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Lecture notes, cheat sheets
History of economic thought. Austrian School of Economics (lecture notes)
Directory / Lecture notes, cheat sheets Table of contents (expand) LECTURE 6. AUSTRIAN ECONOMIC SCHOOL 1. The theory of marginal utility as a theory of pricing One of the main postulates of classical political economy was the position that the cost and price of goods are based on labor costs (or, in another version, production costs). But at the same time, the idea, dating back to Aristotle, continued to live that the exchange value and price of a product is determined by the intensity of the desires of the persons entering into the exchange, the “finest hour” of which dates back to the period of the 70-80s of the nineteenth century. This period went down in the history of economic thought under the name “marginalist revolution.” The term "marginalist revolution" is used when talking about the independent discovery in the 70s of the nineteenth century by K. Menger (Austrian), S. Jevons (English) and L. Walras (Swiss) of the principle of diminishing marginal utility. The essence of this principle or law is well known to all of you: the utility that each subsequent unit of a given product brings (this is what is called marginal utility, and the term itself was fixed and remained in science forever thanks to F. Wieser - author's note) is less than the utility of the previous unit of the product. The analysis of the marginal increments of utility of goods meant the transition in economic science to the analysis of marginal values, the analysis of differential equations and derivatives. But if only a new research method had appeared, it would hardly be possible to rightfully talk about a revolution that had taken place. What is much more significant is that the subject of research itself has changed. Since the time of A. Smith, the main directions of research in economic science have been the issues of ensuring the growth of social wealth and the analysis of the role of various factors of production in this process. We can rightfully say that classical political economy studied economic processes at the macro level, paying special attention to the problems of economic growth, that is, economic dynamics. The marginalist revolution marked the transition of economic research from the macroeconomic level to the microeconomic level. The central issues of economic science have become the study of the behavior of economic entities (consumers and firms) in conditions of limited resources. Economics for the first time became a science that studies the relationship between given goals and given limited means. The essence of economic science has become the search for conditions under which production services are distributed with optimal results between competing goals. These are questions of economic efficiency, and it is the marginal analysis that serves this principle. It should be added that the economic model, which is the subject of marginal analysis, is static, where there is no room for problems of economic growth. But we are primarily interested in the connection of the new approaches that the marginal revolution proclaimed with the concept of pricing. This question has been developed most fully by the representatives of the "Austrian school", and we shall turn to an analysis of their views. As we know, since the time of Aristotle, economists have distinguished two sides in a commodity: use value (or utility) and exchange value (the ability of a commodity to be exchanged for another commodity in certain proportions). The founders of political economy (Smith and Ricardo) used labor as the basis that determines the proportions of exchange (the prices of goods). Utility, considered as the objective ability of a thing to satisfy any human needs, was presented only as a condition for the implementation of the exchange. Representatives of the “Austrian school” not only introduced the concept of subjective utility (value) into economics, but also put it forward as the basis for pricing. To better understand the logic of their reasoning, it is necessary to clarify the difference between objective and subjective utility. The first represents the ability (in principle!) to serve human well-being. Subjective utility or value represents the significance of a given thing for the well-being (life enjoyment) of a given person. Therefore, there may be a situation where a thing has utility, but does not have value. For the formation of value, it is necessary that rarity be combined with utility - rarity is not absolute, but only relative, that is, in comparison with the size of the existing need for things of a given kind. And this means that goods have value if they are not enough to satisfy the corresponding needs, otherwise material goods have no value. The first of the representatives of the “Austrian school” to develop this position was K. Menger (1840-1921), professor of political economy at the University of Vienna. He defended the view that price analysis should be reduced to an analysis of individual assessments. Trying to resolve A. Smith's paradox about water and diamond (namely, to explain why diamond is so expensive and water is cheap, without resorting to the labor theory of value), Menger formulated the principle of diminishing utility. According to this principle, the cost (value) of any good is determined by the least utility that the last unit of the supply has. At the same time, when determining the value of material goods, one should take as a basis not the scale of types of needs, but the scale of the specific needs of this particular person. To illustrate this point, it is appropriate to give a table, which is called the “Menger table”. In this table, vertical rows marked with Roman numerals indicate different types of needs and their importance in descending order: I - represents the most important type of need, for example, for food; V is a type of need of medium importance, for example, the need for alcoholic beverages, X is the least important type of need. The numbers within each vertical row (Arabic numerals) illustrate the decreasing urgency of a given need as it becomes saturated in descending order from 10 to 11.
