WorldSys: Austrian Home Study Course, Week 7

The World Systems Project is going to begin with a thorough examination of Austrian economics, starting with Robert P. Murphy’s outstanding “Austrian Economics Home Study Course”. The plan is to blog my answers to the weekly questions, with posts and book reviews tossed in as I go along. 

It should go without saying that the following contains ‘spoilers’, and if you intend on doing the home study course on your own you might not want to read further.

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This was an unusually difficult set of questions. It’s entirely likely that I have gotten some of this wrong, and I will update it in the future if I remember to revisit this post.

1 What is time preference?

The willingness to defer present consumption for future rewards; or, the willingness to save money.

2 For Mises, is the existence of time preference merely a psychological regularity?

I believe he said it was a ‘praxeological regularity’ — not just something people do sometimes but something that it is within their nature to do.

As of now I’m not sure how I feel about this claim.

3 If I would rather “consume” a package of fireworks next July instead of today, is that a violation of time preference?

No, it is a kind of time preference. Time preference denotes a willingness or lack of willingness to defer consumption. A desire to use fireworks now would denote a high time preference, or in other words a strong tendency towards satisfaction in the present. But a desire to put off using the fireworks until next year would be an indication of low time preference, meaning you’re content to wait until next year to enjoy them.

4 What is the difference between rent and interest?

Rent is a price paid for temporary use of a good. Interest is a broader phenomenon, and can basically be thought of as an exchange rate between present and future goods. A high rate of interest privileges present goods over future ones by making it more expensive to invest in long-term projects, and a low rate of interest makes such projects more appealing by lowering the cost of undertaking them.

5 Can an investor earn interest just in the loan market?

An investor can earn interest in the loan market, yes.

6 What is Fetter’s theory capitalization theory?

The section of “The Great Austrian Economists” dealing with Fetter’s theory of capitalization was extremely condensed and high-level, so I can’t claim to fully understand it. But I will do my best to answer this question.

Fetter defined capitalization as “discounting the future rents in goods”, which I read as “paying a single sum today equivalent to expected value and discounted because that value lies in the future.” Remember that, all things being equal, people tend to prefer present use to future use.

The price of capital goods arises the same way all prices arise: as a result of individuals bidding on them because of the subjective ranking they assign to the goods. An entrepreneur investing in capital goods makes a profit because when the future “arrives” they can make more from those goods than the discounted rate they paid for them.

These inter-temporal comparisons between present and future uses, present and future goods, and present and future preferences are what give rise to interest rates, not the cost of producing a capital good.

The puzzle of interest rates was a significant one, and Rothbard claimed that Fetter was the first economist to derive an explanation of interest rates from a theory of time-preference.

7 Why don’t Austrians think the productivity of capital goods explains interest?

Because interest rates are a result of time-preference, not the productivity of capital goods. Further evidence for this claim comes from the fact that interest rates don’t only arise in connection with capital goods; basically every type of loan has an interest rate associated with it, for example.

8 Is it accurate to describe the interest rate as “the price of money?”

I’m not sure; I don’t think so. It would be more accurate to describe interest as a kind of exchange rate between present and future goods.

9 Mises adopts a “pure” time-preference theory of interest. But isn’t the rate of interest determined by the supply and demand for loanable funds?

This looks to me like the opposite of the mistake made in assuming that interest is explained by the productivity of capital goods (SEE: question 7), and our answer reflects this fact. We believe that interest rates are a result of time-preference because they occur pretty much everywhere that future consumption is evaluated against present consumption. This includes loanable funds markets, but is not limited to just these markets.

10 Do rich people always save more than poor people?

Let me explain why this question is being asked: if we possessed but a shallow understanding of subjective value theory and time preference theory we might assume that rich people, as a rule, always save more than poor people because they have enough excess wealth to handle any pressing needs such as food, water, and shelter. They might then be said to have the luxury of a very low time preference because they have plenty of money left over to be saved.

This is not the case. We have all heard stories of people working their whole lives on meager funds only to give a vast, saved fortune as an endowment to a university. And of course stories of the profligate rich squandering mommy and daddy’s millions are all too common.

WorldSys: Austrian Home Study Course, Week 6

The World Systems Project is going to begin with a thorough examination of Austrian economics, starting with Robert P. Murphy’s outstanding “Austrian Economics Home Study Course”. The plan is to blog my answers to the weekly questions, with posts and book reviews tossed in as I go along. 

It should go without saying that the following contains ‘spoilers’, and if you intend on doing the home study course on your own you might not want to read further.

1 What is the division of labor?

It’s exactly what it sounds like — dividing labor up. People could subsist atomistically, each person growing their own food, making their own shelter, and producing their own clothing. Or each person could specialize in a trade like agriculture or architecture, produce more than they need, trade the surplus, and use the proceeds to buy whatever they want.

This latter option is the division of labor, and for a variety of reasons it is vastly superior to everyone trying alone to provide everything their survival requires. People in different parts of the world are better positioned to provide certain goods. Individuals also bring different talents and aptitudes to the labor market. And by focusing on one skill or a small number of skills people can get really, really good at making whatever they’re specializing in.

