History of Economics

7th Vienna School Part I

Outline:

1st Introduction: Renaissance of the Classic

2nd The most important representatives

3rd The first Gossen's law

4th The second Gossen's law

5th The problem of value-antinomy

6th The attribution problem

7th Principle of positive time preference

8th The Agio theory of interest

9th Power or economic law?

1st Introduction: Renaissance of the Classic

In the next three chapters we will now turn to the neoclassical economics. The classical theories did not only provoke contradiction and thus formed the prelude for both scientific socialism and the historical school. Since about the 1970s, there emerged efforts to revive classical theories in three different places at the same time, after both socialism and, especially in Germany, the historical school had displaced theoretical knowledge. There was a renaissance of the classical, the so-called neoclassical economy and the formation of the school of marginal utility in Vienna, the Lausanne School in Switzerland and Italy, as well as the Cambridge School in Great Britain.

Although the representatives of all three schools endeavoured to carry on the legacy of classicism, all three schools are characterised by a specific issue. The Vienna School was essentially concerned with proving that the value of goods was by no means objectively determined by the supply side, i.e. by the quantity input of the production factors, but that the value of goods was ultimately derived from the utility a good produced for the consumer, i.e. the end consumer. Since these are not objective but subjective quantities, the direction of the Vienna School is also called subjective theory of value. However, this direction is also called the school of marginal utility (Marginalism).

While the discussions of the Vienna School focus on the individual good and the value assigned to this good, the Lausanne School, the second variant of Neoclassicism, is primarily concerned with showing the macroeconomic connections, whereby Walras, the main representative of this direction, attempted to capture these relationships in a system of equations.

Finally, the Cambridge School, the third variant of neoclassicism, devoted itself to the individual market as did the Vienna School, with the difference that the Cambridge School followed the theoretical results of the older classicism much more strongly and never actually abandoned the thesis that cost factors were responsible for the price formation. In contrast to Ricardo, however, the representatives of the English neoclassicism believed that the prices of goods were not only influenced by costs, i.e. by supply factors, but also additionally by the demand side.

In this chapter we want to deal in more detail with the first variant of neoclassicism which is the Vienna School. As already mentioned, the main interest of this group, just as with the old classics, is the question of the determinants of prices, whereby it is not - as with the classics - primarily about the question of the absolute level of prices, but rather of the price relations to each other, and this again because the neoclassicists also recognise the central role of prices in the control of production. As already mentioned, the main interest of this group, just as with the old classics, is the question of the determinants of prices, whereby it is not - as with the classics - primarily a question of the absolute level of prices, but rather of the price relations to each other, and this again because the neoclassicists also recognise the central role of prices in the control of production. Here too, the space that is available forces us to limit ourselves to the core issues of the school of marginal utility: the value theory of the Vienna School.

If one attempts to attribute the value of a good to the utility that this good brings to the end consumer, one is faced with a similar problem as the old classics in their attempt to make the costs responsible for the level of the value of goods. We had seen in chapter 3 of this seminar that a theory that attributes the value of a good to the level of costs required for production faces the problem that such a theory can only satisfy if one assumes a single production factor. If one acknowledges that the production of a good always requires a variety of types of production factors, the problem of no value theory has been solved, since one attributes an unknown (value of a good) to other unknowns (value of several production factors). However, a value theory is only satisfactory if it is possible to attribute the unknown problem variable (value of a good) to variables that can all be assumed as being known.

The herewith comparable problem of the theory of marginal utility is that the value which a good generates on the basis of the utility achieved thereby must be attributed to the individual production factors which were used in the production of the product. Just as the classics had to acknowledge that as a rule several types of production factors are used in the production of a good, the school of marginal utility cannot avoid this insight. Only if a single production factor would be used, such as homogeneous working hours, could the value of the good be attributed 100% to this homogeneous factor. Since it is initially unclear how much each individual factor has contributed to this value generation if several in-homogeneous factors are used, the real problem of any marginal utility theory is to attribute the total values of a good to the production factors involved in its production. And just as the Ricardian value theory focuses on proving that only the standardised working hours required for production are considered as cost factors, the so-called allocation problem to the individual production factors is at the heart of the theory of marginal utility.

2nd The most important representatives

Among the most important representatives of the Vienna School are Carl Menger, Eugen von Böhm-Bawerk and Friedrich Wieser.

Carl Menger lived from 1841 to 1921 and is one of the founders of the marginal utility school. In the year 1871 he published his 'Grundsätze der Volkswirtschaftslehre', in 1883 followed the 'Untersuchungen über die Methode der Sozialwissenschaften und der politischen Ökonomie insbesondere'.

