TOPIC: AUSTRIAN ECONOMICS

Topic: Austrian economics



Topic: Austrian economics

From the second half of the nineteenth century onward, increased emphasis was put on consumption rather than production only, with the introduction of a notion of utility as a measure of individual satisfaction from the consumption of goods or services. Some reflections on utility had already appeared, with the idea that the problem of political economy and the ultimate purpose of all productive activities is to satisfy human wants at best. Yet it was long before utility could be fully integrated within economic models, not least because at first glance, it may have appeared as a subjective, qualitative notion devoid of any objective, let alone quantifiable, attribute.

The solution came from reinterpreting utility not as an absolute but as a relative magnitude, varying from one individual to another and for each individual, depending on the available quantity of a good. One could thus distinguish the total amount of utility from “marginal” utility—namely, the change in the level of utility that results from a given increase in the quantity of the good. Marginal utility was thought to diminish with the quantity consumed, reflecting the capacity of individuals to order the possible uses of successively acquired units: For instance, one would reserve the first gallons of water for drinking and the successive ones for personal hygiene, for housekeeping, and finally for watering plants. In passing, this assumption solved what earlier thinkers considered a paradox—the fact that useful goods such as water or air have low market value: The reason is their abundance, which means that the last increment in quantity generates an extremely small increase in utility. These results suggested an interpretation of self-interested behavior in terms of attempts to raise one's utility to its highest possible level and were obtained independently, in 1871-1874, by William S. Jevons (1835-1882) in Britain, Carl Menger (1840-1921) in Austria, and Léon Walras (1834-1910) in Switzerland.

Discussion

The importance of thinking in terms of marginal variations rather than total magnitudes proved so useful to account for utility and demand that it was subsequently extended to supply. In fact, notions of marginal productivity and marginal cost of production, as opposed to total productivity/cost, had already been introduced (e.g., by Cournot) but were refined and generalized in the 1890s by, among others, John B. Clark (1847-1938), Philip H. Wicksteed (1844-1927), and Knut Wicksell (1851-1926). Marginal reasoning seemed so important that the economic thought of this time period is often referred to as marginalism.

Accounts of the market mechanism of this time period place emphasis on the symmetry of supply-and-demand factors and on the resulting equilibrium. Individual demand and supply are derived, respectively, from agents' calculations of utility (for consumers) and profit/cost (for firms), and market supply and demand are obtained by aggregating all individual values. When market supply equals demand, the market is in equilibrium—that is, the decisions of all households and all firms are consistent with one another. These common traits can be combined with different assumptions to give rise to various models ...