Principles of Economics

Carl Menger



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Chapter 1. The General Theory of the Good

The Nature of Goods
The Causal Connections Between Goods
The Laws Governing Goods-Character
The goods-character of goods of higher order is dependent on command of corresponding complementary goods
The goods-character of goods of higher order is derived from that of the corresponding goods of lower order
Time and Error
The Causes of Progress in Human Welfare


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Chapter 1. The General Theory of the Good

1. The Nature of Goods
Menger begins by establishing a scientific foundation for economic theory.

(1.i.1) All Things are subject to the law of cause and effect.

(1.i.2) It is impossible to conceive of a change of one's person from one state to another in any way other than one subject to the law of causality. If, therefore, one passes from a state of need to a state in which the need is satisfied, sufficient causes for this change must exist.

Useful things satisfy human needs.
Goods are special class of useful things.
A recurring theme in Menger's work is that men must have knowledge and power..

(1.i.3) Things that can be placed in a causal connection with the satisfaction of human needs we term useful things. If, however we both recognize this causal connection, and have the power actually to direct the useful things to the satisfaction of our needs, we call them goods.


(1.i.4) If a thing is to become a good, or in other words, if it is to acquire goods-character, all four of the following prerequisites must be simultaneously present:


A human need.
Such properties as render the thing capable of being brought into a causal connection with the satisfaction of this need.
Human knowledge of this causal connection.
Command of the thing sufficient to direct it to the satisfaction of the need.
True versus imaginary goods. Knowledge of the causal connection is important.

If the question is what determines market price, then all are goods.

If the question is progress or wealth of society, then whether a good is true or imaginary becomes important. Progress is not simply an increase in all goods and wealth is not just aggregate value. Imaginary goods decline with progress.

Examples of imaginary goods that do not possess ascribed attributes (cosmetics, medicines administered by witch doctors) or non-existent needs (pagan idols) are debatable (who is to say what is pagan). Menger does not appear to be a blind adherent subjective utility where some judgements are made.

(1.i.7) A special situation can be observed...(1) when attributes...are erroneously ascribed to things that do not really possess them, or (2) when non-existent human needs are mistakenly assumed to exist. In both cases we have to deal with things that do not, in reality, stand in the relationship already described as determining the goods-character of things, but do so only in the opinions of people. Among things of the first class are most cosmetics, all charms, the majority of medicines administered to the sick by peoples of early civilizations and by primitives even today, divining rods, love potions, etc. For all these things are incapable of actually satisfying the needs they are supposed to serve. Among things of the second class are medicines for diseases that do not actually exist, the implements, statues, buildings, etc., used by pagan people for the worship of idols, instruments of torture, and the like. Such things, therefore, as derive their goods-character merely from properties they are imagined to possess or from needs merely imagined by men may...be called imaginary goods.

(1.i.8) As a people attains higher levels of civilization...the number of true goods becomes constantly larger, and...the number of imaginary goods becomes progressively smaller. It is not unimportant evidence of the connection between accurate knowledge and human welfare that the number of so-called imaginary goods is shown by experience to be usually greatest among peoples who are poorest in true goods.

Goods can be intangible, such as firm's goodwill, copyrights, etc. Menger objects to a pure materialistic bias and concludes that useful human actions (that can be disposed of) may also be classified as goods

It appears Menger supports a simpler rule that all objects of commerce are goods (since exchange implies need, capability, knowledge, and power).

(1.i.9) Of special scientific interest are the goods that have been treated by some...as a special class of goods called "relationships." In this category are firms, goodwill, monopolies, copyrights, patents, trade licenses, authors' rights, and also, according to some writers, family connections, friendship, love, religious and scientific fellowships, etc. It may readily be conceded that a number of these relationships do not allow a rigorous test of their goods-character. But that many of them, such as firms, monopolies, copyrights, customer good-will, and the like, are actually goods is shown, even without appeal to further proof, by the fact that we often encounter them as objects of commerce.

(1.i.11) From an economic standpoint...what are called clienteles, good-will, monopolies, etc., are the useful actions or inactions of other people...Even relationships of friendship and love, religious fellowships, and the like, consist obviously of actions or inactions of other persons that are beneficial to us.

(1.i.12) If...these useful actions or inactions are of such a kind that we can dispose of them, there is no reason why we should not classify them as goods, without finding it necessary to resort to the obscure concept of "relationships," and without bringing these "relationships" into contrast with all other goods as a special category. On the contrary, all goods can, I think, be divided into the two classes of material goods (including all forces of nature insofar as they are goods) and of useful human actions (and inactions), the most important of which are labor services.




2. The Causal Connections Between Goods
Knowledge of causal connections allows for a ranking of goods according to their ability to satisfy needs.
Consumer goods - goods of first order that directly satisfy needs
Inputs (raw materials, capital, labor) - goods of second and higher order that only indirectly satisfy needs.
(1.ii.2) Our well-being at any given time, to the extent that it depends upon the satisfaction of our needs, is assured if we have at our disposal the goods required for their direct satisfaction...The causal connection between bread and the satisfaction of one of our needs is...a direct one, and a testing of the goods-character of bread according to the principles laid down in the preceding section presents no difficulty.

(1.ii.3) n addition to goods that serve our needs directly (and which will, for the sake of brevity, henceforth be called "goods of first order") we find a large number of other things in our economy that cannot be put in any direct causal connection with the satisfaction of our needs, but which possess goods-character no less certainly than goods of first order. In our markets...we also see quantities of flour, fuel, and salt. We find that implements and tools for the production of bread, and the skilled labor services necessary for their use, are regularly traded. All these things...are incapable of satisfying human needs in any direct way...That these things are nevertheless treated as goods in human economy, just like goods of first order, is due to the fact that they serve to produce bread and other goods of first order, and hence are indirectly, even if not directly, capable of satisfying human needs...[T]he relationship responsible for the goods-character of these things, which we will call goods of second order, is fundamentally the same as that of goods of first order. The fact that goods of first order have a direct and goods of second order an indirect causal relation with the satisfaction of our needs gives rise to no difference in the essence of that relationship, since the requirement for the acquisition of goods-character is the existence of some causal connection, but not necessarily one that is direct, between things and the satisfaction of human needs.




3. The Laws Governing Goods-Character
A. The goods-character of goods of higher order is dependent on command of corresponding complementary goods
Goods of higher order are not goods unless all the complementary goods necessary for producing a first-order good are available. The implication is that all goods of higher order do not have intrinsic value but derive their 'goods-character' from first-order goods. Of what use is flour if you can't use it to make bread?
(1.iii.a.1) When we have goods of first order at our disposal, it is in our power to use them directly for the satisfaction of our needs. If we have the corresponding goods of second order at our disposal, it is in our power to transform them into goods of first order, and thus to make use of them in an indirect manner for the satisfaction of our needs. Similarly, should we have only goods of third order at our disposal, we would have the power to transform them into the corresponding goods of second order, and these in turn into corresponding goods of first order.

(1.iii.a.2) t is never in our power to make use of any particular good of higher order for the satisfaction of our needs unless we also have command of the other (complementary) goods of higher order.

(1.iii.a.3) Let us assume, for instance, that an economizing individual possesses no bread directly, but has at his command all the goods of second order necessary to produce it. There can be no doubt that he will nevertheless have the power to satisfy his need for bread. Suppose, however, that the same person has command of the flour, salt, yeast, labor services, and even all the tools and appliances necessary for the production of bread, but lacks both fuel and water. In this second case, it is clear that he no longer has the power to utilize the goods of second order in his possession for the satisfaction of his need, since bread cannot be made without fuel and water, even if all the other necessary goods are at hand. Hence the goods of second order will, in this case, immediately lose their goods-character with respect to the need for bread, since one of the four prerequisites for the existence of their goods-character...is lacking.

(1.iii.a.7) The additional complexity arising with goods of higher than second order lies...in the fact that even command of all the goods required for the production of a good of the next lower order does not necessarily establish their goods-character unless men also have command of all their complementary goods of this next and of all still lower orders.


B. The goods-character of goods of higher order is derived from that of the corresponding goods of lower order.
Since first-order goods derive their goods-character (value) from satisfying a human need, then all higher-value goods must derive their value from satisfying needs. Of what value are flour or even bread is people have no desire or need to eat bread?

(1.iii.b.3) [G]oods of first order lose their goods-character immediately if the needs they previously served to satisfy all disappear without new needs arising for them. The problem becomes more complex when we turn to the entire range of goods causally connected with the satisfaction of a human need, and inquire into the effect of the disappearance of this need on the goods-character of the goods of higher order causally connected with its satisfaction.

(1.iii.b.6) If it is established that the existence of human needs capable of satisfaction is a prerequisite of goods-character in all cases, the principle that the goods-character of things is immediately lost upon the disappearance of the needs they previously served to satisfy is, at the same time, also proven. This principle is valid whether the goods can be placed in direct causal connection with the satisfaction of human needs, or derive their goods-character from a more or less indirect causal connection with the satisfaction of human needs.




4. Time and Error
Another characteristic of Menger's theories (and Austrian Economics) are the importance of time and uncertainty. Knowledge is limited.
Uncertainty related to whether complementarity goods will be produced. Probably referring to both risk and uncertainty, while examples (e.g., changes in weather) relate to uncertainty.

What gives agents confidence that necessary complementary raw materials will be produced? Does not give an account of how coordination takes place. In Chapter 2, Menger asserts that more progressive the economy, the more likely someone else (entrepreneurs) will supply necessary complementary goods (II.i.b.9).

(1.iv.1) The process by which goods of higher order are progressively transformed into goods of lower order and by which these are directed finally to the satisfaction of human needs is...not irregular but subject, like all other processes of change, to the law of causality. The idea of causality, however, is inseparable from the idea of time...Thus, in the process of change by which goods of higher order are gradually transformed into goods of first order, until the latter finally bring about the state called the satisfaction of human needs, time is an essential feature of our observations.

