austrian economics austrian foundations of marginal analysis an other austrian contributions
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Austrian Economics
Austrian Foundations of Marginal Analysis an other Austrian Contributions
Historical Links A. Forerunners of Marginal Analysis (1st
Generation) 1. Concept of Utility
Aristotle - use value 310 BC Jeremy Bentham – concept of utility in utilitarian philosophy end of 18th century
19th century writers - concept of diminishing marginal utility,
marginal productivity theory
2nd Generation marginal utility theorists -
Jevons, Menger and Walras(Menger - 1st generation Austrians)
A. A Revolution in Theory? All 3 thought they had developed a
revolutionary analysis of the forces explaining the determination of prices (stressed demand side).
Jevons - application of marginal analysis to the side of demand
Walras - application of marginal analysis to both demand and supply, and the formulation of a general equilibrium model of the
2nd Generation marginal utility theorists -
Jevons, Menger and Walras(Menger - 1st generation Austrians)
A. A Revolution in Theory? Menger - application of marginal analysis to
both the demand and supply side
Inadequacies in the Classical Theory of Value
1. Classical theory of value found inadequate to explain the forces of prices (stressed supply side). a) Cost of Production theory - lacked
generality b/c could not analyze prices some goods
• 1) Labor theory of value (Ricardo) and cost of production theories (Senior & Mill) required separate explanation for goods with fixed supply b/c value did not depend on production cost.
• 2) Theory suggested prices comes from cost incurred in the past. Jevons, Menger and Walras said large production costs will not necessarily result in high price.
Inadequacies in the Classical Theory of Value b) Marginal utility theory - value
depends on utility (consumption) and comes from the future.• 1) dead stock - goods for which
demand so that prices < cost of production.• 2) Value of factors of production
determined by marginal utility received from consuming final product
Inadequacies in the Classical Theory of Value
• C) Classicals used total or average utility (diamond-water paradox), but it is marginal utility that is significant theory - value depends on utility (consumption) and comes from the future.
What is Utility? 1. Utility - a psychological
phenomenon with unspecified units of measurement.
2. Jevons, Menger and Walras did not use term “marginal utility”
3. Menger used “importance of satisfactions” instead of “utility”
What is Utility? 1. acquired utility -utility of
goods consumed indirectly (acquire utility from the consumption of goods for which they are finally exchanged.
2. diminishing marginal utility -as the consumption of a good increases, its marginal utility decreases
What is Utility? 3. continuous functions - have
smooth curves when plotted (arise from continuously divisible quantity of goods consumed and continuously divisible quantity of utility.
4. discontinuous functions - have steplike curves when plotted (arise from nondivisibility)
Comparisons of Utility
Interpersonal comparisons of utility - comparing the utility of different persons for a good (e.g., and additional amount of income given to a person with high income and to a person with low income) . Jevons, Menger and Walras maintained
interpersonal comparisons not possible
Utility Functions Jevons, Menger and Walras : marginal
utility depends only on the quantity of a good consumed and does not depend on the quantity of other goods consumed (substitute or complementary)
a) Therefore total utility is an additive function:
total utility = f1 (Qa) + f2 (Qb) + f3 (Qc) + . .
b) Modern however assumes:
total utility = f (qA, qB, qC, . . . )
Utility, Demand, and Exchange
1. What distinguished Jevons, Menger and Walras from predecessors (except Gossen): a) Attempted to determine the conditions
that would hold when a consumer is maximizing utility
b) Attempted to develop a theory of exchange
c) J. & W. investigated the relationship between utility and demand
Utility, Demand, and Exchange
What distinguished Jevons, Menger and Walras from predecessors (except Gossen): d) Walras most successful of the 3 in these
attempts b/c of greater mathematical ability & better understanding of interrelatedness of various sectors of economy
Utility, Demand, and Exchange
2. Gossen’s 2nd Law: A consumer maximized utility by spending a limited income so that the last unit if money spent for any particular good yields the same marginal utility as the last unit spent for any other good.
a
MUA = MUB = MUC
PA PB PC
d) Walras most successful of the 3 in these attempts b/c of greater mathematical ability & better understanding of interrelatedness of various sectors of economy
Utility, Demand, and Exchange
2. Gossen’s 2nd Law: A consumer maximized utility by spending a limited income so that the last unit if money spent for any particular good yields the same marginal utility as the last unit spent for any other good.
MUA = MUB = MUC
PA PB PC
The Value of Factors of Production
Jevons and Menger: Factors of production are price-determined; price of factors of production (called intermediate goods or good of higher order) depends on the utility of the produced final good. Causal relationship treated in partial
equilibrium framework
Walras: Saw causal relationships more complex and formulated consideration of value in general equilibrium analysis
Classical versus the Emerging Neoclassical Theory of Value
Classical cost of production theory on inelastic supply (vertical):
Price depends on supply and demand and cost of production may have no influence on supply
Jevons and Menger position on inelastic supply: A Assume supply is fixed and price depends only on demand.
All failed to see interdependence of variables of marginal utility, supply and demand.
Second-Generation Austrians
A. Friedrich von Wieser (1851 - 1926)Austrian school - began with Carl Menger at
University of Vienna late 1800s 1. Wieser was a student of Menger, became
professor at University of Vienna (along with Eugen von Bohm-Bawerk) and both taught Ludwig von Mises and Joseph Schumpeter.
