Mises and Rothbard created a very strong following of fine scholars and brilliant minds. But critiques are always a feature that a very much alive tradition such as the Austrian School needs to have and use for improvement. And sometimes improvement implies bringing back forgotten doctrines of previous generations. In this case, I am referring to the cost-price doctrine for reproducible goods that Eugen Böhm-Bawerk developed but was dismissed entirely by most Misesians and certainly most Rothbardians. On this you can see Robert Murphy’s treatment of cost and price at his MES Study Guide (p.56). Prof. Reisman is rescuing the Böhm-Bawerkian insight that costs, in reproducible goods, are the immediate although not the ultimate determinant of prices, from the Austrian plumb-line that has long ignored that fact, putting an emphasis on marginal utility as if didn’t depend itself on present quantities of fungible goods available. Let’s quote prof. Reisman from his translation and commentary:
“However that may be, the genuine Austrian doctrine on the relationship between value, cost, and marginal utility is to be found first and foremost in the writings of Böhm-Bawerk. Böhm-Bawerk represents the “Real McCoy†of Austrian economics when it comes to the theory of value and price. The present essay is, of course, by no means the only place in which he presents it.”
And prof. Böhm-Bawerk from the same text:
“And now I ask: under these circumstances, has it been worthwhile [337] to raise a great hue and cry against the marginal-value theorists over the fact that they trace the law of costs back to the law of marginal utility? Was it proper to call it a “caprice†when the marginal-value theorists undertook to put forward in the law of marginal utility a unitary law, which subsumed the law of costs rather than merely stood beside it? And is it really the mark of a so much higher scientific standpoint, when one first, with all possible emphasis, declares not marginal utility but costs to be the ultimate cause of the value of goods, however then is forced to explain this alleged ultimate cause in turn on the basis of marginal utility, which is allegedly not ultimate? If it were only a matter of pointing out some injustice to my esteemed opponent, I could confidently conclude my remarks. However, that would be a job only half done, and as a result, fruitless.”
Only when everything has been decided, when the price that has emerged as the result of the interplay of utility valuations as a ready-made price that is already “known,†do people again dredge up cost valuation, which was carefully put aside earlier, and in connection with which, in some measure, they now can no longer be taken at their word, and allow it to “finally triumph.†“A number of buyers appear on the market with the desire for a definite exchangeable good. Each has a subjective utility valuation of the good that differs from that of all other buyers. This utility valuation is the direct valuation. However, as soon the price at which the good is for sale, its objective cost value, is known, cost valuation finally triumphs.â€
“Caprices,†therefore, cannot be eliminated from our valuations; nor from “exact†cost valuations. The difference is only this: Where we directly value according to marginal utility, we base our valuation on our own “caprices.†Where we value “exactly,†according to costs, we base it on other people’s caprices; on the result of the caprices of those hundereds, thousands, or millions of buyers whose demand fixes a definite cost figure as the “highest necessary.†It is immediately to be admitted that such a result of caprices is much more stable than the individual caprice.
We can ask any _real life_ entrepreneur for his position on the matter. Avoiding that insight does not make us Austrians “all-around subjectivists” but in fact divorces theory from entrepreneurial practice (a.k.a. reality, and markets), which is absurd. That is too high a price to pay just to stubbornly and unnecessarily avoid all contact with the British Classics and/or …Marx. The former had a lot of valuable things to say, and reading “Capitalism” by Reisman is a must if one is to have a better perspective of their contributions, specially on the “Macro” front.
Finally, prof. Böhm-Bawerk asks himself and responds brilliantly:
Which Is “More Ultimate,†Costs or Marginal Utility?
Namely, the height of marginal utility is in no way an ultimate, causeless fact, but, as we marginal-value theorists point out, is determined by means of the prevailing relationship of demand and supply. And the size of the supply is in turn, as the marginal-value theorists likewise point out with all requisite definiteness and emphasis, in very large part determined by the state of the conditions of production, by the difficulty of attainment, or, as one is accustomed to say in brief, by the costs of production. Consequently—so it seems—since they do indeed help to determine marginal utility itself, costs are a more primary or more ultimate basis of value than marginal utility, which is influenced by them.
In sum, we need not throw away the baby with the bathwater. Prof. Böhm-Bawerk cost-price doctrine needs to be rescued and put back on the central place it deserves.
{ 6 comments }
I think Buchanan put it best. The classical political economists had a cost theory of value, with a large exception for scarcity rents in the case of non-reproducible goods. There were, in effect, two paradigms: a cost theory for reproducible goods and a utility theory for non-reproducible goods. The marginalists offered a more elegant theory, applying the classical paradigmn for non-reproducible goods to all goods.
What most advocates for the marginal utility theory of value neglect to mention is that the marginalist theory derives value from marginal utility, as B-B said, *given* the snapshot conditions of supply and demand at the point of exchange. So marginal utility changes over time with demand: if the value of the marginal unit exceeds production cost, added production will increase supply until marginal utility falls to production cost. In other words, in practical terms the marginalists are saying exactly the same thing Ricardo said; they’ve just supplied a much more refined *mechanism* for explaining *why* things work the way Ricardo said.
I think in this instance a key point to stress is Boehm-Bawerk’s identification that the cases in which cost of production is the direct, immediate determinant of price, marginal utility is still the ultimate determinant, because it determines the value of the means of production, which value constitutes cost.
An illustration I like to use, and to which everyone is more than welcome, is that of a modification in Boehm-Bawerk’s example of the pioneer with five sacks of grain. As I’m sure readers will remember, Boehm-Bawerk’s example is that the first sack is necessary to keep the pioneer alive through the winter. The utility directly dependent on it is as great as the man’s life itself. But the pioneer has five sacks of grain, not just one. And the most important use to which a fifth sack can be put is merely that of feeding a pet parrot.