(1.iv.3) Goods of higher order acquire and maintain their goods-character, therefore, not with respect to needs of the immediate present, but as a result of human foresight, only with respect to needs that will be experienced when the process of production has been completed.

(1.iv.11) The greater or less degree of certainty in predicting the quality and quantity of a product that men will have at their disposal due to their possession of the goods of higher order required for its production, depends upon the greater or less degree of completeness of their knowledge of the elements of the causal process of production, and upon the greater or less degree of control they can exercise over these elements...Human uncertainty about the quantity and quality of the product (corresponding goods of first order) of the whole causal process is greater the larger the number of elements involved in any way in the production of consumption goods... - that is, the larger the number of elements that do not have goods-character.




5. The Causes of Progress in Human Welfare
What does Menger's theory imply regarding wealth and progress?
Adam Smith didn't quite get it right when he claimed the division of labor is the cause of wealth.

For Menger it is the acquisition of knowledge. The division of labor is perhaps just the consequence of the progress of knowledge and command over production processes.

(1.v.1) "The greatest improvement in the productive powers of labour," says Adam Smith, "and the greater part of the skill, dexterity, and judgment with which it is anywhere directed, or applied, seem to have been the effects of the division of labour." And: "It is the great multiplication of the productions of all the different arts, in consequence of the division of labour, which occasions, in a well-governed society, that universal opulence which extends itself to the lowest ranks of the people."

(1.v.2) In such a manner Adam Smith has made the progressive division of labor the central factor in the economic progress of mankind-in harmony with the overwhelming importance he attributes to labor as an element in human economy. I believe, however, that...other, no less efficient, causes have escaped his attention.

(1.v.5) The further mankind progresses...the more varied become the kinds of goods, the more varied consequently the occupations, and the more necessary and economic also the progressive division of labor. But it is evident that the increase in the consumption goods at human disposal is not the exclusive effect of the division of labor. Indeed, the division of labor cannot even be designated as the most important cause of the economic progress of mankind. Correctly, it should be regarded only as one factor among the great influences that lead mankind from barbarism and misery to civilization and wealth.

(1.v.7) In its most primitive form, a collecting economy is confined gathering those goods of lowest order that happen to be offered by nature...Consumption goods, which before were the product of an accidental concurrence of the circumstances of their origin, become products of human will...as soon as men have recognized these circumstances and have achieved control of them...Increasing understanding of the causal connections between things and human welfare, and increasing control of the less proximate conditions responsible for human welfare, have led mankind, therefore, from a state of barbarism and the deepest misery to its present stage of civilization and well-being...Nothing is more certain than that the degree of economic progress of mankind will still, in future epochs, be commensurate with the degree of progress of human knowledge.



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File last modified: April 1998





Prepared by:
Tancred Lidderdale
tlidderd@doubled.com

Principles of Economics

Carl Menger



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Chapter 2. Economy and Economic Goods

Human Requirements
Requirements for goods of first order (consumption goods)
Requirements for goods of higher order (means of production)
The Available Quantities
The Origin of Human Economy and Economic Goods
Economic goods
Non-economic goods
The relationship between economic and non-economic goods
The laws governing the economic character of goods
Wealth


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Chapter 2. Economy and Economic Goods
Requirements - quantities of goods that will satisfy needs over a planning period
Men must have knowledge of requirements and availability of goods to satisfy requirements

(2.2) The quantities of consumption goods a person must have to satisfy his needs may be termed his requirements.

(2.5) [M]en in civilized societies alone among economizing individuals plan for the satisfaction of their needs, not for a short period only, but for much longer periods of time...Indeed, they not only plan for their entire lives, but as a rule, extend their plans still further in their concern that even their descendants shall not lack means for the satisfaction of their needs.

(2.7) There are two kinds of knowledge that men must possess as a prerequisite for any successful attempt to provide in advance for the satisfaction of their needs. They must become clear: (a) about their requirements­that is, about the quantities of goods they will need to satisfy their needs during the time period over which their plans extend, and (b) about the quantities of goods at their disposal for the purpose of meeting these requirements.




1. Human Requirements
We may be uncertain about our requirements - what our needs will be, the intensity of the needs, and/or the quantities of goods necessary to satisfy those needs.

A. Requirements for goods of first order (consumption goods)
(2.i.a.1) Human beings experience directly and immediately only needs for goods of first order...Requirements for goods of higher order are...dependent upon requirements for goods of first order, and an investigation of the latter constitutes the necessary foundation for the investigation of human requirements in general.
(2.i.a.2) The quantity of a good of first order necessary to satisfy a concrete human need...is determined directly by the need itself...and bears a direct quantitative relationship to it...If, therefore, men were always correctly and completely informed, as a result of previous experience, about the concrete needs they will have, and about the intensity with which these needs will be experienced during the time period for which they plan, they could never be in doubt about the quantities of goods necessary for the satisfaction of their needs­that is, about the magnitude of their requirements for goods of first order.

(2.i.a.3) But experience tells us that we are often more or less in doubt whether certain needs will be felt in the future at all.

(2.i.a.4) Even with needs that we know in advance will be experienced in the time period for which we plan, we may be uncertain about the quantities involved.

(2.i.a.5) In the case of needs about which there is uncertainty as to whether they will arise at all in the time periods for which men make their plans, experience teaches us that, in spite of their deficient foresight, men by no means fail to provide for their eventual satisfaction.

(2.i.a.7) But what has been said here of needs whose appearance is altogether uncertain is fully as true where there is no doubt that a need for a good will arise but only uncertainty as to the intensity with which it will be felt.


B. Requirements for goods of higher order (means of production).
(2.i.b.6) [W]ith respect to given future time periods, our effective requirements for particular goods of higher order are dependent upon the availability of complementary quantities of the corresponding goods of higher order.

(2.i.b.9) The further civilization progresses with a highly developed division of labor, the more accustomed do people in various lines become to producing quantities of goods of higher order under the implicit and as a rule correct assumption that other persons will produce the corresponding quantities of the complementary goods.




2. The Available Quantities
Necessary knowledge also includes determining what quantities of goods will be available to satisfy our requirements.
(2.ii.2) The second factor that determines the success of human activity is the knowledge...of the means available to them for the attainment of the desired ends.

(2.ii.4) To the degree to which men engage in planning activity directed to the satisfaction of their needs, they endeavor to attain clarity as to the quantities of goods available to them at any time. Wherever a considerable trade in goods already exists, therefore, we will find men attempting to form a judgment about the quantities of goods currently available to the other members of the society with whom they maintain trading connections.




3. The Origin of Human Economy and Economic Goods
Difference between economic and non-economic goods is based on a difference in the relationship between requirements and available quantities of goods to satisfy those requirements (needs and scarcity).
A. Economic goods
(2.iiii.a.1) [S]eparate individuals, as well as the inhabitants of whole countries and groups of countries united by trade, attempt to form a judgment on the one hand about their requirements for future time periods and, on the other, about the quantities of goods available to them for meeting these requirements, in order to gain in this way the indispensable foundation for activity directed to the satisfaction of their needs.
(2.iiii.a.2) An investigation of the requirements for, and available quantities of, a good may establish the existence of any one of the three following relationships:

that requirements are larger than the available quantity.
that requirements are smaller than the available quantity.
that requirements and the available quantity are equal.
(2.iiii.a.3) We can regularly observe the first of these relationships where a part of the needs for a good must necessarily remain unsatisfied­with by far the greater number of goods

(2.iiii.a.4) Wherever this relationship appears with respect to a given time period­that is, wherever men recognize that the requirements for a good are greater than its available quantity ­they achieve the further insight that no part of the available quantity, in any way practically significant, may lose its useful properties or be removed from human control without causing some concrete human needs, previously provided for, to remain unsatisfied, or without causing these needs now to be satisfied less completely than before.

(2.iiii.a.5) The first effects of this insight upon the activity of men intent to satisfy their needs as completely as possible are that they strive: (1) to maintain at their disposal every unit of a good standing in this quantitative relationship, and (2) to conserve its useful properties.

(2.iiii.a.6) A further effect of knowledge of this relationship between requirements and available quantities is that men become aware, on the one hand, that under all circumstances a part of their needs for the good in question will remain unsatisfied and, on the other hand, that any inappropriate employment of partial quantities of this good must necessarily result in part of the needs that would be provided for by appropriate employment of the available quantity remaining unsatisfied.

(2.iiii.a.7) Accordingly, with respect to a good subject to the relationship under discussion, men endeavor...: (3) to make a choice between their more important needs, which they will satisfy with the available quantity of the good in question, and needs that they must leave unsatisfied, and (4) to obtain the greatest possible result with a given quantity of the good or a given result with the smallest possible quantity­or in other words, to direct the quantities of consumers' goods available to them, and particularly the available quantities of the means of production, to the satisfaction of their needs in the most appropriate manner.

(2.iiii.a.8) The complex of human activities directed to these four objectives is called economizing...These goods are economic goods in contrast to such goods as men find no practical necessity of economizing.

Implication of scarcity - protection of private property rights is required.

(2.iiii.a.11) f the requirements of a society for a good are larger than its available quantity, it is impossible...for the respective needs of all individuals composing the society to be completely satisfied...Here human self interest finds an incentive to make itself felt, and where the available quantity does not suffice for all, every individual will attempt to secure his own requirements as completely as possible to the exclusion of others.

(2.iiii.a.12) In this struggle, the various individuals will attain very different degrees of success...[T]he requirements of some members of the society will not be met at all, or will be met only incompletely. These persons will therefore have interests opposed to those of the present possessors with respect to each portion of the available quantity of goods. But with this opposition of interest, it becomes necessary for society to protect the various individuals in the possession of goods subject to this relationship against all possible acts of force. In this way, then, we arrive at the economic origin of our present legal order, and especially of the so-called protection of ownership, the basis of property.


B. Non-economic goods
(2.iiii.b.2) The first result of this relationship [the requirements of men for a good are smaller than the quantity of it available to them] is that men not only know that the satisfaction of all their needs for such goods is completely assured, but know also that they will be incapable of exhausting the whole available quantity of such goods for the satisfaction of these needs.
(2.iiii.b.3) [E]conomizing men are under no practical necessity of either preserving every unit of such goods at their command or conserving its useful properties.

