Post Title: Carl Menger
Carl Menger: The Founder of the Austrian School (1840-1921)
“All things are subject to the law of cause and effect. This great principle knows no exception.”
Despite the many illustrious forerunners in its six-hundred year prehistory, Carl Menger (1840-1921) was the true and sole founder of the Austrian school of economics proper. He merits this title if for no other reason than that he created the system of value and price theory that constitutes the core of Austrian economic theory. But Menger did more than this: he also originated and consistently applied the correct, praxeological method for pursuing theoretical research in economics. Thus in its method and core theory, Austrian economics always was and will forever remain Mengerian economics.
Menger’s position as the originator of the fundamental doctrines of Austrian economics has been recognized and hailed by all eminent authorities on the history of Austrian economics. In his eulogy of Menger written upon the latter’s death in 1921, Joseph Schumpeter averred that “Menger is nobody’s pupil and what he created stands . . . . Menger’s theory of value, price, and distribution is the best we have up to now.” Ludwig von Mises wrote that “What is known as the Austrian School of Economics started in 1871 when Carl Menger published a slender volume under the title Grundsätze der Volkswirtschaftslehre [Principles of Economics]…. Until the end of the Seventies there was no `Austrian School.’ There was only Carl Menger.” For F. A. Hayek (1992, p. 62), the Austrian school’s “fundamental ideas belong fully and wholly to Carl Menger. . . . [W]hat is common to the members of the Austrian school, what constitutes their peculiarity and provided the foundations for their later contributions, is their acceptance of the teaching of Carl Menger.”
While there is no dispute regarding Menger’s role as creator of the defining principles of Austrian economics, there does exist some confusion regarding the precise nature of his contribution. It is not always fully recognized that Menger’s endeavor to radically reconstruct the theory of price on the basis of the law of marginal utility was not inspired by a vague subjectivism in outlook. Rather, Menger was motivated by the specific and overarching aim of establishing a causal link between the subjective values underlying the choices of consumers and the objective market prices used in the economic calculations of businessmen. The Classical economists had formulated a theory attempting to explain market prices as the outcome of the operation of the law of supply and demand. Yet, these economists were compelled to restrict their analysis to the monetary calculations and choices of businessmen while neglecting consumer choice for the lack of a satisfactory theory of value. Their theory of “calculated action” was correct as far as it went, and was used in demolishing the protectionist and interventionist schemes of sixteenth- and seventeenth-century mercantilists and the statist fantasies of nineteenth-century Utopian socialists. Thus, Menger’s ultimate goal was not to destroy Classical economics, as has sometimes been suggested, but to complete and firm up the Classical project by grounding the theory of price determination and monetary calculation in a general theory of human action.
In the next section, I give a brief overview of Menger’s life and work. In Section 3, I address in more detail the shortcomings of Classical economics that stimulated Menger’s creativity, and then, in Section 4, elaborate on his contributions to theory and method and their significance for Austrian economics.
LIFE AND WORK
Carl Menger was born on February 28, 1840 in Galicia, which is today a part of Poland. He was the scion of an old Austrian family which included craftsmen, musicians, civil servants, and army officers, all of which had emigrated from Bohemia a generation before his birth. His father, Anton, was a lawyer, and his mother, Caroline (née Gerzabek) was the daughter of a wealthy Bohemian merchant. He had two brothers, Anton and Max: the former, an eminent socialist author and fellow professor in the Law Faculty of the University of Vienna; and the latter, a lawyer and a Liberal deputy in the Austrian Parliament. The Menger family had been ennobled, but Carl himself dropped the title “von” in early adulthood.
After studying economics at the Universities of Prague and Vienna from 1859 to 1863, Menger went to work as a journalist in the Summer of 1863. The young Menger evidently attained prominence in the journalistic profession rapidly, writing a number of novels and comedies (which apparently were serialized for newspapers) and, in 1865, meeting and sharing confidences with the Liberal Austrian prime minister R. Belcredi. In the Fall of 1866, he left the Wiener Zeitung, an official newspaper for which he was then working as a market analyst, in order to prepare for his oral examination for a doctorate in law. After passing this examination, Menger went to work as an apprentice lawyer in May 1867, receiving his law degree from the University of Krakow in August 1867. However, he soon returned to work as an economic journalist and helped to found a daily newspaper.
It was in September 1867, immediately after receiving his law degree, that, reported Menger, he “threw [himself] into political economy.” Over the next four years he painstakingly worked out the system of thought that would so profoundly reshape economic theory. Mengerian economics came to fruition in 1871 with the publication of the Principles, indelibly changing the history of economic thought. As an economic journalist, Menger had observed a sharp contrast between the factors that Classical economics had identified as most important in explaining price determination and the factors that experienced market participants believed exerted the greatest influence in shaping the pricing process. Whether or not this observation was the original inspiration for Menger’s sudden and deep absorption in economic questions after 1867, it surely is consistent with his ultimate goal of reconstructing price theory.
In 1870, Menger obtained a civil service appointment in the press department of the Austrian cabinet (the Ministerratspraesidium), which was then composed of members of the Liberal Party. With a published work in hand and the successful completion of his Habilitation examination in 1872, Menger fulfilled the requirements for an appointment as a Privat-Dozent–basically an unpaid lecturer with complete professorial privileges–in the Faculty of Law and Political Science at the University of Vienna. Upon his promotion to the position of a paid, full-time associate professor (Professor Extraordinarius) in Autumn 1873, Menger resigned from the ministerial press department but continued his private-sector journalistic activities until 1875.
In 1876, Menger won an appointment as one of the tutors of the eighteen-year old Crown Prince, Rudolph von Hapsburg. Over the course of the next two years, Menger tutored Rudolph while traveling with him throughout Europe. Upon his return to Vienna, Menger was appointed by the Emperor Franz Joseph, Rudolph’s father, to the Chair of Political Economy in Vienna’s Law Faculty, where he took up his duties in 1879 as a Professor Ordinarius or Full Professor.
Secure in a prominent academic position, Menger was now able to concern himself with formulating a clarification and defense of the theoretical method he had adopted in his Principles. The latter book had been ignored in Germany because, by the 1870’s, German economics had come almost completely under the sway of the Younger Historical School, which was led by Gustav Schmoller and was bitterly hostile to Menger’s (and the Classical school’s) “abstract” style of economic theorizing. The fruits of Menger’s methodological research were published in 1883 in a book entitled Untersuchungen uber die Methode der Sozialwissenschaften und der politischen Okonomie insbesondere (Investigations into the Method of the Social Sciences with Special Reference to Economics). Where the earlier book had been coldly ignored, the Investigations precipitated a furor among German economists who heatedly responded with derisive attacks on Menger and the “Austrian School.” In fact, this latter term was originated and applied by the German Historicists in order to emphasize the isolation of Menger and his followers from the mainstream of German economics. Menger responded in 1884 with a scathing pamphlet, Irrthumer des Historismus in der deutschen Nationalokonomie (The Errors of Historicism in German Economics), and consequently the famous Methodenstreit, or methodological debate, between the Austrian school and the German Historical school began.
