The Lasting Legacy of Carl Menger

Carl Menger (February 23, 1840–February 26, 1921) is the founder of the Austrian school of economics. He is generally recognized in economics for his contribution to the development of the concept of marginal utility and as a pioneer of the subjective value theory. For Austrian economics specifically, he laid the foundation with his insights on the use of knowledge and foresight, the importance of relative prices, the role of time, and the role of the spontaneous emergence of social institutions. Menger provides a consistent perspective of the economy and delivers a coherent exposition of the complexities of the interrelation among goods, value, exchange, and prices.

Context

Menger defines economics as the science of individual choice. His method of inquiry is based on deductive logic as an instrument to bring to light the hidden structure in the available empirical material. Joseph Salerno characterizes Menger’s methodology as “causal-realistic analysis.”

In his essay on Carl Menger, Friedrich von Hayek points out that at the time of Menger’s writing, progress in economic theory had stagnated in England, while in Germany the second generation of historical economists dominated the field. These German scholars were ignorant of economic theory and regarded theory as useless speculation and possibly even harmful (p. vii).

Nevertheless, the German tradition of economics had exerted an influence on Menger insofar as many continental economists (as in Italy and France) had remained conscious of the contradictions inherent to the determination of prices by production costs based on the labor theory of value. After all, there was Hermann Heinrich Gossen (1810–58), who had formulated the principle of marginal utility in his voluminous treaty, though it was largely unnoticed in academic circles when it was published. In his book of 1854 (translated into English as The Laws of Human Relations and the Rules of Human Action Derived Therefrom [1983]), Gossen formulated the economic law of diminishing marginal utilities in the valuation of the goods relevant to decision-making. Gossen also pioneered the law that equilibrium requires that the ratio of marginal utility to price to be equal for all goods under consideration, a theorem which has become standard in modern microeconomics in its mathematical formulation.

Value Theory

In his Principles of Economics (1871), Menger explains that people trade because both sides gain from exchange. People attribute different valuations to the same specific good. Therefore, in the voluntary exchange of goods, equivalents do not change hands, but both parties are better off than before. Value is subjective. Its degree changes with the individual’s conditions. Decreasing marginal utility means that more of the same good diminishes the value of each unit of the good.

While Menger did not coin the term “marginal utility,” which was introduced later by Friedrich Wieser, the concept was developed by Menger as the magnitude of the importance which an economic agent attaches to the least important satisfaction which he still can secure by a single unit of the available quantity of the good (Grundsätze der Volkswirtschaftslehr, pp. 87, 99). A unit of water to satisfy thirst has a higher ranking than the unit of water used to wash the hands. However, when there is enough water available to satisfy fully the need of washing hands, the unit of water to drink is not more valuable than the same unit of water to wash hands.

Menger’s main contributions, as they are elaborated in his Principles of Economics, include the explanation of the subjective basis of economic value and that exchange ratios represent the foundation of relative prices. Menger elaborated the principles of utility theory and rejected the cost-of-production value theories as they had been developed by classical economists and used by Karl Marx in his exploitation theory.

Well aware of these theories, Menger expounds his principle of marginal utility as the subjective valuation of goods depending on the number of the units of the good that are within the reach of an individual. Marginal utility decreases, and thus the satisfaction that the least valuable unit of the good renders for an individual determines the value of the goods satisfying the higher preferences on this person’s ranking schedule.

Economic Action

Beginning the investigation of the causal relationship between human needs and the availability of the means of their satisfaction led Menger to distinguish between goods of the first, second, and higher orders of goods. Goods of the first order serve for immediate consumption, while higher-order goods serve to produce the goods of the first order. With the concept of complementarity of goods, Menger alerts us to the problems of time and uncertainty.

Betterment is the motivator of economic action. According to Menger, the purpose of the economic activity of an individual is to improve his conditions. Development in the sense of the improvement of personal economic circumstances takes place when the level of individuals’ well-being rises. For this, the production of so-called goods of higher orders is the main means. First-order goods serve directly for consumption, while the goods of the higher orders serve for the production of the goods of the first order. These production goods have no direct utility, but one that is derived from the utility of the final goods.

Economic progress takes place through the increase of human knowledge, the reduction of transaction costs, and the availability of savings. Thus, the extension of free markets is the key to development, along with entrepreneurial action aimed at finding the best ways to create and to cope with the edifice of higher-order goods—the capital structure. Prosperity depends on how well the economy generates knowledge and how effectively the application of the new insights can be accomplished. The criterion of progress is not the accumulation of ever more goods but the satisfaction of the subjective wants of the individuals in their full scope, which would also include leisure and nonmaterial goods.

Exchange and Price

In the context of goods of higher orders, Menger elaborates the principle of imputation, which says that production goods have a derived utility which rests in the utility that individuals ascribe to the final goods that are produced with the help of the higher-order goods (Grundsätze, pp. 138–42).

The concept of “derived utility” applies also to labor. Labor has a value, but it results from the usefulness that it contributes to the final good. In this sense, labor is a good of higher order that is present in all stages of the production process. In each stage, the value of labor is derived from (or “imputed,” as the term was coined by Friedrich Wieser, to it by) its contribution to the end product.

Menger also rejects the idea that prices are one of the most important aspects of the economy or even its most important feature. Prices are “accidental,” Menger explains, because what counts are the underlying exchange ratios. These exchange values, in turn, are determined by the subjective evaluations of the individual economic actors. Prices emerge as reflections of the subjective values of the individual participants in an exchange.

Using the concept of a “commodity” as a good that is meant to be sold on the market, Menger highlights the different degrees of salability of goods. Given that a few specific goods have an exceptionally high degree of salability, which means that they are generally accepted in exchanges, Menger comes to the explanation of the emergence of money in an economy.

Money is not the product of private or official agreement, let alone of a legislative act. Money is not an invention. Money came into use the more people realized that that their economic goals were promoted more swiftly in an exchange by accepting goods with the greatest marketability. Money is the outcome of human economic activities.

Menger stresses that money is a tool to facilitate exchange and as such does not serve as a standard and store of value. Money is not a measuring rod. The basis of exchange is not the trade of equals but the inverse estimation of the trading partners concerning the value of the goods being exchanged. Prices have meaning only as relative prices, as the expression of exchange ratios.

Legacy

Many of Menger’s insights are nowadays part of standard economics. Many more are preserved in the distinct school of Austrian economics. This applies particularly to the notions of foresight and the role of uncertainty, which are fundamental to economic activity in Menger’s perspective.

Despite its wide scope, the Principles of Economics do not include the whole range of topics that Carl Menger wanted to cover. According to Hayek (p. xi), Menger had plans to deliver three more volumes. The second part of the project was to treat “interest, wages, rent, income, credit, and paper money,” the third part was to cover production and commerce, while a fourth part was to discuss and criticize the existing economic system and make proposals for its reform. Probably distracted by the “Methodenstreit,” Menger did not carry out his original plans and thus left much still to do for the succeeding generations of economists. Menger’s original work is full of profound insights. He is rightly cited as the unique founder of the Austrian school of economics.

This is the final part of the series on Carl Menger’s Principles of Economics (1871). The preceding parts covered Menger’s exposition of goods and the economy and his explanations of value, exchange, and price. This final installment gives a summary of the theoretical context of Menger’s masterpiece.