(2.iiii.b.4) Nor can the third and fourth of the above-described phenomena of human economic activity be observed in the case of goods whose available quantities exceed requirements for them.

(2.iiii.b.5) It is clear, accordingly, that all the various forms in which human economic activity expresses itself are absent in the case of goods whose available quantities are larger than the requirements for them, just as naturally as they will necessarily be present in the case of goods subject to the opposite quantitative relationship. Hence they are not objects of human economy, and for this reason we call them non-economic goods.


C. The relationship between economic and non-economic goods
The economic or non-economic character of goods is nothing inherent in them nor any property of them.
Menger's conclusion that economic goods are defined by needs (requirements) and scarcity (available quantities) is conventional, but his approach to this conclusion is not. His approach, establishing the definition for consumer (first order) goods and then extending that to higher goods carries through to his theory of value.

(2.iiii.c.2) t is also evident that the economic or non-economic character of goods is nothing inherent in them nor any property of them, and that therefore every good, without regard to its internal properties or its external attributes, attains economic character when it enters into the quantitative relationship explained above, and loses it when this relationship is reversed.

(2.iiii.c.3) The cause of the economic character of a good cannot therefore be the fact that it is either an "object of exchange" or an "object of property." Nor can the fact that some goods are products of labor while others are given us by nature without labor be represented with any greater justice as the criterion for distinguishing economic from non-economic character...Nor does the fact that a thing is a product of labor by itself necessarily result in its having goods-character, let alone economic character. Hence the labor expended in the production of a good cannot be the criterion of economic character. On the contrary, it is evident that this criterion must be sought exclusively in the relationship between requirements for and available quantities of goods.

Goods may change economic character through changes in population, change in needs, of changes in knowledge. The relationship between requirements and available quantities changes.

(2.iiii.c.6) According to our analysis, there can be only two kinds of reasons why a non-economic good becomes an economic good: an increase in human requirements or a diminution of the available quantity.

(2.iii.c.7) The chief causes of an increase in requirements are: (1) growth of population, especially if it occurs in a limited area, (2) growth of human needs, as the result of which the requirements of any given population increase, and (3) advances in the knowledge men have of the causal connection between things and their welfare, as the result of which new useful purposes for goods arise.

Public goods may be economic goods to society but non-economic goods to individuals.

(2.iii.c.11) In this class must be counted, above all, such goods in highly civilized countries as are produced by the government and offered for public use in such large quantities that any desired amount of them is at the disposal of even the poorest member of society, with the result that they do not attain economic character for the consumers.


D. The laws governing the economic character of goods
The definition of an economic good is extended to goods of higher order.
You don't buy raw materials or hire labor (goods of higher order) to produce something that is not needed (goods of lower order that aren't economic goods)

A necessary, but not sufficient, condition for goods of higher order to be economic goods is that the corresponding goods of lower order are economic goods. Not a sufficient condition because goods of higher order may not be non-economic goods.

(2.iiii.d.1) In our investigation of the laws governing human requirements, we have reached the result that the existence of requirements for goods of higher order is dependent: (1) on our having requirements for the corresponding goods of lower order, and also (2) on these requirements for goods of lower order being not already provided for, or at least not completely provided for. We have defined an economic good as a good whose available quantity does not meet requirements completely, and thus we have the principle that the existence of requirements for goods of higher order is dependent upon the corresponding goods of lower order having economic character.

(2.iiii.d.4) [T]he general principle [is] that the economic character of goods of higher order depends upon the economic character of the goods of lower order for whose production they serve. In other words, no good of higher order can attain economic character or maintain it unless it is suitable for the production of some economic good of lower order.

(2.iiii.d.8) Later, thought and experience lead men to ever deeper insights into the causal connections between things, and especially into the relations between things and their welfare. They learn to use goods of second, third, and higher orders. But with these goods, as with goods of first order, they find that some are available in quantities exceeding their requirements while the opposite relationship prevails with others. Hence they divide goods of higher order also into one group that they include in the sphere of their economic activity, and another group that they do not feel any practical necessity to treat in this way. This is the origin of the economic character of goods of higher order.




4. Wealth
Menger asserts that non-economic goods should not be counted as wealth.
This leads to several interesting paradoxes:

as non-economic goods become scarce, and become economic goods, wealth increases
wealth is not a measure of welfare
the sum of individual wealths is not equivalent to national wealth
No solution to these paradoxes is (or can) be offered, except the caution "when inferences running from the magnitude of the national wealth to the welfare of a people...are involved, the concept of national wealth in the literal sense of the term must necessarily lead to frequent errors."

(2.iv.1) Earlier we called "the entire sum of goods at a person's command" his property [a good is at a person's "command"...if he is in a position to employ it for the satisfaction of his needs]. The entire sum of economic goods at an economizing individual's command we will, on the other hand, call his wealth. The non-economic goods at an economizing individual's command are not objects of his economy, and hence must not be regarded as parts of his wealth...Hence, if there were a society where all goods were available in amounts exceeding the requirements for them, there would be no economic goods nor any "wealth." Although wealth is thus a measure of the degree of completeness with which one person can satisfy his needs in comparison with other persons who engage in economic activity under the same conditions, it is never an absolute measure of his welfare, for the highest welfare of all individuals and of society would be attained if the quantities of goods at the disposal of society were so large that no one would be in need of wealth.

(2.iv.2) These remarks are intended to introduce the solution of a problem which, because of the apparent contradictions to which it leads, is capable of creating distrust as to the accuracy of the principles of our science. The problem arises from the fact that a continuous increase in the amounts of economic goods available to economizing individuals would necessarily cause these goods eventually to lose their economic character, and in this way cause the components of wealth to suffer a diminution. Hence we have the queer contradiction that a continuous increase of the objects of wealth would have, as a necessary final consequence, a diminution of wealth.

(2.iv.9) The situation is different with what is designated by the term "national wealth." Here we have to deal not with the entire sum of economic goods available to a nation for the satisfaction of its needs, administered by government employees, and devoted by them to its purposes, but with the totality of goods at the disposal of the separate economizing individuals and associations of a society for their individual purposes. Thus we have to deal with a concept that deviates in several important respects from what we term wealth.

(2.iv.10) nder our present social arrangements, the sum of economic goods at the disposal of the individual economizing members of society for the purpose of satisfying their special individual needs obviously does not constitute wealth in the economic sense of the term but rather a complex of wealths linked together by human intercourse and trade.

(2.iv.12) It is, then, only necessary that we guard against the error that must arise if we pay no attention to the distinction discussed here. In all questions where the issue is merely the quantitative determination of the so-called national wealth, the sum of the wealths of the individuals of the nation may be designated as national wealth. But when inferences running from the magnitude of the national wealth to the welfare of a people, or when phenomena resulting from contacts between the various economizing individuals, are involved, the concept of national wealth in the literal sense of the term must necessarily lead to frequent errors. In all these cases, the national wealth must be regarded rather as a complex composite of the wealths of the members of society, and we must direct our attention to the different sizes of these individual wealths.


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File last modified: April 1998





Prepared by:
Tancred Lidderdale
tlidderd@doubled.com

Principles of Economics

Carl Menger



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Chapter 3. The Theory of Value

The Nature and Origin of Value
The Original Measure of Value
Differences in the magnitude of importance of different satisfactions (subjective factor)
The dependence of separate satisfactions on particular goods (objective factor)
The influence of differences in the quality of goods on their value
The subjective character of the measure of value. Labor and value. Error.
The Laws Governing the Value of Goods of Higher Order
The principle determining the value of goods of higher order
The productivity of capital
The value of complementary quantities of goods of higher order
The value of individual goods of higher order
E. The value of the services of land, capital, and labor, in particular


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Chapter 3. The Theory of Value

1. The Nature and Origin of Value
The value of goods is derived from the relationship between requirements (needs) and availability of goods (scarcity), or what defined the economic character of goods.

Value is not an inherent in goods, or a property of them, but merely the importance that we first attribute to the satisfaction of our needs

This is a radically different concept from the labor theory of value derived by the Classical economists such as Adam Smith, David Ricardo, and John Mill. Value was an inherent property of goods, based on the labor required to produce them.

(3.i.1) If the requirements for a good...are greater than the quantity of it available to them for that time period, and if they endeavor to satisfy their needs for it as completely as possible in the given circumstances, men feel impelled to engage in the activity described earlier and designated economizing. But their perception of this relationship gives rise to another phenomenon, the deeper understanding of which is of decisive importance for our science. I refer to the value of goods.

(3.i.2) If economizing men become aware of this circumstance (that is, if they perceive that the satisfaction of one of their needs, or the greater or less completeness of its satisfaction, is dependent on their command of each portion of a quantity of goods or on each individual good subject to the above quantitative relationship) these goods attain for them the significance we call value. Value is thus the importance that individual goods or quantities of goods attain for us because we are conscious of being dependent on command of them for the satisfaction of our needs.

(3.i.3) The value of goods, accordingly, is a phenomenon that springs from the same source as the economic character of goods-that is, from the relationship, explained earlier, between requirements for and available quantities of goods. But there is a difference between the two phenomena. On the one hand, perception of this quantitative relationship stimulates our provident activity, thus causing goods subject to this relationship to become objects of our economizing (i.e. economic goods). On the other hand, perception of the same relationship makes us aware of the significance that command of each concrete unit of the available quantities of these goods has for our lives and wellbeing, thus causing it to attain value for us...Value is therefore nothing inherent in goods, no property of them, but merely the importance that we first attribute to the satisfaction of our needs, that is, to our lives and well-being, and in consequence carry over to economic goods as the exclusive causes of the satisfaction of our needs.