It can be seen from the table that a specific need of a more important type may be lower than individual specific needs of a less important type. For example, the eighth unit of the first type of needs will be of less value or less significance for the well-being of the subject than the first unit of the seventh type of needs. The decrease in the value of goods as their number increased, the representatives of the Austrian school associated with a "deeply rooted property of human nature", when the same kind of sensations, repeating incessantly, begin to give us less and less pleasure, and finally, this pleasure turns even into its opposite - into trouble and disgust. Thus, in the theory of value of the Austrian school, it can also represent a negative value. Here we see the formulation of the law of diminishing marginal utility. But how does this provision relate to the concept of pricing? In the most direct way. The value (price) of a thing is measured by the value of the marginal utility of this thing, the utility of the last unit of the stock of the good that satisfies the least important need. To illustrate, it is appropriate to give an example of Robinson, who has five sacks of grain in stock, of which the first is needed in order not to die of hunger, the second is for maintaining health, the third is for fattening poultry, the fourth is for preparing alcoholic beverages, the fifth - for the maintenance of a parrot. What determines the value of one (any) bag of grain? According to the views of the representatives of the Austrian school, the usefulness of the last bag that satisfies the least urgent need. This marginal unit (utility) determines the actual value of the previous units. Marginal utility, in turn, depends on the amount of goods and intensity of consumption of the individual. Thus, the value depends on the degree of utility and degree of rarity. The first defines the highest point to which marginal utility can rise in a pinch; the second is to what point marginal utility actually rises in a particular case. In other words, the height of marginal utility is determined by two factors: subjective (needs) and objective (number of goods), which, in the framework of the reasoning of the Austrian school, remains given once and for all. However, all the arguments about subjective value cannot explain to us the mechanism of market pricing, where, despite all the diversity of subjective assessments, there is a single price for a product. An attempt to resolve this contradiction was made by the most prominent representative of the Austrian school, E. Böhm-Bawerk (1851-1919), by introducing the concept of objective value, by which he means exchange proportions (prices) that are formed during competition in the market. Böhm-Bawerk's pricing process is most easily explained using his now textbook example of the horse market. So, in the market, buyers and sellers face each other, having subjective assessments of how useful the horse is to him.
