Wednesday, 24 October 2012

Economist of The Week - Carl Menger

The late 19th century saw the emergence of modern economics in general, regarding not only the tools and principles of quantitative measurement, but regarding modern macroeconomic schools of thought as well. The earliest of these, the Austrian School of Economics was founded by the economist Carl Menger, and it has a devoted group of proponents to this day.

Source: Wikimedia

Early life

Carl Menger was born in 1840, in an unusual place for an Austrian - precisely in the town of Neu-Sandec in Galicia. His familiy was one of wealthy German-speaking intellectuals - they left Bohemia for Poland a generation earlier. His father was a lawyer, while his mother was the daughter of a wealthy Bohemian merchant. Hence it was no wonder that Carl was destined for a intellectual career - after attending primary and secondary school, he left his family home to study simultaneously at the University of Prague and Vienna from 1859 to 1863.

Education and early career

After finishing his courses in economics and law at university, Carl began to work as a journalist for the Lemberger Zeitung in 1863, a Kraków-based German-language newspaper, writing both comedies and reporting on market events. He left for Vienna in 1866, to work for the more prestigious Wiener Zeitung, while preparing for his oral examinations for a doctorate in law - which he received in the autumn of 1867.

Immersion in economics

The young Menger - still only 27 at the time - 'threw himself' (as he called it) immediately into political economics upon graduation. While continuing to write for the Wiener Zeitung, he noticed that the general expectations of market buyers and sellers at the Austrian markets were different from those that the classical value theory (based on Ricardo and Smith) would have participated - market actors regularly over- or underpayed certain items on the market compared to expectations. Why was that possible? Menger started researching, lasting for five years, and ultimately concluding in a book published in 1871.

Magnum opus

Menger's book Principles of Economics (not unlike Malthus's Principles of Population) was written by a young economist, yet it introduced ideas which radically reorganised contemporary economic theory. (Besides, he was the first want to omit the phrase 'political' from his title, leading to a later surge of popularity of the term 'economics' to describe what this blog is about - check out a great post on this by economist Joseph Ward here)
Namely, his biggest contribution was the introduction of the marginal utility theory. Based on the subjective theory of value firstly advocated by Jean-Babtiste Say (then forgotten), he stated that the price of goods didn't derive from either labour, worker exploitation or total utility, but rather marginal utility - that consumers have multiple needs of different importance, which they will satisfy not equally distributing their resources, but by fulfilling the more important ones first.
To provide an example - remember our chains of examples with cows? Imagine that you have three bags of wheat, a cow and yourself to feed. You'll naturally use the first bag to bake bread for yourself, the second one to feed the cows and the third one to eg. make whiskey. Now what happens when you only have two bags?  You won't start eating 33% less - rather, you'll stop making your moonshine.

The diamond-water paradox

This new approach of pricing was then used to solve a long-standing paradox of classical economics, the diamond-water paradox. This concerns the fact that why do diamonds cost more than drinking water if water is obviously worth more in terms of total utility? (Click to enlarge.)
Source: Wikimedia
In Menger's view, the paradox can be solved by using marginal utility. In his view, the total utility of water is bigger than diamonds - since in small quantities, it is necessary for us to survive. However, water has abundant supplies on earth, meaning that when it's stopped being used as a means of easing human thirst, it's marginal utility decreases. However, diamonds are in such short supply that their mere scarcity drives their initial marginal utility higher than that of water, resulting in the graph above.
(The method of quantitatively measuring marginal utility in the form of utils was actually an invention of the British economist William Jevons, who died an untimely death from drowning)

Later life

Menger became immensely popular and famous in Austria following his publication, and while he initially worked as an Austrian public servant starting from 1870, he continued teaching at the University of Vienna, receiving it's chair of Economics in 1873. Furthermore, he became the economic instructor of the Austrian crown prince Rudolf von Habsburg in 1876 until the prince's suicide.
In 1892, he produced another important article, On The Origins Of Money, in which he argued that the creation and usage of money was a non-governmental phenomenon, and hence state interference in it was destructive.
However, despite continuing academic success, Menger began to feel early the strains and limits of academic research - frustrated by his constant conflicts with the then-predominant younger branch of the German Historical School of Economics, he retired completely in 1903, at the age of 63, and dying much later, in 1924. His son, Karl Menger later became a successful mathematician on his own in the USA.
Menger's theory later laid the foundations for the still-influential Austrian School of Economics - in a twist of irony, the school once so heavily condemned by the now-forgotten Germans.

Britannica Online
Ludwig von Mises Institute
Wikipedia article on Carl Menger

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