(3.i.16) Value is thus nothing inherent in goods, no property of them, nor an independent thing existing by itself. It is a judgment economizing men make about the importance of the goods at their disposal for the maintenance of their lives and well-being. Hence value does not exist outside the consciousness of men. It is, therefore, also quite erroneous to call a good that has value to economizing individuals a "value," or for economists to speak of "values" as of independent real things, and to objectify value in this way. For the entities that exist objectively are always only particular things or quantities of things, and their value is something fundamentally different from the things themselves; it is a judgment made by economizing individuals about the importance their command of the things has for the maintenance of their lives and well-being. Objectification of the value of goods, which is entirely subjective in nature, has nevertheless contributed very greatly to confusion about the basic principles of our science.




2. The Original Measure of Value
A theory of value must go beyond a simple definition of the characteristics of value (a relationship between needs and scarcity). It must be able to explain differences in value among different goods and why the value of a certain good may change (change consists of differences in value through time).
(3.ii.1) In what has preceded, we have directed our attention to the nature and ultimate causes of value-that is, to the factors common to value in all cases. But in actual life, we find that the values of different goods are very different in magnitude, and that the value of a given good frequently changes.

(3.ii.2) If I have adequately described the nature of the value of goods, if it has been established that in the final analysis only the satisfaction of our needs has importance to us, and if it has been established too that the value of all goods is merely an imputation of this importance to economic goods, then the differences we observe in the magnitude of value of different goods in actual life can only be founded on differences in the magnitude of importance of the satisfactions that depend on our command of these goods. To reduce the differences that we observe in the magnitude of value of different goods in actual life to their ultimate causes, we must therefore perform a double task. We must investigate: (1) to what extent different satisfactions have different degrees of importance to us (subjective factor), and (2) which satisfactions of concrete needs depend, in each individual case, on our command of a particular good (objective factor). If this investigation shows that separate satisfactions of concrete needs have different degrees of importance to us, and that these satisfactions, of such different degrees of importance, depend on our command of particular economic goods, we shall have solved our problem. For we shall have reduced the economic phenomenon whose explanation we stated to be the central problem of this investigation to its ultimate causes. I mean differences in the magnitude of value of goods.

(3.ii.3) With an answer to the question as to the ultimate causes of differences in the value of goods, a solution is also provided to the problem of how it comes about that the value of each of the various goods is itself subject to change. All change consists of nothing but differences through time. Hence, with a knowledge of the ultimate causes of the differences between the members of a set of magnitudes in general, we also obtain a deeper insight into their changes.


A. Differences in the magnitude of importance of different satisfactions (subjective factor)
Satisfaction of different needs (derived from a specific quantity of goods?) can be rank ordered.
(3.ii.a.1) As concerns the differences in the importance that different satisfactions have for us, it is above all a fact of the most common experience that the satisfactions of greatest importance to men are usually those on which the maintenance of life depends, and that other satisfactions are graduated in magnitude of importance according to the degree (duration and intensity) of pleasure dependent upon them. Thus if economizing men must choose between the satisfaction of a need on which the maintenance of their lives depends and another on which merely a greater or less degree of well-being is dependent, they will usually prefer the former. Similarly, they will usually prefer satisfactions on which a higher degree of their well-being depends. With the same intensity, they will prefer pleasures of longer duration to pleasures of shorter duration, and with the same duration, pleasures of greater intensity to pleasures of less intensity.

Different levels of satisfaction (or different needs?) can also be rank ordered. Different levels of the consumption of food can range from life-saving to life-threatening.

(3.ii.a.3) [C]careful examination of the phenomena of life shows that these differences in the importance of different satisfactions can be observed not only with the satisfaction of needs of different kinds but also with the more or less complete satisfaction of one and the same need.

(3.ii.a.5) The separate concrete acts of satisfying the need for food accordingly have very different degrees of importance. The satisfaction of every man's need for food up to the point where his life is thereby assured has the full importance of the maintenance of his life. Consumption exceeding this amount, again up to a certain point, has the importance of preserving his health (that is, his continuing well-being). Consumption extending beyond even this point has merely the importance of a progressively weaker pleasure, until it finally reaches a certain limit at which satisfaction of the need for food is so complete that every further intake of food contributes neither to the maintenance of life nor to the preservation of health-nor does it even give pleasure to the consumer, becoming first a matter of indifference to him, eventually a cause of pain, a danger to health, and finally a danger to life itself.

Menger uses a numerical table as an illustration of declining (marginal) satisfaction and how an economizing individual would make decisions. This table should not be taken to mean that he believed in cardinal (measurable) utilities.

(3.ii.a.8) In order to restate the preceding argument numerically, to facilitate comprehension of the subsequent difficult investigation, I shall designate the importance of satisfactions on which life depends with 10, and the smaller importance of the other satisfactions successively with 9, 8, 7, 6, etc. In this way we obtain a scale of the importance of different satisfactions that begins with 10 and ends with 1.

(3.ii.a.9) Let us now, for each of these different satisfactions, give numerical expression to the additional importance, diminishing by degrees from the figure indicating the extent to which the particular need is already satisfied, of further acts of satisfaction of that particular need. For satisfactions on which, up to a certain point, our lives depend, and on which, beyond this point, a well-being is dependent that steadily decreases with the degree of completeness of the satisfaction already achieved, we obtain a scale that begins with 10 and ends with 0. Similarly, for satisfactions whose highest importance is 9, we obtain a scale that begins with this figure and also ends with 0, and so on.

The Roman numerals in the top line of the table designate different goods that are ranked according to the satisfaction produced by the consumption of a single unit of a good.

The figures down each vertical column represent the incremental additions to total satisfaction resulting from increased consumption of one additional unit of the good.

The table is obviously a very simplified abstraction. Menger gives no explanation of how a unit of a good is measured, or compared to units other goods (cost basis?). Possible complementarities are ignored.

I II III IV V VI VII VIII IX X
10 9 8 7 6 5 4 3 2 1
9 8 7 6 5 4 3 2 1
8 7 6 5 4 3 2 1
7 6 5 4 3 2 1
6 5 4 3 2 1
5 4 3 2 1
4 3 2 1
3 2 1
2 1
1


(3.ii.a.11) Suppose that the scale in column I expresses the importance to some one individual of satisfaction of his need for food, this importance diminishing according to the degree of satisfaction already attained, and that the scale in column V expresses similarly the importance of his need for tobacco. It is evident that satisfaction of his need for food, up to a certain degree of completeness, has a decidedly higher importance to this individual than satisfaction of his need for tobacco. But if his need for food is already satisfied up to a certain degree of completeness...consumption of tobacco begins to have the same importance to him as further satisfaction of his need for food. The individual will therefore endeavor, from this point on, to bring the satisfaction of his need for tobacco into equilibrium with satisfaction of his need for food.

(3.ii.a.13) The varying importance that satisfaction of separate concrete needs has for men is not foreign to the consciousness of any economizing man...Wherever men live, and whatever level of civilization they occupy, we can observe how economizing individuals weigh the relative importance of satisfaction of their various needs in general, how they weigh especially the relative importance of the separate acts leading to the more or less complete satisfaction of each need, and how they are finally guided by the results of this comparison into activities directed to the fullest possible satisfaction of their needs


B. The dependence of separate satisfactions on particular goods (objective factor)
With 1 good and 1 need to satisfy, determining of value is easy - it is the importance attributed to satisfying the need.
(3.ii.b.1) If, opposite each particular concrete need of men, there was but a single available good, and that good was suitable exclusively for the satisfaction of the one need (so that, on the one side, satisfaction of the need would not take place if the particular good were not at our disposal, and on the other side, the good would be capable of serving for the satisfaction of that concrete need and no other) the determination of the value of the good would be very easy; it would be equal to the importance we attribute to satisfaction of that need...Hence, according to whether the importance of the given satisfaction to us, in a case such as this, is greater or smaller, the value of the particular good to us will be greater or smaller.

But real life isn't that simple. We have many goods, and many complex needs.

(3.ii.b.2) But in ordinary life the relationship between available goods and our needs is generally much more complicated. Usually not a single good but a quantity of goods stands opposite not a single concrete need but a complex of such needs.

Instead of 10 goods, each satisfying a separate need, we are given the example of a farmer with one good, grain, that may satisfy 10 different needs of different importance. Each successive act of satisfying each need has declining importance. The process is the same.

(3.ii.b.3) An isolated farmer, after a rich harvest, has more than two hundred bushels of wheat at his disposal. A portion of this secures him the maintenance of his own and his family's lives until the next harvest, and another portion the preservation of health; a third portion assures him seed-grain for the next seeding; a fourth portion may be employed for the production of beer, whiskey, and other luxuries; and a fifth portion may be used for the fattening of his cattle. Several remaining bushels, which he cannot use further for these more important satisfactions, he allots to the feeding of pets in order to make the balance of his grain in some way useful.

(3.ii.b.10) If a good can be used for the satisfaction of several different kinds of needs, and if, with respect to each kind of need, successive single acts of satisfaction each have diminishing importance according to the degree of completeness with which the need in question has already been satisfied, economizing men will first employ the quantities of the good that are available to them to secure those acts of satisfaction, without regard to the kind of need, which have the highest importance for them. They will employ any remaining quantities to secure satisfactions of concrete needs that are next in importance, and any further remainder to secure successively less important satisfactions. The end result of this procedure is that the most important of the satisfactions that cannot be achieved have the same importance for every kind of need, and hence that all needs are being satisfied up to an equal degree of importance of the separate acts of satisfaction.

Additional examples are given, but I will not risk tediousness by summarizing them here since we are well acquainted with the concept. But, we should recognize that in the 19th century these examples were probably necessary for readers unfamiliar with this concept.

(3.ii.b.14) Examination of a number of particular cases will fully elucidate the principles here set forth, and I do not wish to shirk this important task, even though I know that I shall appear tiresome to some readers. Following in the path of Adam Smith, I will risk some tediousness to gain clarity of exposition.

In summary, the value goods have is imputed from the importance of the last unit of good applied to the satisfaction of our needs.

(3.ii.b.31) (1) The importance that goods have for us and which we call value is merely imputed.