Buyers' ratings are the maximum prices they could pay for a horse, and sellers' ratings are the minimum prices they would be willing to receive for their horses. At the same time, Böhm-Bawerk introduces another condition: transactions must be profitable for both buyers and sellers. Therefore, none of them will buy (or sell) a horse at a price equal to his own assessment. In other words, no one will exchange utility for equal utility. How, under these conditions, will the price of a horse be determined? Suppose, following Böhm-Bawerk, that the auction will begin with the announcement of its price by buyers - 130 florins. This price is beneficial to all buyers. But she obviously does not suit the sellers: only the first two are ready to sell horses at a given price. There is an imbalance between supply and demand, so there is competition between buyers to increase the Price, which will inevitably lead to the elimination of individual buyers from the market and the return of sellers. As a result of this process, suppose the price settles at just over 200 florins, leaving the market with six buyers and five sellers. The circle has narrowed, but demand is still greater than supply. The price rises further and at the price of 210 florins the sixth buyer will leave the market. Demand equals supply. But sellers, in a natural desire to get as much profit as possible, increase the price by holding the horses. The price rises, but as soon as it exceeds 215 florins, a sixth seller enters the market and the equilibrium is again disturbed. So the price is known. It settled in the range from 210 to 215 florins inclusive. At this price, the demand for horses and their supply are balanced. Consequently, according to Böhm-Bawerk, the market price will fluctuate between the maximum and minimum prices as a result of a collision in the markets of subjective assessments of sellers and buyers. At the same time, the level of the market price cannot be higher than the estimate of the first excluded seller (upper price limit) and lower than the estimate of the first excluded buyer (lower price limit), since otherwise the achieved equilibrium is violated. This pricing scheme is interesting already because it completely ignores not only the role of labor, but it even lacks the concept of "production costs". The only figure in the economic system is the consumer. (As a consumer in this scheme, the seller is also considered, who, at a market price less than his subjective assessment, will himself demand for his products. In our example, he will lead his horse out of the market). The first thing that attracts attention in the theory of value of the Austrian school is the absolute inelasticity of supply. The theory is based on the assumption that the stock of goods is a fixed value. Indeed, under these conditions, the value of a particular commodity (good) depends solely on demand, which varies depending on the marginal utility of these goods. This means that the principle of marginal utility, developed by representatives of the Austrian school, is applicable to the analysis of individual consumption in a subsistence, isolated economy (the so-called Robinsonade principle). And even if we take the Böhm-Bawerk model of a market economy (an example of a horse market), then it does not work in relation to the seller, who is placed in the real conditions of developed commodity production. The seller, the owner of the commodity and its producer, can be guided by the principle of marginal utility in determining the price, selling only excess goods on the market. Therefore, the seller must conduct subsistence farming. However, in a developed market economy, mass production for the market becomes typical, and within the economy the products produced by it are not consumed at all, and the complete absence of utility-based assessments of goods on the part of the households producing them becomes typical. And secondly, the very mechanism of the equation of marginal utility in the process of exchange occurs under the assumption of the available price and the given incomes of the consumer. This means that the subjective assessments themselves are determined by the level of price and the amount of income, and outside the price system there is no quantitative definition of utility. Both critics and followers of this theory drew attention to such obvious shortcomings of the theory of marginal utility as a theory that claims to explain the process of formation of value (cost). When considering the theory of marginal utility, it would be unfair to pass over in silence a man who formulated the law of marginal utility much earlier than representatives of the Austrian school, but whose ideas went unnoticed. It was the German economist G. Gossen, who in 1854 published the work “Development of the laws of social exchange and the resulting rules of human activity,” where he tried to formulate the laws of rational consumption by an individual of a limited amount of goods, which later became known as Gossen’s first and second laws. The essence of Gossen's first law: the amount of satisfaction from each additional unit of a given good in one continuous act of consumption steadily decreases and is equal to zero when saturated. This is nothing more than the law of diminishing marginal utility. According to Gossen, every pleasure is a mathematically determined quantity, decreasing as the pleasure continues. This assumption allowed him to assume that there are very specific moments when a person must interrupt one pleasure and move on to another. The formulation of the rule on the basis of which these points are determined is called Gossen’s second