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The Austrian School and Neoclassical School are two of the most well-known economic theories. The Austrian School, founded in 1871 in Vienna, is a heterodox school of economic thought that emphasizes methodological individualism and the belief that social phenomena are primarily driven by individual motivations and actions. On the other hand, Neoclassical economics, which evolved from the work of Austrian School pioneers like Carl Menger, Friedrich Wieser, and Eugen Bohm-Bawerk, is the dominant approach to microeconomics and emphasizes equilibria and the aggregation of individual behavior to explain economic phenomena. While the Austrian School has made valuable contributions, some argue that its rejection of empirical analysis and modern mathematical modeling limits its applicability and ability to evolve. Neoclassical economics, on the other hand, has continued to develop and influence mainstream economics, incorporating behavioral insights and responding to economic crises. The comparison between these schools is complex, and while both have their strengths and weaknesses, the evolution and influence of Neoclassical economics have been more prominent in shaping modern economic thought.
| Characteristics | Modern Austrian Microeconomics | Neoclassical Microeconomics |
|---|---|---|
| Founding | 1871 in Vienna, Austria-Hungary | 19th century |
| Founders | Carl Menger, Eugen von Böhm-Bawerk, Friedrich von Wieser | Carl Menger, Friedrich Wieser, Eugen Bohm-Bawerk |
| Methodology | Starts with axioms of rationality, uses symbolic logic, rejects mathematical and empirical modelling | Starts with rational choice theory and rational expectations, uses empirical testing |
| Individualism | Strict adherence to methodological individualism | Applies methodological individualism but not as strictly as Austrians |
| Institutions | Emphasizes the role of institutions | De-emphasizes institutions |
| Welfare Economics | Criticizes the neoclassical approach for considering reallocations "efficient" if they are "potentially Pareto superior" | Considers reallocations "efficient" if they are "potentially Pareto superior" |
| Utility Theory | Introduced the subjective theory of value, which states that the value of goods is determined by individual preferences | Uses the utility theory of value, which states that the value of a good is determined by the marginal utility experienced by the user |
| Equilibrium | N/A | Emphasizes equilibria, which are the solutions of agent maximization problems |
| Mathematical Modelling | Accepts mathematical modelling historically but rejects it in modern times | Uses mathematical modelling |
| Influence | Influenced by classical economists such as Adam Smith and David Hume, and early-20th-century figures such as Knut Wicksell | Influenced by Austrian School economists such as Friedrich Hayek |
| Current Status | Ideas are considered obsolete by some, with few contemporary economists identifying as Austrians | Ideas are considered the dominant approach to microeconomics |
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What You'll Learn
Austrian School of Economics
The Austrian School of Economics is a heterodox school of economic thought that emerged in the late 19th century, founded by Carl Menger with his 1871 book, 'Principles of Economics'. It is rooted in the ideas of classical economists such as Adam Smith and David Hume, as well as figures like Knut Wicksell and Menger himself. The Austrian School emphasizes methodological individualism, arguing that social phenomena are primarily driven by the motivations, actions, and self-interest of individuals. They advocate for a subjectivist approach in economics, where economic theory is derived from basic principles of human action. Austrians also contributed to the marginalist revolution of the 1870s, introducing the concept of marginal utility.
In the 20th century, Austrian economists incorporated models and mathematics into their analysis, with some even accepting neoclassical methodology. However, the Austrian School has been criticized for its rejection of modern rigorous mathematical modelling and empirical analysis, which has led to it being considered "stuck in the past". Modern Austrian methodology starts with axioms of rationality, deriving results through symbolic logic rather than empirical testing. This rejection of empirical data and its strong assumptions have made it less appealing to contemporary economists.
The Austrian School split into two camps in the late 20th century. One camp, represented by Mises, considers neoclassical methodology irredeemably flawed, while the other camp, exemplified by Friedrich Hayek, accepts a large part of neoclassical methodology and is more open to government intervention in the economy. Despite criticism and internal differences, Austrian economics has made valuable contributions to the field, influencing modern figures in economics and continuing to shape economic thought today.
When comparing Austrian and neoclassical economics, it is important to note that they have both evolved over time. Neoclassical economics emphasizes equilibria and microeconomics, de-emphasizing institutions. It uses the utility theory of value, where the value of a good is determined by the user's marginal utility. Neoclassical economics has been the dominant approach to microeconomics and, together with Keynesian economics, formed the neoclassical synthesis that dominated mainstream economics from the 1950s onward.
In summary, the Austrian School of Economics, founded in the 19th century, emphasizes methodological individualism and a subjectivist approach. While it has evolved and made valuable contributions, it has been criticized for its rejection of modern empirical methods. The school later divided into two camps with differing views on neoclassical methodology and government intervention. Meanwhile, neoclassical economics, with its focus on equilibria and utility theory, has been the dominant paradigm in mainstream economics.