(3.ii.b.32) (2) The magnitudes of importance that different satisfactions of concrete needs (the separate acts of satisfaction that can be realized by means of individual goods) have for us are unequal, and their measure lies in the degree of their importance for the maintenance of our lives and welfare.

(3.ii.b.33) (3) The magnitudes of the importance of our satisfactions that are imputed to goods-that is, the magnitudes of their values-are therefore also unequal, and their measure lies in the degree of importance that the satisfactions dependent on the goods in question have for us.

(3.ii.b.34) (4) In each particular case, of all the satisfactions assured by the whole available quantity of a good, only those that have the least importance to an economizing individual are dependent on command of a given portion of the whole quantity.

(3.ii.b.35) (5) The value of a particular good or of a given portion of the whole quantity of a good at the disposal of an economizing individual is thus for him equal to the importance of the least important of the satisfactions assured by the whole available quantity and achieved with any equal portion. For it is with respect to these least important satisfactions that the economizing individual concerned is dependent on the availability of the particular good, or given quantity of a good.

(3.ii.b.37) If what has been said is correctly understood, there can be no difficulty in solving any problem involving the explanation of the causes determining the differences between the values of two or more concrete goods or quantities of goods.

What does Menger theory says about the water-diamonds, value-in-use versus value-in-exchange paradox that dogged the labor theory of value? There is no paradox, it's all a matter of needs and scarcity.

(3.ii.b.38) If we ask, for example, why a pound of drinking water has no value whatsoever to us under ordinary circumstances, while a minute fraction of a pound of gold or diamonds generally exhibits a very high value, the answer is as follows: Diamonds and gold are so rare that all the diamonds available to mankind could be kept in a chest and all the gold in a single large room as a simple calculation will show. Drinking water, on the other hand, is found in such large quantities on the earth that a reservoir can hardly be imagined large enough to hold it all. Accordingly, men are able to satisfy only the most important needs that gold and diamonds serve to satisfy, while they are usually in a position not only to satisfy their needs for drinking water fully but, in addition, also to let large quantities of it escape unused, since they are unable to use up the whole available quantity. Under ordinary circumstances, therefore, no human need would have to remain unsatisfied if men were unable to command some particular quantity of drinking water. With gold and diamonds, on the other hand, even the least significant satisfactions assured by the total quantity available still have a relatively high importance to economizing men. Thus concrete quantities of drinking water usually have no value to economizing men but concrete quantities of gold and diamonds a high value.

(3.ii.b.39) In the desert, however, where the life of a traveller is often dependent on a drink of water, it can by all means be imagined that more important satisfactions depend, for an individual, on a pound of water than on even a pound of gold. In such a case, the value of a pound of water would consequently be greater...than the value of a pound of gold.


C. The influence of differences in the quality of goods on their value
Since value is not intrinsic to goods, differences in the kinds of goods that satisfy the same need should not be a factor if a unit of each provides similar satisfaction. Differences in value must arise from their different capacities to satisfy needs, i.e., differences in quality.
(3.ii.c.3) The cases that now remain to be taken into consideration are those in which given human needs may be satisfied by goods of different types or kinds and in which, therefore, given human requirements stand opposite available quantities of goods of which separate portions are qualitatively different.

(3.ii.c.4) In this connection, it should first be noted that differences between goods, whether they be differences of type or of kind, cannot affect the value of the different units of a given supply if the satisfaction of human needs is in no way affected by these differences. Goods that satisfy human needs in an identical fashion are for this very reason regarded as completely homogeneous from an economic point of view, even though they may belong to different types or kinds on the basis of external appearance.

(3.ii.c.5) If the differences, as to type or kind, between two goods are to be responsible for differences in their value, it is necessary that they also have different capacities to satisfy human needs. In other words, it is necessary that they have what we call, from an economic point of view, differences in quality.

Differences in quality may be quantitative or qualitative.

(3.ii.c.6) From an economic standpoint, the qualitative differences between goods may be of two kinds. Human needs may be satisfied either in a quantitatively or in a qualitatively different manner by means of equal quantities of qualitatively different goods. With a given quantity of beech-wood, for instance, the human need for warmth may be satisfied in a quantitatively more intensive manner than with the same quantity of fir. But two equal quantities of foodstuffs of equal food value may satisfy the need for food in qualitatively different fashions, since the consumption of one dish may, for example, provide enjoyment while the other may provide either no enjoyment or only an inferior one. With goods of the first category, the inferior quality can be fully compensated for by a larger quantity, but with goods of the second category this is not possible.

Quantitative. If different quantities of two goods will provide identical satisfaction, then value is simply determined based on those different quantities (e.g., a pound of coal is equivalent in value to 3 pounds of wood when satisfying the need for heating).

(3.ii.c.7) f smaller quantities of a more highly qualified good will satisfy a human need in the same...manner as larger quantities of a less qualified good, it is evident that the smaller quantities of the more highly qualified good will have the same value to economizing men as the larger quantities of the less qualified good. Thus equal quantities of goods having different qualities of the first kind will display values that are unequal in the proportion indicated...Merely reducing these goods to quantities of equal economic effectiveness (a procedure actually employed in the economic activities of men in all such cases) thus completely removes the difficulty in determining the value.

Qualitative. The problem is that satisfying needs (e.g., hunger) may be pleasurable or not. In short, each qualitatively separate good is treated as a separate good, and we have the same problem as before. But, Menger's examples, which I don't include here, are more complicated since he has multiple goods (a good of different qualities) satisfying multiple needs.

(3.ii.c.8) The question of the influence of different qualities on the values of particular goods is more complicated when the qualitative differences between the goods cause needs to be satisfied in qualitatively different ways...The difficulty I am discussing here does not, therefore, lie in the general principle of value determination being inapplicable to these goods, but rather in the...practical application of the general principle of value determination to human economic activity.


D. The subjective character of the measure of value. Labor and value. Error.
Value is subjective, dependent on an individuals perceptions of his needs and how goods may satisfy those needs. These perceptions, and values, are different among different individuals.
Again this is distinctly different from the labor theory of value, under which a good represented the same value to all individuals.

(3.ii.d.1) When I discussed the nature of value, I observed that value is nothing inherent in goods and that it is not a property of goods. But neither is value an independent thing. There is no reason why a good may not have value to one economizing individual but no value to another individual under different circumstances. The measure of value is entirely subjective in nature, and for this reason a good can have great value to one economizing individual, little value to another, and no value at all to a third, depending upon the differences in their requirements and available amounts.

(3.ii.d.3) The value an economizing individual attributes to a good is equal to the importance of the particular satisfaction that depends on his command of the good. There is no necessary and direct connection between the value of a good and whether, or in what quantities, labor and other goods of higher order were applied to its production. A non-economic good (a quantity of timber in a virgin forest, for example) does not attain value for men if large quantities of labor or other economic goods were applied to its production. Whether a diamond was found accidentally or was obtained from a diamond pit with the employment of a thousand days of labor is completely irrelevant for its value. In general, no one in practical life asks for the history of the origin of a good in estimating its value, but considers solely the services that the good will render him and which he would have to forgo if he did not have it at his command...The quantities of labor or of other means of production applied to its production cannot, therefore, be the determining factor in the value of a good. Comparison of the value of a good with the value of the means of production employed in its production does, of course, show whether and to what extent its production, an act of past human activity, was appropriate or economic. But the quantities of goods employed in the production of a good have neither a necessary nor a directly determining influence on its value.

Where value is contingent on the knowledge individuals have of their requirements and available quantities, error is inevitable.

Market outcomes also include this error.

(3.ii.d.6) The importance of a satisfaction to us is not the result of an arbitrary decision, but rather is measured by the importance, which is not arbitrary, that the satisfaction has for our lives or for our well-being. The relative degrees of importance of different satisfactions and of successive acts of satisfaction are nevertheless matters of judgment on the part of economizing men, and for this reason, their knowledge of these degrees of importance is, in some instances, subject to error.

(3.ii.d.8) But what has been said by no means excludes the possibility that stupid men may, as a result of their defective knowledge, sometimes estimate the importance of various satisfactions in a manner contrary to their real importance. Even individuals whose economic activity is conducted rationally, and who therefore certainly endeavor to recognize the true importance of satisfactions in order to gain an accurate foundation for their economic activity, are subject to error. Error is inseparable from all human knowledge.

(3.ii.d.11) For these reasons alone it is clear why the determination of the value of particular goods is beset with manifold errors in economic life. But in addition to value fluctuations that arise from changes in human needs, from changes in the quantities of goods available to men, and from changes in the physical properties of goods, we can also observe fluctuations in the values of goods that are caused simply by changes in the knowledge men have of the importance of goods for their lives and welfare.




3. The Laws Governing the Value of Goods of Higher Order
A. The principle determining the value of goods of higher order
Goods of higher order derive their value from the value of goods of lower order (and ultimately consumer goods of first order) that they produce.
(3.iii.a.3) The existence of our requirements for goods of higher order is dependent upon the goods they serve to produce having expected economic character and hence expected value. In securing our requirements for the satisfaction of our needs, we do not need command of goods that are suitable for the production of goods of lower order that have no expected value (since we have no requirements for them). We therefore have the principle that the value of goods of higher order is dependent upon the expected value of the goods of lower order they serve to produce. Hence goods of higher order can attain value, or retain it once they have it, only if, or as long as, they serve to produce goods that we expect to have value for us.

Because it takes time to built, value of goods of higher order are determined by the expected future value of goods of lower order.

(3.iii.a.4) The prospective value of goods of lower order is often-and this must be carefully observed-very different from the value that similar goods have in the present. For this reason, the value of the goods of higher order by means of which we shall have command of goods of lower order at some future time is by no means measured by the current value of similar goods of lower order, but rather by the prospective value of the goods of lower order in whose production they serve.

(3.iii.a.6) [T]he rise or fall of the value of a good of lower order available in the present has no necessary causal connection with the rise or fall of the value of currently available corresponding goods of higher order.


B. The productivity of capital
Economic (technological) progress extends the chain of higher-order goods and lengthens the time required to build.
People discount future satisfactions.

