Rejecting Classical Cost Theory, Menger Filled the Gap with a New Version of Galiani's and Condillac's Cost Theory

Menger based his theory of imputation entirely on utility and not on costs. He rejected the classical cost theory, but he still had to explain the value of the factors of production, for otherwise an empty spot remained in his system. He filled the gap with a new version of Galiani's and Condillac's cost theory. Not the value of the cost goods determines the value of the finished goods, but the opposite is true; the value of the consumer goods or, in Menger's terminology, the value of the goods of lower order determines the value of the factors of production or goods of higher order. Menger introduced an interesting refinement into Condillac's statement: not the actual marginal utility of the consumer good but the presumed future value determines the value of capital, labor, and land. Menger, in a theory of production and distribution, emphasized the time element much more strongly than Galiani and even Gossen.

Menger understood quite well that the transfer of value creates a new problem, because factors of production are complementary. They work together in the production of consumer goods. Menger, like Gossen, tried to find a key with which the marginal value of consumer goods can be distributed on each factor inside the factor combination; in this Gossen was more skeptical and cautious than Menger. The latter believed indeed that the problem can be solved and that he had already done so. His interpretation contains ideas which Gossen had already mentioned, and some new suggestions which his student Boehm-Bawerk had refined. Menger's and Boehm-Bawerk's theorem will be discussed together. What Menger thought about this problem is not as important as the fact that he started a discussion in the Austrian camp which is still going on.

—Emil Kauder, A History of Marginal Utility Theory, Princeton Legacy Library (Princeton, NJ: Princeton University Press, 1965), 79.

“Menger's Law” States That the Value of All Goods Derives Ultimately from the Utility of the Services of Consumer Goods

Carl Menger, the founding theorist of the Austrian School of Economics, suggested that the material world was composed of goods and services and considered the end of all economic activity to be the consumption of valuable services produced by goods of various “orders.” He divided goods into two exclusive kinds: free goods and economic goods. Free goods are those for which, at a zero price, less would be desired than is available. By contrast, economic goods are those for which, at a zero price, more would be desired than is available. Economic goods are scarce, have value, and will command a positive price if freely traded. Economic goods have value because they yield desirable services. These services provide consumers with utility.

Economic goods may, in turn, be divided into two types: those whose services yield utility directly, first order or consumption goods, and those whose services provide utility indirectly, production goods, or higher-order goods. Production goods provide services that are used in the production of other production goods successively in a supply chain leading to the emergence of consumer goods that provide services yielding utility. Thus, the value of all goods derives ultimately from the utility of the services of consumer goods (Israel Kirzner has called this “Menger’s Law”).

The distinction between stocks and flows is fundamental and important and often neglected. People do not desire goods “in themselves”; they desire what flows from having or renting them. It is the services of goods that are the ultimate objective of economic action. As Menger points out, these can be obtained directly from nature or indirectly by production, using produced instruments of production, production goods.

—Peter Lewin and Nicolas Cachanosky, Austrian Capital Theory: A Modern Survey of the Essentials, Cambridge Elements in Austrian Economics (Cambridge, UK: Cambridge University Press, 2019), 5.

James Buchanan Wrote That the Opportunity-Cost Concept Was Explicitly Developed by the Austrian School Economists

For Wicksteed, the only sense in which cost plays a role in the explanation of the market price is that in which cost is the anticipated value of a prospective alternative which is, at the moment of production decision, being rejected in favor of what it is decided to produce.

It is this view of Wicksteed which led Professor James Buchanan to write that the

opportunity-cost conception was explicitly developed by the Austrians, by the American, H.J. Davenport, and the principle could scarcely have occupied a more central place than it assumed in P.H. Wicksteed's Common Sense of Political Economy.

As Buchanan has emphasized, Wicksteed's work “was a major formative influence on the cost theory that emerged in the late 1920s and early 1930s at the London School of Economics [LSE].” Certainly Robbins's own recognition of the Austrian School during these years, and his own intellectual leadership at the LSE at this time must have helped cement the perception of intellectual affinity linking Wicksteed with the Austrian School.

—Israel M Kirzner, “Philip Wicksteed: The British Austrian,” in 15 Great Austrian Economists, ed. Randall G. Holcombe (Auburn, AL: Ludwig von Mises Institute, 1999), 107.

People Evaluate Goods Based on “Marginal Utility,” i.e., People Value Goods Unit by Unit

One of the most important advances in economic theory was the realization that people valued goods unit by unit, rather than comparing entire classes of goods against each other. Using their jargon, economists now say that people evaluate goods based on marginal utility.