Carl Menger became famous mainly because he defended the justification of an economic theory in the dispute over methods with Gustav von Schmoller, which could prove exact laws in a similar way to natural science (here, for example, the theory of mechanics).

He tried to demonstrate that the price of a good would depend ultimately on the utility that the final consumer receives from the consumption of that good. In this context, it was important to note that the increase in utility, the so-called marginal utility, would decrease with each quantity consumed. The price of a good is finally determined by the utility of the last consumed unit.

Moreover, it is owed to Carl Menger that he was able to explain the already in classicism discussed but unsolved problem of value-antinomy. The classical problem of value-antinomy consisted in the fact that valuable goods such as air and water attain almost no value, but that gold and precious stones with a low use value attain a very high price. We will discuss this problem in detail below.

Eugen von Böhm-Bawerk lived from 1851 to 1914, was one of the most important Austrian representatives of the marginal utility school and for a long time was Austrian Minister of Finance. Especially his work on: 'Kapital und Kapitalzins. Positive Theorie des Kapitals', published in 1884, as well as the 'Geschichte und Kritik der Kapitalzinstheorie', published in 1889 attracted attention.

Particularly his agio theory of interest attracted great attention. According to this theory, interest is paid because, among other things, it must be expected that consumers underestimate future needs. However, enterprises were willing to pay interest primarily because the invested capital generally increased productivity.

Friedrich von Wieser lived from 1851 to 1926 and was best known for his two major works, 'Über den Ursprung und die Hauptgesetze des wirtschaftlichen Wertes' published in 1884 and 'Der natürliche Wert' published in 1889.

In contrast to Carl Menger and Eugen von Böhm-Bawerk, Friedrich Wieser was convinced that the problem of attribution could not be solved by the methods proposed by Carl Menger and Eugen von Böhm-Bawerk, but only on the basis of a simultaneous system of equations.

3rd The first Gossen's law

Among the most important theorems of the marginal utility school are the two so-called Gossen's laws. As the name already indicates, these laws were already developed about 20 years earlier by Hermann Heinrich Gossen. Hermann Heinrich Gossen lived from 1810 to 1858 and had already described these connections in 1854 in his work: 'The Development of the Laws of Exchange among Men and of the Consequent Rules of Human Action'.

The first Gossen's law states in its original form that the utility that one derives from the consumption of a good increases with increasing consumption, but that the increase in utility, which is called marginal utility, decreases with each additional unit of consumption.

We can illustrate this regularity in a diagram on which the total utility of the consumption of a single good is drawn on the ordinate and the respective unit of goods is drawn on the abscissa:

From this function we can then derive the course of the marginal utility of the respectively last consumed unit of goods by drawing the marginal utility on the ordinate and the unit of goods on the abscissa:

Let us take a closer look at these functions: In the origin of coordinates (i.e. the zero point) the total utility is zero, the marginal utility is not defined. For the consumption quantity 1, the ordinate value of both the total utility and the marginal utility is just the utility value of the first unit of goods consumed.

In the further course, the total utility increases respectively the marginal utility decreases, but with ever decreasing values. For the question how these functions develop further, three variants are conceivable. Firstly, it would be possible that for each additional unit of consumer goods the utility increases - albeit at ever lower values - here the total utility curve approaches asymptotically the saturation point, but this is never reached with finite values.

In a second variant, the total utility function reaches the saturation point, but does not rise any further with a further increase in goods; thus, from this point on the curve runs parallel to the abscissa. The marginal utility curve in contrast intersects the abscissa, but does not continue in the negative range:

In a last variant, finally, the utility functions also reach the saturation point; if the quantity of consumer goods continues to increase, then a reduction in utility occurs, however. The total utility curve takes a downward course, while the marginal utility curve changes over into the negative field: this means that from the point of intersection of the marginal utility curve with the abscissa axis, each additional consumption unit causes a negative utility (misuse or harm).

Surely, variants one and two represent extreme cases, which are encountered in reality only in the rarest cases. The rule is probably to be found in variant three, in which the increase in utility becomes negative beginning with a critical amount, i.e. changes from a positive utility into a negative damage.

Let us take as an example a person who is dying of thirst and now drinks several glasses of water. The first glass of water is extremely beneficial to someone who is dying of thirst, as it prevents this person from dying of thirst and perishing. The second and maybe third glass of water may even increase the well-being. However, if this person drinks more glasses of water, he will soon reach a point of discomfort (disgust) and the utility perhaps may even turn into damage.