In the meantime, Menger’s writing and teaching had begun by the mid- `seventies to attract a number of brilliant followers, most notably Eugen von Böhm-Bawerk and Friedrich von Wieser. Between 1884 and 1889 the works of these men, and of numerous others also influenced by Menger, began to pour forth in great abundance, leading to a coalescence of an identifiable Austrian school. By the late `eighties Mengerian doctrines were also being introduced to non-German speaking economists in France, the Netherlands, the United States, and Great Britain.
After he retired from active participation in the Methodenstreit in the late 1880’s, Menger’s interests shifted back from methodological concerns to questions of pure economic theory and applied economics. In 1888, he published a notable article on capital theory, Zur Theorie des Kapitals. Also during this period, Menger served as the leading member of a commission charged with reforming the Austrian monetary system, a role which stimulated him to deeply ponder problems of monetary theory and policy. The result was a spate of articles on monetary economics published in 1892, including Geld (Money), a pathbreaking contribution to monetary theory. Menger continued in academic life until he resigned his professorship in 1903, but, unfortunately, despite the fact that he lived until 1921, he produced no more major works.
THE CLASSICAL SCHOOL AND THE STATE OF ECONOMIC THEORY ON THE EVE OF THE PUBLICATION OF MENGER’S PRINCIPLES
When Menger seriously turned his attention to economic theory in 1867, there existed a mighty though deeply flawed system of economic theory that had been constructed mainly by the British Classical School, namely David Hume, Adam Smith, and David Ricardo. To their undying credit, the Classical economists were successful in demonstrating that price phenomena–product prices, wages, and interest rates– were not the product of historical accident or the arbitrary whim of sellers but were determined by universal and immutable economic law, viz., the law of supply and demand. They also showed how prices, through the calculations and actions of profit-seeking businessmen, effectively regulated the production process. They concluded that, in those industries where the selling price exceeded the average cost of the product by a greater than normal margin, business owners were motivated by prospective profits to expand their output from existing enterprises, while additional output was forthcoming from new enterprises initiated by capitalist-investors eager to share in the supranormal profits. Conversely, in those industries where product prices failed to cover per unit costs, the universal quest for profit and aversion to loss among businessmen led existing firms to contract their output or discontinue production altogether, while discouraging entry by new competitors into the industry. Moreover, as the production of goods expanded in those industries where higher-than-normal profits were being reaped, supply increased relative to demand and the profit rate tended to diminish back to a normal level as prices declined toward their “natural” level in relation to production costs. In the case of industries where production was shrinking due to losses, the decrease in supply relative to demand drove prices up toward (and beyond) average costs to their natural level, causing losses to disappear and a normal level of profit to emerge in the process.
In the Classical view, then, both prices and production behaved according to definite laws of cause and effect. Prices were determined by the interaction of all market participants, so that the actual price of any good reflected the momentary equilibrium of supply and demand; the allocation of resources to the various processes of production was governed by the calculations and choices of profit-seeking (and loss-avoiding) businessmen, which meant that, in the long run, resources were allocated among the various branches of production so as to ensure a tendency to equalize at some normal or natural level the “rate of profit” or rate of return on all capital investment. Classical economics, therefore, did indeed contain an embryonic theory of human action, but their theory was incomplete because it focused narrowly on the calculating businessman, the proverbial “economic man”, who “bought in the cheapest and sold in the dearest markets.” In other words, the Classical theory of prices and production was a theory of calculable action only, i.e., of action in the marketplace, a realm where all means and ends, costs and benefits, and profits and losses could be calculated in terms of money. While this was a great achievement and a bold step forward in economic science, it left out of account the subjective and nonquantifiable valuations and preferences of the consumer, the raison d’être of all economic activity.
To explain this neglect, we turn to the aforementioned great flaw in Classical economics: its value theory. In attempting to analyze the value of goods as a foundation for its theory of price, the Classical economists commenced by focusing on abstract categories or classes of goods, e.g., bread, iron, diamonds, water, etc., and their general usefulness to humankind. These broad categories that grounded classical value theory were the alternative to focusing on a specific quantity of a concrete good and its perceived importance to a choosing individual. They were thus at a loss to resolve the famous “paradox of value”: why the market price of one pound of bread is almost negligible compared to the price of an equal weight of gem-quality diamonds, despite the fact that bread is indispensable in sustaining human life while diamonds are useful only for aesthetic enjoyment or ostentatious display. To proceed any further in their analysis, the Classical economists were thus forced to sever value into two categories, “use value” and “exchange value.” The former referred to the importance of a good in serving human wants while the latter indicated simply the market price of the good. Dismissing use value as a given and as an unexplained precondition of exchange value, they went on to concentrate their analysis exclusively on exchange value. This approach to value theory naturally prevented the Classical economists from developing a complete theory of human action that integrated the choices of consumers with the calculations and choices of businessmen.
Unable to ground their price theory in the subjective values of consumers, the Classical economists turned to objective costs of production to solidify their theoretical system. This focused attention on the objective costs of production accorded the technical conditions under which goods are produced equal status with human choices as the active determinants of economic activity. As a result, a bifurcated and contradictory price theory was established. According to this theory, as we noted above, market prices–prices that were actually paid in everyday transactions–are determined by supply and demand. However, only supply was actually explained, as the result of the monetary calculations of profit-maximizing businessmen, while the demands for the various consumer goods were taken as given. While human choices determined day-to-day market prices for all goods, in the long run the exchange value of “reproducible” goods was driven inexorably toward the “natural” price established by their costs of production, which themselves remained unexplained. “Scarcity” goods, those whose supplies could not be augmented by the production process, such as antiques, rare coins, paintings of the Old Masters, and so on, were treated as a separate and relatively unimportant category of goods whose exchange values were governed entirely by supply and demand. Thus the split in Classical value and price theory. But there also existed an unresolved contradiction, at least in the case of reproducible goods: although the emergence of actual prices at every moment are completely accounted for by human calculation and action, they also harbor a mysterious tendency to gravitate toward a level determined by factors wholly unrelated to human volition.