Used (Robinson Crusoe) verbal models instead of mathematics
Second-Generation Austrians
A. Friedrich von Wieser (1851 - 1926) First to use the term “marginal utility” Imputation -process by which factors of
production receive value from final goods (price-determined)
Intramarginal final goods - have higher relative marginal utility in a set a goods; value depends on cost of production (price-determining)
Second-Generation Austrians
A. Friedrich von Wieser (1851 - 1926)
Marginal good - the good with the lowest
marginal utility in a set of goods; value depends on marginal utility
Eugen von Bohm-Bawerk
Fellow student, friend and brother-in-law of Wieser; became better known in Britain and U.S. than Wieser
Used verbal models instead of mathematics
Eugen von Bohm-Bawerk
Profits and Interests
. Bohm-Bawerk perceived that marginal productivity theory failed to explain profits and interest.
1. Difference between profits and interest had not yet been distinguished.
a) Roles of capitalist and entrepreneur were combined in classical economic theory.
Eugen von Bohm-Bawerk
B. Profit Theory1. Classical economists recognized 3 element of profits: a payment for the use of capital (now classified as interest) a payment to the entrepreneur for management services rendereda payment that compensated for the risks of business activity
2. J.B. Clark called payment for entrepreneur’s management services and the assumption of risk a wage, not profit.
Eugen von Bohm-Bawerk Eugen von Bohm-Bawerk saw a
relationship between profits and interest rates
He then dwelt on why interest were at the level they were and concluded that there was three psychological levels determining interest rates
Eugen von Bohm-Bawerk Present goods are worth more than
an equal amount of future goods ($1 today is preferred to $1 a year from now b/c $1 received today could be lent and thus worth more in the future.
Eugen von Bohm-Bawerk 3 reasons for interest rates:
Different circumstances of want and provision in the present and in the future. Marginal utility decreases as goods increase.
Systematic underestimation of future wants, and the goods to satisfy them. Lack of imagination and willpower in individuals, and uncertainty regarding length of life.
Eugen von Bohm-Bawerk 3 reasons for interest rates:
Interest exists b/c of the technical superiority of present good over future goods. Goods produced by roundabout (capitalistic) method gain technical superiority at every stage of production and increases the flow of final goods as opposed to the direct method (e.g., catching a fish by hand involving no capital goods).
Joseph Alois Schumpeter(1883-1950)
born in Austria and emigrated to America
Student of Bhm-Bawerk at the University of Vienna
He was finance minister of Austria Left Austria in order to avoid Hitler’s
onslaught
Joseph Alois Schumpeter Taught at Harvard University Important works: Theory of Economic Development, 1911
(translated to English in 1934). Business Cycles, 1939 Capitalism, Socialism, and Democracy,
1950 (3rd. edition) Ten Great Economists, 1951. History of Economic Analysis, E.B.
Schumpeter (ed.), 1954.
CONCEPTS DISCUSSED BY SCHUMPETER
He argued studying the history of economic thought was important in that it presented the ways of the mind.
Creative Destruction is the internal mechanism by which the market continuously improves on it self.
CONCEPTS DISCUSSED BY SCHUMPETER
Innovation vs. invention. While inventions are helpful, it is the act of applying innovation that actually improves the society.
Some of the ways in which he described innovation:
CONCEPTS DISCUSSED BY SCHUMPETER Some of the ways in which he
described innovation: creation of new product or new quality
product creation of new method of production opening of new market the capture of new source of supply
CONCEPTS DISCUSSED BY SCHUMPETER
Some of the ways in which he described innovation: new organization of industry (i.e.
creation or abolition of market power) He also described the difference
between Entrepreneur vs. Manager
CONCEPTS DISCUSSED BY SCHUMPETER
Business Cycles and the importance of the Tax system cutting off the incentive for the entrepreneur.
Failure of the market system stems from its successfulness
Ludwig von Mises(1881-1973)
born in Austria and emigrated to America
Student of Bhm-Bawerk at the University of Vienna
Ludwig von MisesMayor Works
Human Action (1st edition, Yale, 1949; 2nd revised edition, Yale, 1963; 3rd revised edition, Regnery, 1966). Bureaucracy (Yale, 1944; Arlington House, 1969). Omnipotent Government (Yale, 1944; Arlington House, 1969). Socialism (Yale, 1951; Jonathan Cape, 1969). The Theory of Money and Credit (Yale, 1953; Foundation
for Economic Education, 1971).
Ludwig von MisesMayor Works
The Anti-Capitalistic Mentality (Van Nostrand, 1956; Libertarian Press, 1972).
Theory and History (Yale, 1957; Arlington House, 1969).
Epistemological Problems of Economics (Van Nostrand, 1960).
The Free and Prosperous Commonwealth (Van Nostrand, 1962).
Planning for Freedom (2nd edition, Libertarian Press, 1962).
The Ultimate Foundation of Economic Science (Van Nostrand, 1962.)
The Historical Setting of the Austrian School of Economics (Arlington House, 1969).
Ludwig von Mises While he had many contributions one of
his most important comes from his explanation of the value of money:
Marginal Utility of Money comes from two sources:
Value from the value of the goods it can buy. Value from the subjective use value of its
own because it can be held for future purchases. (today that would be called the “purchasing power”)
Ludwig von Mises His importance can be seen today
by the fact that Auburn University has established a well know institute in this country under his name: Ludwig Von Mises Institute.