2 What is the law of association?

The law of association is the name given by Mises to what is usually known as the law of comparative advantage. The idea is that even if one person is strictly better at everything than another person, both are better off if they still specialize and trade. If the owner of a store is better at sales, running the cash register, and sweeping the floors than an assistant it does not follow that the store owner should try to do everything on her own. She should choose the handful of tasks at which she is most best at and do those.

3 Which party benefits from a voluntary trade?

If a trade is voluntary it’s exceedingly likely that both parties benefit. It’s of course possible that a person might regret a voluntary transaction because they do not derive as much joy as they thought they would from an item, but there is nothing inherent in voluntary transactions that means one party is exploiting another.

4 Should someone trade with a man who has a lower productivity in every good?

Yes, see the answer to question 2.

5 Give an example of a price formed in a barter economy.

One pound of butter = two loaves of bread.

6 For Austrians, what is the ultimate cause of market prices?

The subject valuations of marginal goods made by individuals. If I am making shirts to trade, I will continue to make shirts until I’ve arrived at a point at which no one can offer me anything I’d like more than I’d to possess a shirt. Every one else in the economy is also making subjective valuations of a similar kind, and the sum of these valuations determines the price of a good.

7 Do prices measure value?

Not directly. Value is a phenomenon occurring at the level of the individual — an individual values a car or a book. When multiple individuals in an economy value a good and begin to compete for it, a price is established from all their demand curves.

8 If someone thinks a TV is worth more than its purchase price (say $100), why doesn’t he keep buying TVs until he runs out of money?

Because he doesn’t value each new TV equivalently. The first TV might be worth greater than $100, but the second might only be worth $50, the third $15, and the fourth might actually be of negative utility because he has no way to transport or store it.

9 If value is subjective, does that mean market prices are subjective too?

Not if ‘subjective’ means ‘arbitrary’. ‘Subjective’ means ‘occurring in the mind of a human being acting purposefully’. There can be objective facts about subjective states — if you are hungry, for example, that is a true fact about your conscious experience. Likewise, if more people subjectively value oranges than apples, the market price will be an objective manifestation of that fact.

10 What is an equilibrium price?

The price at which supply and demand are equal. The equilibrium price for tires is whatever price allows everyone who wants tires, and can afford them, to have them.

11 What is the source or cause of prices for factors of production?

It is the same source of prices in consumer goods: subjective valuations. Each producer must weigh the cost of an additional piece of machinery against what could be done with the money. And each unit of the factor of production will be subject to the same diminishing marginal utility as a loaf of bread purchased at the super market.

12 In economics, what is the difference between desiring and demanding a good?

Demanding a good is more forceful. We all desire things we aren’t willing to pay for — like being in absurdly good shape. If you could snap your fingers and be 5% body fat with a 40” vertical and a deadlift of 500 pounds I’m sure you would. But if you’re not willing to spend a decade pursuing these goals, then you don’t demand them in an economic sense.

13 Why are demand curves downward sloping?

Because, as described with the law of diminishing marginal utility, each successive unit of a good does less to satisfy your desires. The demand curve for cheese slopes downward because you might really enjoy the first piece of cheese, somewhat enjoy the second piece of cheese, only mildly enjoy the third piece of cheese, and be nauseous at the thought of eating cheese after that.

14 Are supply decisions purely objective, or do they involve value judgements?

They involve value judgments. A factory owner can invest in more machinery to expand production, but that might not be worth the extra expenditure and effort.

15 Would we expect different prices for the same good to persist on the market?

In an idealized model, perhaps not. But consumers might favor one brand of toothpaste over another because, rightly or wrongly, they believe one brand to be more reliable than the other, even if both brands are chemically indistinguishable. In reality there are innumerable little factors such as this which can lead to long-term price differences for goods that are, for all intents and purposes, identical.

WorldSys: Austrian Home Study Course, Week 5

The World Systems Project is going to begin with a thorough examination of Austrian economics, starting with Robert P. Murphy’s outstanding “Austrian Economics Home Study Course“. The plan is to blog my answers to the weekly questions, with posts and book reviews tossed in as I go along. 

It should go without saying that the following contains ‘spoilers’, and if you intend on doing the home study course on your own you might not want to read further.

1 What is the difference between a valid argument and an argument with a true conclusion?

A valid argument is one with a conclusion that bears a certain kind of relationship to it’s premises, specifically: if the premises are true then the conclusion must follow. The classic textbook example is:

  • All men are mortal;
  • Socrates is a man;
  • Therefore, Socrates is mortal.

If it is true that all men are mortal and it is true that Socrates is a man then in must necessarily follow that Socrates is mortal.

But there are an infinite number of arguments which have true conclusions but which aren’t valid because they don’t follow from their premises:

  • I am the king of England;
  • The moon is made of cheese;
  • Therefore, 2 + 2 = 4.

We can see that, while the conclusion is incontrovertibly true, it is a total non sequitur with respect to its premises. What on Earth do my heavenly mandate or the constitution of heavenly bodies have to do with truisms of basic arithmetic?

Absolutely nothing.

2 For [Hans-Herman] Hoppe what is the subject matter of economics?

Hoppe defends the view that economics is a pure science dealing with human action. It studies the consequences of the inescapable fact that human beings engage in purposeful, goal-directed behavior.