Regarding the question concerning the determination of the incomes of the factors of production, the Classical analysis was almost completely worthless because, once again, it was conducted in terms of broad and homogeneous classes, such as “labor” “land” and “capital.” This diverted the Classical theorists from the important task of explaining the market value or actual prices of specific kinds of resources, instead favoring a chimerical search for the principles by which the aggregate income shares of the three classes of factor owners–laborers, landlords and capitalists–are governed. The Classical school’s theory of distribution was thus totally disconnected from its quasi-praxeological theory of price, and focused almost exclusively on the differing objective qualities of land, labor, and capital as the explanation for the division of aggregate income among them. Whereas the core of Classical price and production theory included a sophisticated theory of calculable action, Classical distribution theory crudely focused on the technical qualities of goods alone.
This was the unsatisfactory state in which Menger found economic theory in the late 1860’s. It is true that a subjective-value school, which traced its roots back through J.-B. Say, A. R. J. Turgot, and Richard Cantillon to the Scholastic writers of the Middle Ages, flourished on the Continent during the whole period of the Classical school’s ascendancy in Great Britain. And Menger himself, a renowned bibliophile, was nurtured and steeped in the writings of the German-language branch of this subjective-value tradition. However, while writers associated with this tradition repeatedly emphasized that “utility” and “scarcity” are the sole determinants of market prices and, in some cases, even formulated the concept of marginal utility, none before Menger was able to systematically elaborate these insights into a comprehensive theory of the pricing process and of the economy in general.
MENGER’S RECONSTRUCTION OF ECONOMIC THEORY
A. The Nature and Scope of Economic Theory
As noted above, Menger did not intend to overthrow Classical economics. He was quite comfortable with its emphasis on the universality and immutability of economic law, its theory of short-run price determination, and the laissez-faire policy conclusions it derived therefrom. Rather, Menger’s intentions were to reconstruct Classical economics on firmer foundations by grounding the supply-and-demand theory of price and the theory of monetary calculation in the choices and actions of consumers and to repair its superstructure by healing the rift between the theory of price and the theory of distribution. Menger boldly proclaimed his intention of subsuming all the branches of economics under a reconstructed price theory in his Preface to the Principles, writing “I have devoted special attention to the investigation of the causal connections between economic phenomena involving products and the corresponding agents of production, not only for the purpose of establishing a price theory based upon reality and placing all price phenomena (including interest, wages, ground rent, etc.) together under one unified point of view, but also because of the important insights we thereby gain into many other economic processes heretofore completely misunderstood.”
Menger recognized that at the center of “a price theory based upon reality” and of economic theory in general is human action-and human action alone. As Menger epigrammatically put it in preliminary notes written while the Principles was in preparation: “Man himself is the beginning and the end of every economy” and “Our science is the theory of a human being’s ability to deal with his wants.” While the centrality of human want satisfaction had been affirmed by earlier writers in the subjective-value tradition, Menger alone was successful in forging a method of economic theorizing–it was later to be dubbed “praxeology” by Ludwig von Mises–that was consistent with this insight. Thus he began his scientific inquiry by meditating upon the nature of human striving to satisfy wants and then deducing its immediate implications. By proceeding in this way, Menger was able to perceive immediately that the process of want satisfaction is not purely cognitive and internal to the human mind, but depended crucially upon the external world and, therefore, upon the law of cause and effect. This explains why Menger began his economic treatise with the statement that “All things are subject to the law of cause and effect.” Without reference to this great law of objective reality, the human striving to attain goals is logically inconceivable, because, as Menger argued, subjective states of satisfaction are links in the same causal chain that includes objective states of the world:
“One’s own person, moreover, and any of its states are links in this great universal structure of relationships. It is impossible to conceive of a change of one’s person from one state to another in any way other than one subject to the law of causality. If, therefore, one passes from a state of need to a state in which the need is satisfied, sufficient causes for this change must exist. There must be forces operating within one’s organism that remedy the disturbed state, or there must be external things acting upon it that by there nature are capable of producing the state we call satisfaction of our needs.”
But the direction of causation is not one-way–from objective states of the world to subjective states of satisfaction. For Menger, it is two-way, because, by conceiving the law of cause and effect, man is able to recognize his total dependence on the external world and transform the latter into a means to attain his ends. Man, thus becomes the ultimate cause–as well as the ultimate end–in the process of want satisfaction. In his notes, Menger expressed and emphasized the causal interrelationships between the subjective and the objective aspects of action by means of parallel trinities of linked concepts: “ends-means-realization/man-external world-subsistence/wants-goods-satisfaction.”
B. The Theory of Goods
Menger’s emphasis on the law of causality led him to devote the first twenty-five pages of the Principles to explicating “the general theory of the good, ” in the course of which he radically reformulated the concept of a good in praxeological terms. For Menger goods are those elements of the external world that are integral to the causal process of want satisfaction and upon which action operates. Once again, passages in Menger’s pre-Principles notebooks are illuminating:
Our general dependence on the external world: in its entirety the external world is presented to us as a whole in which we live. Dependence on certain portions of this external world, or on some relationships in it, which must be brought into certain relations to us. To this end, these portions must be particularly suited. Such things are called goods, insofar as they have the capacity to satisfy human wants (serving ends amounts to the same thing). [All underlining is Menger’s.]##
In the Principles, Menger lists four conditions that must exist in order for an element of the external world to have “goods-character”:
- A human need.
- Such properties as render the thing capable of being brought into causal connection with the satisfaction of this need.
- Human knowledge of this causal connection.
- Command of the thing sufficient to direct it to the satisfaction of the need.
Now, with the formulation of the second and third prerequisites, Menger’s analysis of goods appears to stray from its praxeological foundations, because people often do act on the basis of erroneous knowledge of causal relationships. The prices paid for “miracle cures” and the services of spirit mediums are, after all, real market prices that must be explained by economic theory. In fact, Menger implicitly recognizes this by introducing a distinction between “true” goods and “imaginary” goods, which, in the latter case, “derive their goods-character from properties they are imagined to possess or from needs merely imagined by men.” But this is a value-laden and entirely superfluous distinction that is irrelevant to Menger’s substantive and praxeological analysis because his price theory is capable of completely accounting for the prices of both categories of goods. To render Menger’s definition of goods consistent with his actual economic analysis the two offending prerequisites must be replaced by one, positing an opinion or belief by the actor that there is a causal connection between the thing and the satisfaction of the human need in question.