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Neoclassical Synthesis
The neoclassical synthesis (NCS), also known as the neoclassical-Keynesian synthesis, is a movement and paradigm in economics that combines the macroeconomic thought of John Maynard Keynes with neoclassical economics. It emerged in the mid-20th century as an attempt to reconcile the differences between these two schools of thought and create a more comprehensive theory of macroeconomics. The synthesis emphasizes the role of market forces in the economy while also acknowledging the need for government intervention in certain circumstances. According to the neoclassical synthesis, the economy operates according to neoclassical principles in the long run, but Keynesian policies can be effective in the short run for stimulating economic growth and reducing unemployment. It also emphasizes the importance of monetary policy in controlling inflation and maintaining economic stability.
The neoclassical synthesis was formulated by economists such as John Hicks, Franco Modigliani, and Paul Samuelson, and it dominated economics in the post-war period from the 1950s to the 1970s. It allowed postwar Keynesians to argue that there was no fundamental incompatibility between microeconomic and macroeconomic theory. The synthesis suggested that while Keynesian descriptions of market behaviour may be true in the short run, the classical theory of Adam Smith and Alfred Marshall was correct in the long run. This perspective became known as the "neo-Keynesian theory", and it became the dominant viewpoint, particularly in America, after the Great Depression.
However, the neoclassical synthesis faced challenges in the 1970s due to the advent of stagflation and the work of monetarists like Milton Friedman, which cast doubt on the synthesis' conceptions of monetary theory. This led to the development of new ideas and the emergence of new Keynesian and new classical economists, who strived to incorporate Keynesian and neoclassical characteristics into their respective schools. These schools eventually formed a "new neoclassical synthesis", which underpins the mainstream of contemporary macroeconomic theory and serves as an important theoretical foundation for central banks like the Federal Reserve.
The new neoclassical synthesis combines elements from both the new classical and new Keynesian schools, achieving a consensus on acceptable methodology, the importance of empirical validation, and the effectiveness of monetary policy. It recognizes the importance of intertemporal general equilibrium foundations, allowing for the examination of both short-run and long-run impacts of economic changes within a single framework. The new synthesis also addresses the Lucas critique, uses rational expectations, and accepts that central banks can control inflation through monetary policy.
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Austrian Methodology
The Austrian school of economics advocates strict adherence to methodological individualism, the concept that social phenomena and economic theories result primarily from the motivations, actions, and self-interest of individuals. Austrians seek to understand the economy by examining the social ramifications of individual choice, believing that all economic phenomena are filtered through the human mind and can be explained by aggregating the behaviour of individuals. This approach is known as subjectivism, which states that the value of goods is determined by individual preferences and subjective factors such as knowledge, time, and expectations.
The Austrian school was one of three founding currents of the marginalist revolution of the 1870s, introducing the subjectivist approach in economics and the theory of marginal utility. They believe that economic analysis is universally applicable and that the appropriate unit of analysis is the individual and their choices. These choices are determined by subjective preferences and the margin on which decisions are made, with the logic of choice being the essential building block for developing a universally valid economic theory.
In the 20th century, Austrian economists incorporated models and mathematics into their analysis, with some accepting neoclassical methodology and others regarding it as irredeemably flawed. While Austrian methodology has been criticised for overstating its differences with neoclassical economics and failing to rebuild economics on substantially different foundations, it has nonetheless made valuable contributions to the field, such as the subjective theory of value, marginalism in price theory, and the formulation of the economic calculation problem.
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Neoclassical Microeconomics
Neoclassical economics is the dominant approach to microeconomics and, together with Keynesian economics, formed the neoclassical synthesis, which dominated mainstream economics as "neo-Keynesian economics" from the 1950s onward. The term neoclassical economics was originally introduced by Thorstein Veblen in his 1900 article "Preconceptions of Economic Science", in which he related marginalists in the tradition of Alfred Marshall to those in the Austrian School.
Neoclassical economics emphasizes equilibria, which are the solutions of agent maximization problems. Regularities in economies are explained by methodological individualism, the position that economic phenomena can be explained by aggregating over the behavior of agents. The emphasis is on microeconomics, and institutions, which might be considered as before and conditioning individual behavior, are de-emphasized. Economic subjectivism accompanies these emphases. Neoclassical economics uses the utility theory of value, which states that the value of a good is determined by the marginal utility experienced by the user. This is one of the main distinguishing factors between neoclassical economics and other earlier economic theories, such as Classical and Marxian, which use the labor theory of value, which states that value is determined by the labor required for production.