Because the incentive to engage in production is dependent on the value of future satisfaction, which is discounted, economic progress is restrained.

(3.iii.b.1) The transformation of goods of higher order into goods of lower order takes place, as does every other process of change, in time. The times at which men will obtain command of goods of first order from the goods of higher order in their present possession will be more distant the higher the order of these goods. While it is true, as we saw earlier, that the more extensive employment of goods of higher order for the satisfaction of human needs brings about a continuous expansion in the quantities of available consumption goods, this extension is only possible if the provident activities of men are extended to ever more distant time periods.

(3.iii.b.3) There is, in this circumstance, an important restraint upon economic progress. The most anxious care of men is always directed to assuring themselves the consumption goods necessary for the maintenance of their lives and well-being in the present or in the immediate future, but their anxiety diminishes as the time period over which it is extended becomes longer. This phenomenon is not accidental but deeply imbedded in human nature. To the extent that the maintenance of our lives depends on the satisfaction of our needs, guaranteeing the satisfaction of earlier needs must necessarily precede attention to later ones...Similar considerations are involved even with satisfactions having merely the importance of enjoyments. All experience teaches that a present enjoyment or one in the near future usually appears more important to men than one of equal intensity at a more remote time in the future.

Moreover, goods (or labor) that might be available for current or near consumption may be the inputs required for production of future goods whose value is discounted.

(3.iii.b.8) These goods, which the individual making the transition previously used as goods of lower order, and which he might continue to use as goods of lower order, must now be employed as goods of higher order if he wishes to take advantage of the economic gain mentioned earlier. In other words, he can procure this gain only by employing goods, which are available to him, if he so chooses, for the present or for the near future, for the satisfaction of the needs of a more distant time period.

Capital (economic goods that can satisfy future needs) is required for economic progress.

(3.iii.b.9) [E]ach individual can participate in the economic gains connected with employment of goods of higher order...only if he already has command of quantities of economic goods of higher order in the present for future periods of time-in other words, only if he possesses capital.

(3.iii.b.12) Some economists represent the payment of interest as a reimbursement for the abstinence of the owner of capital. Against this doctrine, I must point out that the abstinence of a person cannot, by itself, attain goods-character and thus value. Moreover, capital by no means always originates from abstinence, but in many cases as a result of mere seizure (whenever formerly non-economic goods of higher order attain economic character because of society's increasing requirements, for example). Thus the payment of interest must not be regarded as a compensation of the owner of capital for his abstinence, but as the exchange of one economic good (the use of capital) for another (money, for instance).


C. The value of complementary quantities of goods of higher order
The aggregate present value of all the complementary quantities of goods of higher order necessary for the production of a good of lower or first order is equal to the prospective value of the product.
But it is necessary to also include the services of capital and the activity of the entrepreneur.

(3.iii.c.1) In order to transform goods of higher order into goods of lower order, the passage of a certain period of time is necessary. Hence, whenever economic goods are to be produced, command of the services of capital is necessary for a certain period of time. The length of this period varies according to the nature of the production process. In any given branch of production, it is longer the higher the order of the goods to be directed to the satisfaction of human needs.

(3.iii.c.2) During these time periods, the quantity of...capital is fixed, and not available for other productive purposes.

(3.iii.c.) In the preceding section, we saw that command of quantities of economic goods for given periods of time has value to economizing men, just as other economic goods have value to them. From this it follows that the aggregate present value of all the goods of higher order necessary for the production of a good of lower order can be set equal to the prospective value of the product to economizing men only if the value of the services of capital during the production period is included.

The price of services of capital is determined by the interest rate.

Restrictions on credit constrain economic activity.

(3.iii.c.5) A person who has at his disposal the goods of higher order required for the production of goods of lower order does not, by virtue of this fact, have command of the goods of lower order immediately and directly, but only after the passage of a period of time that is longer or shorter according to the nature of the production process. If he wishes to exchange his goods of higher order immediately for the corresponding goods of lower order, or for what is the same thing under developed trade relations, a corresponding sum of money, he is evidently in a position similar to that of a person who is to receive a certain sum of money at a future point in time (after 6 months, for example) but who wants to obtain command of it immediately...All this, however, explains at the same time why the productive activity of a people is greatly promoted by credit. In by far the greater number of cases, credit transactions consist in handing goods of higher order over to persons who transform them into corresponding goods of lower order. Production, or more extensive fabrication at least, is very often only possible through credit; hence the pernicious stoppage and curtailment of the productive activity of a people when credit suddenly ceases to flow.

Entrepreneur's labor service also represents a good of higher order.

That one activity of an entrepreneur is "obtaining information" implies that technical progress is not a spontaneous occurrence.

Similar to Adam Smith's "undertaker." Menger's required "act of will" might be implicit in Smith's characterization (Wealth of Nations, Book 3) that "a merchant is commonly a bold, a country gentleman a timid undertaker."

(3.iii.c.6) The process of transforming goods of higher order into goods of lower or first order...must also always be planned and conducted, with some economic purpose in view, by an economizing individual. This individual must carry through the economic computations of which I have just been speaking, and he must actually bring the goods of higher order, including technical labor services, together (or cause them to be brought together) for the purpose of production...Above all we must bear in mind that an enterpreneur's own technical labor services are often among the goods of higher order that he has at his command for purposes of production...Entrepreneurial activity includes: (a) obtaining information about the economic situation; (b) economic calculation-all the various computations that must be made if a production process is to be efficient; (c) the act of will by which goods of higher order are assigned to a particular production process; and finally (d) supervision of the execution of the production plan so that it may be carried through as economically as possible...After what has been said, it will be evident that I cannot agree with Mangoldt, who designates "risk bearing" as the essential function of entrepreneurship in a production process, since this "risk" is only incidental and the chance of loss is counterbalanced by the chance of profit.


D. The value of individual goods of higher order
How do you allocate value to complementary goods of higher order, which do not satisfy needs directly? A marginal approach. Take one unit of a higher order good away, what happens to quantity or quality of the final product and the value of satisfaction(s) realized?
(3.iii.d.1) [T]he opinion could arise that we are dependent, for the satisfaction of concrete needs, not on command of an individual concrete good (or concrete quantity of some one kind of good) of higher order, but rather on command of complementary quantities of goods of higher order, and that therefore only aggregates of complementary goods of higher order can independently attain value for an economizing individual.

(3.iii.d.2) [T]he various goods of higher order need not always be combined in the production process in fixed proportions.

((3.iii.d.4) But even where particular goods of higher order cannot be replaced by quantities of other complementary goods, and a diminution of the available quantity of some particular good of higher order causes a corresponding diminution of the product (in the production of some chemical, for instance), the corresponding quantities of the other means of production do not necessarily become valueless when this one production good is lacking. The other means of production can, as a rule, still be applied to the production of other consumption goods, and so in the last analysis to the satisfaction of human needs, even if these needs are usually less important than the needs that could have been satisfied if the missing quantity of the complementary good under consideration had been available.

(3.iii.d.5) [T]he value of a given quantity of a particular good of higher order is not equal to the importance of the satisfactions that depend on the whole product it helps to produce, but is equal merely to the importance of the satisfactions provided for by the portion of the product that would remain unproduced if we were not in a position to command the given quantity of the good of higher order. Where the result of a diminution of the available quantity of a good of higher order is not a decrease in the quantity of product but a worsening of its quality, the value of a given quantity of a good of higher order is equal to the difference in importance between the satisfactions that can be achieved with the more highly qualified product and those that can be achieved with the less qualified product. In both cases, therefore, it is not satisfactions provided by the whole product that a given quantity of a particular good of higher order helps to produce that are dependent on command of it, but only satisfactions of the importance here explained.

How do we account for possibility that values of complementary higher order goods may also be affected? The other higher order goods may now satisfy a need of lower importance, which was not previously satisfied. This would represent a credit against the value of satisfactions lost.

(3.iii.d.6) Even where a diminution of the available quantity of a particular good of higher order causes the product (some chemical compound, for example) to diminish proportionately, the other complementary quantities of goods of higher order do not become valueless. Although their complementary factor of production is now missing, they can still be applied to the production of other goods of lower order, and thus directed to the satisfaction of human needs, even if these needs are, perhaps, somewhat less important than would otherwise have been the case. Thus in this case too, the full value of the product that would be lost to us for lack of a particular good of higher order is not the determining factor in its value. Its value is equal only to the difference in importance between the satisfactions that are assured if we have command of the good of higher order whose value we wish to determine and the satisfactions that would be achieved if we did not have it at our command.

(3.iii.d.7) If we summarize these three cases, we obtain a general law of the determination of the value of a concrete quantity of a good of higher order...[T]he value of a concrete quantity of a good of higher order is equal to the difference in importance between the satisfactions that can be attained when we have command of the given quantity of the good of higher order whose value we wish to determine and the satisfactions that would be attained if we did not have this quantity at our command.

Value of higher order goods includes a consideration of opportunity cost with respect to complementary higher order goods. The value of one higher order good (imputed from the value of the product) will be higher if the value of a complementary good in its alternative use is lower.

(3.iii.d.9) If we examine this law with respect to what was said earlier about the value of the complementary quantities of goods of higher order required for the production of a consumption good, we obtain a corollary principle: the value of a good of higher order will be greater (1) the greater the prospective value of the product if the value of the other complementary goods necessary for its production remains equal, and (2) the lower, other things being equal, the value of the complementary goods.


E. The value of the services of land, capital, and labor, in particular
Economic theory to this point had always treated land (and rent) separately from labor or capital. This was a consequence of the labor theory of value, which could not attribute differences in rent arising from different fertility of land to labor services.
In general, Menger criticizes theory that treats the price of labor differently from the price of land (rent), differently from the price of capital, and differently from the price of goods.

First, Menger observes that land is an economic good, and should be considered no differently than other economic goods.

(3.iii.e.1) Land occupies no exceptional place among goods. If it is used for consumption purposes (ornamental gardens, hunting grounds, etc.), it is a good of first order. If it is used for the production of other goods, it is...a good of higher order. Whenever there is a question, therefore, of determining the value of land or the value of the services of land, they are subject to the general laws of the determination of value.

