A New Path for Economics: Menger’s Principles of Economics

According to his son’s introduction to the 1923 edition of the Grundsatze, Carl Menger started the deeper study of economics in the fall of 1867. A renewal in science was long overdue, especially because, as was later reported by Wieser and Hayek, Menger did find a deeply unsatisfactory and blatant discrepancy between theories taught at academic level and economics practically used in ministerial offices and in the business world, especially at the stock exchange, which Menger had analysed as a journalist.

When Menger entered the field, the Classical School (Adam Smith, David Ricardo and John Stuart Mill) was under heavy criticism by the so-called “Historicists”, who based their attack on the works of Wilhelm Roscher in the 1840s and his method of drawing historical parallels based upon factual investigation. They tended to combine a variety of elements into a somewhat arbitrary perspective since the criteria for selecting facts were not all clear and depended much on the creativity of the historian. Philosophers also built various theories of knowledge upon which Menger would draw in his private notes, albeit showing signs of doubt as to their validity. Yet, Menger dedicated his 1871 Principles to Roscher and also wrote an obituary of him in 1894.

While Menger kept Roscher in high esteem, he fiercely opposed Roscher’s successors. The historical method displayed too many flaws, widespread in journals and edited series (see Grimmer-Solem 2003). After Roscher, Karl Knies and Bruno Hildebrand had indeed raised the issue and tried to mend the method. The form later given to it by Gustav von Schmoller, the leader of the so-called “Younger historical school”, Menger met with hostility. Conversely, Schmoller discarded Menger’s innovative work. In fight­ing Schmoller, Menger displayed talents in polemics because of which he was labelled “anti-historical”.

Menger’s own Grundsatze were indeed meant to provide such grounds. He states the point in the first opening sentences of the Grundsatze. Menger wishes to bring rigorous causal analysis to socio-economic phenomena. Menger thus ranks in the history of economics with innovators such as Franςois Quesnay or Adam Smith, and his own contemporaries Walras and Jevons. Menger’s theory revolves around three concepts: human satisfaction of needs, availability of resources and saleability (or marketability). The exchange of goods between human beings depends on the relationship between the agent’s economic self and the quantities of things found to be both satisfying his/ her needs and available and marketable in the environment at the moment the need is felt. Menger does not make any difference between the need for goods or for services. It is granted that all agents are set in a certain environment due to history and geogra­phy, local customs and climate, as the Historicists stressed. Yet, agents nevertheless all have basic needs, like hunger, thirst, accommodation and so on which need analysis at theoretical level. And only these objects that are satisfying/available/marketable become goods, and can be properly called economic goods.

Menger then ranks those goods, from first order (meaning “direct consumption”) up to higher orders: second order goods are used to produce first order ones, third order goods to make second order ones, and so on.

The ranking of one good that is considered in a given “line” of production does not depend upon the nature of this good, but upon the position it takes in both production and consumption. Its rank is not determined by any given quantity of labour used in it, nor by any intrinsic feature else than its natural power to satisfy a need under given (sub­jectively known) cognitive circumstances: indeed, in any two different processes where it enters, the same good may perfectly be ranked differently - wheat used as a seed and wheat to make bread are differently ranked.

Moreover, Menger’s basic principles leave plenty of room to express the subjectivity of the agent - and that was a revolution against the objectivist views borne by both the Classics and the Historicists. Whether Menger fully completed this revolution, that is in itself a controversial issue (for a negative view, see Lachmann 1978). Anyhow, Menger for­mulates a new law of value, from reasoning on “marginal value”, the last unit used by the consumer. This is the core of his Grundsatze, Chapter 3 entitled “Die Lehre vom Werthe”. Menger provided his new economic thinking within his version of marginalist reasoning. A subsection bears the title “subjective factor” and aims at measuring the original value of goods along such new principles illustrated in a triangular-shaped table (Table 2).

