As many of you know, I'm Dr. Mark Thornton here at the Ludwig von Mises Institute.
On behalf of Lew Rockwell and the entire Institute, I'd like to welcome you all here this week,
and also our viewers on the World Wide Web as well.
Our conference this week is on the fundamentals of economic analysis, a causal, realist approach.
I've heard so many people in my lifetime who say, oh, I just don't get economics.
You may have that same feeling or you may know lots of people who say the same thing.
Well, this week, these 15 hours, you will get all the basics about what economics is all about and be able to do your own economic analysis as well.
We have two speakers this week. Our first speaker is Dr. Joseph Salerno.
Professor Salerno is a senior fellow here at the Ludwig von Mises Institute.
He's the director of the Mises Summer Research Program.
Program. He's a professor of economics at Pace University, and he is the editor of the
quarterly journal of Austrian Economics. Our second speaker this week is Dr. Peter Klein.
Peter is also a senior fellow at the Mises Institute, and he is the director of the Contracting
and Organizations Research Institute, and a professor at the University of Missouri.
Both our speakers this week are known star teachers in graduate business economics.
Professor Salerno will begin the week with a lecture on scarcity, choice and value.
Good morning everyone.
Let me say a few words by way of introduction about the title chosen for the lectures.
In particular, why the subtitle?
What does it mean to say it's a causal realist approach?
Really it refers to a broad movement in economics that began when Carl Menger wrote his great
Principles of Economics in 1871 and it flourished and really dominated economics through World
War I and began to diminish in the 1920s. Included not just Austrian economists, so
We wanted a broader approach. It included others that followed Menger in America, Sweden, Italy, the Netherlands and France.
Some of the famous names were Clark, Federer and Davenport in the United States, Wickstede in Great Britain,
Augusto Graziani in Italy, Leroy Bouillieu in France, and many, many others.
Now Menger emphasized that economics was a unified science involving the search for cause and effect relationships or causal laws that would explain the prices, wages, and interest rates that are actually observed.
Menger was actually a journalist before he became an economist, an economic journalist, and he observed the markets very closely.
and he noted that, in fact, prices changed as a result of factors that were not really included in the classical theory of prices.
Let me just give you a quote that sort of sums up this approach, I think, very well.
It puts price theory at the center of economics where it properly belongs.
This quote comes from the preface to Menger's book, Principles of Economics.
It says, I have devoted special attention to the investigation of the causal connections between economic phenomena involving products and the corresponding agents of production, which we would call factors of production of resources.
Not only for the purpose of establishing a price theory based upon reality and placing all price phenomena, including interest, wages, ground rent, together under one unified point of view, but also because of the insights we thereby gain into many other economic processes heretofore completely misunderstood.
So notice what I've highlighted there, or bolded, causal connections based upon reality from one unified point of view.
That sums up the causal realist approach.
Now, what happened to this approach? This is not a history of thought seminar, but I do want to say just a few words about what happened to the approach.
Because that's certainly not the approach that's reflected in current day textbooks.
As I said, the causal realistic approach to economics became really an international enterprise, and most economists were involved in it.
Unfortunately, it veered off the track, the economics profession veered off the track in the interwar period, in the 1920s and especially in the 1930s.
There were three factors that led to this.
to this. First of all, Alfred Marshall in in the United Kingdom or in Great
Britain introduced through a very famous and much-used textbook written in 1890,
he introduced partial equilibrium analysis that focused on business firms
in particular markets while abstracting from or ignoring the unity of all
economic phenomena. He also tended to downplay the role of the consumer and of
and Consumer Demand, and his work was extremely influential and pretty much swept Great Britain between 1890 and 1910 or World War I,
and then in the United States became the dominant theoretical approach by the 1920s.
A second factor that led to the decline of this causal realist approach was a shift from explaining actual prices,
The prices that we actually observe, prices that, for example, Matt actually paid for that Dr. Pepper today, unless he took it free from the Institute, actually observed prices.
It shifted focus from that, explaining those things, which Menger had insisted on, to explaining equilibrium prices that we find in the model of perfect competition.
Now, that model was formalized and introduced into economics by the American economist Frank Knight in the 1920s.
By the 1930s, the economics profession had not only veered off track, but had actually jumped the tracks.
By then, we had the monopolistic competition revolution.
What that did was to portray almost every single real-world firm, except maybe a tiny farmer in Iowa, as charging monopolistic prices.
Then we had the Keynesian Revolution shortly thereafter, a few years later, and that severed the connection between laws governing the microsphere of consumers, firms, and markets, and it propounded sort of a new and contradictory principle or set of principles to explain macro phenomena like unemployment, depression, inflation, as if these things were not intimately tied to the price system.
and the rise of mathematical economics in the 1930s.
That had previously been, well, I want to use the word cult,
but a small set on continental Europe,
especially in the French-speaking Switzerland and France.
And suddenly, when it made its way to Great Britain and then to the US,
it exploded in popularity.
So by the 1950s, economics was definitely on the wrong track.
And there's a wonderful quote by someone named Townsend introducing a book of readings on modern price theory in 1970 or 71.
And what he does is he goes through the people that were part of the causal realist movement and sort of says that these people have been forgotten or their price theory is no longer relevant.
So he says the shades, meaning the ghosts or specters, of Jevons, Menger, Edgeworth, Wicksteed, Vicksel, Clark and Fischer, almost all of whom were involved in following that approach, the cause of realist approach, may justifiably be offended by the attribution of modern price theory to two sources, Alfred Marshall and Leon Volras.
But these two scholars have had far and away the most influence on 20th century thought, and that is absolutely true.
In contrast with Marshall's down-to-earth struggle with the interpretation of the detailed working of the economy stands Walrass's grand construction of general equilibrium.
In a typical British or American textbook on price theory, nine-tenths of the content stem from Marshall's work, general equilibrium only getting a notice in the last chapter appendix.
That's still pretty much true for undergraduate textbooks.
Now, the course that we will be giving is what you would have gotten in college, or in contemporary universities, had this tragic diversion of economics not occurred.
Now, let me just say a few words about what economics is and what economics is not, before I get into the substantive analysis.