law in economics. The essence of Gossen's second law: maximum satisfaction of needs with a limited number of available goods is achieved when the consumption of each good stops at the point where the intensity of pleasure (utility) is leveled out and becomes the same for everyone. In other words, in order to obtain maximum utility from the consumption of a given set of goods over a certain period of time, it is necessary to consume them in such quantities that the marginal utility of all consumed goods would be equal to the same value. Various pleasures, according to this law, must be interrupted at such moments in time that as a result the last, infinitesimal particles of all pleasures are equal. One version of the formulation of this law is as follows: “In order to achieve maximum pleasure in life, a person must distribute his time and energy in achieving various types of pleasures in such a way that the value of the ultimate atom of each pleasure received is equal to the fatigue that he experienced spending your energy at the last moment.” Considering the conditions of a monetary economy and denoting marginal utility as MU, and the price of a product as P, the essence of Gossen’s second law can be expressed by the following equation:
This law can be interpreted as the law of equal marginal utilities per monetary unit of income. The consumption of each commodity continues until the marginal utility per unit of income (say, a ruble) spent on it becomes exactly equal to the marginal utility per ruble spent on any other commodity. And although Gossen's theory of consumption does not seem to be a very successful abstraction, Gossen's laws formed the basis of microeconomic theory for the next century, and the utility maximization methodology proposed by him entered economics as a classic decision-making logic. 2. Theory of production costs According to the ideas of the Austrian school, the only factor determining the proportions of the exchange of goods, and, accordingly, the price, is their marginal utility. This led to the logical conclusion that productive (capital) goods have no value, since they do not directly satisfy human needs, that is, they do not have direct utility. But it is quite obvious that in a real economy, productive goods have value and their prices form the cost of production. How is the problem of production costs solved within the framework of the ideas of the Austrian school? In economics, the theory of production costs, like the theory of value, exists in two versions: the theory of objective and subjective costs. Recognition of the objective nature of costs is characteristic of the classical school, where the prices of production factors were derived from the so-called natural rates of remuneration, and their levels were determined by individual theories. Land rent was defined as the differential surplus over and above the marginal cost of cultivating the land, wages as the long-term cost of the worker's livelihood, and profit as the residual. Within the framework of the classical school, the reality of production costs was not questioned. But it is no coincidence that the Austrian School is called a subjective psychological school. She announced that real costs are nothing more than an ancient delusion, and one of the representatives of the Austrian school, F. Wieser (1851-1926), developed a subjective theory of costs. The starting premises of this theory are two provisions. The first provision states that productive goods are future, potential goods, their value is derivative and depends on the value of the final product that brings immediate satisfaction. Consequently, it is not the costs of production that give value to products, but, on the contrary, the costs of production acquire value from their products, just as the moon shines by the reflected light of the sun (in the figurative expression of Böhm-Bawerk). It turned out, according to the views of the representatives of the Austrian school, that consumer goods themselves give value to those production resources or factors that are involved in their production. Goods of the first order (consumer goods - author's note) convey value to the goods of higher orders that are needed so that those very first-priority goods can be born. This idea is the famous "theory of imputation" of the Austrian school. The second proposition boils down to the assertion that supply is the reverse side of demand - the demand of those who possess the goods. At sufficiently low prices, producers themselves will show demand for their products. In our example with the horse market, if the market price is below the value of the horse's usefulness by a particular seller, he will take it away from the market, since he estimates its usefulness in his household higher. It follows that supply is driven not by real costs, but by the costs of abandoning other uses, including use by the producer himself. In other words, costs are nothing more than the necessary payment for diverting resources from other use cases; as prices offered for the services of factors used for its production by other competing producers. We can rightfully consider Wieser to be the author of the "opportunity cost concept", which presented both demand and supply as dependent on utility, reducing all costs to the forfeiture of utility. In this theory, costs are nothing more than a form in which an individual is informed of the "desirability" of the possession of a thing by some other person. But what is the mechanism of formation of the value of productive goods? Having singled out the smallest marginal utility from the sum of consumer goods that are created by a certain