From textbooks to Treasury, neoclassical economics has long been the bedrock of Australian economic thinking. Its tidy equations and rational-agent models underpin everything from Reserve Bank forecasts to superannuation policy. But as 2025 brings fresh shocks—think climate volatility, housing affordability crises, and AI-driven job shifts—many are asking: is neoclassical theory still fit for purpose, or does Australia need a new economic toolkit?
What is Neoclassical Economics? The Core Pillars
Neoclassical economics rose to dominance in the late 19th and early 20th centuries, building on the classical ideas of Adam Smith but with a sharper focus on individual decision-making and mathematical modelling. At its heart, the theory rests on three central assumptions:
- Rational agents: People and firms are presumed to make decisions that maximise their utility or profit, using all available information.
- Marginalism: Choices are made at the margin. Prices and wages reflect the value of the last unit bought or sold.
- Market equilibrium: Supply and demand interact to naturally find a balance, setting prices and allocating resources efficiently.
This logic has shaped everything from Australia’s competition laws to how the RBA targets inflation. The idea is that left to their own devices, markets will self-correct and produce optimal outcomes—provided government intervention is minimal and information flows freely.
Australian Economic Policy Through a Neoclassical Lens
In Australia, neoclassical thinking is hardwired into fiscal and monetary policy. For example:
- Reserve Bank interest rate settings: The RBA’s inflation targeting regime relies on the idea that changes in rates influence rational spending and saving decisions, nudging the economy back to equilibrium.
- Tax reform: Debates about the GST, negative gearing, or company tax often rest on neoclassical predictions about incentives and market behaviour.
- Superannuation and retirement policy: The design assumes individuals will optimise their lifetime savings, responding predictably to tax and regulatory changes.
Even the 2025 Federal Budget reflected this: Treasury forecasts on productivity, labour supply, and wage growth all rely on models steeped in neoclassical assumptions.
Critiques and Challenges in 2025
While neoclassical economics provides a powerful toolkit, its limitations are under sharper scrutiny than ever. Key criticisms include:
- Unrealistic rationality: Behavioural economists have shown Australians often act irrationally—over-spending, under-saving, or ignoring risks (as seen in the 2024 buy-now-pay-later boom).
- Externalities and inequality: Neoclassical models struggle with real-world issues like climate change, where market prices fail to account for environmental damage. In 2025, government intervention in carbon pricing and disaster insurance is increasingly necessary.
- Market failures: The housing crisis, with prices outstripping wages and rental stress surging, highlights markets’ failure to deliver equitable outcomes. State interventions, such as Victoria’s 2025 rent cap trials, are direct responses to these shortcomings.
- Technological disruption: The rise of AI and automation is rapidly changing labour markets in ways neoclassical models find hard to capture. Skills mismatches and regional unemployment are testing the idea that workers and firms can seamlessly adjust.
As the Productivity Commission’s 2025 review notes, “Australia’s economic challenges are increasingly complex and interconnected, requiring policy tools that go beyond marginal analysis and perfect competition.”
What’s Next? The Future of Economic Thinking in Australia
Does neoclassical economics still have a place? Most experts say yes—but with caveats. It remains a valuable starting point for understanding markets, but needs to be blended with insights from behavioural economics, ecological economics, and systems thinking. In practice, this means:
- More nuanced modelling of human behaviour in policy design—using real-world data, not just theory.
- Greater focus on sustainability and externalities, particularly as Australia aims for net zero by 2050.
- Policies that address inequality and market failures directly, rather than assuming markets will self-correct.
Universities and think tanks are already evolving their curricula and models. Expect more hybrid approaches in Treasury and Reserve Bank policy work throughout the coming decade.