3 Do other free market schools share the Austrian methodology?

No. The Austrian methodology focuses on a priori knowledge deduced from self-evident axioms. The Chicago School, in contrast, is far more focused on empirical research.

There are plenty of non-Austrians who do utilize Austrian insights, however.

4 What does praxeology mean?

‘Praxis’ means ‘practice’ or ‘action’, and ‘praxeology’ is therefore the study of human action. It is not synonymous with economics, for economics is but one branch of the broader praxeological framework.

5 What is the ultimate starting point of praxeology?

Praxeology begins with what is called ‘the action axiom’, which states that man acts. From this deceptively simple starting point further economic principles such as the law of marginal utility and the law of supply and demand are deduced.

6 If economic theorems are tautologies, do they teach us anything new about the world?

They can. A tautology like “p or not p” does not really get us anywhere, but a tautology like “a person chooses their highest ranked preference first because otherwise they would’ve chosen differently” does get us somewhere. In particular, it allows us to begin understanding the Austrian notion of ordinal, subjective value rankings, which is crucial to an understanding of the whole marginalist philosophy of economics.

7 When Mises first wrote on methodological matters, did he think he was offering a critique of orthodox economics?

No. When Mises began writing it was common to reason about and explain economics with the same reliance on truths deduced from axioms which characterizes Austrianism. Mises believed that he was taking economics as it was practiced and giving it firmer foundations, not building an entirely new structure.

8 Were any of the classical economists praxeologists?

No, praxeology grew out of 19th and 20th century attempts to reform the errors of classical economists. William Harold Hutt wrote many Austrian-themed works while considering himself squarely in the classical tradition, but he is the only exception of which I’m aware.

9 Give an example of a praxeological theorem.

If a transaction between two people is non-voluntary then one person profited at the expense of another.

10 Since economic theorems are always valid, does that mean their conclusions apply to every situation?

No. An economic theorem’s validity derives from the fact that it must follow from its premises, but if the premises don’t hold then the conclusion may or may not follow. The world is complicated and for any given situation there are innumerable mitigating factors which could make economic analysis less straightforward.

A well-known economic truism is that an increase in the supply of a good will decrease demand for that good. So if a dress shop doubles their supply of a certain dress and demand goes up have we refuted the laws of supply and demand? No: perhaps Kim Kardashian was seen wearing the dress and now her fans are clamoring to get their hands on one.

11 To be scientific, shouldn’t we test economic laws?

I have a confession to make: I’m a huge fan of empiricism. This means the Austrians are unlikely to invite me to their philosophy parties.

But it is crucially important that we never lose sight of the fact that what we’re trying to understand is reality, and that our deductive principles and our models might have to be changed on the basis of new discoveries.

But having studied Austrianism I’ve become more aware of the fact that there are certain kinds of claims for which observational evidence is not required or even relevant.

Consider the claim that a ball cannot be blue all over and green all over at the same time. I suppose one could try to test this with a ball and some cans of spray paint; but if we saw someone undertaking experiments of this sort, or founding an Institute for Research Into Non-Contradiction, we’d be feel that they simply didn’t understand what ‘all over’ or ‘at the same time’ means.

Likewise, in high school we all learned that on a plane the interior angles of a triangle sum up to 180°. Empirical confirmation of this fact isn’t necessary if one understands the proof. Moreover, if someone did draw a triangle whose interior angles summed to 179° we would all assume they’d made a small error in their measurement, not that all of geometry was now in question.

Or how about this one: the Austrians claim that the Great Depression was the result of government policies and that a hands-off approach would’ve made the recovery much, much quicker. Keynesians, on the other hand, think that not only is the market to blame for the downturn but that without extensive interventions the recovery would’ve taken much, much longer.

As we are dealing with a matter of history there isn’t any way to turn back the clock, try something different, and then compare the results. Instead we must evaluate these claims on the basis of sound theory, for there is no other way.

12 What does synthetic a priori mean?

It means a statement the veracity of which cannot be established by formal logic and for which experimental observation is also not required. A true synthetic a priori statement follows from axioms which cannot be denied without implicitly relying on them — e.g. one cannot deny that existence exists without confirming existence. With such axioms in hand we can derive synthetic a priori truths by reflecting on how things must necessarily be. Kant, who developed this framework, gave geometry as an example of a body of true synthetic a priori statements. Geometry begins with axioms like the definition of a line and derives further statements which could be tested (like: ‘the interior angles of a right triangle sum to 180°’) but which usually aren’t tested.

13 Does praxeology assume that all people are perfect calculators?

No, it assumes that they engage in purposeful behavior and have a hierarchy of wants.

14 Does praxeology assume all people are basically selfish?

No.

WorldSys: Austrian Home Study Course, Week 4

The World Systems Project is going to begin with a thorough examination of Austrian economics, starting with Robert P. Murphy’s outstanding “Austrian Economics Home Study Course“. The plan is to blog my answers to the weekly questions, with posts and book reviews tossed in as I go along. 

It should go without saying that the following contains ‘spoilers’, and if you intend on doing the home study course on your own you might not want to read further.

1 Why did Hayek receive the Nobel Prize in economics?

For his work on the Austrian theory of the business cycle.

