Austrian School of Economics

References

• Austrian School of Economics Wikipedia Article

Definitions/Related

• Historical School of Economics
• • The historical school of economics was an approach to academics economics and to public administration that emerged in the 19th century in Germany, and held sway there well into the 20th century. The professors involved compiled massive economic histories of Germany and Europe.
  • The historical school held that history was the key source of knowledge about human actions and economic matters, since economics was culture-specific, and hence not generalizable over space and time.
  • The school rejected the universal validity of economic theorems, and they saw economics as resulting from careful empirical and historical analysis instead of from logic and mathematics - they rejected mathematical modeling.
  • Most members were social policy advocates - concerned with social reform and improved conditions of the common man during period of heavy industrialization.

• • Thoughts of the historical school:
  • • Method is never neutral.
    • • Don't think that you can be progressive if you use a theory that is primarily utilized to distract people from what really matters
    • State and economy naturally belong together.
    • The main subject of economics is the human person
    • • Not about scarcity. It is about the plight of the human person.
• Subjective Theory of Value
• • The subjective theory of value (STV) is an economic theory for explaining how the value of goods and service are not only set but also how they can fluctuate over time. The contrasting system is typically known as the labor theory of value.
  • The theory claims that the value of a good is not determined by any inherent property of the good, nor by the cumulative value of components or labor needed to produce it, but instead is determined by the individuals or entities who are buying (and/or selling) that good.
  • This theory has helped explain why the value of non-essential goods can be higher than essential ones, and how relatively expensive goods can have relatively low production costs.
• Marginalism
• • Theory of economics that attempts to explain the discrepancy in the value of goods and services by reference to their secondary, or marginal, utility. Marginalism is an integral part of mainstream economic theory.
• Economic Calculation Problem
• • Criticism of using central economic planning as a substitute for market-based allocation of the factors of production.
• Marginal Utility
• • Describes the change in in utility (pleasure or satisfaction resulting from the consumption) of one unit of a good or service. Marginal utility can be negative, positive, or zero.
• Praxeology
• • In philosophy, this is the theory of human action, based on the notions that humans engage in purposeful behavior, contrary to reflexive behavior and other unintentional behavior.
• Liquidity Preference
• • Liquidity preference is the demand for money, considered as liquidity. First developed by John Maynard Keynes in his book General Theory of Employment, Interest, and Money (1936) to explain determination of the interest rate by the supply and demand for money.
  • The demand for money as an asset was theorized to depend on the interest foregone by not holding bonds (here, "bonds" can be understood to also represent stocks and other less liquid assets in general, as well as government bonds). Interest, in Keynesian analysis, is a reward for parting with liquidity. According to Keyes, money is the most liquid asset. Liquidity is an attribute to an asset. the more quickly an asset is converted into money the more liquid it is said to be.
• Time Preference
• • Time preference is the current relative valuation placed on receiving a good or some cash at an earlier date compared with receiving it at a later date. Time preference are captured mathematically in the discount function. The higher the time preference, the higher the discount placed on returns receivable or costs payable in the future.

Notes

The Austrian school is a heterodox school of economic though that advocates strict adherence to methodological individualism, the concept that social phenomena result primarily from the motivations and actions of individuals along with their self interest. Austrian-school theorists hold that economic theory should be exclusively derived from basic principles of human action.

• The Austrian school originated in Vienna with the work of Carl Menger, Eugen von Bohm Bawerk, Fredrick von Wiser, and others. It was methodologically opposed to the Historical school.
• Among the theoretical contributions of the early years of the Austrian school are the subjective theory of value, marginalism in price theory, and the formulation of the economic calculation problem, each of which has become an accepted part of mainstream economics.

History

• The Austrian school owes its name to members of the historical school of economics, who argued against the Austrians during the late 19th century Methodenstreit  ("methodology struggle"), in which the Austrians defended the role of theory in economics as distinct from the study or compilation pf historical circumstance.
• The school originated in Vienna in the Austrian Empire with Carl Menger's 1871 book Principles of Economics, which was one the first modern treatises to advance the theory of marginal utility
• Sometime during the middle of the 20th century, Austrian economics became disregarded or derided by mainstream economists because it rejected model building and mathematical and statistical methods ion the study of economics.
• After the 1940s, Austrian economics can be divided into two schools of economic thought based on to what degree the government should interfere in the economy.

Many theories developed by "first wave" Austrian economists have long been absorbed into mainstream economics. These include Carl Menger's theories on marginal utility, Fredrich von Weiser's theories on opportunity cost and Eugen Bohm von Bawek's theories on time preference, as well as Menger and Bohm-Bawek's criticisms on Marxian economics.

• Former American Federal reserve Chairman Alan Greenspan said that the founders of the Austrian school: reached far into the future from when most of them practiced and have had a profound and, in my judgment, probably an irreversible effect on how most mainstream economists think in this country.

Theory

The Austrian school theorizes that the subjective choices of individuals including individual knowledge, time, expectation, and other subjective factors cause all economic phenomena. Austrians seek to understand the economy by examining the social ramifications of individual choice, an approach called methodological individualism. It differs from other schools of economic thought, which have focused on aggregate variables, equilibrium analysis, and societal groups rather than individuals.