Analysis. Okay, first of all, a very famous or much-used definition of economics is still around, is that it's a box of tools, or a toolbox, because it was very popular in the 1930s, which provides means for answering certain questions and solving problems, okay? Supply and demand is part of the toolbox, theory of the firm is part of the toolbox. Now, in this view, some of the tools eventually outlive their usefulness, they become dull,
and they must be replaced by new tools, okay?
So new tools must be continually developed.
There's no obvious relationship among tools except that they give, quote,
satisfying answers to questions.
Not true answers, but satisfying answers, okay?
A second characterization of economics that I hate is a way of thinking, okay?
A way of thinking about the world and its problems.
This sounds very fuzzy and nice and, okay, but it's not scientific.
Contemporary textbooks often have introductory chapters on how economists think.
Not what economists think, not what the true laws of economics are, but how they think.
So they think in terms of benefits and costs and supply and demand, the structure of incentives and strategic situations now more and more, etc.
And they think about social problems and policies in terms of simple models with unrealistic or oversimplified or even false assumptions.
And they really never address, in this way of thinking, the full reality of economic phenomena.
Now, I'm not against false assumptions. They do play an auxiliary role in economics.
But in this characterization of economics, we really never get beyond the false assumption.
My all-time least favorite characterization is that economics is a set of open questions,
that economists debate endlessly about and that have no right, quote-unquote, answers.
For example, what is the role of knowledge in the economy? You can debate endlessly about that.
Is entrepreneurial activity equilibrating or disequilibrating?
This has been debated since the 1970s and there still doesn't seem to be a resolution.
Do people always act rationally in their own interest or are there behavioral quirks and propensities that prevent them from doing so?
Are expectations exogenous or endogenous to the market process?
These are all questions that economists like to debate.
But now think about physics, chemistry, geology, these sciences, they're practitioners, now I'm not talking about the philosophers of natural sciences,
but I'm talking about the actual practicing physicists, chemists and geologists.
Do they look on their sciences as a set of open questions to be debated endlessly?
Or are they eager to give solutions to problems and answer questions and move on to the next question?
Not to say that they don't make mistakes, they certainly do, or that some of the truths aren't complete and must be further refined. That's certainly true.
But as sciences, these bodies of knowledge are regarded as systematic bodies of knowledge, or science, about an aspect of the real world.
They don't consider themselves debating societies.
So, economics as a substantive body of universal truths, or that's how I would define it, as a substantive body of universal truths about cause and effect relationships in the real world of human economic activity.
These truths we call the laws of economics and Menger called them exact laws.
So, what does economic analysis, the other part of our title, what does that mean?
Economic analysis involves a systematic application of these laws.
There are still new laws to be discovered in economics.
The world is continually changing.
We have different data to reason upon.
New laws, new refinements of already existing theories and laws are always possible and certainly are to be welcomed.
At any given moment, we do have a systematic body of truth.
And so analysis involves the systematic application of these laws or theories to the explanation of the causes or consequences of concrete conditions that we observe in history.
Why is there an apartment shortage in New York City? How can we explain that?
Well, there's a law, a law of price controls that we have and that we apply to explaining these phenomena or this type of phenomena.
So that's sort of a very short introduction to what we will be doing in this course and how we view economics and how we view the development of economics.
Now, we start with a very mundane insight, but nonetheless very, very true, and that is that it's a fact that people are continually striving to achieve goals.
They ceaselessly seek to improve their conditions, as they see those conditions.
They struggle to satisfy their wants, or in Mises' words, they want to remove what's called felt uneasiness.
This is a little bit awkward, so I'll avoid that term.
What does that mean? That means that humans are imperfect and unfulfilled beings.
A perfect being wants nothing, because want literally means defect or lack.
So because we're imperfect beings, we have wants that we're continually striving to satisfy in order to improve conditions.
But as soon as we say act, we mean that people consciously use means to achieve their ends.
You attended this seminar. You had to use your time to get here. You had to use other resources, money, your energy.
In attending the seminar you have to stay awake, you have implements to write with and so on.
So there's a complex of means that you bring together to use to achieve the end of this seminar.
Which may not be the ultimate end, the ultimate end is to improve your economic understanding.
So what are the prerequisites of action?
What does it take for someone to want to act, to engage in action?
That person must be dissatisfied with the existing situation.
That is, you feel there is a defect in your knowledge of economics.
And you want to improve that.
And you must have an ability to conceive a more satisfactory state of affairs.
That is, you believe that, in fact, you are capable of learning more about economics by attending the seminar.
And finally, you must have ideas about how to achieve the more desired state.
In other words, you must know that the seminar exists, you must know how to get here, you must know a lot of things.
And then bring those means together to get here.
The absence of any of these conditions, any of those three conditions, dissatisfaction, conception of a better state,
and ideas about how to bring about that better state, all three must be present, otherwise you will not act.
So, for example, if someone wants to, let's say, a man asks a woman out on a date and wants to maybe talk to her under a moonlit sky and so on,
so he can conceive of, there's a lack, that is, he wants an intimate conversation with her, he has ideas about how to, or rather he conceives of the better state,
There is no technology that exists. He has no ideas about how to bring about a moonlit sky at that moment.
So that action does not take place.
Or someone might want to go to a baseball game, see the Braves and Mets play, let's say.
And yet, you have the lack, you have the conception of the better state, but the forecast is for rain.
State, but the forecast is for rain. At this point, there's no technology for you to avoid that rain, so the action doesn't take place.
And likewise, one last quick example, people who are Beatles fans, fanatics such as myself, might long for a Beatles reunion, but there's no technology, there's no ideas about how to resurrect John and George.
So you get the idea. Again, it goes back to the point that individuals or human beings are imperfect beings and that the stimulating factor in acting is the lack of something, that you have ideas about how to overcome.
Okay, so let's get to scarcity.
Action implies that all human wants are not instantaneously fulfilled, and that means they're therefore scarce.
We say that a thing is scarce when there is not enough of it to fulfill every human want for it.
So, things like hamburgers, CDs, BMWs, anything that in a market economy has a price is indeed scarce.
No matter how abundant they get, we never live in a post-scarcity world.
We always have scarcity with us.
That's the veil of tears that was referred to in the Bible.
That is that we must make our living by the sweat of our brow.
That is we must expend means to achieve ends, the ends being the production of these scarce goods.
Let's think about what a post-scarcity world would look like for a moment.
Because it's a good way of really grasping what scarcity means.