2 Under which Austrian did Hayek actually study?

Friedrich von Wieser, and he also attended Mises’s legendary economics Privatseminar in Vienna.

3 What caused Hayek to abandon his socialist views?

Hayek’s interest in both economics and socialism stemmed from his desire to ameliorate the suffering of the poor. When Mises published Socialism, wherein the great man compellingly made the case that socialist ownership of the means of production would make economic calculation flatly impossible, Hayek was converted to Austrianism.

4 How did Hayek spread the Misesian cycle theory to the English world?

Hayek built on Mises to derive a theory of economic fluctuation based on credit expansions from financial institutions, and this was compelling enough to land him an invitation to lecture at the London School of Economics. There he met such future luminaries as Lionel Robbins, J.R. Hicks, Arnold Plant, George Shackle, and many others. Hayek was able to make the case for the Austrian theory of the business cycle to these people, many of whom gradually accepted his ideas. Through them the core ideas of Austrianism spread throughout the English-speaking world.

5 Name some reasons why Hayek may not have offered a full-scale refutation of Keynes’s General Theory.

Though Keynes and Hayek clashed on a number of occasions in the 1930’s, Hayek was in general reluctant to engage in direct confrontations with his colleagues in economics. And Hayek later claimed that Keynes changed his mind so often there was no real point in working out a detailed critique of General Theory if it was just going to be obsolete in a few years.

6 Which major economists attacked Austrian capital theory?

Two of the most prominent were the Italian Piero Sraffa and the American Frank Knight. For a variety of reasons, however, Austrianism had begun to fade from public view.

7 After leaving the LSE (London School of Economics), where did Hayek teach, and in what capacity?

At the University of Chicago as part of the Committee on Social Thought.

8 How did Mises and Hayek differ in their views on society?

The two men approached the defense of capitalism from very different angles. Mises was a rationalist fond of deductive arguments, while Hayek argued that the market order was better at incorporating diffuse knowledge into price signals and encouraging trial-and-error learning. Mises used reason to arrive at capitalism while Hayek repeatedly stressed the disastrous effects of an inappropriate faith in the power of reason.

9 What is a “Hayekian triangle”?

The Hayekian triangle is a diagrammatical representation of the fact that production is a temporal process requiring a vast amount of coordination between present and future goods and present and future demand.

Investments in capital goods like harvesters, mining equipment, or robots for assembling cars must be made in the present on the premise that people will want whatever those goods can make in the future. Investment in capital goods does not happen all at once, of course, but occurs in various stages; the production of a watch must first begin with pulling the required metals out of the ground, then proceeds to refining those metals somewhere, then moves on manufacturing the precision components which go into a watch, and eventually it must all be assembled (probably in a factory).

Getting all of this lined up so that people ultimately have the goods they want is one of the central problems of a complex economy, and the Hayekian triangle helps to illustrate the issue.

10 Describe some of Hayek’s insights on knowledge.

Hayek was a complexity theorist of some renown who believed that the task of economics was not to understand how an economy allocated scarce resources for diverse ends but how an economy utilized knowledge which was scattered among many different minds and not known to anyone in its totality. Much of the knowledge required to make an economy work is not only not centralized anywhere, and is not only not the kind of thing that is easy to articulate, but may not even be consciously known by the people who possess the knowledge! It is, in other words, tacit knowledge.

Such information is not available to central planners and cannot be made available to them, even in principle. An evolving market, therefore, is the best way to use this information to everyone’s benefit.

On this basis Hayek made a distinction between unplanned order (cosmos) and planned order (taxis). A taxis, like a business enterprise or a bureau, can only deal with problems of extremely limited complexity. A cosmos on the other hand is able to evolve solutions to much more complicated problems — but must be left alone if it is to succeed in doing so.

11 Why did Hayek describe competition as a “discovery procedure”?

Because he saw that markets make use of distributed, tacit knowledge by continuously discovering it. Tacit knowledge is found and utilized when firms hire workers to grow oranges, build houses, or manage teams of people. Moreover, individual people pursuing their own ends cause knowledge to percolate through the economy, showing up in the prices of goods and services.

12 What is a ‘spontaneous order’?

An order that is not planned by a central authority but instead emerges out of many smaller parts as they compete and coordinate. Nobody plans a modern capitalist economy, but one falls out of millions of individuals working, innovating, improvising, and consuming.

13 Describe some of the controversies in interpreting Hayek’s thought.

While Hayek was a preeminent economist squarely in the Austrian tradition he was not simply a follower of Mises. He differed from Mises in his interpretation of the socialist calculation debate: while Mises believed that collective ownership of the means of production made an effective socialist economy impossible, Hayek is thought to have believed it merely made an effective socialist economy really, really unlikely.

Hayek pointed out that there are two kinds of ‘liberalism’: a rationalist variety that derives laissez-faire deductively from first principles, and an English common-law variety that is wary of the over-application of an engineering mindset to economics problems while stressing the organic complexity of social orders. Hayek was mostly a champion of the latter liberalism.

There are those who go further and postulate a similar split in Austrianism itself, with the Hayekian faction emphasizing the diffusion of knowledge and the communicative powers of the pricing system and the Misesian faction emphasizing the effects of government intervention on monetary calculation.