production good, Wieser called it the marginal product. Using this concept, Wieser formulated the law: the marginal utility of the marginal product determines the price of the productive good that went into its production, and the corresponding part of the production costs, which determine the marginal utilities of other, non-marginal consumer products produced from the specified good (the so-called Wieser's law). A rather heavy construction, which required the introduction of such a concept as "marginal utility of the marginal consumer good." But the difficulties did not end there. After all, in fact, the totality of productive goods (labor, capital, land) is involved in the creation of consumer goods. Representatives of the Austrian school were faced with the need to resolve a rather difficult question: what part of the value of consumer goods should be attributed (imputed) to this or that productive good. And although their theory is not complete, the approach to the problem seems to be quite definite. It is recognized that in order to obtain “economic benefit” the joint action of several material goods is required, and if one of them is missing, the goal cannot be fully achieved. Menger called such material goods Complementary (mutually complementary). The total value of a given group of material goods is determined by the magnitude of the marginal benefit that all these material goods can bring when used together. If, for example, three material goods: A, B and C form a complementary group, and if the marginal benefit that these material goods can bring when used together is 100 units, then the value of all three material goods together will also be equal to 100. However, In real life, a situation is common when individual members of a complementary group retain the ability to bring a certain benefit outside of sharing. Let us assume, taking our example, that good A, taken separately, can provide marginal benefit - 10, B - 20, C - 30 units. Therefore, the total marginal benefit in the case of separate use will be 50 units. The question arises: to which factor should we attribute the “surplus” of marginal utility that arises when goods are shared? Representatives of the Austrian school, in particular Böhm-Bawerk, believe that this surplus of utility should fall on the share of the goods that are most difficult to replace. Böhm-Bawerk confirms the correctness of his hypothesis by citing the fact that it is in practical life that production costs, which are expenses on replaceable production goods (hired labor, raw materials, equipment), are subtracted from the total amount of income. Net income is attributed to members of the complementary group that cannot be replaced (land, factories, entrepreneurial abilities). This position is a peculiar combination of J.B. Say's concept of the three factors of production with the theory of marginal utility. But even if we accept this position, the question remains open about the mechanism for clearly quantifying the share of each factor in the price of the product. Representatives of the Austrian school have no answer to this question. Concluding the question about the theory of costs of the "Austrian school", it should be said that for all its imperfections, many provisions have become part of modern economic theory. In particular, this is the provision that the value of the means of production is of a derivative nature, which has entered the modern course as a provision on the derivative nature of the demand for factors of production, depending on the demand for final products, and, of course, the concept of opportunity costs. 3. Böhm-Bawerk's theory of interest Since any economic theory is quite logical and complete, one should not be surprised that the concept of opportunity costs is also present in the theory of capital and interest, developed by one of the most prominent representatives of the Austrian school Böhm-Bawerk. He considers this problem in Capital and Profit (1879). The theory of interest as a subjective category is present in its rudimentary form both in the above-mentioned English economist Senior, who considers interest as a payment for the “abstinence” of the capitalist, and in J. S. Mill. But this theory acquired harmony and completeness precisely from Böhm-Bawerk, who explained interest using the principle of “diminishing marginal utility” and the concept of opportunity costs, common to the Austrian school. Böhm-Bawerk's theory of interest is sometimes called the "psychological theory of interest." What is the source of interest? Interest, according to Böhm-Bawerk, arises from the abandonment of current income in favor of the future. There are always people in society who are willing to pay for the pleasure of having money today. The opportunity to have an income today, and not in the future, receives its assessment, which is the rate of interest. But why are people willing to pay for the possession of goods today? The reason for this, according to Böhm-Bawerk, is rooted in people's underestimation of the future, resulting from an underdeveloped imagination, the transience of life and uncertainty about the future. As a result, there is an excess demand for consumer credit, which leads to a positive rate of interest. Thus, the origin of interest is associated by Böhm-Bawerk with the factor of time. But it is not only the consumer who values current goods above future ones, but also the owner of money capital. The reason is that the latter presupposes an increase in the future of this good, and consequently, a decrease in its marginal utility in the future compared to the present. By the way, this explains why in a dynamically