Neoclassical Macroeconomics

Abstract

In this chapter we review the foundations of neoclassical economics, which is the dominant framework for the analysis of growth, trade and business cycles. Our objective is to introduce the fundamental tools of macroeconomic analysis, most of which will be widely used in the rest of the book, and to emphasize advantages and disadvantages of the traditional approach to the analysis of aggregate phenomena. The neoclassical approach relies on three main assumptions. The first one is about the rational behavior of agents, who take decisions to maximize utility under rational expectations, and about the rational behavior in the management of the firms, whose aim is profit maximization. This leads to decisions based on marginal calculus: agents set marginal utility equal to zero and firms equate marginal revenues to marginal costs.