The classic illustration of this new way of thinking is the so-called “water-diamond paradox.” At first glance, it seems odd that the price of water should be so low—restaurants will serve it for free!—while the price of diamonds should be so high. (Try asking your waiter for a complimentary glass filled with diamonds.) If economists think that the value of goods is ultimately related to humans trying to satisfy their subjective goals, how can diamonds possibly be more valuable than water? After all, you can’t satisfy too many goals if you die of thirst.

In the early 1870s, three different economists independently worked out the solution to this problem: Yes, it’s true that the way to explain the value of an object, is to get inside the head of the person who values it and understand his goals. But when this person makes actual choices in the real world, he never faces the tradeoff of “all the water” versus “all the diamonds.” If that really were the choice, then the person would most probably pick the water. But in normal life, there is so much water available that any particular gallon of it, has a very low value. In contrast, there aren’t enough diamonds to go around to satisfy all the uses people have for diamonds. That’s why any particular diamond is still quite valuable. Economists would say that diamonds are scarcer than water.

—Robert P. Murphy, Lessons for the Young Economist (Auburn, AL: Ludwig von Mises Institute, 2010), 59-60.

“A Priori” to Mises Means “Independent of Any Particular Time or Place”; It Does Not Imply Independence from all “Experience”

Praxeology represents an attempt to escape the nihilistic implications of both historicism and empiricism. It affirms the operation of inviolable laws within the realm of human action. It purports to establish the universal validity of these laws by deducing them from the allegedly incontestable truth that people act purposefully, the “axiom of action.” Although supposedly irrefutable, this axiom is not merely “analytic,” i.e., non-empirical or vacuous. It is based upon the reality of the pursuit of ends and the choice of means for their attainment that distinguishes all mental (and, hence, human) activity. Thus a priori to Mises means “independent of any particular time or place.” It does not imply independence from all “experience,” although it does denote independence from the sort of sensory experience that empiricism and positivism emphasize: “It rests on universal inner experience, and not simply on external experience, i.e., its evidence is reflective rather than physical.” Sense data alone, on the other hand, could not reveal to us the essential purposefulness of human actions.

—George A. Selgin, Praxeology and Understanding: An Analysis of the Controversy in Austrian Economics (Auburn, AL: Ludwig von Mises Institute, 1990), 14.

Mises Regarded Keynes's “G” As the Most Unscientific Balancing Wheel Economic Managers Could Employ

By the same token, Mises has no stomach for the idea that a nation could simply deficit-spend its way to prosperity, as advocated by many of Keynes’s followers. He holds that such economic thinking is fallaciously based on governmental “contra-cyclical policy.” This policy calls for budget surpluses in good times and budget deficits in bad times so as to maintain “effective demand” and hence “full employment.”

But Mises regards the “G” in Keynes’s “full employment” formula of Y = C + I + G; (National Income = Consumption Spending + Investment Spending + Government Spending) as about the most unstable, politics-ridden, and unscientific balancing wheel that the economic managers could employ. For one thing, the formula ignores the political propensity to spend, good times or bad. And for another, it ignores market-sensitive cost-price relationships and especially the proclivity of trade unions and minimum wages to price labor out of markets—i.e., into unemployment.

Thus he holds Keynesian theory, in practice, proceeds through fits of fiscal and monetary expansion and leads to inflation, controls, and ultimately stagnation. Further, “G,” so used, generally means the secular swelling of the public sector and shrinking of the private sector—a trend that spells trouble for human liberty. In a way, he anticipated and rebutted the Keynesian thesis a quarter-century ahead of Keynes in his 1912 work, The Theory of Money and Credit, in which he contended that uneconomic wages and forced-draft credit expansion, and not capitalism per se, carried the seeds of boom and bust.

—William H. Peterson, Mises in America (Auburn, AL: Ludwig von Mises Institute, 2009), 12-13.

Economic Law Triumphs over the Attempts to Confer Upon Bad Money the Purchasing Power of Good Money

Such a law, among others, was considered to be that of supply and demand, which again and again had been observed to triumph over the attempts of powerful governments to render bread cheap in lean years by means of “unnatural” price regulations, or to confer upon bad money the purchasing power of good money. And inasmuch as in the last analysis, the remuneration of the great factors of production—land, labor, and capital—in other words, the distribution of wealth among the various classes of society, represents merely one case, although the most important practical case of the general laws of price, the entire all-important problem of distribution of wealth became dependent upon the question of whether it was regulated and dominated by natural economic laws, or by the arbitrary influence of social control. . . .