developing economy (which implies an increase in the income of the population), the rate of interest will always be positive. People maximize utility throughout their lives, and then, in the face of rising income, an increase in current consumption will provide more utility than an increase in consumption in the future. Thus, with Böhm-Bawerk, the whole problem is reduced to the price of time. Here we see an unexpected similarity with the views of F. Aquinas, who considered interest as a payment for the time provided by the lender to the borrower. However, time, like the "waiting" of the capitalist, cannot in itself be a source of value, just as our sitting under it cannot be the source of the ripening of the fruit of a tree. At best, this can be seen as a condition, but by no means as a cause. To admit that the source of all forms of income, including interest, is the unpaid labor of workers, as Marx did, Böhm-Bawerk cannot, and therefore offers a rather original solution to the problem. According to his logic, "labor is the boon of the future", since it creates a product after a certain time. Consequently, the worker, in Böhm-Bawerk's theory, appears as the owner of the "future good", and the entrepreneur who hires the worker gives him the "present good" in the form of wages. Such is the process of exchange of goods between workers and employers. The benefits created by labor after the expiration of time, due to the lower valuation of future benefits compared to the present, will exceed in value the amount of remuneration paid for labor. This excess will be the percentage or profit. According to Böhm-Bawerk, the voluntary nature of the exchange reflects the equivalence and fairness of the relationship between the employer and the worker. As we can see, in Böhm-Bawerk all capital is presented in the form of means of subsistence advanced by the workers, and he considers the capital market as a market of advances in which today's income is exchanged for the future. The rate of interest expresses the conditions under which these alternatives are available to individuals. Thus, the rate of interest is determined by the exchange of labor for consumer goods. Workers underestimate the future, because they cannot wait long for the fruits of their labor, and therefore the results of the net productivity of capital are appropriated by its owner. It should be noted that Böhm-Bawerk could not give a clear answer to the question of who should determine the difference in the value of present goods and future goods. It was necessary to find some kind of objective evaluation factor, since the subjective evaluations of neither the worker nor the capitalist were suitable for this role. Therefore, Böhm-Bawerk includes in the theory of interest the idea of indirect ("roundabout" - in his terminology, author's note) methods of conducting production, meaning by them the lengthening of the period of production based on the use of capital-intensive processes. This elongation is justified by the known number of production links of an intermediate nature, which takes place before the creation of the good. If, for example, Robinson Crusoe, argues Böhm-Bawerk, uses part of the time for the manufacture of tools to the detriment of collecting the necessary food, then his supply of consumer goods will decrease. However, in the future, more advanced tools of labor will allow Robinson to significantly increase the supply of goods compared to the present. This expresses the net productivity or productivity of capital. This means that the role of capital in production lies in the fact that it makes it possible to use more productive "roundabout" methods of production, which, however, also require large expenditures of time. Böhm-Bawerk put forward the position that the value of interest is determined by the lengthening of the periods of production of individual goods as a result of the development of indirect methods of production. Thus, the value of interest is determined by the net productivity of capital, that is, its ability to bring a certain excess of product in excess of the cost of its application, where the interest just measures the additional increase and serves as an indicator of the net productivity of capital. At the same time, the technical superiority of today's goods over future goods lies, according to Böhm-Bawerk, in the fact that today's goods invested in roundabout production will make it possible to obtain more product in the future than the same amount of goods invested in direct production in the future. It must be said that this is a weak point of his theory, since the investment itself is limited by the time during which we are willing to wait before we begin to receive a return. And although in Böhm-Bawerk's theory interest acts both as a reward for waiting and as an indicator of the net productivity of capital, in the end everything again comes down to a positive norm of time preference. The ideas of the Austrian school became widespread and, as we shall see later, became an integral part of many economic theories. However, the obvious "one-sidedness" of the theory of marginal utility, which claims to explain all economic processes, predetermined the growth of the influence of the English and American economic schools, to the consideration of the views of whose representatives we will turn. Author: Agapova I. I. << Back: Marxist political economy (Economic views of K. Marx. Social and philosophical views of K. Marx) >> Forward: Anglo-American School of Economics (The theory of marginal productivity by J. Clark. Economic views of A. Marshall)
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