There used to be an old commercial that said,
let Hertz put you in the driver's seat, and it was on television.
And as soon as the person wanted to be in the driver's seat,
he would just drop down into this convertible.
So immediately upon wishing for something,
there was no scarcity, you'd have it.
The crazed socialist writer, Charles Fourier,
Fourier once said that, or claimed that, once we have socialism, the oceans will be filled with lemonade and roasted chickens will fly into our mouths.
That's a post-scarcity world, okay?
Of course, you don't get there via socialism.
You get to a super scarce world via socialism.
So in other words, all wants, in a post-scarcity world, all wants are satisfied as effortlessly and instantaneously as your want for air.
No one thinks about getting air. There is no want of air, actually. There is no lack of air in a normal situation.
So we do not employ means to achieve the end of getting sufficient air.
Now, in other situations, in outer space or at great depths in the ocean, there must be means employed to get air.
And those means then are costly, the air tanks and so on.
So, scarcity is a condition where unlimited human wants or goals confront limited means, okay?
We call these scarce means goods, okay?
So, goods unqualified are scarce means, okay, to ends.
Now, scarcity implies two things.
One, limitation and two, desirability.
The tuberculosis bacterium or the malaria parasite, they're very, very rare,
But they're not scarce, because they're not desirable, okay?
On the other hand, air is very, very desirable, but again, in a normal situation, it is not scarce, okay?
It's a free good. It is more than enough for all human wants for air, okay?
So let me just characterize goods a little bit more.
Goods are concrete means that directly or indirectly satisfy wants or serve the achievement of human ends, okay?
We can classify goods in two ways. We have consumer goods, now they directly serve human ends, or at least the services of the goods serve human ends.
So if you have an automobile, the automobile, we in popular language refer to it as a consumer's good, but actually it's not the automobile itself,
but it's the services of the automobile in getting you around and allowing you to perform various errands, that is the end.
It's really the service of the good that is always the end. The hamburger itself really provides one service. Once it's eaten, it's gone.
So the consumer goods refers to the final good, the good that directly satisfies your desire.
And it tends to be, technically speaking, the services that are that final consumer good.
Now they can be exchangeable, the everyday goods that we purchase on the market, or they can be non-exchangeable goods. Love, friendship, fame, reputation, all of those things are desirable, they're all scarce, and we must employ means to get all of them.
But once we have them, let's say you have true love with your spouse, there's no way to sell it, and there's no way to buy it, to buy true love.
Now, that doesn't mean that you don't expend scarce means, which you may buy on the market to get true love.
You buy flowers, you buy jewelry, you spend money on dinners, and so on.
And that plus other means may bring about a state of true love.
But again, it cannot be directly bought on the market.
Several of the means that go into it certainly can be.
And once had, it cannot be sold, obviously.
The second category of goods is producer goods. They indirectly serve human ends. They're what we call the original factors of production. That's one category. They tend to be nature-given. They're there.
Everyone is born with a certain amount of human energy, which we call labor, the capacity for labor. And there are resources, which we call natural resources, that surround us in the environment.
Elements of the environment that are not man-made is what we call land.
So that includes forests, fisheries, mineral deposits, the actual ground land.
Farmland is not land in the economic sense, or not completely land in the economic sense.
Because farmland, in order to be fertile and arable, must be produced.
So farmland is really a capital good. It's a mixture of the original land and other resources that bring it to the state where you can use it in farming.
So farmland is actually a capital good. So land means something that is given by nature, that is not human.
And finally technology, or rather the second category is intermediate factors of production, which we call capital goods.
tools, machines, means of transportation, raw materials, and half-finished products, such as farmland.
In other words, farmland is a half-finished product in the sense that the final product,
that it gives forth the corn or the wheat or the tomatoes, are the final consumer's good.
So farmland is a capital good.
Technology, that's the third category of producers' goods.
Technology is really ideas or recipes about how to combine and transform means into ends.
Now, one interesting quirk about technology is that once it's discovered, technology, unless it's proprietary or it can be kept secret, is no longer scarce.
So when the first primitive man discovered how to build a fire and others observed him,
He may have employed means to bring about this new technology, but once he discovered how to build a fire by rubbing, let's say, two sticks together, others could also use that technology without decreasing the use for anyone else.
So in that case, technology is no longer scarce.
Certainly, discovery of new technology does require means, and in fact, you have huge departments of firms today that are R&D departments, research and development departments.
Which brings us to time. Time, all actions take time.
They begin in the present and they end in the future, or they end at some point in the future, and therefore, time is a scarce means.
This implies immediately that human actors prefer to achieve their goals as quickly as possible, all other things given or all other things equal.
The universal preference for attaining the one's end sooner rather than later is called time preference.
Now let me give you an implication of what it would be like to have a negative time preference, give you a better idea of what time preference is.
I'll give a few implications.
Well, let's say that you have a frozen dinner that will last for a long period of time.
And when you go home this evening, you're hungry and you want to consume that frozen dinner.
But if you had negative time preference, that is, if you preferred to have your ends achieved in the future rather than the present,
at the point of eating that dinner, you would say, you know what, I value this dinner more tomorrow than I do today.
that I do today. So you wouldn't eat it. But then when tomorrow came, you would make the same judgment.
So you would never eat that frozen dinner. You would never use any durable good, any good that could be used in the future.
You would never use it now. Why? Because you have all of the things equal, you have a preference for it in the future.
Let me give you another example, which I give my undergraduates. Let's say a man wants to ask a woman for a date.
and he goes up to her and says, what are you doing next week?
How can we get together?
And she says, I'm busy next week.
And he says, what about in two weeks?
And she says, no, no, I'm busy.
He says, I'll be visiting friends.
And he says, well, what about next month?
Can we make plans in advance so that you're not locked into any other social engagement?
She says, you know what, I'm busy next month.
So let's say he then says, well, when can I see you?
And she says, well, maybe five years from now.
OK, now, in a world where there's real time preference, that's a brush off.
We interpret that as a brush off, OK?
In a world of negative time preference, he prefers that date five years from now.
She says, that's great.
In fact, that's better than going out tonight.
So, you know, he writes it in his date book.
OK, so anytime one acts, it demonstrates time preference
Because it pulls one's goals closer in time, even if those goals are far off.
Let me give you an example.
Or even if those goals take a long period of time to achieve.
