“What is meant by the neoclassical (free-market) approach to business and how does it differ from a Socialist school of economic thought? Discuss their implications for people in contemporary economies.”
Today, the approach a business should take in order to be successful is often debated as it can have an impact on the contemporary economy. It could be said that businesses are the principal driving force in any economy as they encourage growth through job opportunities and the trading of goods and services. Using a range of diversified sources, this essay aims to explore two of the most dominant approaches to business and their significance on the economy. The essay is divided into three parts with the focus of the first part on defining the economic problem of scarcity and the two approaches. The second part of the essay addresses how the two approaches attempt to solve the economic problem of scarcity, whilst the third part investigates the implications that both approaches have on the economy.
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A comprehensive definition of economics is ‘the social science that studies the choices that individuals, businesses, governments, and entire societies make as they cope with scarcity’ (Bade and Parkin, 2002 as cited in Backhouse and Medema, 2009). The economic problem of scarcity is a basic yet indispensable challenge for all societies. Scarcity in economics can be defined as ‘the excess of human wants over whatever could be produced’ (Sloman and Norris, 2010 as cited in Osman, 2020). This definition is further supported by Wetherly and Otter (2018) who state that the wants of human beings are unlimited, but at any one moment in time, there is a limit to the resources available to produce the goods and services to satisfy demand. It is regarded as a problem because a society must make decisions about how to allocate resources efficiently. Some examples of scarcity include water, land, gas, and labor.
The neoclassical (free-market) approach is concerned with Adam Smith’s theory of economic activity, specialization of goods, and division of labor. Smith used the metaphor of an invisible hand to represent the instincts of human nature that direct behavior (Wight, 2014). According to Prateek Agarwal (2020), a free-market economy is a type of economy that promotes the production and sale of goods and services with little or no government involvement. Agarwal (2020) also highlights that in a free-market economy order and power are decentralized, with individuals making their own voluntary economic choices. Therefore, society controls the production, allocation, and distribution of goods. Based on the work of Karl Marx, a socialist school of economic thought is quite dissimilar to the neoclassical (free-market) approach. In a socialist economy, the government has control over the production, allocation, and distribution of goods. A key difference between the two approaches is that in a neoclassical (free-market) economy individuals and companies own resources such as land and factories which are known as private ownership, whereas in a socialist economy, there is public ownership of utilities and transport.
In order to create an efficient economic environment, goods and services must be allocated, produced, and distributed correctly. Once all three issues have been addressed appropriately, the economic problem of scarcity will have been improved but not resolved as the desires of society are unlimited. The neoclassical (free-market) system aims to tackle the problem of scarcity by allocating scarce resources to where the highest amount of profit is expected. As a result of more profit being generated, businesses can encourage economies of scale which can lead to lower prices for consumers. Lower prices are incentives for customers to spend more and consequently more wants and desires are fulfilled. The buying habits of consumers impact which goods and services should be produced through their preferences and tastes. On the other hand, a socialist school of economic thought would struggle to identify a solution to the problem of scarcity as there is a lot of government involvement which means that the government would intervene when markets are failing for example. Government intervention is often regarded with contempt as it is susceptible to government failure leading to a counterproductive allocation of scarce resources.
An implication of the neoclassical (free-market) approach for entrepreneurs is that it allows business owners to innovate at any time in order to satisfy the ever-changing needs and wants of consumers. This is due to there being limited government involvement meaning that there is more freedom and an increase in opportunities for private companies to compete against one another. Furthermore, an implication of the free-market approach is that market failure is possible, and without engagement from the government, calamitous consequences can not be ruled out. An example of market failure is the 2008 banking crisis; there was a surge in unemployment as an appreciable amount of businesses collapsed which lead to an escalation in homelessness. On the contrary, a prime implication of the socialist school of economic thought is that individuals are not exploited. Under a socialistic economy, each member of society has access to basic food, healthcare, and education, thus a reduction in poverty levels. However, unlike the free-market approach, socialism lacks innovation. Competitiveness and entrepreneurs are not rewarded resulting in slow economic growth.
In conclusion, the two approaches differ rather a lot with the primary focus of the neoclassical (free-market) approach being on profit and the focus of the socialist approach being on equality. For the purpose of the economy, the neoclassical approach is the preferred system as it stimulates rapid growth and it is the approach that is most likely to improve the economic problem of scarcity.
References
- Agarwal, P. (2017). Free Market: Advantages & Disadvantages. [online] Intelligent Economist. Available at: https://www.intelligenteconomist.com/free-market/.
- Backhouse, R.E. and Medema, S.G. (2009). Retrospectives: On the Definition of Economics. Journal of Economic Perspectives, [online] 23(1), pp.221–233. Available at: https://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.23.1.221.
- Osman, K. (2020). The economic problem. [online] Available at: https://www.researchgate.net/publication/344780754_The_Economic_Problem.
- Wetherly, P. and Otter, D. (2018). The business environment : themes and issues in a globalizing world. Oxford: Oxford University Press.
- Wight, J.B. (2007). The Treatment of Smith’s Invisible Hand. The Journal of Economic Education, 38(3), pp.341–358.
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