The Neoclassical Economic Model (which I will refer to as classical economics, mostly throughout) has been the dominant
model since Adam Smith
wrote Wealth of Nations
and got the ball rolling on hands-off economics. The concept is that the market
works itself out on its own. The fixing is done by the price
system, which is possible for providing full employment
. If unemployment
were to occur, automatic adjustment within the price system would bring the economy
back to full employment.
The classical model runs on three assumptions:
All Markets Clear Instantly
This means that market changes happen instantly. This theory goes on the thought that if the oil supply changes, the price and demand will immediately change to equilibrium.
No Money Illusion
Money illusion basically means that inflation doesn't exist. If your income goes up 3% over the past year, you feel like you're getting more money. However, if inflation went up 5%, then your spending power has gone down.
Complete Crowing Out On Investment
Lets create a simple economy that makes only pencils. p is the total number of pencils, c is the amount of consumption by the private sector, while g is the amount of consumption by the government.
p = c + g
Crowding out means that if the consumption is maxed out, and government consumption increases, private consumption must decrease to keep the equation equal.
The model also assumes perfect competition, which we all know isn't always true
Because of the above assumptions
, there are many arguments
against the classical model, the most notable and popular is the Keynesian model. However, a lot of governments still follow a version of the classical model since conservative governments believe in hands off economics