Having identified the nature of a good, Menger proceeds to elucidate what he calls “the causal connections between goods,” with the goal of identifying “the place that each good occupies in the causal nexus of goods.” “Goods of the lowest order” are consumer goods, like bread for instance, which are used to directly satisfy human wants. In Menger’s words, “the causal connection between bread and the satisfaction of one of our needs is . . . a direct one.” Factors of production, on the other hand, are “goods of higher order,” having only “an indirect causal connection with human needs.” For example, flour and the services of ovens and bakers’ labor are second-order goods whose goods-character stems from the fact that, when they are combined in the process of production to yield a quantity of bread, they operate as an indirect cause of the satisfaction of the human want for bread. Likewise wheat, grain mills and millers’ labor constitute third-order goods, which attain their goods-character from their usefulness in the production of second-order goods. The same applies to fourth- and fifth-order goods in the production of bread. In short, according to Menger, “The process by which goods of higher order are progressively transformed into goods of lower order and by which these are directed finally to the satisfaction of human needs is . . . not irregular but subject, like all other processes of change, to the law of causality.” It is their position in this causal order of want satisfaction that endows elements of the external world with their goods-character. In a world of kaleidic and uncaused change, human wants would not be sufficient to endow things with the quality of a good, and purposive action would therefore be impossible.
Menger draws a further distinction: between those goods whose available quantity exceeds the amount necessary to satisfy all human wants for them and those available in a quantity that is insufficient to fully satisfy human wants for them. The former Menger designates “non-economic goods” and the latter, “economic goods.” In the case of non-economic goods, because of their superabundance relative to wants, people need take no definite action with regard to them. With regard to economic goods, however, an individual must undertake to economize them in order to satisfy his wants for them as fully as possible. Economizing involves, among other things, ranking the wants for a particular good according to their greatest urgency or importance and then choosing to allocate units of the good only to those uses that serve the most important wants, while leaving unsatisfied the less important wants. Also, just as in the case of their goods-character, the economic character of higher-order goods also derives from the economic character of the lower-order good which they cooperate in producing. Thus, for example, in a region where pure water is naturally superabundant for all human purposes, neither water nor manmade reservoirs and water pumps, pipes, and filters need be economized. For Menger, then, the operation of economizing is nothing more or less then purposive behavior or action, as this latter term is understood by Mises and the proponents of the modern praxeological paradigm. Both Menger’s “economizing man” and Mises’s “acting man” apply scarce means so as to attain their most highly valued ends.
Inherent in the idea of economizing is the notion of property. For Menger, “human economy and property have a joint economic origin,” which is rooted in the condition of scarcity. Thus property is neither “an arbitrary invention” nor merely an aggregation of heterogeneous objects. It is a praxeological category that refers to a purposively created structure of goods that is adjusted through the operations of economizing to serve the structure of ends aimed at by an individual actor. According to Menger, “[A person’s] property is not . . . an arbitrarily combined quantity of goods, but a direct reflection of his needs, an integrated whole, no essential part of which can be diminished or increased without effecting realization of the end it serves.” It is no exaggeration to say that Mengerian economics is as much about goods and property as it is about knowledge and expectations.
Menger’s analyses of the order and of the economic character of goods taken together demolish the foundations of the Classical cost-of-production theory. First, the proposition that the economic character of lower-order goods is derived from the fact that the goods of a higher order employed in producing them possess an economic character established prior to the causal production process, according to Menger, “. . . contradict[s] . . . all experience, which teaches us that, from goods of higher order whose economic character is beyond all doubt, completely useless things may be produced, and in consequence of economic ignorance actually are produced. . . .” In other words, the cost-of-production theory is at a loss in explaining how scarce and valuable resources can be and are used to produce products whose market value is zero because they are not useful, directly or indirectly, in serving human wants. This problem aside, the fatal flaw in a theory which seeks to explain the economic character of lower-order goods in terms of the economic character of goods of a higher order is that it is merely a “pseudo-explanation.” As Menger argued, “If we explain the economic character of goods of first order by that of goods of second order, the latter by the economic character of goods of third order, this again by the economic character of goods of fourth order, and so on, the solution of the problem is not advanced fundamentally by a single step, since the question as to the last and true cause of the economic character of goods always still remains unanswered.”
C. The Theory of Value
This brings us to the question of value which so vexed, and ultimately defeated, the Classical economists. Because they were tragically unable to grasp that specific quantities and not entire classes of goods were the object of human action, the Classical economists dropped `use value’ from their analysis. But Menger, with his unblinking focus on individual action, easily recognized the profound significance of the concept of the marginal unit–the quantity of a good relevant to choice–for the whole of economic theory.
In his notes, Menger compared “species value,” the value of an abstract class of goods, to the “individual value” or “concrete value” attaching to specific units of a good. Dismissing the former as completely irrelevant to action in the real world, Menger argued that, “In the case of species value, we compare, on the one hand, the properties of a good without considering its quantity, and on the other, human wants without taking into account individuality. . . . In real life there are only concrete goods and concrete wants.” In fact, the subjective ranking of the different satisfactions yielded by a definite quantity of a good is implied by the very notion of action. As Menger explained: “The varying importance that satisfaction of separate concrete needs has for man is not foreign to the consciousness of any economizing man. . . . Wherever men live, and whatever level of civilization they occupy, we can observe how economizing individuals weigh the importance of satisfaction of their various needs in general, how they weigh especially the relative importance of the separate acts leading to the more or less complete satisfaction of each need, and how they are finally guided by the results of this comparison into activities directed to the fullest possible satisfaction of their needs (economizing).”
By cogitating on the essence of economizing or action, Menger was thus able to conclusively demonstrate that the want for any good is actually a series of wants for a definite unit of the good. And, by implication, only actual units of a good are relevant to human choice: “Not species as such, but only concrete things are availableto economizing individuals. Only the latter, therefore, are goods, and only goods are the objects of our economizing and of our valuation.”
Having established that only specific wants and specific units of goods pertain to the valuational process, Menger proceeded to define value as “the importance that individual goods or quantities of goods attain for us because we are conscious of being dependent on command of them for the satisfaction of our needs.” In other words, “the value of all goods is merely an imputation of this importance [of satisfying our needs] to economic goods.” It follows, then, for Menger, that “. . . value does not exist outside the consciousness of men…. [T]he value of goods is entirely subjective in nature.” One would be wrong to interpret this last statement as a radical subjectivist dismissal of the realm of external reality. For Menger’s emphatic distinction between the value of a thing and the thing itself is actually intended as a means of elucidating the indissoluble ontological link between the realm of cognition and the realm of objective causal processes that comes into being by virtue of valuation and economizing. Thus Menger wrote: “The value of goods is therefore nothing arbitrary, but always the necessary consequence of human knowledge that the maintenance of life, of well-being, or of some ever so insignificant part of them, depends upon control of a good or a quantity of goods. . . . For the entities that exist objectively are always only particular things or quantities of things and their value is always something fundamentally different from the things themselves; it is a judgment made by economizing individuals about the importance their command of the things has for the maintenance of their lives and well-being.”