Often enough one has seen governmental price regulations to be incapable of providing cheap bread in lean years. Every day we may see strikes failing, when they are directed towards the attainment of wages “not justified in the economic situation,” as it is commonly expressed. The question, therefore, is not whether the “natural” or “purely economic” categories on the one hand, and the “social” categories on the other, do exert any appreciable influence on the terms of distribution; that both do, no intelligent person will deny.

The sole question is this: how much influence do they exert? Or, as I have expressed myself several years ago, in reviewing an older work by Stolzmann entitled “Die Soziale Kategorie,”

The great problem, not adequately settled so far, is to determine the exact extent and nature of the influence of both factors, to show how much one factor may accomplish apart from, or perhaps in opposition to, the other. This chapter of economic theory has not yet been written satisfactorily.

I should like to go almost so far as to say that, until quite recently, not even a serious attempt has been made to elaborate this problem by either one of the two great schools that compete with each other in the perfecting of our science: the theoretical school, represented primarily by the well-known “marginal-utility theory,” and the historic or sociological school, which, in its struggle against both the old classicists and the modern marginal-value theorists, likes to place the influence of control (Macht) into the very heart of its theory of distribution.

—Eugen von Böhm-Bawerk, Control or Economic Law (Auburn, AL: Ludwig von Mises Institute, 2010), 7, 9.

As Forrest Gump Might Say: “Austrian Economics Is a Lot Like a Box of Chocolates”

The meetings of the Mises Kreis [Mises Circle] always started punctually at seven on a Friday evening. Mises would be sitting at his desk and usually he had a large box of chocolates that he passed around. The meeting would last until half past nine or ten, after which the participants would have dinner at the Italian restaurant ‘Anchora Verde’. Those who wanted to continue the discussion would then head to Café Künstler (Kurrild-Klitgaard, 2003). But undoubtedly the most striking ritual of the Mises Kreis has to be the songs that Felix Kaufmann wrote in honor of the seminars. The songs deal with the critical spirit of the circle (‘Geschliffener Geist in Mises-Kreis’), particular debates within the circle, the Austrian tradition (‘Der letzte Grenadier der Grenznutzenschule’). Other songs were written for special occasions; there is a song of celebration for the opening of the statistical institute, a goodbye song to Mises when he departed for his position in Geneva in 1933 and a song lamenting this departure. One of the most striking of these songs is called ‘Der Nationalökonom im Paradies’ (The economist in Paradise). So no, that is not a typo in the subtitle of this chapter in case you were wondering.

Now it is easy to think of these songs as a kind of curiosity, but that would be too easy. Many years later, Haberler was still able to sing these songs word for word, and he emphasizes that all regular participants could recite these songs (Haberler in Kaufmann, 1992). The songs were written to well-known melodies and Haberler stresses that these songs were meant to be sung, not to be read (although even reading them is a delight). Such rituals established a certain rhythm to the meetings of the Mises Kreis, and provided a sense of belonging where the university could not do so. The songs legitimized the discussion taking place in the Mises Kreis. Take for example, the following fragment: “An economist moved to Germany / A learned position to pursue / This should have been a certainty / For in Wien he’d learned a thing or two / But the good man learned the tragic tale / Marginal Utility was deceased” (Kaufmann, 1992). In the official Mises-Kreis song, all the rituals discussed, including the delicious chocolates, are celebrated. In the final verse of the song — the epigraph to this chapter — Kaufmann wonders whether all these intellectual discussions lead anywhere, while life outside goes on as usual. Was it not easier to follow the stream, instead of attempting to change its course? Only to conclude affirmatively: “And yet there’s no tradeoff at hand / Somehow we must take a stand” (Kaufmann, 1992).

Such rituals established internal coherence and legitimacy, the overlap between the circles meant that a strong internal identity would also become known in other circles. In fact, there was a curious interdependence between all these Kreise. The identity of such circles was often defined in opposition to other circles. The Mises Kreis was opposed to the positivism of the Wiener Kreis and the romantic universalism of the Spann Kreis.

—Erwin Dekker, The Viennese Students of Civilization: The Meaning and Context of Austrian Economics Reconsidered, Historical Perspectives on Modern Economics (New York: Cambridge University Press, 2016), e-book.