Let's say you want to produce a very fine wine.
It takes 10 years to do that.
The point is time preference comes into play because you begin to produce it now.
As soon as you begin to produce it now, you pull into the present,
or you pull towards the present, towards you, the production of the wine.
You could always postpone it.
It would always be 10 years away from any given moment.
So you could postpone it into the future for years and years and years if you had negative time preference.
But if you have positive time preference and this is high on your value scale, as we'll talk about in a moment,
you will embark on the production process.
That shows time preference.
If someone wants to become a surgeon and knows that they face four years of pre-med, three years of medical school, and then two or three years of training and a specialty, and a year of an internship, that's eight or nine years in the future.
Once again, because that person enters college as a pre-med student, that person is showing that time is scarce, that he'd rather become a surgeon sooner rather than later.
Technically, or technologically, he can't become a surgeon for eight years, but he's embarked on the project and shown that time he'd rather achieve that goal, let's say, sooner rather than later.
Now let's talk a little bit about production. When human beings are simply confronting nature, nature is very niggardly, meaning very stingy.
It doesn't yield its fruits easily to human beings, which means that human beings have to rearrange the elements of the environment to make the environment more productive and to increase their standard of living.
So very few goals can be realized without production.
So production, remember, is driven by the need or the want to satisfy or by the drive to satisfy wants.
Now, one thing that production is not, and this was pointed out in 1802 by Jean-Baptiste Say, who was a subjective value theorist, it is not the creation of goods and services.
Say said, look, only God can create. Men can only rearrange, transform.
And so up to that point, it was up to 1802, and sometimes, in fact, in my managerial textbook that I used a few years ago, they talked about production as the creation of goods and services.
Services. So 200 years out of date these books. In any case it's really the
combination and transformation of elements of the environment to a more
valuable, into a more valuable good. So you're transferring, you're
transforming, let's say, labor and the mineral deposit or the oil deposit and
the machinery that's used, the drilling equipment, transforming all of those
You're not creating gasoline, you're transforming other elements, so that gasoline will then be yielded by the production process.
And just to give you a quick, simple overview of it.
Simple overview of it. In the causal realist approach, production is looked on, in which time is important, production is looked on as the transformation of original factors, land and labor, into capital goods, which are then combined with more elements of the environment, more labor, more land, and transformed into consumer goods, which then serve to achieve one satisfaction for the
Or another way of putting it is that the original resources, land and labor, are combined and intermediate goods are produced and they are themselves then transformed into the final goods and the final goods are what is consumed.
Now we use an imaginary construct in economics and this is a false assumption.
It's not unrealizable, but it's unrealistic, and that is, we imagine a human being alone on an island, and there are real problems with that.
I mean, it can happen, but it's unrealistic, so we call it an imaginary construct.
The key with using false assumptions is that you can drop them later on and they're not essential to the conclusions.
Their only function is to enlighten the researcher and to point him in the right direction.
They're meant to isolate the essential cause and effect relationships.
If you drop them, like if you drop the assumption of perfect competition and you find that everything changes,
If you suddenly assume rivalries competition, then that model has no function.
The perfectly competitive model is not wrong for economics because it's untrue or false.
It's wrong because it absolutely has no function.
It doesn't shed light on the essential cause and effect relationships in the real world
because of many of the assumptions that it makes.
Crucial economics does allow us to get at the causal laws.
So, Crusoe is there and alone with his own labor energy confronting the natural resources on the island.
We're going to use that for a little while.
As I said, it's not logically impossible, but it is very, very unrealistic.
For example, a single human being could never develop language, let's say.
Without language, let's say, and without language, thought cannot be refined, so it's a matter of question whether a human being could actually be a human being, if somehow they were alone from the beginning, or at least whether they could think like a human being.
Alright, so as we'll see when we get to production,
Crusoe can become more productive by, instead of fishing with his hands,
if that's the only food available, standing there for hours and trying to grab fish,
which he may be successful in doing, if he could construct the net, that would improve his productivity.
And so saving, as we'll see, is extremely important, saving and investment in capital goods,
The production of capital goods is very, very important to pushing back the bounds of scarcity that constrain him on that island.
One point we want to make now, and again this is a topic for a later class that we're going to have here.
The technology without capital really does nothing for Cousteau. Let's say Cousteau is an engineer, but he has no materials on the island.
He wouldn't be able to produce the net. He wouldn't be able to produce any shelter.
As much knowledge as he has about how to produce these things.
You need saving, you need means that we call capital goods and so on in order to make yourself more productive.
What about choice and value? Here's where we're getting into the essence of action.
Because their goods are scarce, the means to ends are scarce,
This implies that one cannot achieve all his ends and therefore must choose which goals to pursue and which ones to renounce.
Remember, we're defective beings. We lack many, many things. We have limitless wants, effectively.
But the means for achieving these wants are strictly limited at any given moment in time. They're finite.
So, we must choose which wants to satisfy with our means and which wants to renounce or to forego.
So, this choice presupposes a ranking of ends, according to their importance to the individual chooser or actor.
And this involves a subjective valuation of which end will yield more satisfaction, which end will yield less satisfaction.
This subjective ranking event, we call a value scale.
Now, one thing to keep in mind, people do not walk around with value scales fixed in their heads.
They don't walk around and say, I like that Porsche better than that Cadillac.
Or, I like Coke better than Pepsi.
Or, I like Britney Spears. No one would say that.
So the value scale comes into being only when the individual is confronted with the necessity of choosing how to allocate some set of resources.
And let me just give you an example of what value scales might look like.
I want to cover part of it up here.
Okay, let's take the Crusoe example first.
For example, first, Crusoe was on his island. He has 12 hours of labor, after which, you know, he's exhausted and can't labor anymore, so he's got a fixed stock of 12 hours of labor each day.
And let's assume all of these ends that I've listed absorb four hours, okay?
So if they absorb four hours, that means that he can only achieve three of these ends, and they go on, they're more than the sixth one to keep going.
What he will do is to rank those ends according to which ends he believes will yield him the greatest satisfaction.
So as he's done it here, he prefers four fish, to eight coconuts, to five pounds of wild mushrooms, to four hours of swimming and sunbathing, to a hammock and so on.
So he will try to then allocate his resources or he will allocate his resources so as to achieve the production of fish, coconuts and wild mushrooms.