The evolution of neoclassical economics can be divided into three phases. The first phase (a pre-Keynesian phase) is dated between the initial forming of neoclassical economics (the second half of the nineteenth century) and the arrival of Keynesian economics in the 1930s. The second phase is dated between the year 1940 and the mid-1970s. During this era, Keynesian economics dominated the world's economy, but neoclassical economics did not cease to exist. It continued in the development of its microeconomics theory and began creating its own macroeconomics theory. The development of the neoclassical macroeconomic theory was based on the development of the quantity theory of money and the theory of distribution. One of the products of the second phase was the Neoclassical Synthesis, representing a special combination of neoclassical microeconomics and Keynesian macroeconomics.
The Austrian School is a heterodox school of economic thought that advocates strict adherence to methodological individualism, the concept that social phenomena result primarily from the motivations and actions of individuals along with their self-interest. Austrian-school theorists hold that economic theory should be exclusively derived from basic principles of human action. The Austrian School originated in 1871 in Vienna with the work of Carl Menger, Eugen von Böhm-Bawerk, Friedrich von Wieser, and others. It was methodologically opposed to the Historical School, in a dispute known as Methodenstreit, or methodology quarrel.
In a modern Austrian methodology, one is supposed to start with the axioms of rationality and derive results/conclusions from there through some logical chain that is based not on regular mathematics but on something resembling symbolic logic. Modern Austrian School strongly rejects mathematical and empirical modeling, in favor of what is called praxeology. In modern neoclassical methodology, one can also start from some axioms and usually starts with rational choice theory and rational expectations, but one is then supposed to empirically test predictions made by the model and test it against other models where the assumptions are relaxed. For example, modern research in microeconomic theory often incorporates behavioral insights into what would otherwise be a neoclassical model, by, for example, tweaking assumptions on utility functions or relaxing the assumption of rational expectations by allowing for switching between rational and adaptive expectations.
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Austrian Economic Contributions
The Austrian School of Economics, founded in 1871 in Vienna, is a heterodox school of economic thought that has made significant contributions to the field of economics. The school's early theoretical foundations were laid by Carl Menger, Eugen von Böhm-Bawerk, Friedrich von Wieser, and others, and it was methodologically opposed to the Historical School.
One of the Austrian School's major contributions is the introduction of the subjectivist approach in economics, which is known as the "Marginal Revolution." This revolution introduced the idea of marginal utility, where economic agents make decisions based on their consumption of the "next unit," weighing the costs and benefits of each action. The subjective theory of value, proposed by the Austrian School, argues that the value of goods is determined by individual preferences rather than intrinsic factors. This theory was a significant departure from classical economic theories, which focused on the labour theory of value.
Another key contribution of the Austrian School is their emphasis on methodological individualism, the concept that social phenomena result primarily from the motivations and actions of individuals, along with their self-interest. Austrian economists believe that economic theory should be derived exclusively from basic principles of human action and that economic truths can be discovered through "thought experiments" that don't necessarily rely on data. This focus on individualism also extends to their view of institutions, which they consider secondary to individual behaviour.
In the 20th century, Austrian economists incorporated models and mathematics into their analysis, with some economists arguing that Austrian methodology is consistent with macroeconomics. However, Austrian economics has been criticised for its lack of empirical rigor and rejection of model building, mathematics, and statistical methods, causing it to be disregarded by some mainstream economists.
Today, there are two major camps of Austrian thinkers. One camp staunchly opposes government intervention and rejects much of neoclassical economic theory, following the philosophies of Ludwig von Mises and Murray Rothbard. The other camp, led by Friedrich Hayek, accepts a larger part of neoclassical methodology and is more open to government intervention. Despite their differences, both camps have contributed to our understanding of economics and continue to influence economic thought.
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Frequently asked questions
Modern Austrian microeconomics rejects mathematical and empirical modelling in favour of an approach called praxeology, while neoclassical microeconomics uses mathematical modelling and empirical testing.
The Austrian School of Economics was founded in 1871 in Vienna, with the work of Carl Menger, Eugen von Böhm-Bawerk, Friedrich von Wieser, and others. Neoclassical economics also emerged in the second half of the nineteenth century, with the work of Carl Menger, Friedrich Wieser, and Eugen Bohm-Bawerk. Austrian economics can be divided into two schools of thought, with one camp, exemplified by Mises, considering neoclassical methodology irredeemably flawed, and the other camp, exemplified by Friedrich Hayek, accepting a large part of neoclassical methodology.
Austrian microeconomics is based on methodological individualism, which argues that models should be built from the ground up by analysing individual actors and actions. Neoclassical microeconomics emphasises equilibria, which are the solutions of agent maximisation problems, and uses the utility theory of value, which states that the value of a good is determined by the marginal utility experienced by the user.
Austrian microeconomics is considered by some to be stuck in the past due to its rejection of empirical analysis, and it has been criticised for misunderstanding neoclassical economics and overstating its differences. Neoclassical microeconomics has been criticised for its propensity to declare certain situations "inefficient", which may violate subjectivism. However, it has also made important discoveries that Austrian economists have not appreciated.