(3.iii.e.2) A widespread school of economists has recognized correctly that the value of land cannot validly be traced back to labor or to the services of capital. From this, however, they have deduced the legitimacy of assigning land an exceptional position among goods.

(3.iii.e.6) Differences in the fertility and situation of pieces of land are doubtless among the most important causes of differences in the value of the services of land and of land itself. But beyond these there exist still other causes of differences in the value of these goods. Differences in fertility and situation are not even responsible for these other causes, much less a general principle explaining the value of land and services of land. If all pieces of land had the same fertility and equally favorable locations, they would yield no rent at all, according to Ricardo. But although a single factor accounting for differences between the rents they yield may then indeed be absent, it is quite certain that neither all the differences between the rents nor rent itself would, of necessity, disappear. It is evident rather that even the most unfavorably situated and least fertile pieces of land in a country where land is scarce would yield a rent, a rent that could find no explanation in the Ricardian theory.

(3.iii.e.7) Land and the services of land, in the concrete forms in which we observe them, are objects of our value appraisement like all other goods. Like other goods, they attain value only to the extent that we depend on command of them for the satisfaction of our needs. And the factors determining their value are the same as those we encountered earlier in our investigation of the value of goods in general.

Menger also strikes a strong blow at the traditional explanations for the price of labor (that the price of labor naturally returns to the subsistence level).

Again, labor can be treated as another economic good.

(3.iii.e.11) The fact that the prices of labor services, like the prices of the services of land, cannot without the greatest violence be traced back to the prices of their costs of production has led to the establishment of special principles for this class of prices as well. It is said that the most common labor must support the laborer and his family, since his labor services could not otherwise be contributed permanently to society; and that his labor cannot provide him with much more than the minimum of subsistence, since otherwise an increase of laborers would take place which would reduce the price of labor services to the former low level. The minimum of subsistence is therefore, in this theory, the principle that governs the price of the most common labor, while the higher prices of other labor services are explained by reducing them to capital investment or to rents for special talents.

(3.iii.e.12) But experience teaches us that there are labor services that are completely useless, and even injurious, to economizing men. They are therefore not goods. There are other labor services that have goods-character but not economic character, and hence no value (...the labor services connected with some unpaid office, for example)...Labor services are therefore not always goods or economic goods simply because they are labor services; they do not have value as a matter of necessity. It is thus not always true that every labor service fetches a price, and still less always a particular price.

(3.iii.e.13) Experience also informs us that many labor services cannot be exchanged by the laborer even for the most necessary means of subsistence...while a quantity of goods ten, twenty, or even a hundred, times that required for the subsistence of a single person can easily be had for other labor services...A laborer's standard of living is determined by his income, and not his income by his standard of living. In a strange confusion of cause and effect, however, the latter relationship has nevertheless often been maintained.

(3.iii.e.14) [T]he prices of actual labor services are governed, like the prices of all other goods, by their values. But their values are governed, as was shown, by the magnitude of importance of the satisfactions that would have to remain unsatisfied if we were unable to command the labor services.

Unique characteristic of labor that affects its value is that it may, at the same time, be a first order and higher order good. Labor may satisfy (or reduce satisfaction of) needs directly (i.e., provide enjoyment or be unpleasant).

(3.iii.e.15) A special characteristic of labor services that affects their value consists in the fact that some varieties of labor services have unpleasant associations for the laborer, with the result that these services will be forthcoming only for compensating economic advantages...But the value of inactivity to most laborers is much less than is generally believed. The occupations of by far the great majority of men afford enjoyment, are thus themselves true satisfactions of needs, and would be practised, although perhaps in smaller measure or in a modified manner, even if men were not forced by lack of means to exert their powers. The exercising of his powers is a need for every normal human being.

Unique characteristics of entrepreneurial activity. First, it is an economic good (has value) but it is not a commodity (not intended for exchange). The second factor strikes me as less unique. There may be many economic goods that require complementary economic goods before production takes place.

(3.iii.e.16) Entrepreneurial activity must definitely be counted as a category of labor services. It is an economic good as a rule, and as such has value to economizing men. Labor services in this category have two peculiarities: (a) they are by nature not commodities (not intended for exchange) and for this reason have no prices; (b) they have command of the services of capital as a necessary prerequisite since they cannot otherwise be performed. This second factor limits the amount of entrepreneurial activity in general that is available to a people.

And, of course, the past debates about the morality of rent and interest (usury) were formed on false foundations.

(3.iii.e.19) One of the strangest questions ever made the subject of scientific debate is whether rent and interest are justified from an ethical point of view or whether they are "immoral."...But it seems to me that the question of the legal or moral character of these facts is beyond the sphere of our science. Wherever the services of land and of capital bear a price, it is always as a consequence of their value, and their value to men is not the result of arbitrary judgments, but a necessary consequence of their economic character. The prices of these goods (the services of land and of capital) are therefore the necessary products of the economic situation under which they arise, and will be more certainly obtained the more developed the legal system of a people and the more upright its public morals.

And, on redistribution of wealth.

(3.iii.e.20) It may well appear deplorable to a lover of mankind that possession of capital or a piece of land often provides the owner a higher income for a given period of time than the income received by a laborer for the most strenuous activity during the same period. Yet the cause of this is not immoral, but simply that the satisfaction of more important human needs depends upon the services of the given amount of capital or piece of land than upon the services of the laborer. The agitation of those who would like to see society allot a larger share of the available consumption goods to laborers than at present really constitutes, therefore, a demand for nothing else than paying labor above its value. For if the demand for higher wages is not coupled with a program for the more thorough training of workers, or if it is not confined to advocacy of freer competition, it requires that workers be paid not in accordance with the value of their services to society, but rather with a view to providing them with a more comfortable standard of living, and achieving a more equal distribution of consumption goods and of the burdens of life. A solution of the problem on this basis, however, would undoubtedly require a complete transformation of our social order.



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File last modified: April 1998





Prepared by:
Tancred Lidderdale
tlidderd@doubled.com

Principles of Economics

Carl Menger



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Chapter 4. The Theory of Exchange

The Foundations of Economic Exchange
The Limits of Economic Exchange


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Chapter 4. The Theory of Exchange

1. The Foundations of Economic Exchange
Menger opens by noting that Adam Smith never explained why people exchange goods (Wealth of Nations, Book 1, Chapter 2). Perhaps Menger is somewhat unfair, since Smith's remarks are more extensive than suggested here.

Menger first gives examples (not included here) of situations in which individuals would not exchange, to show that there is no benefit intrinsic to the act itself (people don't trade just because they enjoy it).

(4.i.1) Whether the propensity of men to truck, barter, and exchange one thing for another be one of the original principles in human nature, or whether it be the necessary consequence of the faculties of reason and speech," or what other causes induce men to exchange goods, is a question Adam Smith left unanswered. The eminent thinker remarks only that it is certain that the propensity to barter and exchange is common to all men and is found in no other species of animals.

(4.i.4) The propensity of men to trade must accordingly have some other reason than enjoyment of trading as such. If trading were a pleasure in itself, hence an end in itself, and not frequently a laborious activity associated with danger and economic sacrifice, there would be no reason why men should not engage in trade in the cases just considered and in thousands of others.

For Menger, economizing (rational maximizing) individuals exchange in order to increase satisfaction of their needs. The key element is that people value a unit of a commodity differently. One unit of grain is valued differently by Farmers A and B. Again, a subjectivist view of value.

(4.i.6) To begin with the simplest case, suppose that two farmers, A and B, have both previously been carrying on isolated household economies. But now, after an unusually good harvest, farmer A has so much grain that he is unable, however profusely he may provide for the satisfaction of his needs, to utilize a portion of it for himself and his household. Farmer B, on the other hand...is assumed to have had an excellent vintage in the same year. But his cellar is still filled from previous years, and...he is considering pouring out a part of the older wine in storage which dates from an inferior vintage year. Each farmer has a surplus of one good and a serious deficiency of the other...It is therefore evident that we have encountered a case in which, if command of a certain amount of A's goods were transferred to B and if command of a certain amount of B's goods were transferred to A, the needs of both economizing individuals could be better satisfied than would be the case in the absence of this reciprocal transfer.

(4.i.7) But we would construe this relationship too narrowly if we were to confine our attention to cases in which a person who has command of a quantity of one good larger than even his full requirements suffers a deficiency of a second good, while another person has a comparable surplus of this second good and a deficiency of the first. For the relationship in question can also be observed in less obvious cases in which one person possesses goods of which certain quantities have less value to him than quantities of another good owned by a second person who is in the reverse situation.

(4.i.8) As an example, let us suppose that...each of the two farmers can employ the whole quantity of the good at his command in some fashion useful to himself and his household...Thus, although to the grain farmer a certain portion of his grain...and to the wine grower a certain portion of his wine...has only a small value, it nevertheless has some value, since directly or indirectly the satisfaction of certain of his needs depends on that portion. But the fact that a [bushel] of grain...has a certain value to the first farmer by no means excludes the possibility that a [keg] of wine...may have a higher value to him...Similarly with the second farmer, the fact that a keg of wine has a certain value to him by no means excludes the possibility that a bushel of wheat may have a higher value to him.

Knowledge and power are once again the key ingredients (like Adam Smith's "reason and speech.").

(4.i.10) If, in addition, the two economizing individuals (a) recognize the situation, and (b) have the power actually to perform the transfer of the goods, a relationship exists that makes it possible for them, by a mere agreement, to provide better, or more completely, for the satisfaction of their needs than would be the case if the relationship were not exploited.

Following the central theme of Adam Smith, individuals act in their self-interest.

(4.i.11) The same principle that guides men in their economic activity in general, that leads them to investigate the useful things surrounding them in nature and to subject them to their command, and that causes them to be concerned about the betterment of their economic positions, the effort to satisfy their needs as completely as possible, leads them also to search most diligently for this relationship wherever they can find it, and to exploit it for the sake of better satisfying their needs.