In this famous table, magnitudes of value (Arabic numerals) are the weight that the agent attributes to “units” of goods, whose classes (in Roman numerals) are ranked, top line, by order of the “importance” they have for the agent who wishes to satisfy needs

Table 2 Triangular-shaped table illustrating the Mengerian exposition of marginal value

Source: Menger (1871 [1968-70], I: 93).

he or she subjectively feels. The table reads in columns, along successive units of goods: the agent attaches an intensity of 10 to the first unit of good I, of 9 to a second unit of the same, and so on by decreasing intensity. So as to obtain maximum satisfaction, the agent would do all he could to get the first unit (as “10” only occurs once in the table): say, a glass of water, were he dying of thirst in a desert. A second unit of the same would already bring less enjoyment (“9”) and could be traded for a first unit of good II, and so on. Despite cardinality being used with numerals, only ranking is important and this scheme is ordinal, a point later much debated, when comparing the Austrian notion of marginal utility with “utility functions”. Value that lies at the “margin” of an agent’s needs displays the value of the good. The last unit thereof the agent wants is what deter­mines what the agent is ready to trade for it. This “marginal” position in the triangle thus indicates the measure of substitutes the agent would be ready to give away to be satisfied. The intensity of needs is ranked and value derives only from such a subjective individual valuation.

Choice widens as needs become less urgent. Once water is provided in the desert, one may choose between dates or a cereal grown in some oasis nearby: Menger himself draws on such examples. Unit after unit of good, by recurrence, his reasoning operates until all needs get satisfied. For instance, as thirst gets finally quenched, one more glass of water bears no more “value”, hence “zero” value lies at the end. Differences of magnitude in the significance that goods bear subjectively explain the ranking of units enjoyed. At the individual level, the “diamonds versus water” story of classical economics seems to fade away, as Menger offers no wholly sociological analysis of diamonds as instruments to signal riches and power but purely subjective terms.

Menger then begins Chapter 4 of the Grundsatze, entitled “Die Lehre vom Tausche”, quoting Smith only to rebuke Smith’s supposed human “inner tendency to exchange”, then rejecting in turn labour-commanded theory and labour-value alike.

Like Menger, Walras and Jevons were concerned with properly understanding value. In discovering the reasoning “at the margin” and in explaining the process of utility­maximizing that combines a subjective valuation of needs with the scarcity of avail­able resources, Menger, Walras and Jevons brought about a “revolution”. They were somehow anticipated by Gossen (and Thunen as regards marginal productivity theory). Some other German thinkers such as Karl Heinrich Rau or Karl-Hans von Mangoldt ought to be mentioned as well. Menger indeed read part of their works (as reported by Kauder 1957), but mainly opposed them; see his manuscript marginalia and his note­books and drafts. Maffeo Pantaleoni later accused Menger of having plagiarized Gossen. The archives however show that this accusation cannot be sustained, since Menger (who noted down the date of acquisition of his books) got hold of, and read Gossen’s volume (published in 1854) only after 1880, therefore after he had published his own Grundsatze.

To be fair, Menger acknowledged the laws Gossen had elaborated. Yet, Gossen focused on the fact that consumption takes time, whereas Menger changed the insight that the intensity of pleasure decreases with time into the idea that the degree of value that an individual subjectively attributes to goods decreases with “more units of goods” and determines pricing, which is the goal that Menger pursues in assessing marginal value. Besides the two fundamental “laws” which Gossen rightly drew through complex geometrical construction and analysis, especially the law of maximization (Gossen’s so-called “second law”), Menger judges all the rest in Gossen as being erroneous and condemns him together with Bastiat. He writes:

Gossen fails: to his mind, (technical) labour occupies a place indeed absolutely exceptional... [Also] all defects coming from the mathematical methods in the field of psychological investi­gations may be found there. Only enjoyment [Genieβen} and enjoyment only - and not what is effective for life and for human welfare (the utmost enjoyment of one’s whole life). Only labour and enjoyment, just like in Bastiat.

Whether Menger is right or wrong, this note (our translation) that appears at the back of the first flyleaf of his own copy of Gossen’s 1854 exposition shows that Menger reproaches Gossen with a lack of adequate concepts that the (then incipient) mathemati­cal method cannot mend in his eyes, and the use of deficient labour-value while Menger would insist on differentiating hedonistic pleasure and subjective satisfaction of needs to determine value based upon “self-felt” utility.

