Principles of Economics

Summary

Principles of Economics (Grundsätze der Volkswirtschaftslehre) is the book with which the Austrian economist Carl Menger founded what became the Austrian School of economics. Published in Vienna in 1871 and dedicated to the German historical economist Wilhelm Roscher, it appeared in the same year as William Stanley Jevons's Theory of Political Economy and three years before Léon Walras's Elements of Pure Economics; together the three books are credited with the marginal revolution that replaced the classical cost-of-production theories of value. Menger begins not with labour or land but with human needs. A thing becomes a good when people recognize that it can satisfy a need and have command of it. Goods of lower order, such as bread, serve needs directly; goods of higher order, such as flour, ovens and the baker's labour, serve them indirectly, and their character as goods derives from the goods of lower order they help to produce. Because production takes time, it involves uncertainty and error, and economic progress depends on growing knowledge of these causal connections. Economic goods are those whose available quantity is smaller than the requirements for them. Such goods must be economized, and this, Menger argues, is the origin of property. Value is not something inherent in goods or a quantity of labour embodied in them but a judgment people make about the importance of the goods at their command for satisfying their needs. The value of any unit depends on the least important satisfaction that it secures, an idea later economists called marginal utility, and the value of higher-order goods is derived from the expected value of the products they help to make. On this foundation Menger builds theories of exchange, which occurs when each party values what he receives more than what he gives, and of price, formed within limits set by these valuations under isolated exchange, monopoly and competition. Later chapters treat use value and exchange value, the marketability of commodities, and money, which he explains as an institution that emerged without design from individuals' efforts to trade their goods for the most saleable ones. The book shaped the work of Eugen von Böhm-Bawerk and Friedrich von Wieser, and through them Ludwig von Mises and F. A. Hayek. Its emphasis on individual valuation, time, knowledge and spontaneously evolved institutions became characteristic of Austrian economics, while its theory of value was absorbed into mainstream microeconomics.

Plot or Argument

• Preface

  Menger proposes to reduce complex economic phenomena to their simplest elements, open to observation, and to show how the complex arise from them according to definite principles.

• I. The general theory of the good

  A good is a useful thing whose capacity to satisfy needs is recognized and commanded by people. Goods of lower and higher order; the role of time, error and knowledge in production; the causes of progress in human welfare.

• II. Economy and economic goods

  Economic goods are those whose requirements exceed available quantities; scarcity requires economizing, which is the origin of property and of the economic character of goods.

• III. The theory of value

  Value is the importance individuals attach to goods because they depend on them for satisfying needs. It is measured by the least important satisfaction secured by a given unit, and the value of goods of higher order derives from the prospective value of their products.

• IV-V. Exchange and price

  Exchange takes place when each party values what he receives more than what he gives up. Prices are formed within the limits of these valuations, in isolated exchange, under monopoly and under competition.

• VI-VII. Use value, exchange value and the commodity

  Use value and exchange value are two forms of economic value; commodities differ in their marketability, which depends on the number of buyers, the extent of markets and other circumstances.

• VIII. The theory of money

  Money arises without plan as people accept the most saleable commodities in exchange, until one or a few goods become generally accepted; the state may confirm but does not create this institution.

Lessons

• Value is in the eye of the valuer

  Menger teaches that goods have value because people judge them important for their needs, not because labour was spent on them. This simple idea transformed economics and explains why the same item can be worth different amounts to different people.

  • Why is a glass of water worth more to a traveller in the desert than to someone beside a river?
  • How does Menger's view differ from the labour theory of value of Ricardo and Marx?

• Thinking at the margin

  The value of a unit of a good depends on the least important use it would serve. Choices are usually about one more or one less, not all or nothing.

  • Explain the diamond-water paradox using Menger's reasoning.
  • Give an everyday example of a decision made at the margin.

• Institutions no one designed

  Menger's account of money shows how a useful institution can emerge from individual actions without anyone planning it. The idea influenced Hayek's later work on spontaneous order.

  • How, according to Menger, did money come into being?
  • What other institutions might have arisen in a similar way?

Context

In German-speaking universities of the 1860s economics was dominated by the historical school of Wilhelm Roscher and others, which favoured historical description over abstract theory, while in Britain the classical tradition of Smith, Ricardo and Mill explained value by costs of production. Menger, working as an economic journalist in Vienna, sought a theory grounded in individual needs and choices.

Composition

Menger wrote the book in the late 1860s and published it in Vienna in 1871 as the first, general part of a larger work that he never completed. It was dedicated to Roscher. Menger later planned a revised edition; a second edition prepared from his papers by his son Karl Menger appeared posthumously in 1923. The English translation by James Dingwall and Bert F. Hoselitz was published in 1950 with an introduction by Frank Knight, and a 1976 edition added Hayek's introduction.

Reception

The book won Menger a chair at Vienna and attracted followers, including Böhm-Bawerk and Wieser, who developed the Austrian School. Gustav Schmoller and the German historical school rejected his methods, leading to the Methodenstreit. Its subjective theory of value became part of mainstream economics, while Austrian economists such as Mises and Hayek built on its themes of knowledge, time and spontaneous order.