He will renounce, even though they're valuable to him, swimming and sunbathing and building a hammock.
At least on this day, at that moment in time, he makes that choice.
Now let's take someone who receives a gift from a rich aunt.
I wish I had one of those when I graduated.
A $10,000 college graduation gift.
And each of those ends, let's assume, absorbs a whole $10,000.
Now, he would love a new car, okay, or he would love to just spend his money with his friends and party for a whole year, take a year off and live on that $10,000.
But he has an even more important end, and that is to see Europe. So he chooses to go on the European vacation.
Now, this is not relevant if he doesn't have the $10,000. He can walk around and say, you know if I had $10,000 I'd choose this and not that. That's not relevant to economics, okay?
It may be true, people may psychologize and think about these things, but it's not relevant to price formation.
The actual choice is relevant to how prices are determined and what those prices are.
In any case, in this example, he then chooses the European vacation.
And finally, you yourselves certainly had to make a choice on coming here, the fellows here, to accept this Mises Fellowship.
You could have had a summer job, so you had to forgo income from a summer job. Let's say that was ranked second.
Or you could have spent the summer at your family's lake house, or you could again party with your friend. That's always a popular thing.
So you have demonstrated by being here as summer fellows that you've chosen this end, that this is most important to you.
Now, there's a few things, properties of value scales that we want to talk about.
First of all, value scales are strictly ordinal. They cannot measure the value between, or the value difference between different ends.
This person cannot say that the European vacation, he values the European vacation twice as much as the new car.
And the new car is six times as much as, let's say, partying all summer.
There is no unit of measurement for subjective satisfaction or utility.
Not even money can exist or operate as a measuring device for value.
A few years ago, I saw a Paul McCartney concert in Madison Square Garden.
I believe I paid $125 for the ticket.
I would have paid up to $150. I don't think I would have gone above that.
And then a little bit later that summer I saw Rod Stewart in concert, and I think I paid $75 for that, which was sort of on the march, I wouldn't have gone if it was any higher than that.
But now can I say, let's assume that I would have paid $150 for the Paul McCartney concert, or I did, let's say, let's say I did pay $150, I only paid $125, and just to make the arithmetic easy here,
Does that mean that I value the Paul McCartney concert twice as much as the Rod Stewart concert?
Of course not. All that means is that I value the Paul McCartney concert above the $150,
which I value above the Rod Stewart concert, which I value above the $75.
It's a strict ranking, because money itself is a good, it's not some sort of ethereal, abstract measuring device.
It's a property that's transferred in exchange.
Every exchange in a market economy, in a developed market economy, always involves money as one half of it.
All money is property, and it's valued in relation to all the other things on people's value scales.
That's a very important point.
But what about utils?
We see that name sometimes in textbooks.
But then we can ask, what in God's name is a util?
It has no fixed extension in space, like a yard or a pound or a column of mercury to measure temperature.
In fact, value is an intensive and not an extensive magnitude.
and there was a debate in the 1930s and when economists really first recognized this fully and on one side of the debate was Lionel Robbins who followed Menger and the other Austrians and he was one of the first to really state the case for ordinal utility very strongly in the early 1930s and he pointed out that value was like love.
In fact, love is one aspect of value. He said, you may be dating three different women and you may ask one of the three to marry you.
All you can say is that you prefer this woman as a spouse, the second woman, the third woman.
That's what you've demonstrated. Can you say that you love this woman three times as much or ten times as much as the second woman?
Are you choosing a woman? No, but in this case you're choosing a spouse and that choice is made as a result of an ordinal ranking of these women as potential spouses.
And value in any aspect of life is no different than this. There's no way to measure the differences in value between the things that you desire.
Sometimes you hear economists say, use the term maximizing utility.
Okay, now that means nothing more than to choose to allocate scarce means to the highest ranked ends on your value scale.
So, the new college graduate maximizes utility by spending the $10,000 on European vacation.
U.S. Fellows maximize utility by coming to the Mises Fellowship for the two months rather than spending those two months in a summer job, let's say.
The other thing to keep in mind is that value scales do not just apply to quote economic ends.
In fact, strictly speaking, there are never economic ends.
There's no such thing as economic ends.
Economics is a relationship between a means and ends, between scarce means and unlimited ends.
What we must point out is that all ends are ranked and compared on a value scale, whether they are material, cultural, spiritual.
To give you an example, a biblical example, Judas Iscariot chose 30 pieces of silver over his loyalty to Jesus.
So we compared loyalty to Jesus to a certain sum of money. He may not have done it for a lower sum of money.
But he sold him out, as we say. When you sell someone out, that's being done as a result of your value scale.
Of valuing the material end more than what you might want to call the spiritual end.
But that doesn't matter. As human choosers, all ends are in there and are compared ordinarily, whether we like it or not.
You might take the case of a woman who must choose to spend her evening either caring for her children, volunteering at her church, or in part-time employment to supplement funds for her kids' college education.
So there are material ends mixed with spiritual ends, mixed with ends that are related to the family and love and so on.
And she might very well choose to spend her evening working on a given evening.
Another property of value skills is that value skills are only relevant to and revealed by action, not by talk.
Let's say someone says, I love my wife and family and I am committed to putting aside a certain amount of money for my children's education.
for education, for putting good food on the table and so on, but then he passes by a bar, he has his paycheck, or he's cashed his paycheck, he has the money from the paycheck, and he sees his friends in the bar and he impulsively goes in and spends it all on alcohol, okay?
Well, some economists, even today, would say he's departing from his true value scale,
which is that that money is best spent or maximizes utility by being spent on education and good food for his children and so on.
No, he hasn't. He may have done this for months before, but now he's changed his mind. His value scale has changed.
We are not prisoners of our value scales.
Despite what we've done in the past or how we've committed ourselves to acting in a certain way in the future,
what's relevant for economics is how we do act in the future.
He's demonstrating that he prefers drinking that alcohol with his friends to putting aside money for family needs.
Another property of value scales is that only the actor can know his own value scale.
He only reveals a small part of it in action, okay?
So, if Matt purchased that Dr. Pepper today, he's demonstrated that he values that Dr. Pepper to, let's say, the one dollar he paid for it,
and anything else he could get for that dollar, okay, at that point in time, okay?
We must also keep in mind that value skills are liable to continual and rapid changes.