If value consists in a judgment about the significance of “concrete” things in producing satisfaction of “concrete” wants, how are such judgments arrived at? That is, what is the value of a specific thing to a person who seeks to employ it to satisfy his wants? It was in his answer to this question that Menger not only solved the paradox of value, but laid the foundations for the reconstruction of price theory, and, hence, of all of economic science. To illustrate his answer, let us examine the case of a hypothetical farmer who has a number of different wants that can be satisfied by a sack of grain. His most pressing want for a sack of grain is for use in producing a quantity of bread necessary to sustain his existence during the forthcoming year. Of next greatest importance is satisfaction of the want for an additional quantity of bread that allows him to preserve his health and vigor for the year. Ranked progressively lower in importance are uses for a sack of grain that satisfy the following wants: 3rd. for seed-grain to ensure a harvest a year hence, and thus his continued existence and health in the future; 4th. for the production of beer and whiskey; 5th. for feed to maintain farm animals whose dairy and poultry products allow him to enjoy a varied diet. We may further assume that the farmer experiences an additional fifteen unidentified wants of progressively lower rank, so that he would be unable to completely satisfy his wants for a sack of grain with a harvest yielding less than twenty sacks.
If we now suppose that his current harvest yields five sacks of grain of equal quality, then grain is for him a scarce good that must be economized-that is, used in satisfying only his five most important concrete wants, while foregoing the satisfaction of his fifteen less important wants. What is the value of a sack of grain in this case? Since all five sacks are, by hypothesis, qualitatively identical, they must be equal in value, and, yet, they satisfy wants of manifestly unequal importance.
Menger (1981, p. 131) brilliantly answered the question by restating it: “[W]hich satisfaction would not be obtained if the economizing individual did not have the given unit at his disposal–that is, if he were to have command of a total amount smaller by that one unit?” In light of Menger’s discussion of economizing, the obviously correct answer to this question is “only the least of all the satisfactions assured by the whole available quantity.” In other words, regardless of which particular physical unit of his supply was subtracted, the actor would economize by choosing to reallocate the remaining units so as to continue to satisfy his most important wants and to forego the satisfaction of only the least important want of those previously satisfied by the larger supply. It is, thus, always the least important satisfaction that is dependent on a unit of the actor’s supply of a good and, that, therefore, determines the value of each and every unit of the supply. This value-determining satisfaction soon came to be known as the “marginal utility.” As Menger formulated the law of marginal utility: “Accordingly, in every concrete case, of all the satisfactions secured by means of the whole quantity of a good at the disposal of an economizing individual, only those that have the least importance to him are dependent on the availability of a given portion of the whole quantity. Hence the value to this person of any portion of the whole available quantity of the good is equal to the importance to him of the satisfactions of the least importance among those assured by the whole quantity and achieved with an equal portion.”
In our example, the value of each of the five sacks of grain possessed by the farmer is determined by and equal to the importance of the fifth-ranked satisfaction, which he derives from the consumption of milk and eggs. Should one of the sacks be inadvertently destroyed by fire, the marginal utility and, hence, the value of a sack of grain would increase to the satisfaction he expects from a year’s provision of beer and whiskey. Should a pack of marauding foxes now leave him with only one sack, its value would rise higher still, to the importance he attaches to his very life. On the other hand, should a bumper harvest yield fifty sacks of grain–far exceeding his hypothesized twenty wants for a sack of grain–the marginal utility and value of a sack would sink to zero, because the satisfaction of none of his wants depends on possession of a fiftieth, or even a twenty-first, sack.
Thus by applying the law of marginal utility, Menger was able to provide a straightforward and incontrovertible resolution to the paradox of value that had so bedeviled Classical economics and prevented its development into a full-blown theory of human action. According to Menger, it is because diamonds and gold are extremely rare while water tends to be abundantly available that: “Under ordinary circumstances, therefore, no human need would have to remain unsatisfied if men were unable to command some particular quantity of drinking water. With gold and diamonds, on the other hand, even the least significant satisfactions assured by the total quantity available still have a relatively high importance to economizing men. Thus concrete quantities of drinking water usually have no value to economizing men but concrete quantities of gold and diamonds a highvalue.”
Having thus repaired the Classical split between “use value” and “exchange value”, and firmly rooted price theory in consumer valuations and choices, Menger turned his attention to the bifurcation perpetrated by the Classical economists between price theory and distribution theory, or between the pricing of consumer goods and the pricing of the factors of production. Once again, Menger used the law of marginal utility to provide a solution of absolute and universal validity. He also refuted, once and for all, the Classical contention that, in the long run at least, price is determined by costs of production.
Menger began by pointing out that only satisfaction of wants is directly significant to human beings. Consumer goods, or goods of the first order, attain value, therefore, only because people are cognizant of their dependence on specific quantities of these goods for the satisfaction of specific wants, and, hence, “impute” to these goods the importance of the satisfactions that depend upon them. Goods of higher orders, the factors of production that cooperate in the production of consumer goods, have no immediate connection with the satisfaction of human wants, but through the causal production process they do indirectly bear on the process of want satisfaction. Thus, the value of a certain quantity of consumer goods is imputed to the goods of the second order employed in its production, because the latter are a necessary, if indirect, cause of the satisfaction which is directly attributable to the stock of consumer goods. The same value-imputation analysis applies to the value of goods of the third, fourth, and higher orders. Concluded Menger: “Thus, as with goods of the first order, the factor that is ultimately responsible for the value of goods of higher order is merely the importance we attribute to those satisfactions with respect to which we are aware of being dependent on the availability of the goods of higher order whose value is under consideration. But due to the causal connection between goods, the value of goods of higher order is not measured directly by the expected importance of the final satisfaction, but rather by the expected value of the corresponding goods of lower order.”
If “the value of goods of higher order is dependent upon the expected value of goods of lower order they serve to produce,” then, as Menger argued, costs of production, which are nothing but the sums of the prices paid for various kinds of higher-order goods, cannot possibly determine the prices of consumer goods because the costs themselves are ultimately determined by these prices. Furthermore, as Menger pointed out, the cost-of-production theory of price determination cannot account for the prices of the services of land and of labor, which are nature given and, hence, have no costs of production themselves. In contrast, the Mengerian theory of value imputation easily explains these prices in the same manner as the prices of any other species of concrete goods: as proximately derived from the value of the lower-order goods or–if they themselves are goods of the first-order–of the satisfactions that are directly dependent upon them.