As Boehm-Bawerk explains matters, it is clear that if rats or other vermin should destroy the first sack, which we can distinguish from all the others by virtue of its carrying a tag labeled “sack for survival,†the actual loss that will be experienced is not that of the man’s life, but the loss merely of the parrot. Indeed, this is the essence of the marginal utility principle: the value of all units of a supply is governed by that of the least important among them, i.e., by the value of the marginal unit.
Now for the modification of the example. Suppose that the pioneer has used the contents of the first sack to of grain to make flour, from which he makes a supply of biscuits. These are “biscuits for survival.†For if he had had only one sack of grain, he would have used it to make these biscuits and it would be through them, that his life had depended on the one and only sack.
Imagine now that rats destroy his supply of biscuits, labeled “biscuits for survival.†Is the man’s life threatened? No. Because he started with five sacks of grain and still has four of them left. He can replace the biscuits by withdrawing once again the sack of grain originally destined for feeding the parrot and using it to produce a fresh supply of biscuits. The value of the biscuits is being governed by the value of the marginal product of the grain, namely, the value of the parrot. It’s still a matter of marginal utility.
But here’s the critical link that Boehm-Bawerk (and Wieser too, incidentally) recognized. Namely, what communicates the far lower, marginal value of the parrot to the value of the biscuits and reduces it from its extremely high direct utility to the much lower, marginal utility of the parrots, is the value of the grain. The value of the grain is the communicating link for the transmission of marginal utility.
The chain of causation of value is that the value the biscuits is being governed in the first instance by the much lower value of the grain, which in turn is governed by the value of the marginal product of the grain, namely, that of the parrot.
What needs to be stressed here is that when we say that the value of the biscuits is being governed by the value of the grain, we are saying that in this case the value of a product is being governed by its by cost of production. For the value of the grain is the cost of producing the biscuits. This is what Boehm-Bawerk and Wieser recognized and which has since been forgotten.
But, of course, the full context is that the value of the means of production is in turn governed by the value of the marginal product. Determination of price by cost, according to Boehm-Bawerk and Wieser, is determination of the value of supra-marginal products by the lower value of the marginal products. Determination of price by cost is merely an aspect, a very important aspect, of determination of price by marginal utility.
I think in this instance a key point to stress is Boehm-Bawerk’s identification that the cases in which cost of production is the direct, immediate determinant of price, marginal utility is still the ultimate determinant, because it determines the value of the means of production, which value constitutes cost.
An illustration I like to use, and to which everyone is more than welcome, is that of a modification in Boehm-Bawerk’s example of the pioneer with five sacks of grain. As I’m sure readers will remember, Boehm-Bawerk’s example is that the first sack is necessary to keep the pioneer alive through the winter. The utility directly dependent on it is as great as the man’s life itself. But the pioneer has five sacks of grain, not just one. And the most important use to which a fifth sack can be put is merely that of feeding a pet parrot.
As Boehm-Bawerk explains matters, it is clear that if rats or other vermin should destroy the first sack, which we can distinguish from all the others by virtue of its carrying a tag labeled “sack for survival,†the actual loss that will be experienced is not that of the man’s life, but the loss merely of the parrot. Indeed, this is the essence of the marginal utility principle: the value of all units of a supply is governed by that of the least important among them, i.e., by the value of the marginal unit.
Now for the modification of the example. Suppose that the pioneer has used the contents of the first sack to of grain to make flour, from which he makes a supply of biscuits. These are “biscuits for survival.†For if he had had only one sack of grain, he would have used it to make these biscuits and it would be through them, that his life had depended on the one and only sack.
Imagine now that rats destroy his supply of biscuits, labeled “biscuits for survival.†Is the man’s life threatened? No. Because he started with five sacks of grain and still has four of them left. He can replace the biscuits by withdrawing once again the sack of grain originally destined for feeding the parrot and using it to produce a fresh supply of biscuits. The value of the biscuits is being governed by the value of the marginal product of the grain, namely, the value of the parrot. It’s still a matter of marginal utility.
But here’s the critical link that Boehm-Bawerk (and Wieser too, incidentally) recognized. Namely, what communicates the far lower, marginal value of the parrot to the value of the biscuits and reduces it from its extremely high direct utility to the much lower, marginal utility of the parrots, is the value of the grain. The value of the grain is the communicating link for the transmission of marginal utility.
The chain of causation of value is that the value the biscuits is being governed in the first instance by the much lower value of the grain, which in turn is governed by the value of the marginal product of the grain, namely, that of the parrot.
What needs to be stressed here is that when we say that the value of the biscuits is being governed by the value of the grain, we are saying that in this case the value of a product is being governed by its by cost of production. For the value of the grain is the cost of producing the biscuits. This is what Boehm-Bawerk and Wieser recognized and which has since been forgotten.
But, of course, the full context is that the value of the means of production is in turn governed by the value of the marginal product. Determination of price by cost, according to Boehm-Bawerk and Wieser, is determination of the value of supra-marginal products by the lower value of the marginal products. Determination of price by cost is merely an aspect, a very important aspect, of determination of price by marginal utility.
Oh snap! Dr. Reisman posted on the blog comments section
I’m bookmarking this.
I’m no economist, but agree that marginal value is important. As far as the costs of production are concerned, they are are important not for determining value, but mainly for determining how worthwhile that production is compared to the value placed upon the produced goods. In other words, entreprenuers must look at the costs of production and decide if it’s worth the effort to produce or not. Why make this harder than it needs to be?
Get this, Carson and Reisman on the same page and they’re in agreement!
… or at least I think so
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