People, as I said before, are not prisoners of their value scales, because value scales don't exist apart from action.
They come into being at the moment that we are forced to decide how to use resources.
That is, at the moment of choice.
One other thing to keep in mind is that when economists say that people choose rationally,
they do not mean that their choices are selfish, hedonistic, ethical, responsible,
People calculating legal, moral, non-impulsive or non-self-destructive.
They simply mean that the action is purposeful.
If it means anything more than that, it has nothing to do with economics.
That is to say that people consciously choose means to achieve highly desired ends or their
most highly desired ends.
The heroin addict, the bank robber, the suicide, all these people are acting rationally in
In the economic sense, the bank robber doesn't use a banana to hold up a bank.
He uses a gun. He uses means that are adapted to achieving the end.
The suicide doesn't jump off a two-foot stool. He jumps off a bridge.
He's acting purposefully.
And similarly with the murder and so on.
To say that these people are acting irrationally is to impose a value judgment on what they're doing.
Okay, now let me get to the concept of psychic revenue and cost, psychic profit and loss.
Now, remember we pointed out that all actions take time and they're aimed at improving conditions, not now, but at some point in the future.
It could be a few minutes in the future, okay, or it could be years in the future.
And it's improving conditions that compare to what would have emerged in the future if you did not act in that way.
So that's the sort of comparison you make.
Now, because all action is future oriented, it involves uncertainty.
We never know completely how the future is going to develop.
We know many things about the future.
It's just plain wrong to say that the future is completely unknowable.
That's incorrect.
We know many, many things.
We also know many things about people close to us through what Mises calls phymology, which is simply interacting with other people. We gain understanding of their characters and so on.
For example, I know that when I come back from Auburn that my wife will not have cleaned out the bank accounts and moved all the furniture out of the house and be gone.
I know that, from knowing her character or from understanding her character.
Let me just define these terms very quickly and then I'll give you an example of what I'm talking about.
Psychic benefit of revenue is the expected satisfaction from an action.
So the psychic benefit is the expected satisfaction from the European vacation.
The psychic cost is the greatest satisfaction that's sacrificed or given up in an action.
So that person, in effect, the cost of the European vacation is not the $10,000.
That's a mistake that people make. That's the price. That's the market price.
That's the amount of property that has to be exchanged.
The cost is the next highest valued end that could have been obtained had that person not chosen the European vacation.
So psychic profit results, and now I can move this slightly.
Psychic profit results when the benefit is greater than the cost.
Ex ante, meaning from the perspective of before the action is undertaken, benefit always is greater than cost because otherwise the person would have not acted in that way.
If he really believed that the new car would give him more satisfaction than the European vacation, then they would have been switched on his value scale and he would have chosen the new car.
The fact that he didn't means that he believes benefit is greater than cost.
is Greater Than Cost. Now, ex post, after the action, he could make a mistake because of the uncertainty.
It could turn out that he was right, benefit was greater than cost, and he's happy with his action.
The term regret crops up here. People have regrets all the time. The reason why they have regrets is because of uncertainty.
They didn't know how things would turn out, and they chose wrongly.
Now, if he regrets going to Europe, if there's a, you know, because of the Iraq War, there's a huge wave of anti-Americanism there, and it's bad weather, and they don't like the food, and so on, and they come back and say, you know what, I should have bought that car, okay?
Well, then in that case, there was a psychic loss, okay? That is, the benefit was less than the cost. They wasted resources. They chose something that had a lower value than they believed it would have.
If they were to do it over again, they would have chosen differently.
Now, we all know people that continually regret their actions.
Some people are better at making choices than other people.
Those people, the people that are consistently better at making choices are good entrepreneurs in their daily lives.
People are consistently mistaken in making their choices.
I knew someone who was at his third college by his junior year when I was there.
That person is a bad entrepreneur in the everyday life sense.
But life is full of regrets because of uncertainty and error that inevitably attends the uncertainty.
We don't have perfect knowledge of the future. If we did, we wouldn't act at all.
we just let things play themselves out because if we knew the future it means we could not change it
because we don't know the future
that we have
on a very basic level
let me get to the
value and the law of marginal utility
okay
you may be familiar with the paradox of value
and it's also sometimes called the water diamond paradox or the bread diamond paradox.
And this paradox bedeviled British classical economics from 1776 when Adam Smith wrote until 1870
when it was finally resolved fully by Carl Menger.
The product goes as follows, bread, let's use bread, bread has a high use value but a low exchange value relative to diamonds,
which has a low use value and high exchange value, meaning that bread sells for a low price on the market,
but bread is a staff of life, I mean bread sustains life, so it has a very, very high use value.
On the other hand, diamonds have a very, very high exchange value that is priced on the market, but a very, very low use value.
They're used to decorate for decorative reasons. They certainly aren't essential to sustaining human life like bread is.
They're used for reasons of vanity and so on, for ostentation.
So how do we explain this?
Well, Menger explained it, and explained it with the law of marginal utility.
And that law says that as the supply of a good possessed by an individual increases,
all other things equal the marginal utility and therefore the value of each unit of the supply decreases.
Now, this law, Menger derived this law from using Cruso-economics.
Okay, so it's an extremely useful assumption in economic reasoning, even though it's unrealistic, the assumption of a personal law on an island.
It does shed light on some direct implications of human action.
Now, let me just, before getting to the example, let me just define the word supply.
Supply refers to the units of a good that are interchangeable or homogeneous in the services they render in achieving an end, okay?
So, in other words, we're assuming that every slice of bread is like every other slice of bread, okay?
They all have the same nutritional content and so on, okay?
Or at least from the point of view of the actor, they have the same nutritional content.
So the example I'll give you is, and it's based on Menger's example, not exactly his example, but it's based on his example, is the following.
Let's say that these are his ends, and there are many more than six, four sacks of wheat.
He's just harvested the wheat on his island, and let's assume that he has five sacks.
Okay, and each one of these ends will absorb a full sack of wheat over the course of the year until the next harvest.
Okay, so the most important end, according to Crusoe, is to sustain his life for the year.
But he needs a second sack of wheat to bake bread to keep him healthy.
Okay, one sack just barely keeps him alive.
Third, he wants to stay alive for another year, so he's going to use one sack for the next harvest.
The fourth sack he'll use directly to feed farm animals, which will allow him to get eggs and milk and meat.