While up to this point Menger’s analysis succeeds in identifying consumer valuations as the general cause of the values and prices of both consumer goods and productive factors, it still leaves unexplained the prices of individual factors. The reason is that a good of a lower order can only be produced by “complementary” quantities of higher-order goods. As Menger realized, by its very nature, production must involve more than one kind of factor of production. Now it would appear, therefore, that it is impossible to impute partial quotas of the value of the lower-order good to each of the various higher-order goods that cooperate in its production. However, once again, with dazzling analytical acumen, Menger wielded the law of marginal utility to hit upon the correct solution.
Menger pointed out that, in most production processes, higher-order goods need not be combined in the rigidly fixed proportions that characterizes chemical reactions. In other words, if one of the complementary factors that cooperates in the production of grain, let us say, fertilizer, is partially or completely withdrawn, then there will result a reduction of the output of wheat rather than a nullification of the entire production process. This implies, Menger argued, that the share of the value of a particular quantity of a higher-order good can be isolated from the aggregate value of the complementary goods combined in the given production process. Thus, if a diminution of a hundredweight of fertilizer, all other things equal, causes a drop in the grain harvest of ten sacks, then the value of this unit of fertilizer to the farmer is precisely equal to the marginal utility of ten sacks of grain, comprising the satisfactions he chooses to forego as a result of the loss of the ten sacks.
Menger summarized the “general law of the determination of the value of a concrete quantity of a good of higher order” as follows: “Assuming . . . that all available goods of higher order are employed in the most economic fashion, the value of a concrete quantity of a good of higher order is equal to the difference in importance between the satisfactions that can be attained when we have command of the given quantity of the good of higher order whose value we wish to determine and the satisfactions that would be attained if we did not have this quantity at our command.”
D. Time, Property, and Entrepreneurship
Because Menger conceived the processes of transforming higher-order into lower-order goods (production) and of imputing value from lower-order to higher-order goods (imputation) as conjoint causal processes, he accorded time an integral role in both. According to Menger: “The idea of causality . . . is inseparable from the idea of time. A process of change involves a beginning and a becoming, and these are only conceivable as processes in time. . . . Thus in the process of change by which goods of a higher order are gradually transformed into goods of the first order, until the latter finally bring about the state called the satisfaction of human needs, time is an essential feature of our observations.”
If, indeed, “the time period lying between command of goods of a higher order and possession of the corresponding goods of lower order can never be eliminated,” then the production process is inherently uncertain. For factors beyond the actor’s technical knowledge or control, such as changes in soil properties or in weather, may affect the quality or quantity of the first-order goods that are yielded by the production process. This technical uncertainty associated with production can be greatly mitigated but never completely extinguished by the improvement of technological knowledge, which, in effect, provides the actor with better foresight of the outcome of a time-consuming causal process.
But technological knowledge cannot ameliorate other kinds of uncertainty that are inextricably bound up with production. Since any production process is undertaken to satisfy future wants, the actor must be able to foresee these wants. Indeed, as Menger pointed out, “its success will be dependent principally upon correct foresight of the quantities of goods [actors] will find necessary in future time periods,” while “a complete lack of foresight would make any planning of activity directed to the satisfaction of human wants completely impossible.” Nonetheless, despite the fact that people are unable to foresee their future circumstances with perfect certainty, Menger did not believe that they are utterly ignorant of their future wants. Recourse to previous experience permits them to foresee with approximate certainty many wants that they will experience during their planning period. About other wants, e.g., for medicines and fire extinguishers, they remain “more or less in doubt.” But despite their “deficient foresight,” people do act successfully to satisfy even these wants. Menger concluded that “The circumstance that it is uncertain whether a need for a good will be felt during the period of our plans does not, therefore, exclude the possibility that we will provide for its eventual satisfaction, and hence does not cause the reality of our requirements for goods necessary to satisfy such needs to be in question.” Thus uncertainty for Menger is not a obstacle to but a condition of action.
For Menger, “A second factor that determines the success of human activity is the knowledge gained by men of the means available to them for the attainment of the desired ends.” As a prerequisite of want-satisfaction, actors are concerned “to measure and take inventory of the goods at their disposal.” The more exact knowledge regarding the kinds and quantities of existing higher-order goods provided by these operations, the more accurate will be the forecasts of consumer goods forthcoming to satisfy future wants during the planning period. The acquisition of such data is especially important for production planning in a developed market economy where the ownership and location of the supplies of various higher-order goods tend to be dispersed. But even if we consider “the lowest levels of civilization . . . complete lack of this knowledge would make impossible any provident activity of men directed to the satisfaction of their needs.”
Now, a causal production process must be “planned and conducted . . . by an economizing individual.” The set of functions necessary for actuating such a process Menger designates as “entrepreneurial activity.” As we have just seen, for Menger, the entrepreneur’s most important function is anticipating future wants, estimating their relative importance, and acquiring the technological knowledge and knowledge of currently available means. In the absence of such entrepreneurial foresight and knowledge, there could be no imputing of value from satisfactions to higher-order goods, and rational resource allocation would be impossible. For, as Menger repeatedly emphasized, due to the time lapse inherent in production, “the value of goods of higher order is governed, not by the value of corresponding goods of lower order of the present, but rather by the prospective value of the product.” This means, according to Menger, that the production process and the value-imputation process originate simultaneously in the same act of entrepreneurship: “The value of goods of higher order is, in all cases, regulated by the prospective value of the goods of lower order to whose production they have been or will be assigned by economizing men.”
Entrepreneurial activity comprises a number of additional functions bound up with the praxeological category of property. These include “economic calculation,” involving the various computations needed to ensure the technical efficiency of the production process, i.e., the most valuable use of property. A third entrepreneurial function is “the act of will” by which higher-order goods are purposively allocated to the chosen production process. Finally, there is “supervision of the execution of the production plan so that it may be carried through as economically as possible.” Clearly, the last two functions entail property-ownership and, therefore, mark the Mengerian entrepreneur as a capitalist-entrepreneur. Menger states explicitly that “command of the services of capital” is a “necessary prerequisite” for performing economic activity. Moreover, in large firms, although he may employ “several helpers” whose activities are quite extensive, the entrepreneur himself will continue to perform all four characteristic functions enumerated above, “. . . even if they are ultimately confined . . . to determining the allocation of portions of wealth to particular productive purposes only by general categories, and to selection and control of persons.”