• Ludwig von Mises organized his version of the subjectivist approach, which he called praxeology in 1949, in a book published in English as Human Action. In it, Mises stated that praxeology could be used to deduce a priori theoretical economic truths and that deductive economic thought experiments could yield conclusions which follow irrefutably from the underlying assumptions. He argues that conclusions could not be inferred from empirical observation or statistical analysis and argues against the use of probabilities in economic models.

Fundamental Tenants

• Methodological individualism
• • In the explanation of economic phenomena, we have to go back to the actions (or inaction) of individuals; groups or "collectives" cannot act except through the actions of individual members/ Groups do not think; people think.
• Methodological subjectivism
• • In the judgements and choices made by individuals on the basis of whatever knowledge they have or believe to have, and whatever expectations they have regarding external developments and the consequences of their actions.
• Tastes and preferences
• • Subjective valuations of goods and services determine the demand for them so that their prices are influenced by consumers.
• Opportunity Costs
• • The costs of the alternative opportunities that must be foregone; as productive services are employed for one purpose, all alternative uses have to be sacrificed
• Marginalism
• • in all economic designs, the values, costs, revenues, productivity and so on are determined by the significance of the last unit added to or subtracted from the total
• Time structure of production and consumption
• • Decisions to save reflect "time preferences" regarding consumption in the immediate, distant, or indefinite future and investments made in view of larger outputs expected to be obtained if more time-taking production processes are undertaken.
• Tenets held by the Mises Branch of Austrian Economics:

• • Consumer Sovereignty
  • • The influence consumers have on the effective demand for goods and services and through the prices which result in free competitive markets, on the production plans of producers and investors, is not merely a hard fact but also an important objective, attainable only by complete avoidance of governmental interference with the markets and of restrictions on the freedom of sellers and buyers to follow their own judgement regarding quantities, qualities, and prices of products and services.
  • Political Individualism
  • • Only when individuals are given full economic freedom will it be possible to secure political and moral freedom. Restrictions on economic freedom lead, sooner or later, to an extension of the coercive activities of the state into the political domain, undermining and eventually destroying the essential individual liberties which the capitalistic societies were able to attain in the 19th century

Contributions to Economic Thought

Opportunity Cost

• Developed in the late 19th century by Fredrich von Wiser
• opportunity cost is the cost of any activity measured in terms of the value of the next best alternative foregone (that is not chosen). It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices.

Capital and Interest

• The Austrian theory of capital and interest was developed by Eugen Bohm von Bawerk. He stated that interest rates and profits are determined by two factors, namely supply and demand in the market for final goods and time preference.
• Austrian economists reject the notion that interest rates are determined by liquidity preference, instead recasting it as a particular expression of time preference.

Inflation

• In Mises's definition, inflation is an increase in the supply of money:

In theoretical investigation there is only one meaning that can rationally be attached to the expression Inflation: an increase in the quantity of money (in the broader sense of the term, so as to include fiduciary media as well), that is not offset by a corresponding increase in the need for money (again in the broader sense of the term), so that a fall in the objective exchange-value of money must occur.

Economic Calculation Problem

• The economic calculation problem refers to a criticism of planned economies. What the calculation problem essentially states is that without price signals, the factors of production cannot be allocated in the most efficient way possible rendering planned economies ineffacious.
• Austrian theory emphasizes the organizing power of markets. Hayek stated that market prices reflect information, the totality of which is not known to any single individual, which determines the allocation of resources in an economy.

Business Cycles

• The Austrian theory of the business cycle focuses on banks' issuance of credit as the cause of economic fluctuations.
• Mises posited that fractional reserve banks extend credit at artificially low interest rates, causing businesses to invest in relatively roundabout production processes which leads to an artificial "boom". Mises stated that this artificial "boom" then led to a misallocation of resources which he called "malinvestment" - which eventually must end in a "bust".
• Mises surmised that government manipulation of money and credit in the banking system throws savings and investment out of balance, resulting in misdirected investment projects that are eventually found to be unsustainable, at which point the economy has to rebalance itself through a period of economic recession. For Austrians, the only prudent strategy for government is to leave the money and the financial system to the free market's competitive forces to eradicate the business cycle's inflationary booms and reactionary busts, allowing markers to keep people's savings and investment decisions in place for well-coordinated economic stability and growth.

A Keynesian would suggest government intervention during a recession to inject spending into the economy when people will not. However, the heart of Austrian macroeconomic theory assumes the government "fine tuning" through expansions and contractions in the money supply orchestrated by the government are actually the cause of business cycles because of the differing impact of the resulting interest rate changes on different stages in the structure of production.

Central Banks

• Some Austrians believe in a strong central bank to regulate commercial banks, while others argue for the gold standard.

Criticism

General

Mainstream economists generally reject modern-day Austrian economics, and argue that modern-day Austrian economists are too unwilling to use mathematics and statistics in economics.

• Economist Paul Krugman stated that Austrians are unaware of holes in their own thinking because they do not use explicit models.

Taxation and Welfare

• Some economists criticize Austrian economics due to their beliefs about government not interfering with the economy though high taxation and social services.

Methodology

• Critics generally ague that Austrian economics lack scientific rigor and rejects scientific methods and the use of empirical data in modeling economic behavior. Some economists describe Austrian methodology as a priori or non-empirical.

Business Cycle Theory

• Mainstream economic research regarding Austrian Business Cycle Theory finds that it is inconsistent with empirical evidence.