Because Hayek was prolific and characterized his own writings as more exploratory than authoritative there are several different Hayeks one can read from his work. In any case, his was one of the 20th centuries most probing minds and all possible Hayeks are worthy of study.

WorldSys: Austrian Home Study Course, Week 3

The World Systems Project is going to begin with a thorough examination of Austrian economics, starting with Robert P. Murphy’s outstanding “Austrian Economics Home Study Course“. The plan is to blog my answers to the weekly questions, with posts and book reviews tossed in as I go along. 

It should go without saying that the following contains ‘spoilers’, and if you intend on doing the home study course on your own you might not want to read further.

1 Did Mises always intend to be an economist?

No, he began more interested in history.

2 What book formed Mises’s initial views on economics?

Carl Menger’s magisterial Principles of Economics. Mises had formed certain free-market convictions as a result of his empirical observations, but this book opened his eyes to a universe of positive economic theory which could enrich and extend what he’d learned on his own.

3 What was Mises’s major post from 1909 until he left Austria?

He was an economist at Vienna’s Chamber of Commerce, where he was able to win a number of important battles for sound money and sound economics.

4 In monetary theory, what was the “problem of the Austrian circle”?

While the Austrians had done spectacular work in what today would be called microeconomics there didn’t seem to be a way to apply their analysis to money. People subjectively value goods, and all the competing/intersecting subjective valuations together constitute market demand. But money appears to be a different thing because no one wants money for its own sake, they want money because of what it can buy.

This would seem to trap us in a circular argument: demand precedes and determines price for all goods except money, which people want because it already has purchasing power attained because people want it.

5 In The Theory of Money and Credit, how did Mises solve this problem?

By successfully developing a theory of money grounded in individual choice and consistent with Austrian views on price while simultaneously deploying one of his greatest contributions to economics: the regression theorem.

Mises noticed that the ‘price of money’ regresses backward until the development of money as a unit of exchange in predominantly barter economies. People value a dollar based on what they know a dollar could buy them yesterday; they valued a dollar yesterday because of what a dollar could buy them the day before that.

Keep subtracting days until you arrive at the point that gold or silver became a medium of exchange. At that point these were actual commodities bartered against other commodities and evolving into ‘money’ because they are easier to carry around and divide into smaller units.

In this way, Mises broke the circularity of the money argument and incorporated monetary theory into the edifice of Austrianism.

6 In what sense did Mises’s monetary theory integrate micro- and macroeconomics?

The Misesian monetary theory integrated micro- and macroeconomics because it was able to ground the most staunchly macro phenomenon — money, thought to be a radically different from other goods and resistant to similar ‘subjective value’ analysis — in the most staunchly micro phenomenon — individual choices.

7 In what sense did Mises differ from Menger and Böhm-Bawerk on the nature of utility?

Both of the earlier Austrians left indications that they believed utility to be measurable in some important way. That is, it was meaningful to speak of a good’s ‘total utility’ and attempting in some way to connect this with its marginal utility. Mises argued firmly for utility being ordinal; that is, that goods can be ranked in order from most to least preferred, but one can’t attach units to this valuation and say that one values apples ‘three utilons’ more than pears.

Moreover, the utility of a carton of eggs bears no fixed mathematical relationship to the utility of one egg. Instead, we are now dealing with the single utility of one larger unit (namely: a carton of eggs).

I confess that this is something I’ll have to engage with more down the road because it seems to me that there must surely be a sense in which utility can be thought of in the aggregate. Otherwise how can we say that a freer society is preferable to one of slavery and serfdom? Perhaps Mises would say that such judgments are perfectly valid but not with the purview of economics? I don’t know.

8 What were the three building blocks (formed by previous economists) that Mises used to construct his theory of business cycles?

They were: a boom-bust model of business cycles which already existed in the Currency School; the distinction between the ‘natural’ rate of interest and the ‘bank’ rate of interest developed by Swedish economist Knut Wicksell; the capital and interest theory of Böhm-Bawerk.

9 How did Mises contribute to the debate over socialism?

Immensely. There had been ample pushback against socialist intellectuals in the decades prior to Mises, but this had mostly centered on problems of incentivizing such distasteful chores as taking out the trash and the obvious fact that socialism would require quite a lot of coercion to be made workable.

In a series of breathtaking articles Mises argued forcefully that the collective ownership of the means of production could not succeed even on its own terms. The issue is that such a scheme would make prices completely inert. How could a central planner possibly calculate profit and loss if the state were in sole control of the means of production? Would a given unit of lumber be better used making additional apartment complexes, going toward a gymnasium, being used to build a concert hall? Now multiply this same question across everything the government uses to produce anything.

This ‘calculation argument’ sent the socialist intellectual world scrambling to formulate a reply. By the 1930s many were satisfied that communist theorists like Oskar Lange had succeeded in answering, but modern Austrians contend that the history of communism in the 20th century eloquently proved Mises and Hayek correct.

10 What is praxeology?

Praxeology is the science of human action, of which economics is but a part. It begins with the action axiom — ‘man acts’ — and the proceeds to deduce a variety of a priori truths that together constitute a framework required for any understanding of human beings.