Let's say he's domesticated some chickens and he's found cattle and so on on the island.
And fifth, he's kind of lonely, so he's going to transform the fifth sack into vodka for some entertainment.
And if he had a six-sack, he would keep parrots as pets and feed them, at least they could talk to him in some way.
But in any case, he only has five. Now, the question is, what is the value of a sack of wheat?
Is it the value attached to the highest ranked end, or is it some average of all of the ends?
See, what Menger has done here now is to break away from the classical form of reasoning,
which was to think about bread as an abstract category versus diamonds as an abstract category.
He's looking at it in terms of concrete units that the actor is choosing to allocate.
So, in a sense, he solved the question, he solved the problem by the way he set up, by the question he asked.
Now, the question that he asked is the following.
If a fox broke into where he's storing the wheat and devoured the sack intended for the second end,
would he give up a year's supply of bread and go on with the other four ends?
That is, would he give up eating the bread to sustain his life?
Well, of course not. Since they're the supply of the same good, they're interchangeable.
What would he do? What would any purposeful individual do?
Just reallocate the fifth sack to the second end.
Now, no matter which sack the fox devours, what end does Crusoe renounce?
The lowest. The satisfaction from the lowest ranked end. That is known as the marginal end, the least valued of the ends that could be covered by the supply, that could be satisfied by the supply.
Utility is another word for satisfaction. So what he would give up is the marginal utility. But not only that, the marginal utility, that is the satisfaction from the lowest ranked end, is the value of all of those sacks.
Because every one of those sacks is marginal.
When you have a supply of five units, in this case, no matter which one you lose, what value do you lose?
You lose the marginal utility.
So Menger's answer was, in fact, that the marginal utility determines the value of each unit of the supply.
Now, if that fifth one is gone, and he only has four remaining, what happens to the value of each sack?
It increases. It increases, why? Because the marginal utility has gone up.
Now, he calls it dependent.
The dependent end is the fourth end.
If something happens to one of the remaining four sacks,
he loses a greater satisfaction than if he had five units.
So, as the supply of a good decreases, the marginal utility rises.
As the supply of a good decreases, the marginal supply of a good increases, excuse me,
the supply of the value of the good declines.
or the marginal utility and the value of the good decline.
The value depends on the marginal utility, the marginal utility depends on the supply, okay?
Now, let's change the example a little bit and posit the following scenario.
Let's say there's a farmer who has two different supplies.
He has three horses and two cattle, okay?
They serve different ends. They're not interchangeable.
The question is, and that's his value scale,
he'll use the first horse, that's most important to him,
for plowing, the second horse for plowing,
makes his burden easier if he has two horses pulling the plow.
Third end is milk for the year, which he would get from the cow,
and the fourth end is to slaughter a second cow for beef,
and the fifth end, because he has a third horse, is for pleasure riding.
Now his barn is on fire,
And he can only save one animal, okay?
Well, obviously, he's going to save the less, he's going to save the more valuable animal, okay?
Which animal does he leave behind in the barn?
Well, forget about looking at the top, you look at which animal has the lower margin utility.
And that animal is the least valuable animal, which is what?
Horses have lower values than cows in this situation.
Because their marginal utility is lower.
So he would save two cows and two horses and allow the third horse to perish.
You don't look at the top of the value scale.
You always look at the marginal units in the value scale.
Now, once that's happened and he's left with two horses and two cows,
which animal has a greater value, a horse or a cow?
The horse does. The horse's marginal utility is higher than the cow's marginal utility.
So, the solution of the paradox of value is, again, to focus on people's action in allocating concrete units to specific ends.
It's not to focus on abstract classes of goods and to say, well, of course, water is more important than diamond.
or, of course, bread is more important than diamond.
Well, that's not true.
Why do diamonds have a higher value?
Because in relation to human ends, in a normal situation, they are much scarcer than bread or water.
You can always change the example and come up with a situation in which someone would, in fact, trade, let's say, a pint of water for a diamond.
Let's say someone has been in the desert for three days and hasn't had any water, so he's on the point of dying of thirst.
And let's say that this person is Kobe Bryant and he has that eight million dollar purple diamond that he bought for his wife to make up for his infidelity.
Okay, so would he trade that diamond for one pint of water if he comes upon someone who has a pint of water?
After having not had water, consumed water for three days?
Of course he would. Why?
Because now water is scarcer than diamonds in relation to the ends that they serve.
So the reason why, fortunately, water has a lower price and bread has a lower price than diamonds
It's precisely because it's so abundant in relation to our ends, okay?
Now, what about total utility?
If you've had economics courses, total utility is often defined as the integral of all marginal utility, okay?
Or marginal utility is referred to as a derivative of the total utility, okay?
It's in terms that they try to add up or to integrate utility as if it was some substance or some unit, which it's not.
According to the causal realistic way of looking at things, the marginal utility of the entire supply of a good of an individual is a total utility.
So if someone approached Friday, I'm sorry, Crusoe was approached by Friday, the second person on the island, who had a horse and he was asked if he wanted to trade for the five sacks of wheat, then he would compare the utility of the total supply, we would call that total utility.
Marginal utility. If he made the exchange, it implies that he values a horse more than the five sacks of wheat.
Okay, so you might look at something like this to summarize the laws of marginal utility and total utility.
First, at the top, marginal utility, notice that the first unit that the person has has a higher marginal utility than the second, has a higher marginal utility than the third unit, and so on.
Now, notice I have not put any objective unit on the y-axis there, on the vertical axis, because it can't be measured. Utility cannot be measured.
It's simply the relative heights that indicate that the first unit is ranked higher than the second unit, which is ranked higher than the third unit.
In the case of total utility, referring to the supply of wheat,
And this is, let's say, Crusoe's value scale after he's approached by Friday for the horse.
Crusoe may very well not want to make the exchange six sacks of wheat, okay, because he values the total utility of six sacks, or the marginal utility of the six sacks of wheat, which is, let's say, is total, higher than one horse, but he values the horse higher than the five sacks of wheat, which in turn values higher than the four sacks of wheat, okay.
So, total utility basically tells us this, that people value more units of a good of the same good higher than fewer units of the same good.
So, you would rather have four cars than three cars, and three cars than two cars.
So, basically it's just simply saying that with more units of a good you can satisfy more ends.