Within enterprise theory, a distinction is made between partial marginal product and marginal level product. While the partial marginal product refers only to the change in a single production factor (while the other production factors remain constant), it is spoken of the marginal level product when all production factors are changed proportionally. The question suggests itself whether similar phenomena do not also occur in household theory, i.e. whether one cannot also speak of a partial marginal utility and a marginal level utility, whereby both curves in the household theory do not refer to the use of production factors but to individual consumer goods respectively to total income.

Such a reference is made if one does not follow the course of utility as a function of the consumption of individual goods, but rather asks how the utility of a household changes when the privately disposable income of this household changes.

Also here, it is generally assumed that an increase in income (i.e. an increase in the disposable amount of consumption) leads to an increase in utility, but that with a continuous increase in income there is a diminishing increase in the utility of the income unit that was added last:

We can also observe the three variants distinguished above with regard to the marginal utility course in relation to income: first, the marginal utility curve can approach the abscissa asymptotically, it can intersect the abscissa and then follow the abscissa, or it can finally reach into the negative range. Further down, however, we will see that the third variant is probably to be expected here only very rarely; more likely is the first variant, according to which every income increase brings a certain additional utility.

Let us remain with the parallels to production theory. There we distinguish between two different laws of diminishing returns: the classical variant and the Cobb-Douglas production function. Whereas the Cobb-Douglas production function assumes a decrease in the partial marginal revenue from the initial application of a production factor, the classical variant of the law of revenue initially recognises an increasing marginal revenue and only from a critical quantity of the applied production factor onwards a decreasing marginal revenue.

What is the position on this issue in the theory of consumer choice? Do we have to expect the possibility also here that the marginal utility increases with small consumption quantities and only then, again, from a critical consumption quantity on, we can expect a decreasing marginal utility?

To illustrate this, let us take an example: a person listens to a violin concerto by Wolfgang Amadeus Mozart for several times. We can certainly assume that this person has not yet perceived all the musical subtleties of this concerto when he is listening to it for the first time, that some sounds and harmonies will only be perceived after a second or third listening session, and that in this respect the second or even third listening session will provide greater musical enjoyment than listening to this concerto for the first time. Thus, here the marginal utility would indeed increase initially. But at a certain point of repetitions, these additional gains in musical enjoyment would be used up, a further listening would bring no more utility, the charm of the new would disappear.

When discussing the laws of diminishing returns, it is assumed that the chosen technique determines at which input ratio of the individual production factors an optimal result can be achieved. The fact that an increase in a production factor initially leads to a growth of earnings must then be explained the way that the examined production factor was initially used in a suboptimal quantity. In this case, the increased use of this factor leads to an approximation of the optimal input ratio. But once this is achieved and the examined production factor continues to be used increasingly, one departs from the optimal input ratio again with the consequence that the marginal revenues of this production factor now decrease.

Similar considerations apply to the course of the marginal utility curve. Here too, it can be said that an optimum utility is achieved when consumer goods in a complementary ratio are in a very specific input ratio. If we start our breakfast by eating, for example, five slices of bread with a tiny amount of butter, the marginal utility of butter will certainly increase if we consume increased amounts of butter, but here too, the marginal utility of butter will probably decrease once a certain amount of butter is reached.

The example of listening to a piece of music, however, indicates a different context. We assume here that playing a concert evokes a multitude of impressions and that our receptiveness is not sufficient to register all these impressions during a single listening session. This circumstance means that the musical enjoyment of the second and perhaps third listening is even greater. However, as soon as all the impressions are recognised, the reason for a further increase in musical enjoyment lapses.

We continue with the parallels to the enterprise theory. When discussing the Cobb-Douglas production function, we assume that here the law of diminishing marginal returns is only valid for the partial marginal returns, but that the marginal level product must be considered as constant. Here too, there is something like an optimal input ratio of the production factors, and any deviation from this ratio results in diminishing marginal returns.

In the field of marginal utility theory, can we also expect that although the partial marginal utility decreases with increased consumption of a good, the marginal utility of income must be regarded as constant? Here again, we just assumed that there is an optimal input ratio for complementary consumer goods.

Nevertheless, it is unlikely that a constant marginal utility level can be expected if income increases and the structure of the goods consumed is maintained. Although there are good reasons for the marginal utility of income to be constant, this is not related to the fact that the structure of consumption remains constant.

Let us take again the example of bread and butter as a spread. Although it is certainly true that there is such a thing as an optimum composition of this bundle of goods consisting of bread and butter, it cannot be concluded thereof that a mere multiplication of this bundle of goods brings unlimited increases in utility. On the contrary, it is just when a person would eat more and more bread spread with butter that saturation would occur very soon, and this means that the marginal utility of this bundle of goods would decrease once a certain amount is reached.