Mises endorsed a variant of methodological dualism when he decided that separate techniques were required for studying men and molecules. Molecules might behave but they don’t act in the sense of taking purposive steps to achieve a goal. Therefore a science of human action must begin with different premises and use a different approach. Mises advocated for careful, rigorous deduction.

11 Name some economists influenced by Mises.

F.A. Hayek, Oskar Morgenstern, Gottfried von Haberler, Fritz Machlup.

12 What were the main themes of Omnipotent Government and Bureaucracy.

The former made the case that both leftwing and rightwing collectivism are undergirded by statist totalitarianism. The latter pointed out the many ways in which bureaucracies, both in governments and nonprofit organizations, are fundamentally different from profit-seeking enterprises by virtue of facing an entirely different set of incentives.

13 What was the German-language predecessor of Human Action?

It was called Nationalökonomie, and Human Action was a version so extensively revised and updated as to be a whole new book.

14 Did the American economics profession welcome Mises?

He had some allies and students, he found a teaching position at the New York University Graduate School of Business, and he found a publisher for Human Action, but by and large no, he was not welcomed by America’s economic intellectuals.

15 Was Mises a believer in logical positivism?

No. He penned a critique of it called The Ultimate Foundation of Economic Science: An Essay on Method, and was dismayed to see some of Hayek’s implicit endorsements of neo-positivism.

WorldSys: Austrian Economics Home Study Course, Week 2

The World Systems Project is going to begin with a thorough examination of Austrian economics, starting with Robert P. Murphy’s outstanding “Austrian Economics Home Study Course“. The plan is to blog my answers to the weekly questions, with posts and book reviews tossed in as I go along. 

It should go without saying that the following contains ‘spoilers’, and if you intend on doing the home study course on your own you might not want to read further.

1 What is marginal utility

Utility can be thought of as ‘usefulness’ or ‘satisfaction’, and margin means ‘this unit in this context’. One never chooses ‘chocolate cake’ as an abstract class, but a slice of chocolate cake at a specific time in their lives.

For most people most of the time the first slice has high utility because chocolate cake is sugary and delicious. The next slice has less utility because appetite for sugary deliciousness isn’t unlimited. By the third slice they’re probably tiring of cake, and by the fourth they might be positively sick of it. At a certain point they crossover into negative utility — the chocolate cake is actually making them nauseous.

When you’ve had no chocolate cake the first slice has a high marginal utility because it is the very first slice. After you’ve finished the first slice the second slice is evaluated on the margin; that is, in light of the fact that you’ve already had a slice, and compared to other foods you could be eating. As noted above the second slice will have less utility on the margin, the third less still, and the fourth even less.

2 What is the law of diminishing marginal utility

Extending the analysis from the previous question we can see that each successive unit of a good, evaluated on the margin, diminishes in utility. Displaying the wondrous depths of the imagination for which economists are famous, this phenomenon is called ‘the law of diminishing marginal utility’.

3 Can utility be compared between different people?

Not directly, but obviously we can use people’s testimony and their actions to decide on who ranks a given good more. In fact, this is the basis of exchange. The only reason two people will trade goods is because they each value what the other person has more than they value what they currently have.

4 If we take money from a rich man and give it to a poor man, have we raised total social utility?

No, Austrians don’t talk about ‘total social utility’ or try to compare utilities between people. It’s possible that a given poor person would value $100 more than a given rich person, but this needn’t be the case. Plenty of impecunious ’SurferDudez’ genuinely don’t, like, care about money, man.

5 does marginal utility involve a cardinal conception of utility? I.e., are there units of utility?

No. People value units of goods, but in Austrianism it makes no sense to speak of units of utility (such as ‘utilons’).

6 What is the purpose of Böhm-Bawerk’s example involving sacks of grain?

To demonstrate a somewhat tricky principle at the foundations of subjective/marginal value theory: that the value of a good is determined by the least-pressing use to which it could be put. Or stated another way, if you have several units of a good, the value of any of them is equivalent to the satisfaction lost by the loss of one unit.

Böhm-Bawerk asks us to imagine a farmer with five sacks of grain, to each of which he allots a purpose. The first sack is used to keep him alive until the next harvest; the second, to fill out his diet and bring him to full health; the third, to add culinary variety by allowing him to feed chickens with the grain; the fourth, to distill brandy; the fifth, to raise parrots which he finds entertaining.

Having five sacks of grain, the value of the fifth sack is whatever pleasure would be lost by not being able to keep parrots. If he did lose one sack, then he’d have four, and the value of the fourth sack would be the brandy he wouldn’t be able to enjoy.

This is a neat illustration of the law of diminishing marginal utility.

7 What is the water-diamond paradox?

The water-diamond paradox was a sticking point in classical economics deriving from their lack of a sound theory of subjective value. The question is: why is water so much less valuable than diamonds even though the former is required for life and the latter is not? This issue led classical economists into all number of specious distinctions (e.g. between ‘use value’ and ‘exchange value’) and blind alleys because they had no way of tying prices to the values of acting individuals.

Crucially, what they missed is that nobody chooses between the abstract category ‘diamonds’ and the abstract category ‘water’. Instead, everybody chooses between a specific unit of diamonds or water. Given how abundant water is in much of the world each successive unit of it is less valuable than a diamond because diamonds are very rare. But these valuations are entirely subjective and can change from person to person, or even change at different times for the same person.

