In 1871, Carl Menger, the founder of Austrian school, wrote The Principles of Economics, where he tries to show how factor prices depend on product prices; and how labour supply depends on utility of leisure. Menger admitted that value and utility are totally subjective, independent of labor and other inputs. In his Theory of Value he showed the hypothetical values of marginal utility.
Menger’ work made the significant impact into the economic theory in 19th century and it even began a new school of economic thought – Austrian school. There were several prominent economists in the school including Ludwig von Mises who wrote the paper on dependence of interest rates on time preference, Boehm Bawerk has made the significant impact into the theory of capital and interest, Friedrich von Hayek, another Austrian, stated that economic calculation required the competitive enterprise of markets, he was against socialism and considered that socialism would not be effective. Basically, Austrian school put emphasis on the importance of basing theory on individuals and their subjective values. Besides marginal analysis, Austrian theory underlines the complex reality of human nature on the market, the uncertainty of the future, the importance of the various aspects of capital, and the unstructured nature of knowledge.
Besides Menger, two other economists, Jevons and Walras founded marginal utility theory that came to dominate neoclassicism. Walras showed how all prices could be determined together in a general equilibrium, with a model of an entire economy where prices of goods and services are the solution for the entire system. He was the first who stated that prices and income are independent. Jevon shows how relative prices must depend on marginal utility. Both Jevons and Walras ignore production, analyzing “pure exchange”. In addition to French economists, the English school, led by Alfred Marshall, developed the theory of supply and demand, integrating utility theory and classical cost theory with demand and supply curves. Marshall also developed theory of factor supply: invented concept of “real cost” as sacrifice (applying to capital as well as labour). Developing partial equilibrium analysis Marshall is considered to be practical since he applied this analysis to particular markets and industries.
Comparing with Jevons and Walras, it is obvious that Menger used his analytical apparatus and not used mathematics in his work. For those economists, economics was basically concerned with the explanation of prices and resource allocation. For Menger theory, however, pricing and resource allocation were only of secondary interest, because he thought that mathematics would not be able to cover the complex reality of human nature. Menger considered that math can be used only where there is no change.
Where Walras and other neoclassic economists stated that equilibrium pattern of prices should be view from a logic of marginal utility, Menger had different point of view and rejected the statement that the same product sell everywhere for the same price. Such price uniformity might arise in some historical settings, Menger would surely acknowledge, but the main problem would be to explain how such uniformity was formed, and not to impose it by assumption. So, Jevons, Walras and Marshall worked on expounding logic of assumed equilibrium prices on with explaining the formation of prices as Menger did.
Since the Austrian economists hold all costs and benefits to be subjective and, therefore, not measurable, only the individual can decide what actions are efficient or inefficient. Often the individual may decide, after the fact, that a decision was not efficient. In the actual process of acting to achieve an end, an individual will discover what works best. And even then, what worked best this time may not work best next time. But a person cannot know this without the process of acting.
One of the most important differences in the vision of economics is Austrian economists’ view of Central Planning. Austrian economists considered that companies in the real world did not have perfect knowledge, they did not know what a successful competitive strategy was until they tried it. They stated that competition was a "discovery procedure”. Mises and Hayek were not only prominent economists, but also excellent prophets because they have predicted long ago the failure of centrally planned economies (for instance, USSR) in which the resource were allocated in order to meet the most basic human needs. Their point was that all people in an economy possess knowledge (about quality, about materials). This knowledge is constantly changing and dispersed throughout the economy. In a centrally planned economy the information available to the planners is a tiny fraction of the amount in various people's heads. Therefore, much information in a centrally planned economy is never acted on. Socialism holds that the means of production should be in collective hands. This means no buying or selling of capital goods and thus no prices for them. Without prices, there is no profit and loss test. Without accounting for profit and loss, there can be no real economy. Should a new factory be built? Under socialism, there is no way to tell. Everything becomes guesswork.
However in a free market, only individuals know the current situation on the market and if one wants to manage it centrally, he will be bound to fail. Free market allows people to bid for resources, which in turn generates market prices for these resources. People can make their own decision of what goods to buy or sell, and how to use them. The very act of buying a good at a particular price signals the producer to continue producing and selling this good. A market price summarizes the diverse knowledge of millions of individual human beings as they act in the market. The producer does not have to know why customers choose their products, only that they do. And profits are also knowledge signals in the market that direct resources into one industry and out of another. This is why Austrian economists have always been highly critical of central planning and strong supporters of a free market.
Thus, Menger had very different vision of economics from Walras, Jevons and Marshall whether because of his view on subjective valuation, on disequilibrium, on his lack of mathematics – I should recognize that much of his work and insights have contributed to the development of modern economics, in general, and to the foundation of Austrian school, in particular. At present, their analysis of central planning is used by many prominent economists.
References:
- Ecklund, Robert B. Jr and Rober Hebert, \\\"A History of Economic Thought and Method\\\" 4th edition, McGraw-Hill, New York, 1997.
- "Classics in Economic Thought, McGraw-Hill, 1996. (Hereafter, CET)