That's what total utility is telling, the notion of total utility.
It really has no other function.
Whenever choice is made, you're dealing with the marginal utility of the total supply, if you're exchanging all of your wheat for a horse.
Okay, I will end there and then take questions.
Yes?
Yes.
You say that you cannot assign particular values to a place, and I fully agree with you when it comes to luck.
and the other example.
However, we cannot make a significant difference between that sort of giving of a choice.
And one thing depends on the other.
The other example is mainly the ticket price.
We're willing to pay $150 for the park, only $75 for the other thing.
Okay, let me see if I can summarize this for those who are viewing this. Doesn't the fact that
Goods or exchange for money give us some idea of the objective amount of difference in value between different goods.
Well, my answer to that is that, again, we often forget that money is property.
It's a species of property. It's a kind of property that we own.
And that when we have an exchange in a money economy, a sum of units of this property is being exchanged for a sum of units of other property.
So I don't want to repeat myself and sort of sidestep your question, but what I would say is that once again it's really like exchanging four apples for one plum,
Let's say four plums for one apple or eight plums for one orange.
It doesn't mean we like, just because we're willing to exchange twice as many plums for the orange as we are for the apple,
it doesn't mean we somehow value the orange twice as much as the apple.
Because plums themselves are simply goods that have subjective values.
What we can say is what has actually happened, that we're willing to pay twice as many plums for an orange as we are for an apple.
And the same thing is true with ticket prices, for example, willing to pay $150 for a McCartney ticket, but only $75 for a Rod Stewart ticket.
Let me put it in another way, that money obeys the law of marginal utility like any other form of good.
And in fact, money itself is subjectively valued.
The reason why we value money is because we know that we can exchange it for other things.
So, also we know that there's uncertainty in the future and we may not know exactly when we're going to be getting our money in common.
We might not know exactly when, for example, we're going to make expenditures on various things.
So we will always hold some money in our cash reserves, in our cash balances, as a result of a decision between spending the money on other goods now and holding it for the future.
So what I'm trying to say is that money is also, or our holding of money and our getting of money, is also the result of these ordinal decisions that we make according to marginal utility.
I don't know if I'm completely satisfied. Money is just like anything else.
Because we can count it in units, because it's more finely divisible, let's say, does not mean that it becomes a measuring rod.
because ultimately between you and me let's say there's different we put place
different values on money vis-a-vis other goods okay okay I think we had
How do you look at money? Do you value $150 twice as much as you value $75, which is probably not just like, if you had two loads of bread, you wouldn't value that necessarily twice as much as one load of bread because you don't need the money.
The second end, the end fulfilled by the second unit, has a lower value.
And the point you make about money is absolutely correct.
You value the first $75 more highly than the second $75.
So you cannot add them up and say, well, now $150 is twice as valuable as $75.
There's no way to say that. It's not because of the law of marginal utility.
So that's a very instructive point.
Yes.
You made a point to say that production is not the creation of goods and services, rather
the combination of labor and nature to transform elements of the goods and services?
Correct.
And I was trying to get my head around that and just kind of think, well, what is the
political significance of this distinction?
Do you recognize the idea of political economy as a valuable term, or is the Austrian School doing political economy,
and is there a political implication to this distinction between the creation of goods and services and the transformation of elements into this culture?
Combination and transformation of resources into final goods and services versus the creation of goods and services.
And what are the implications for political economy?
I don't really see any direct implications, though I do see a certain implication, and that is the following.
is the following, that since transformation and combination take time, and creation doesn't give you that feeling of time,
it implies that some people are going to have to save and invest for this transformation to take place.
Those people, as we'll see in a later lecture, are the capitalists.
So, in other words, once you talk about production as combination and transformation,
Then you're bringing in a function for the entrepreneur who's the one who combines these elements of the environment as well as intermediate goods,
and the capitalist or the capitalist aspect of the entrepreneur who is the one who waits for his income during the period in which the transformation of these elements are taking place, that is, during the production process.
So actually, yes, you're right, it's actually a penetrating question. There are implications for political economy.
I think you had your hand up.
back to the first question. I believe you said you would be willing to pay $175 for the first ticket, and maybe if you would have been able to go three years up for much less, then you would have had those $2 amounts, and if you compare those, you'd have an entirely different number.
So, the point being made is that in the example of tickets paying $150 for McCartney and $175 for Rod Stewart, the dollar amounts could be compared in ratios, is that what you're saying?
Yes, but you said you'd be willing to pay more, and the ratio would change. In your mind, you were willing to pay more.
is called consumer surplus.
Now, that has a quantitative connotation in the mainstream economics.
The wrong branch of economics.
But in Austrian economics, it's a useful term, consumer surplus.
But it simply means that you have simply a sum of money.
That is, with no connotation of measuring the value.
It simply allows us to specify a maximum selling price, a maximum buying price that someone has in mind versus a price that's actually paid.
So what competition does, by the way, is to drive down prices, competition among different brands and so on.
It drives down prices so that we don't have to pay our maximum buying prices for any given good.
Any other questions? Comments? Objections? Expletives? Yes.
The concept of marginal value, the value at the margin, that is, in mathematics, it's a concept.
If you also try to get the mathematical terms of the economic section of the book starting, I guess, in theory,
Okay, the question is, why not, since I use the word marginal, and it was introduced by Menger, actually by his follower, Wieser, who actually used the term marginal,
And since it does have, in one of its definitions, one of its uses, a mathematical connotation, or it is a mathematical concept, why not accept that and affirm the legitimacy of using mathematical economics to discover economic laws?
Well, the causal-realist approach uses the term marginal in a very different sense, but still it's a common sense use of the word, and that is relevant, the relevant unit.
There is no implication of arithmetic operations when we talk about the relevant unit, so it's used in that sense, in that non-mathematical sense.
Okay, the mathematical sense is a specialized use of the word marginal.
So I think if you looked it up in the dictionary, and this is a question really of semantics, it really is.
If you looked it up in the dictionary, you would see both senses there.
And we were emphasizing the non-mathematical qualitative sense of the relevant unit, the unit under consideration by the actor.
And because economics is about action, and action itself isn't quantifiable,
Okay, or at least the value that's used in evaluating goods in action, that's not quantifiable, we're using it in the non-mathematical sense.
Any other questions?
Okay, thank you.