Neo Classical Economic Growth

March 4th, 2009 | economics -

Readers Question: Explain why New Classical economists would argue that supply-side policies are the most effective way of increasing the equilibrium level of output.

New Classical economists base their analysis on neoclassical lines. This is a simplification of the theory, but neo classical economics makes many assumptions including:

Consumers / firms are rational
Markets operate efficiently
People act independently with perfect information.

In macro Economics the main assumption of Neo Classical economics is the idea Real Output is determined by supply side (micro) factors. They argue Long Run Aggregate Supply is inelastic.

They argue an increase in Aggregate Demand (faster than growth of LRAS) will be inflationary and not affect the Real Level of Output.

Basically, neo classical economists argue that it is supply side factors that influence the growth of productive capacity and Real Output.

Neo Classical economists dismiss the role of expansionary fiscal policy. They argue government attempts to boost aggregate demand merely cause crowding out (Higher government spending leads to higher borrowing from the private sector so the private sector have less to spend)

Personally, I have never understood why neo classical theories have gained so much support within the economics profession.