The four functions Menger describes as the core of entrepreneurship are simply the praxeological implications of property in higher-order goods. This explains why, in Menger’s view, the knowledge an actor acquires and the expectations he forms are not autonomous but are strictly governed by the structure of goods constituting his property and his chosen ends. As an “economizing man” who actuates and guides an uncertain causal process, Menger’s entrepreneur is a dynamic actor who profits by actively seeking out the most valuable uses for his property and is not merely a passive “risk-bearer” whose profits represent a reward for investing in risky ventur es.
E. The Theory of Price
We now turn to price theory, the coping stone of Mengerian economics. Menger viewed the explanation of prices on the basis of the law of marginal utility as the final step in linking the Classical theory of monetary calculation to the general process of human want satisfaction. For if the active element in determining the prices of goods of all orders is marginal utility, and if entrepreneurs base their economic calculations on these prices, it can then be demonstrated that purposeful actions undertaken to satisfy human wants are the ultimate determinant of resource allocation and income distribution in the market economy.
As a prelude to elaborating his theory of price, Menger was forced to clarify the cause and essence of exchange. Menger recognized that prices were formed during individual acts of exchange and that exchange was purposefully undertaken as part and parcel of the causal process of want satisfaction. Unfortunately, because of their tendency to conceive the human want for a good abstractly and generically rather than concretely and individually, the Classical economists had no alternative but to identify the motive to exchange with an alleged innate proclivity of human beings “to truck and barter.” It was thus left to Menger to elaborate a theory of exchange in terms of human wants.
Once again resorting to his trusty law of marginal utility, Menger was able to provide a simple and definitive solution to the problem. Menger (1981, pp. 183-87) illustrated this solution with an example along roughly the following lines: Suppose that there exist two farmers, A and B, each of whom owns a supply of a different good, horses and cows. Assuming that A possesses six horses and B, six cows, Menger posed the question: “How many horses and cows would A and B agree to exchange?” In answer, Menger argued that the two parties would continue to exchange one horse for one cow as long as the value of the good each received exceeded the value of the good he gave up, that is, as long as the two parties valued the goods they exchanged in inverse order. Specifically, A would agree to exchange the first of his six horses for a cow, if and only if, the marginal utility, and, therefore, the value of a horse– in this case, equal to the sixth-ranked satisfaction attributable to a horse–was less than the marginal utility and value of a cow–since he was starting with a zero supply, equal to the highest-ranked satisfaction dependent on his possession of one cow. Moreover, once the exchange has been completed, the marginal utility and value of horses to A will rise to the fifth-ranked satisfaction dependent on a horse, and the marginal utility and value of an additional cow to him will fall to the second most important satisfaction yielded by a cow. Transposing cows and horses, this same analysis applies to B. With the marginal utility of the good sold increasing and the marginal utility of the good purchased declining for both parties with each exchange consummated, further exchange would eventually cease when either A or B (or both) no longer values the good he is to receive above the good he must cede.
As Menger summed up his analysis: “This limit [to exchange] is reached when one of the two bargainers has no further quantity of goods which is of less value to him than a quantity of another good at the disposal of the second bargainer who, at the same time, evaluates the two quantities of goods inversely.” Now, if this occurs for A after the fourth exchange, it means that the value of each one of his remaining supply of two horses exceeds the value of the fifth cow offered by B. Thus A’s refusal and B’s offer to exchange demonstrates that both currently places a higher value on a horse than on a cow and, therefore, there exists no basis for additional exchanges because there no longer prevails inverse valuations of the goods by the two parties.
The cessation of exchange also implies that the two parties have exhausted the mutual benefits from trade. These benefits consist in the opportunity of each trader to satisfy more important wants with his restructured property than he was able to satisfy with his initial, pre-exchange supplies of goods. Therefore, for Menger, exchange is as much a part of the causal process of want satisfaction as production is. Menger used this insight to demonstrate the fallacy of the Classical position, which theorized that exchange and the activities of middlemen are unproductive, arguing that “The effect of an economic exchange of goods upon the economic position of each of the two traders is always the same as if a new object of wealth had entered his possession. . . . For the end of the economy is not the physical augmentation of goods but always the fullest possible satisfaction of human needs.”
In the course of demonstrating the limits to exchange, Menger originated the praxeological method of analyzing the real-world pricing process. Since every causal process has a beginning and an end, a complete explanation of the process involves a description of the factors that precipitate it and maintain it in motion, and the factors that cause its cessation. Central to this analytical method is the concept of what Boehm-Bawerk called “momentary equilibrium” and Mises called “the state of rest.” In the example above, the exchange process continues as along as A and B rank the values of the two goods in inverse order; the process is suspended and the state of rest emerges when the inverse valuations no longer hold. In the real world, it is true, individual valuations of goods are in constant flux due to changes in consumer wants and the technical conditions of production, thus continually recreating the conditions of further exchange. However, this does not nullify Menger’s analysis. In fact, it is precisely the notion of the state of rest that is necessary to delimit a particular act of exchange. Explained Menger (1981, p. 188): “. . . the foundations of economic exchanges are constantly changing and we therefore observe the phenomenon of a perpetual succession. But even in this chain of transactions we can, by observing closely, find points of rest at particular times, for particular persons, and with particular kinds of goods. At these points of rest, no exchange of goods takes place because an economic limit to exchange has already been reached. [Emphases added.]”
Menger’s explanation of how prices are determined follows naturally from his analysis of exchange. Menger defined prices as “the quantities of goods actually exchanged.” As part of the overall want satisfaction process, however, “Prices are only incidental manifestations of [economic] activities, symptoms of an economic equilibrium between the economies of individuals.” This means that the emergence of a realized price–i.e., an actual exchange of definite quantities of two goods–coincides not only with the consummation of the exchange process but also with the attainment of a momentary state of rest by the parties involved in the exchange. In the example above, the sum of four horses that A paid for four of B’s cows constitutes both the realized price of the transaction and the exchange of the specific quantities of goods necessary to establish a temporary exchange equilibrium between A and B with respect to horses and cows. Similarly, in a modern monetary economy, at any moment in time, every money price actually observed indicates the exchange of the quantities of goods necessary to facilitate the achievement of catallactic states of rest by each pair of transactors. For each individual this state takes the form of a temporary lull, of longer or shorter duration, before the market is reentered and another exchange is initiated. It is during this interlude that the mutual advantages of exchange are perceived to be exhausted. For example, a consumer exiting a supermarket is, at least momentarily, in a state of rest with respect not only to the various items of food she has purchased, but with respect to her money assets and all other species of exchangeable goods that compose her property. This state of catallactic quiescence will be disturbed, sooner or later, when she again finds herself confronting a prospective seller whose valuations of a good and its purchase price are the inverse of her own.