The reason for this is that the human body is built in such a way that it cannot consume unlimited quantities of goods; this applies not only to food, but for all kinds of reasons probably to most conceivable goods. If the increase in prosperity manifests itself solely in the fact that of the same goods simply more quantities are consumed, the human being reaches the limits of receptiveness, discomfort and boredom arise, which cause diminishing marginal utilities.

Nevertheless, it may be true that despite an increased income, the utility growth does not decrease with the correct consumer behaviour. The requirement for this is, however, that innovative goods are consumed again and again, which differ in their quality from the goods previously consumed. And in the invention of innovative consumer goods man has shown himself to be tireless. Although in the course of the history of teaching, there have been repeatedly personalities who prophesied that very soon saturation would have to be expected, that for this reason consumption would not increase with income and that therefore mass unemployment would ultimately be expected due to insufficient consumer demand.

These gloomy predictions have not come true yet. As Alois Schumpeter has shown, these predictions have been repeatedly refuted by the course of history, because these prophets lacked the imagination to envision that human need is basically almost insatiable.

4th The second Gossen's law

Now we will deal with the so-called second Gossen's law. While the first law describes the dependence of the utility conceptions on the quantity of consumption and in this respect represents a hypothesis about human behaviour, the second Gossen's law is about a maximisation rule. It specifies how the individual consumer should behave in order to maximise his utility. Thus, it is not claimed here that the consumer always or even only in the majority of cases behaves in a way that is utility-maximising, but only that he must behave according to this rule if he wants to maximise his utility.

Now it is necessary to consider, however, that a large part of the classicists and especially neoclassicists have indeed assumed that people in general do in fact behave in this way, i.e. try to maximise their utility. However, it is extremely difficult to prove such a more extensive hypothesis. For either one understands the thesis of utility maximisation in the sense of hedonism, according to which people tend to always act in a manner that is pleasure-oriented and avoiding dislike. However, such a narrow interpretation of the thesis of utility maximisation is by no means shared by the majority of scientists. It is also hardly possible to be proven empirically. Or else one deliberately expands this concept and adds up each attempt to approach arbitrary objectives in such a way that in the final result the highest possible degree of aim achievement is reached. Although such behaviour can often be determined empirically, the concept of utility maximisation is expanded here to such an extent that it becomes almost an empty formula.

An empty formula is always present when none of the conceivable alternatives can be excluded and when this statement is thus always valid. In contrast, the empirical validity of a hypothesis is all the greater the more conceivable alternatives are excluded as factually impossible.

Let us illustrate that the concept of utility maximisation is often extended in such a way that no real empirically valid hypothesis is concealed under this term. Suppose we observe a person who takes a 500 euro note from his wallet and burns it in front of everyone with the help of a lighter. This certainly represents a behaviour that is generally considered irrational and therefore apparently contradicts the objective of utility maximisation. With €500 some useful goods or even services could have been bought.

But even such a behaviour can - if one wants to - still be regarded as utility maximising if one chooses the broadest possible concept of utility maximisation. Thus, for example, one could point out that the one who performs such an obviously irrational act still increases his utility and thus maximises it, since he has just such a great pleasure in this act and especially in the display of this action, that it is of more value to him and thus provides greater utility than if he had purchased certain goods for this sum of money.

Here, the concept of utility maximisation becomes indeed a meaningless empty formula. No effort is made at all to determine under which conditions a utility-maximising behaviour is present and, above all, under which conditions this rule is violated. It is referred to the fact that precisely because such behaviour can be observed empirically, the observed person expresses through his actions that it brings him a gain in utility and that of all the alternatives known to this person, it is also the one that brings him the greatest utility.

Here it is implicitly assumed that every human being behaves in a utility-maximising way in all his actions, that a non-utility-maximising behaviour is not conceivable at all. When one speaks of utility maximisation, here one does not want to make any empirically contentful statement about the behaviour of humans, which could also be wrong; one rather uses this formula to show which actions are necessary to achieve the aims that a human has set for himself.

Let us remain once again with the comparison of the enterprise theory. There, the thesis of utility maximisation corresponds to the thesis of profit maximisation. This thesis may now be just as questionable as the thesis of utility maximisation if we really wanted to claim that all entrepreneurs behave in a profit-maximising manner. Nevertheless, the thesis of profit maximisation can be interpreted in such a way that it becomes a realistic hypothesis, namely if we assume that there is intense competition, which provides strong incentives to take every possible profit in order to be able to survive in the economic competition.