Comparisons

• Human Action: A Treatise on Economics

  Mises described himself as a follower of Menger; Human Action builds his subjective theory of value into a general theory of human choice.

• The Road to Serfdom

  Hayek, who edited Menger's collected works, carried his ideas about knowledge and undesigned institutions into the argument against central planning.

• Socialism: An Economic and Sociological Analysis

  Mises's critique of socialist calculation depends on Menger's account of how the value of productive goods is derived from consumers' valuations.

• Capital, Volume I

  Published four years apart, Capital and Menger's Principles offer opposing accounts of value: labour embodied in goods versus the importance people attach to them.

• On the Principles of Political Economy and Taxation

  Menger rejects the classical cost-of-production theory of value that Ricardo set out, reversing its direction: costs take their value from products.

• The Wealth of Nations

  Menger's treatment of the paradox of value answers the puzzle of water and diamonds that Smith posed but explained by labour cost.

• Principles of Political Economy

  Mill had declared the theory of value complete in 1848; Menger's book, published in 1871, the year of Mill's last revision, overturned it.

• A Treatise on Political Economy

  Say had already grounded production in the creation of utility; Menger developed the subjective side of value much further.

Quotes

For Students

A reading companion for classical Christian high school students. See the student guide.

Reading Guide

Watch for

• How the book begins with causes and needs rather than with labour, land and capital.
• The distinction between goods of lower and higher order.
• The definition of economic goods by comparing requirements with available quantities.
• The account of value as a judgment about importance for satisfying needs.
• The explanation of money as an undesigned institution.

Key terms and names

Good

A thing that can be brought into a causal connection with the satisfaction of human needs, recognized as such and commanded by people.

Goods of higher order

Means of production, such as raw materials, tools and labour, that satisfy needs indirectly through the goods they help to produce.

Economic good

A good whose available quantity is less than the requirements for it, so that it must be economized.

Subjective value

The importance an individual attaches to a good because the satisfaction of a need depends on it.

Marginal utility

Later economists' name for Menger's principle that a unit's value depends on the least important satisfaction it secures.

Marketability

How easily a commodity can be sold at economic prices; the most marketable goods become money.

Methodenstreit

The 1880s dispute over method between Menger and Gustav Schmoller of the German historical school.

Seminar Questions

1. Comprehension What four conditions does Menger say must be met for a thing to become a good?
2. Comprehension What distinguishes economic goods from non-economic goods?
3. Comprehension How does Menger explain the origin of money?
4. Interpretation Why does Menger insist that the value of productive goods is derived from the value of their products rather than the reverse?
5. Interpretation How does Menger connect scarcity with the origin of property?
6. Interpretation In what ways does Menger's approach differ from that of the classical economists?
7. Big Question If value depends on individual judgment, can there be such a thing as a just price?

Faith Connections

• Matthew 13:45-46 (Scripture)

  The merchant who sells all he has for one pearl of great price illustrates Menger's point that value lies in the importance a person attaches to a good, not in its cost.

• Luke 14:28 (Scripture)

  Counting the cost before building a tower reflects the economizing foresight Menger places at the centre of economic life.

• Augustine, City of God XI.16 (Church Fathers)

  Augustine observes that people often value things by their usefulness to them rather than by their rank in nature, a distinction close to Menger's subjective account of value.

Logic and Rhetoric

Central argument: Goods derive their character from their capacity to satisfy human needs. When goods are scarce relative to needs they must be economized, which gives rise to property and value. Value is the importance people attach to particular quantities of goods, determined by the least important satisfaction they secure, and the values of productive goods, prices and money all follow from these individual valuations.

Rhetorical device: step-by-step illustration. Menger traces the value of goods through simple cases such as an isolated farmer allocating his grain among uses of declining importance.

Debate: Resolved: that the value of a good depends on the importance people attach to it, not on the labour required to produce it.

Memory Work

Value is thus nothing inherent in goods, no property of them, nor an independent thing existing by itself.

Writing Prompts

Essay: Explain Menger's theory of value and use it to resolve the paradox of why water, so useful, is often cheap while diamonds are expensive.

Comparison with Capital, Volume I: Menger and Marx published within four years of each other but disagreed fundamentally about value. Compare their theories and argue which better explains prices in a modern economy.

Creative Prompts

• Classroom

  Recreate the classic Austrian example of a farmer with several sacks of grain, which Menger sketched and Böhm-Bawerk made famous: have students rank the uses of each sack and decide which use would be given up if one sack were lost, then explain what this shows about value.

• Essay

  Menger argues that money emerged without anyone designing it. Write an essay tracing how a commodity such as salt, cattle or cigarettes could become money in a community without a government.

• Dialogue

  Write a conversation between Menger and Karl Marx about why a rare painting and a loaf of bread have the prices they do.

Further Reading

• Human Action, Ludwig von Mises

• Capital and Interest, Eugen von Böhm-Bawerk

  Böhm-Bawerk's development of Menger's ideas, including his critique of earlier interest theories.

• Investigations into the Method of the Social Sciences, Carl Menger

  Menger's 1883 book on method that began the Methodenstreit.