essays

Mar 1, 1981

Austrian vs. Neoclassical Economics: Equilibrium

“Neoclassical economics ignores the…market process in organizing information [to] facilitate individual decision-making and…subjective…welfare.”

Israel M. Kirzner
New York University

“General Equilibrium and Beyond: I, The ‘Austrian’ Perspective on the Crisis.” The Public Interest, (Special issue 1980):11–122.

Neoclassical economic theory is currently in crisis. Despite essentially sound historical roots, its historical development has produced a misunderstanding of the workings of market capitalism. We need to reconstruct our economic understanding by studying neoclassical historical roots and by heeding the insights of the “Austrian” school of economics.

In the development of mainstream economics, late nineteenth-century insights into demand-side factors were subordinated to concern with market equilibrium conditions. Consequently, the key elements of the role of the entrepreneur, the dynamics of the market process, and the nature of competition were overlooked, misunderstood, or miscast.

While not denying the usefulness of the concept of equilibrium as a tool of analysis, Austrian economists (Menger, Mises, Hayek, etc.) view the really important aspects of the market economy to be those concerning the nature and function of market processes. Whereas the Austrian tradition has adhered to these historical roots, the neoclassical static model of perfect competition diverted attention from market processes. By losing sight of these processes, neoclassical economists have tended to misunderstand the requirements for, and benefits of, dynamic competitive markets.

This historical forgetfulness and inattention actually represents “…a failure to recognize the role of knowledge in the face of radical uncertainty, and of learning processes in dynamically competitive markets,” coupled with the “…failure to recognize the nature and significance of entrepreneurial discovery in an uncertain world.”

In addition, neoclassical concern with normative questions of social well-being suffers from flawed “aggregate” approach that illegitimately extends the notions of choice and well-being from the level of the individual to the level of the collective. More importantly, neoclassical economics ignores the key role of the market process in organizing information both to facilitate individual decision-making and to promote individual subjective and (thus, incommensurable) welfare. In this dynamic setting, market prices are always disequilibrium prices that make aggregative measurements inappropriate at the same time that they affect and are affected by individual decision-making.

“Economic theory needs to be reconstructed so as to recognize at each stage the manner in which changes in external phenomena modify economic activity strictly through the filter of the human mind.”