However, it is not possible, also regarding the thesis of utility maximisation, to assume similar incentives of the market, which then more or less also lead to a maximisation of the utility as a rule. If, for example, a consumer pursues altruistic objectives to a great extent, then he is still not forced out of the market as a consumer if he is not ready to give up these altruistic objectives and seek his utility in the sense of an exclusive self-interest. If his economic activities have led to the achievement of a high income, then this high income also allows this same consumer the opportunity to realise his altruistic objectives.

If he is really convinced that the realisation of altruistic objectives will bring him greater satisfaction than if he tries to increase his pleasure in the sense of hedonism, then the behaviour of other consumers who do not share this altruism will not force him to abandon these altruistic objectives. In other words: the market does not provide comparable incentives for utility maximisation in the sense of selfish behaviour, which we can observe with behaviour according to the profit maximisation maxim.

Now what does the second Gossen Law say? As long as the marginal utility of the income is not the same for all types of use, an increase in utility can be achieved by deducting parts of the income from those uses for which the marginal utility is lower and by allocating these parts of the income to those uses for which the marginal utility is even higher. This is because, by definition, the loss of utility in the types of use with lower marginal utility is lower than the increase in utility in the uses with higher marginal utility. On balance, the utility increases with such a reorganisation.

Conversely applies that a household in which the marginal utility of income is the same for all types of use, no further increase in utility can be achieved by changes in use. Thus, under these conditions (same marginal utility in all types of use of the income) the maximum utility is reached. Each change would lead to a reduction of the total utility.

Since we can assume on the basis of the first Gossen's law that the marginal utility decreases for those uses which are now consumed more and that, conversely, the marginal utility increases for those uses which are now consumed less, there is a two-sided approximation of the marginal utility of the individual types of use with the consequence that sooner or later this reorganisation will lead to a situation in which the marginal utility of income is the same for all uses. There is not very much lost from this basic statement either if we consider that the quantities of goods can of course not be divided into infinitely small units in reality. In this case, we are simply speaking of the fact that maximum utility is achieved when the marginal utility is approximately the same in all uses and cannot be approximated by further substitutions.

5th The problem of value-antinomy

Already at the presentation of the most important representatives of the Vienna School we pointed out that Carl Menger had succeeded in solving the problem of value-antinomy of classicism. In this section we will deal with this problem in more detail.

The classicists were unable to solve the problem that certain goods such as air and water are vital, but still do not achieve value on the markets, while conversely other goods such as gold or precious stones sometimes achieve a very high market value, even though the utility of these goods is relatively small compared to the first group of goods.

Carl Menger solved this problem, which was unsolved in the classical era, by differentiating between the total utility that a good provides and the marginal utility of the last unit of goods consumed. When we speak of a good having a particularly high value, we refer the concept of utility to the total utility of this good. The first glass of water may save us from dying of thirst, thus it has an infinite utility, but the second and third glass may still bring a certain increase in utility by quenching our thirst even further. However, from a certain amount of water on we do not obtain any additional utility, the marginal utility has dropped to zero.

But when we speak of value in terms of the required market price, we refer to marginal utility (i.e. the utility of the last unit consumed). We must assume that the price on the market corresponds to the marginal utility of the quantities of goods sold. Indeed, if a consumer seeks to maximise his utility, he will expand his demand for a consumer good as long as the consumption of the last unit brings an increase in utility that is greater than the utility he would have obtained if he had spent these parts of his income on another good.

Air and water were regarded as free, i.e. not scarce, goods in the time in which the classicists and neoclassicists lived, which for these very reasons could be satisfied to the point of saturation. But since - as we have shown in the previous section - the marginal utility and with it the price obtained on the market diminishes with increasing consumption, the actual price (value) of these goods is almost zero.

Conversely, the amount of available gold pieces or precious stones is extremely small, which means that compared to air or water, we still obtain a remarkably high market price.

Some critical remarks on the selection of these goods may be appropriate. Whereas in Carl Menger's time air and water could indeed be classified as free goods, for which no price had to be paid consequently, this is no longer the case in our times.

Let us take the example of water. It may seem to an unbiased observer that even today he can take a glass of water from the tap without paying a price. But the first impression is deceptive. For a long time now, the waterworks and the municipal administration have been charging high fees for water and sewage, the amount of which also depends on the amount of water consumed.

The same applies to the available air, even if, of course, when breathing oxygen, we are not attached to clocks that measure the consumption of air. The daily production as well as the daily consumption leads in many ways to a pollution of the air, so that only with high costs the state can let the air be cleaned again in such a way as it is needed for our daily life. However, since air is not an individual but a collective good, we do not pay for the use and consumption of air in individual prices, but by way collectively levied taxes.