Criticism of Neoclassical Theory

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The standard neo-classical assumption is that a business firm seeks to maximize profits from producing and selling an output in a market. What happens in real life, however, is that there are other objectives firms might decide to pursue and this has implications for price, output and economic welfare.


However, many behavioral economists argue that since a corporation is an organization with various groups such as the employees, managers, shareholders and customers, they may likely have different objectives or goals. The dominant group at any moment in time can give greater emphasis to their own objectives - for example the main price and output decisions may be taken at local level by managers - with shareholders taking only a distant view of the company's performance and strategy.
Business firms have been traditionally viewed as a profit-maximizing entity which should set the amount of output where marginal cost equals marginal revenue in the quadratic curve shown in the Unit 1 study guide. The use of mathematical formulas- especially that of the derivative- have influenced many scholars to adapt the view. Mainstream economics literature has been dominated by this idea for a long time and has since earned its distinction as the Neo-Classical theory of the firm.
However, William J. Baumol (1967) argues that the theory is flawed. In real life, the firm will look to set prices at revenue maximizing levels. The standard marginal cost/marginal revenue paradigm, according to him, is unrealistic and fails to take time (along with many factors) into consideration. ...
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