Menger parted company also with the other two “fathers of marginalism”, Walras and Jevons. He reasoned in terms of process and the dynamics by which individuals act: while seeking satisfaction, they discover how beneficial exchange is for that purpose. The science of exchange (or “catallactics”, a term later coined by Hayek) and Menger’s atten­tion to praxis (“praxeology”, a term later coined by Ludwig von Mises) find their origins in Chapter 4 of the Grundsatze, describing why and how agents trade. As the quantities of goods they need may be more or less available and saleable, trade between agents pre­vails. Jevons also stressed that point as early as 1871. Menger firmly rejected the notion that labour-value may ever be a determining factor for pricing goods on markets in real life: it is never the case that what it costs to produce (to the seller) is what determines the final selling price, but only what it means to the buyer to acquire and what the seller is ready to trade for. Discussing the limits within which buyer and seller agree to trade (horses against cows, and then cereals for horses in examples developed in Chapters 4 and 5), Menger does not seek equilibrium but a range of relative prices emerges, between whose limits exchange will actually happen.

From the following quote that Menger takes from Rossi, it may be inferred that it was precisely this process the Viennese was looking for: “if you could follow the thousands vicissitudes of the market, the contracting partners, and analyse rigorously the positions they take, and weigh, so to speak, the needs that explain them, then you would truly have solved the whole issue” (handwritten in the copy owned by Menger of the original French edition; Menger 1871 [1968-70], I: 108, Menger’s emphasis).

In his Grundsatze, as in later methodological writings, Menger speaks of “Atomismus” (atomism). Just as reasoning upon “units” of good and ranking orders set conditions for the satisfaction of needs to be a decreasing function of units being further enjoyed, Menger also treats agents as discrete, thus referring to “atoms”. The economist can observe such agents and see they are akin to individuals endowed with subjectivity. Their needs are understandable, and ultimately preferences can be assigned to agents who are not mere “material” atoms but express feelings, emotions, are more or less rational, more or less ignorant. Menger did not speak of “revealed preferences”. He better defined a strictly individual basis for economic analysis, later to be called “methodological indi­vidualism”. Max Weber later admitted adopting this view.

A parallel existed between marginal reasoning and a then very well-known experimen­tal law, the so-called “fundamental Law of Psychophysics” (or Weber-Fechner Law, from Ernst Weber and Gustav Fechner) stating that sensation increases with stimu­lus after an initial threshold is overcome and before satiety sets in. Whether pleasant (a soft touch, the satisfaction of some need, like quenching thirst) or painful (fatigue from labour, for instance), would this process take in the description of individual satisfaction of economic needs reckoned by Menger? The economist acknowledged an analogy but he rejected the view that this “law” could be a basis for economic theory. The result of experiments could always be debased by new experiments, while other psychological researches are surely to happen regarding the nature of the mind, and that was not Menger’s object. Menger argued in favour of pure theory, based on the logic of individual decision.

It is not coincidental that archives show that Menger wanted to change the title of his 1871 Grundsatze to Reine theoretische Wirtschaftslehre (Pure Theoretical Economics). The contents of the volume indeed make Menger’s intentions clear: Chapters 5 to 7 display the necessary elements to build a pure theory of how prices emerge (Chapter 5), how to distinguish “value-in-use and value-in-exchange” (Chapter 6) and how to gradu­ally extend the analysis to all kinds of commodities and market (dual trade, monopoly, general competition: Chapter 7). Menger retains that trade gets done within price ranges, which themselves derive from negotiations on available quantities wished for and effec­tively take into consideration all sorts of conditions that he lists.

In the last chapter (Chapter 8) of his Grundsatze, Menger seemed to insert a his­torical analysis of money, a fact which has sometimes puzzled commentators, as if there appeared some inconsistency. Quite the contrary: Menger echoes therein Karl Knies’s Das Geld (1885), the book that was then the reference on historicist monetary theory, yet only to overturn the latter’s method. Menger rejects inductive inquiry and conceives of the emergence of money as illustrating his concept of increasing “Absatzfahigkeit” (“saleability”) in payment systems. Menger reiterated his views in his 1892 essays on “Geld” (money), a series of different, yet matching texts in German, French and English (Latzer and Schmitz 2002; Campagnolo 2005).