8 Does the term subjective theory of value imply that Austrians consider their theory to be true only for some people?

No. ‘Subjective’ here simply means ‘in the mind of an acting human being’. The value of a good derives from some person’s valuation of it, not from objective, inherent properties, but this does not mean value is arbitrary. Rather, Menger held that value arises from men’s knowledge of the requirements of their life — i.e. they value bread because it feeds them, flour because it makes bread, wheat because it makes flour, and so on.

9 Can marginal utility analysis be applied to money.

Of course. Money is valuable because it allows for the possession of other goods, and therefore all the principles of marginal utility apply to it.

10 Why were the ideas of Menger so revolutionary? What did the classical economists believe?

The classical economists tried to develop a theory of market prices using supply and demand, but faced grave difficulties because they had no theory of value by which to understand consumer choice. Stated more plainly, the classical economists wanted to explain the price of oranges by looking at how orange growers and merchants made economic calculations, while having no way at all of referencing individual preferences for oranges. Upon this shaky foundation they erected a relatively sophisticated theory of prices and production but a profoundly crude theory of distribution, with a focus on big, homogeneous categories like ‘land’, ‘labor’, and ‘capital’. Their subsequent investigations were aimed at discovering the laws by which the aggregate income of these categories could be understood.

But Menger’s insights were profound even by the standards of previous subjective value theorists. He was not the first person to discuss concepts like ‘utility’ and ‘scarcity’, but he was the first to develop them into a consistent, integrated framework which explained prices and economic activity more generally.

He did not set about to destroy classical economics; his aim, rather, was to take their immutable economic laws, their emphasis on supply-and-demand, and their laissez-faire policy prescriptions and to put them on a sounder basis rooted in individual consumer choice — while simultaneously healing the divide between the sophisticated pseudo-praxeological theory of prices and production on the one hand and the crude, cartoonish theory of production on the other.

11 Isn’t the value of a good equivalent to the amount of resources used to produce it?

No. This ‘labor theory of value’ was one of the products of the deficient value theory of classical economics.

12 Other pioneers of marginal utility analysis used mathematical expositions. Why didn’t Menger?

Because Menger pioneered the concept of ordinal value rankings, as opposed to cardinal value rankings. Cardinal rankings have numbers attached to them, such as “I value pancakes ten times more than I value waffles”, a fact which might make them amenable to certain kinds of mathematical analysis. But ordinal rankings do not have any numbers attached. Menger, and his Austrian heirs, reject the idea of cardinal value rankings and the mathematical implications thereof in favor of a purely ordinal conception of value.

13 Why did Schumpeter say that “Menger is nobody’s pupil”?

Because Menger more or less invented the core ideas of Austrianism out of whole cloth. To be sure these ideas had intellectual predecessors, but Menger alone produced a framework in which they were set upon a foundation, integrated, and applied consistently.

14 What is Menger’s theory of goods?

Menger’s great study of economics began with the recognition that man is embedded in a tapestry of cause and effect, and though value is subjective, satisfaction even of subjective values must be related causally to the external world.

Goods, on this view, are those parts of the world that are a crucial aspect of the causal process by which human beings satisfy their wants. Humans value chairs because chairs are causally related to the satisfaction of the human desire to sit. Humans value ice cream because ice cream is causally related to the human desire to eat sugary dairy products. Humans value condoms because — well, I surely needn’t spell that out.

Not all goods are created equal; there is a hierarchy. Lower-order goods are those, like bread, which directly satisfy a desire like hunger. Second-order goods are those, like flour, which are used to make or procure lower-order goods. We can go on: third-order goods might include wheat, grain, mills, and labor used in manufacturing bread.

Humans value third-order goods (grain) because they value second-order goods (flour) because they value lower-order goods (bread) because they sometimes get hungry.

This distinction implies an important corollary: man must rank his preferences and act to satisfy the highest preference first.

Note that this is a powerful alternative to the labor theory of value which held sway among classical and marxists economists. This theory held that the value of bread derived from the costs of producing it. But this cannot account for the fact that, in economic ignorance, people routinely use scarce higher-order resources to make goods that nobody wants. Quite apart from this, it faces further ignominy because it cannot derive the actual prices of the means of production. It has to take them as a give and then work down from there to get the value of bread. Pretty crummy as explanations go.

Menger inverted this reasoning and solved both problems.

15 Would Menger classify oxygen as a good?

No. In addition to the hierarchy of lower- and higher-order goods, Menger made a further distinction between economizing and non-economizing goods. An economic good is a good like bread which is scarce and therefore subject to economizing. That is, I have to think about how much I want bread, how important it is relative to other uses of my money, and so on.

A non-economic good is something that exists in superabundance, like oxygen, and so is not ‘valued’ in the way that scarce goods like diamonds and tomatoes are valued. No one thinks to themselves ‘I have to make sure to allocate an appropriate amount of time and money to breathing today’, because oxygen is everywhere. It therefore doesn’t count as a ‘good’.

WorldSys: Austrian Economics Home Study Course, Week 1

The World Systems Project is going to begin with a thorough examination of Austrian economics, starting with Robert P. Murphy’s outstanding “Austrian Economics Home Study Course“. The plan is to blog my answers to the weekly questions, with posts and book reviews tossed in as I go along. 