Menger used this method of analysis to demonstrate that prices are determined exclusively by the subjective valuations of market participants. He began with a simple analysis of exchange between two isolated individuals. Person A1 owns a horse while Person B1 owns a supply of wheat. If, based on his estimations of the relative marginal utilities of the two goods to him, B1 will pay up to a maximum of eighty sacks of wheat to obtain the horse and A1 will part with the horse for no less than ten sacks of wheat–again, based on considerations of marginal utility–then the basis for exchange exists, because, for prices between ten and eighty sacks of wheat per horse, A1 and B1 value the horse and the wheat inversely. This being the case, and assuming A1 and B1 are known to each other, the price paid under these conditions will settle somewhere in the range of ten to eighty bushels per horse. The exact price will be the subject of higgling between the two and will depend upon their relative bargaining skills. At the instant the exchange takes place, the price is realized and vanishes, and a state of rest immediately ensues for the two parties that is characterized by an improvement in the want satisfaction of each and a temporary pause in their catallactic activities.
Let us now introduce two more prospective horse buyers into this market, B2 and B3, whose maximum purchase prices for a horse are sixty and fifty bushels of wheat, respectively. Assuming B1’s maximum buying price remains constant at eighty, the equilibrium price range must contract to sixty-one to eighty bushels, as competition on the buyers’ side drives the price up to a level sufficiently high to exclude all but the single most capable buyer. Only a price of sixty-one bushels or above will cause a distribution of goods that is consistent with a state of rest for all participants in the market. For example, at a price of seventy bushels, only B1, the buyer, ranks the horse above the purchase price, while A1, the seller, and B2 and B3, the excluded buyers, all rank the purchase price above the horse and are content to depart the market without it. If the example is altered so that A1 now brings two horses to market, with minimum selling prices of thirty and ten bushels, respectively, then the equilibrium price range will fall and shrink further to fifty-one to sixty bushels of wheat, with B1 and B2 each buying a horse at this price. For it is only a realized price in this range that is capable of producing the lull in the catallactic process that follows from a redistribution of goods in accordance with the complete exploitation of the mutual benefits from exchange.
Menger summed up the general principle of price formation under “monopoly trade,” i.e., a market in which, as above, one side of the market consists of a single seller, as follows: “Price formation takes place between limits that are set by the equivalent of one unit of the monopolized good to the individual least eager and least able to compete who still participates in the exchange [B2, in the above example] and the equivalent of one monopolized good to the individual most eager and best able to compete of the competitors who are economically excluded from the exchange [B3, in the example].”
Menger recognized, moreover, that the same principle that underlies price formation in the case of monopoly does not only apply to “monopoly,” but is an absolutely true and exact law of economics that applies universally to the formation of price in all markets. According to this law, dubbed the law of “marginal pairs” by Böhm-Bawerk, in every market the actual price will always settle at a level that completely dissipates the mutual gains from additional exchange and culminates in a state of rest. Wrote Menger: “Each given economic situation sets definite limits within which price formation and the distribution of goods must take place, and any price and distribution of goods that is outside these limits is economically impossible. . . . Whether a given quantity of a commodity is sold by a monopolist or by several competitors in supply, and independently of the way in which the commodity was originally distributed among the competing sellers, the effect on price formation and on the resultant distribution of the commodity among the competing buyers is exactly the same.”
It is his overarching concern with the causal process of want satisfaction that explains why Menger gives equal emphasis in this passage to “price formation” and “the distribution of goods.” Goods are the proximate cause of want satisfaction and, therefore, the immediate motive for engaging in exchange. This also explains Menger’s focus on historically realized prices, because these prices are, in Menger’s words, simply the “quantities of goods actually exchanged”; hence, it is their payment that generates the mutual improvement of satisfaction among market participants. The momentary “points of rest” that loom so large in Menger’s price theory are the states that prevail immediately after these prices have been paid, when there exist no further opportunities for the mutual enhancement of satisfaction among market participants.
Since the Principles was intended as the first general part of a multi-volume treatise that Menger was never able to complete, it does lack an explicit and detailed discussion of the pricing of the factors of production and, thus, of the money costs of production that are used in the economic calculations of entrepreneurs. This gap in Mengerian price theory was ably filled by Böhm-Bawerk who, in 1886, elaborated the “law of costs”-today we call it the law of marginal productivity-which explained pricing in factor markets in a manner fully consistent with Menger’s explanation of the pricing of consumer goods by the law of marginal utility. With the completion of the Mengerian theory of the pricing process, business entrepreneurship and monetary calculation are finally integrated with consumer choice into a general theory of human action.
This then is Menger’s greatest achievement and the essence of his “revolution” in economics: the demonstration that prices are no more and no less than the objective manifestation of causal processes purposefully initiated and directed to satisfying human wants. It is thus price theory that is the heart of Mengerian and, therefore, of Austrian economics. In a profoundly insightful passage in his eulogy, Schumpeter emphasized this aspect of Menger’s contribution: “What matters, therefore, is not the discovery that people buy, sell, or produce goods because and in so far as they value them from the point of view of satisfaction of needs, but a discovery of quite a different kind: the discovery that this simple fact and its sources in the laws of human needs are wholly sufficient to explain the basic facts about all complex phenomena of the modern exchange economy, and that in spite of striking appearances to the contrary, human needs are the driving force of the economic mechanism beyond the Robinson Crusoe economy or the economy without exchange. The chain of thought which leads to this conclusion starts with the recognition that price formation is the specific economic characteristic of the economy-as distinct from all other social, historical, and technical characteristics-and that all specifically economic events can be comprehended within the framework of price formation. From a purely economic standpoint the economic system is merely a system of dependent prices; all special problems, whatever they may be called, are nothing but cases of one and the same constantly recurring process, and all specifically economic regularities are deduced from the laws of price formation. Already in the preface of Menger’s work [the Principles], we find this recognition as a self-evident assumption. His essential aim is to discover the law of price formation. As soon as he succeeded in basing the solution of the pricing problem, in both its `demand’ and `supply’ aspects, on an analysis of human needs and on what Wieser has called the principle of `marginal utility,’ the whole complex mechanism of economic life suddenly appeared to be unexpectedly and transparently simple.”
Schumpeter (1969, p. 90) concluded that, despite Menger’s other substantial contributions, his “theory of value and price . . . is, so to speak, the expression of his real personality.” If this is so, Menger’s personality lives on in the flourishing praxeological paradigm of contemporary Austrian economics.
Hayek on Knowledge