.

The assumptions are.

People act "as if" they were rational, i.e. maximizing something.
People act "as if" they were self-interested.

Assumptions and Critical Reasoning

Even if the assumptions of rationality and self-interest are not literally true, they play a key role in critical reasoning in economics.
It is always too easy to assume that "other people" are irrational. This idea should be viewed with great suspicion.
Conversely, it is a lot easier for people to say that they have the public interest at heart than to act that way -- so we should be cautious about believing that, too.

Always be suspicious of the easy answer.

Models

One thing we have all learned from neoclassical economics is the importance of models .
A model (of a particular subsystem of the economic system) is a description of these interdependencies in terms of mathematics, pictures, a computer programming language, or some similar descriptive language, together with a theory of the dynamics of the subsystem.
For an example, let's explore a model basic to neoclassical economics and all modern microeconomics.

Scarcity

Goods and services of all kinds are scarce. That simply means that we do not have enough resources to produce all of the goods and services that anybody might like to have.
Productive resources are always scarce, since we cannot increase the output of one kind of product without decreasing that of another.
Of course, our economy produces many kinds of goods and services, so that we may be able to understand that better if we think in terms of a model.
For our model, let us think of an economy that produces just two kinds of goods: "gadgets" and food.

Production Possibility Frontier

At any given time, a country cannot produce more machines without producing less of something else. (In this case, the country produces less food). We can express this by a model based on the relationship between the amounts produced of the two goods. This relationship is called the "production possibility frontier."
Table 1 below shows a PPF for the model country.

Machines	food
0	2000
1000	1980
2000	1920
3000	1820
4000	1680
5000	1500
6000	1280
7000	1020
8000	720
9000	380
10000	0

A Diagram

Here is a diagram of the production possibility frontier in the table on the previous screen. A combination of food and machines is said to be "feasible" if the economy has enough resources to produce both.

Figure 1

Opportunity Cost

A key point here is the trade-off between gadgets and food. Whenever we increase the output of gadgets we must decrease the output of food. This is a cost: it is the "opportunity cost" of the increase in production of gadgets.

Definition: The "opportunity cost" of any good or service as the value of all the other goods or services that we must give up in order to produce it.

The opportunity cost of the decision to increase the output of gadgets in the model economy consists of the food the model economy must give up as a result.

Fundamental Questions

Any modern economic system must somehow decide the answers to four fundamental questions:

What will be produced?
By what methods?
Using what resources?
For whom?

These define the scope of pretty much any course in microeconomics.

Summary

Summary on Neoclassical Economics:

There is scarcity whenever we have to make a choice between different uses to which resources can be put;
Our limited resources and technology set a limit to how much of any good or service that we can produce;
We can increase the production of one good only by diverting resources from another good;
We suffer an "opportunity cost," that is, the loss of the opportunity to enjoy the other good.
The allocation of resources is a social problem in any modern economy.

A Surprise Application

Neoclassical economics has become "a new [computer] programming technology," according to Bernardo Huberman and Tad Hogg.
In "Distributed Computation as an Economic System," they write "it may surprise even professional economists to learn that economics is of help in allocating computational resources to programs that run in these systems. ... The reason is that computer networks can be regarded as a community of concurrent processes, [and] face the same issues as people in a market. ... Some of the best-known programs already using these ideas include computational resource allocation and thermal markets for controlling building environments, which have shown increased performance when compared to the traditional operating systems."
As grandmother told me, nothing you learn is ever wasted and you never know when it will come in handy.

Moving On ...

Now let's move on and look at a model basic to neoclassical and pretty much any other kind of economics: Supply and Demand