It should go without saying that the following contains ‘spoilers’, and if you intend on doing the home study course on your own you might not want to read further.

1 Why is the school called “Austrian”?

Austrian economics takes its name from the fact that it was developed in Austria in the latter part of the 19th century by Austrian thinkers.

2 Who was the founder of the Austrian school?

The founding of Austrian economics is usually traced to the publication of Carl Menger’s Principles of Economics in 1871, which kicked off what is now known as the marginal revolution and developed ‘subjective value theory’ as an answer to various quandaries presented by classical and marxist economists. It’s important to note that, while Menger is considered the father of Austrianism, he is no longer given sole credit for subjective value theory; both William Stanley Jevons and Leon Walras published similar ideas at around the same time. 

3 According to [Thomas C. Taylor’s book Introduction to Austrian Economics], what was the primary contribution of Wieser?

One of Menger’s greatest students, Friedrich Von Wieser, expanded Menger’s ideas by developing the crucial notion of ‘opportunity costs’. That is: a key factor driving the cost of a product is the bids made by various actors wanting to utilize scarce resources in their own productive processes. So part of why golf clubs cost $is because more than one person wants to use the steel/rubber/leather that goes into making a golf club for other purposes, and makes bids for those items. 

4 According to [Thomas C. Taylor’s book Introduction to Austrian Economics], what was the primary contribution of Böhm-Bawerk?

Eugen Von Böhm-Bawerk was another of Carl Menger’s famous students. His contributions to Austrianism were in his realization of the importance of the time element in decision making and resource allocation. All things being equal people value present goods more than future goods; when a capitalist accrues profits from the difference between what a good costs to make and what it can be sold for, therefore, they are being rewarded for their willingness to forgo consumption now to invest in a production process that yields more goods at some later point. On this analysis, the Marxist view that capitalists are inherently exploitative is simply mistaken.

5 What was the methodenstreit?

The methodenstreit was the controversy over the appropriate methodology for economic analysis which erupted in the late 19th century and, in many ways, is ongoing. As will be explained shortly, Austrianism is set on foundations radically different from those of the Keynesian and neoclassical mainstream. 

6 Describe the popularity of the Austrian school in different time periods.

The Austrians enjoyed a good deal of popularity in the period between 1871 and approximately 1940. All of its major luminaries, especially Friedrich von Hayek and Ludwig Von Mises, were widely respected and taken seriously. A conflux of forces changed that, and the Vienna-born school of thought tumbled to a nadir in popularity during the 40’s, 50’s, and 60’s. During this time Mises alone continued to present Austrianism as a coherent and compelling body of ideas (though Hayek was producing important work throughout this period, he was at the London School of Economics and then the university of Chicago, and it’s conceivable that if Mises had not survived the rise of Nazism in Europe Hayek would today be remembered as simply an unusual Chicago economist. If that had been the case, Austrianism might have been lost). 

As it happened Mises wound up at the University of New York, where he influenced such economists as Murray Rothbard and Israel Kirzner. An institute was founded with his name and in his honor in 1982. This, together with the voluminous output of various Austrian-influenced thinkers and the awarding of a Nobel prize in economics to Hayek in 1974 have contributed to a renaissance in Austrianism. There are now Austrians in a number of major academic institutions, the Mises institute has made astonishing strides in educating lay people on the importance of free-market ideas, and Austrians are expanding the main body of theory to faraway places like derivatives markets. 

7 How does the Austrian school differ from the neoclassical mainstream? 

From the foundations on up. Austrianism was once in the mainstream, but a desire to copy the methods of the ‘hard sciences’ like physics led neoclassical economists to begin focusing on things like the mathematical properties of economic equilibria. This caused their focus to narrow substantially, leaving out parts of the market process Austrians consider essential to a proper understanding of economic activity. 

8 How does Austrian macroeconomics differ from orthodox Keynesianism? 

In almost every conceivable way. One would never hear an Austrian seriously talking about ‘boosting aggregate demand’, as if what people want doesn’t matter as much as that they want. Austrians consider as seriously mistaken the Keynesian technique of utilizing gigantic aggregates like ‘demand’ and ‘production’ in models so high-falutin’ and mathematical as to be nearly metaphysical. Indeed, the core Austrian notion that the boom and bust cycle is driven by malinvestment in underproductive sectors of the economy resulting from unrestricted credit expansion simply doesn’t make any sense in Keynesian terms. 

9 Are all Austrians necessarily in favor of laissez-faire?

As far as I can tell, yes. While it’s true that Austrians are almost always libertarians and that many libertarians are Austrian, the two are not identical. Austrianism bills itself as a value-free science of economics, while Libertarianism is almost always a prescriptive philosophy that holds liberty as the ideal and individual rights as unassailable. Austrians usually don’t argue against price controls (to take one example) on moral grounds, therefore, but simply because they cannot accomplish what the bureaucrats say they can accomplish, even in principle. 

10 Is Austrian economics really just a political philosophy?

No, it’s a robust economic philosophy. To be sure, it has plenty to say about the success or failure of various political schemes, but it is not limited to that. 

11 Who were the most important followers of Mises?

Probably Murray Rothbard and Israel Kirzner.