This is the second lecture given at the Mises University. Any errors are mine, feel free to point them out so that I can correct them.
This lecture was given by Prof. Salerno.
Introduction
- Fathers of the marginalist revolution:
- Menger (logical)
- Jevons (mathematical)
- Walras (mathematical)
- Menger (logical)
- Jevons and Walras thought that Marginal Utility was a quantity; Menger thought it was personal utility.
- According to Menger, Austrian economics is the expounding of Marginal Utility.
- Menger is considered the founder of the Austrian school by all of his successors.
- Before Menger, economists thought that price was determined by the cost of production.
- Menger: Prices are determined by changes in peoples preferences and needs. He thus set out to determine the relationship between objective things and prices.
The Classical School
- Members:
- D. Hume
- D. Ricardo
- A. Smith
- D. Hume
- Prices are determined by supply and demand; the Classicists focused on the businessman and did not focus on the consumer.
- Prices are determined by natural law.
- Entrepreneurs make decisions via these prices.
- Prices are determined by natural law.
- Classical explanation:
- Prices increase.
- Entrepreneurs see this.
- Entrepreneurs thus produce more of that which is priced higher.
- Prices then fall down, so that profits approach the normal rate of interest.
- Prices increase.
- The Classical economists focused on the businessman, but didn’t consider why prices changed.
- Classicists wrongly looked at classes of goods, not just specific goods on the margin.
- Classicists faced the paradox of use value vs. exchange value, the so-called ”Paradox of Value”: Diamonds have a low use-value, but a high exchange value — how do you explain this?
- Classicists tried to determine / understand value through the “objective”; value was determined by the cost of production.
- Note: Menger renamed use-value to subjective value, exchange value to objective value.
- Can explain the price of an SUV by the Cost of Production (COP), but not the price of some rare antique; this is absurd.
- Classicists did not answer the Socialists because they didn’t focus at all on the underlying institutions making all of this possible.
Menger’s Approach
- Man is the beginning and cause of all economic activity.
- From Bastiat: All economics is to satisfy human wants.
- Menger linked the satisfaction of human wants to the actual prices, which no-one had done before him.
- All things are subject to cause and effect.
- Humans are means and ends to the economic politic.
- Dual causality:
- Goods are consumed for the satisfaction of human wants.
- The satisfaction of human wants is what causes the production of goods.
- Goods are consumed for the satisfaction of human wants.
- Focused on goods.
- Four prerequisites to a Good:
- Human need.
- Objective capacity in thing to satisfy that human need.
- Humans must know that the thing can satisfy the need, and know how to use
that thing to satisfy the human need.
- Human beings must have the ability to control the thing.
- Human need.
- A few notes on the Four prerequisites to a Good:
- Mises: (2) is wrong: People only need to believe that the
thing can satisfy a human need; thus, criteria (2) and (3) are redundant and can be
combined into one criteria. Carl Menger had already partially accounted for this with the term “imaginary good”.
- Economic goods: Economic goods meet all four criteria and are scarce in relation to human needs. Today, in modern Austrian economics, we just say “good” and don’t refer to “non-economic” goods as goods at all; e.g., we do not refer to the air as a good in most cases.
- Mises: (2) is wrong: People only need to believe that the
Marginal Utility to Determine Price
- With understanding of what it means to be an economic good, we can explain price.
- Consider 5 sacks of wheat in Crusoe economics, and these value-scale:
- 1st sack — life
- 2nd sack — health
- 3rd sack — seed for future harvest
- 4th sack — feed for farm animals
- 5th sack — whiskey
What determines the value of a sack of wheat?
- If he loses a sack, he’s going to lose his 5th use-ranking.
- He loses the satisfaction from the lowest ranked end that can be satisfied with the given supply — Marginal Utility.
- So, he values it at its Marginal Utility.
- As supply increases, the lowest ranked end that can be satisfied goes down the value scale, so that Marginal Utility decreases; thus, price decreases (diminishing Marginal Utility).
- 1st sack — life
- Consider the following value-scale in Crusoe economics, where Crusoe has three horses and two cows…If he had to lose one, which would it be?
- 1st: Horse — plow
- 2nd: Horse — plow
- 3rd: Cow — milk
- 4th: Cow — cheese / butter
- 5th: Horse — riding
It would be a horse, because the horses have the lowest Marginal Utility.
- 1st: Horse — plow
- There are no units of Marginal utility, but simply rankings; e.g., one may rank product X above the price paid, or product Y above the price paid.
Implications of Marginal Utility
- The structure of causality is like such, with subjective price-determination via imputation from consumer-wants to producer-goods prices:
want-satisfaction => rendition of service or goods => consumer goods => producer goods
- The objective structure of production, however, of course, goes in reverse:
producer goods => consumer goods => rendition of service or goods => want-satisfaction
- Classicists have it exactly wrong when they say value is determined by the Cost of Production.
- Production goes the other way, from producer goods to consumer want-satisfaction.
- Orders of goods:
- Higher — producer
- Lower — consumer
- Higher — producer
- complementary goods are higher order goods used together to produce the goods one level below them, with regards to the orders of goods.
- Law of Marginal Productivity
- Valuations at exchange are not the same between trading parties, as the Classicists say, but are reversed. If John trades oranges to Eric in return for Eric’s apples, it is because John values the apples he receives more than the oranges he is giving up. More precisely, with each trade, John places a higher marginal value on the apple he receives than on the orange he loses; likewise, with each trade, Adam places a higher marginal value on the orange he receives than on the apple he loses. Trade stops when either John or Adam places a higher marginal value on what he would be giving up than on what he would be gaining.
{ 4 comments }
Interesting definition of complimentary goods. I’ve always thought of A and B as being complimentary if I value A more if I also have B and vice versa. In many typical examples (e.g., bread and butter, wine and wine glasses) I suppose two goods are being combined to create a new, even “lower” good. Is this really the case for all complimentary goods?
Just FYI, economic goods are complementary (with an ‘e’) when they join together to complete a whole. Complimentary (with an ‘i’) goods would be quick with praise. -g-
Regards, Don
I think here Dr. Salerno was referring to “complements in production”, and for that he gives the standard definition.
The more common definition that you cite is somewhat related to the other though, understanding that a lot of what we consider to be “consumer goods” are actually just very low order capital goods.
Classic example: hotdogs and hotdog buns. These are actually low order capital goods that we combine to produce the real consumption good: a hotdog in a hotdog bun.
Austrians realize that a lot of (virtually all) goods can be either capital or consumer, depending on the use that consumers put them to.
This blog entry reflects is my basic understanding from reading the section in _Human Action_ concerning marginal utility. However, in the case of homogeneous goods (the sack of wheat example) Mises assumes (as reflected in this example) that each unit meets one need. Mises does discuss putative counterexamples which involve objective use-value, but does not seem to provide an argument to show that one unit per need is appropriate for subjective use-value. Why cannot one unit be sufficient for one need, but two units together provide for a greater, more urgent need?
We might say that these two units are complementary goods, which are put together to form the two-unit final consumer good, and that therefore what we are dealing with is objective use-value. But aren’t sacks of wheat, for example, divisible? And if a half a sack of wheat is insufficient to prevent starvation, while a full sack is sufficient, then is this to be regarded as objective use-value? Does it all depend on whether we obtain wheat in 1-sack or half-sack increments?
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