2. The Limits of Economic Exchange
A numerical example is provided to illustrate the incentive for exchange. The method is similar to the example on value provided in Chapter 3.

(4.ii.7) Suppose...there live two frontiersmen who maintain friendly intercourse with each other. It is assumed that the compass and intensity of their needs are exactly the same. Each of them requires several horses to work his land. One horse is absolutely necessary if he is to be able to produce the food required for the maintenance of his and his family's lives. A second horse is required to produce the somewhat greater amount of food needed for an adequate diet for himself and his family. Each of the farmers could use a third horse to transport the timber and firewood he finds necessary from the forest to his log cabin, to draw loads of sand, stones, etc., and to work a field on which he will raise some luxury foods for his and his family's enjoyment. A fourth would be used solely for pleasure, and a fifth horse would have only the importance resulting from its availability as a substitute in case one of the other horses should become incapacitated. But neither of the frontiersmen could use a sixth horse. It is assumed also that each of them would need five cows to meet his full requirements for milk and milk products, that there is the same gradation in the importance of their needs for these products, and that a sixth cow could not be used by either of them.

(4.ii.8) For greater clarity, let us cast the situation just described in numerical form. We can represent the graduated importance of the satisfactions that are provided for by the possessions of the two frontiersmen with a set of numbers that decrease in arithmetic series, with the series 50, 40, 30, 20, 10, 0, for example.

(4.ii.9) Assuming that A, the first frontiersman, has 6 horses and only one cow, while B, the other frontiersman, has one horse and 6 cows, the successive degrees of importance of the satisfactions provided for by the possessions of the two persons can be represented in the following table:

A B
Horses Cows Horses Cows
50 50 50 50
40  40
30  30
20  20
10  10
0  0


(4.ii.10) t is easily seen that the basis for economic exchange operations is here present...A and B could both provide considerably better for the satisfaction of their needs if A were to give B a horse and if B were to give A a cow in exchange.

A B
Horses Cows Horses Cows
50 50 50 50
40 40 40 40
30  30
20  20
10  10


(4.ii.12) It is easily seen that each of the two traders obtained an economic gain from this first exchange...But it is just as certain that the basis for economic exchange operations has by no means been exhausted by this first exchange.

In a footnote, Menger criticizes the Germa economists who deny that there are economic benefits of trade. To Menger, it's not what goods you get (or an increase in the total number of goods as in James Mill' comparative advantage analysis), but the increase in the satisfaction of needs.

(4.ii.12.a) These considerations completely disprove the contention of a number of economic writers (Lotz and Rau, for example, among the more recent German writers) who have denied the productivity of trade. The effect of an economic exchange of goods upon the economic position of each of the two traders is always the same as if a new object of wealth had entered his possession. Trade is therefore no less productive than industrial or agricultural activity.

Menger continues with this analysis (with tables), taking it to the point of complete exchange to illustrate the limit of exchange, where total satisfaction is maximized.

(4.ii.24) Thus we see that in the reality of practical life men do not trade indefinitely and without limit. We see instead that particular persons, at any given time, with respect to any given kinds of goods, and in any given economic situation, reach a certain limit at which they cease to make further exchanges.

(4.ii.25) A social economy is made up of individual economies, and what has been said above is therefore just as valid for the trade of entire peoples as it is for single economizing individuals. Two nations, one chiefly engaged in agriculture and the other primarily in industry, will be in a position to satisfy their needs much more completely if each exchanges a portion of its produce for the produce of the other (the first nation a portion of its agricultural produce and the second a portion of its manufactures). But they will not undertake the exchange indefinitely and without limit. At any given point in time they will reach a limit beyond which any further exchange of agricultural produce for manufactures will be uneconomic for both nations.

One of the core foundation of Austrian economics. The world is constantly changing. The only equilibrium we reach is when exchange does not take place.

(4.ii.26) It is, of course, true that in the trade of individuals, and still more in the commerce between whole peoples, the values goods actually have for men can generally be observed to be subject to constant fluctuations. These fluctuations occur principally because new quantities of goods are continually coming into the hands of the various economizing individuals through the production process. As a result, the foundations for economic exchanges are constantly changing, and we therefore observe the phenomenon of a perpetual succession of exchange transactions. But even in this chain of transactions we can, by observing closely, find points of rest at particular times, for particular persons, and with particular kinds of goods. At these points of rest, no exchange of goods takes place because an economic limit to exchange has already been reached.

There are transactions costs in exchange, and these costs limit the extent of trade.

(4.ii.29) If men and their possessions...were not separated in space, and if the mutual transfer of command of goods between one economizing individual and another did not therefore generally require the shipping of goods and many other economic sacrifices, the full economic gains resulting from an exchange transaction would accrue to the two participants. But such cases are very rare...Freight costs, loading charges, tolls, excise taxes, premiums for marine and other insurance, costs of correspondence, commissions and other sales costs, brokerage charges, weighages, packaging costs, storage charges, the entire cost of the commercial banking system, even the expenses of traders and all their employees, etc., are nothing but the various economic sacrifices which are required for the conduct of exchange operations and which absorb a portion of the economic gains resulting from the exploitation of existing exchange opportunities...Indeed, these economic sacrifices often render exchange impossible when it would be possible if only these "expenses," in the general economic sense of the term, did not exist.

Economic progress reduces transactions costs.

(4.ii.30) Economic development tends to reduce these economic sacrifices, with the result that even between the most distant lands more and more economic exchanges become possible which previously could not have taken place.

Since exchange contributes to increased satisfaction of needs, those involved in facilitating exchange are productive.

Welfare is not measured in goods, but in satisfaction of needs.

(4.ii.31) Implicit in what has been said is an explanation of the source from which all the thousands of persons who are intermediaries in trade derive their incomes. Because they do not contribute directly to the physical augmentation of goods, their activity has often been considered unproductive. But an economic exchange contributes, as we have seen, to the better satisfaction of human needs and to the increase of the wealth of the participants just as effectively as a physical increase of economic goods. All persons who mediate exchange are therefore...just as productive as the farmer or manufacturer. For the end of economy is not the physical augmentation of goods but always the fullest possible satisfaction of human needs. Tradespeople contribute no less to the attainment of this end than persons who were, for a long time, and from a very one-sided point of view, exclusively called productive.



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File last modified: April 1998





Prepared by:
Tancred Lidderdale
tlidderd@doubled.com

Principles of Economics

Carl Menger



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Chapter 5. The Theory of Price

Price Formation in an Isolated Exchange
Price Formation Under Monopoly
Price formation and the distribution of goods when there is competition between several persons for a single indivisible monopolized good
Price formation and the distribution of goods when there is competition for several units of a monopolized good
The influence of the price fixed by a monopolist on the quantity of a monopolized good that can be sold and on the distribution of the good among the competitors for it
The principles of monopoly trading (the policy of a monopolist)
Price Formation and the Distribution of Goods Under Bilateral Competition
The origin of competition
The effect of the quantities of a commodity supplied by competitors on price formation; the effect of given prices set by them on sales; and in both cases the effect on the distribution of the commodity among the competing buyers?
C. The effect of competition in the supply of a good on the quantity sold and on the price at which it is offered (the policies of competitors)


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Chapter 5. The Theory of Price
Price is not a fundamental feature of exchange, but only a "symptom". The fundamental feature of exchange is the increase in satisfactions (utility) realized. Rejection of the objectivist theories of value (e.g., Classical labor theory of value).

The issue is that exchange is not an exchange of equivalent values as claimed by the adherents of the labor theory of value (e.g., the product of 1 hour of labor exchanges for another product of 1 hour of labor).

Menger does not provide a model of how prices are formed (a theory of production is absent - individuals are assumed to be endowed with a given quantity of goods and no explanation is provided on how that endowment was achieved), but derives a set of propositions from analysis of a set of market conditions.

The approach in this chapter is to evaluate a series of market conditions characterized by the number of sellers and buyers, beginning with bilateral monopolists. The mechanism with with price (or quantities exchanged in barter) is established is identical in each market (monopolistic or competitive). The only thing that changes is the optimal strategy of the seller.

(5.1) However much prices, or in other words, the quantities of goods actually exchanged, may impress themselves on our senses, and on this account form the usual object of scientific investigation, they are by no means the most fundamental feature of the economic phenomenon of exchange. This central feature lies rather in the better provision two persons can make for the satisfaction of their needs by means of trade. Economizing individuals strive to better their economic positions as much as possible. To this end they engage in economic activity in general. And to this end also, whenever it can be attained by means of trade, they exchange goods. Prices are only incidental manifestations of these activities, symptoms of an economic equilibrium between the economies of individuals.

(5.2) [S]ince prices are the only phenomena of the process that are directly perceptible, since their magnitudes can be measured exactly, and since daily living brings them unceasingly before our eyes, it was easy to commit the error of regarding the magnitude of price as the essential feature of an exchange, and as a result of this mistake, to commit the further error of regarding the quantities of goods in an exchange as equivalents. The result was incalculable damage to our science since writers in the field of price theory lost themselves in attempts to solve the problem of discovering the causes of an alleged equality between two quantities of goods. Some found the cause in equal quantities of labor expended on the goods. Others found it in equal costs of production. And a dispute even arose as to whether the goods are given for each other because they are equivalents, or whether they are equivalents because they are exchanged. But such an equality of the values of two quantities of goods (an equality in the objective sense) nowhere has any real existence.

(5.6) A correct theory of price must instead be directed to showing how economizing men, in their endeavor to satisfy their needs as fully as possible, are led to give goods (that is, definite quantities of goods) for other goods.




1. Price Formation in an Isolated Exchange
In the simplest (primitive) economy have two-party exchange (bilateral monopoly). Price is indeterminate. Price falls within a range determined by differences marginal utilities of the two traders. The expected market price is simply the mean of the range (a result similar to that of an Edgeworth box). Price may deviate from this because of personal characteristics, but this is outside economic theory.

(5.i.1) In the previous chapter, we saw that the possibility of an economic exchange of goods is dependent on an economizing individual having command of goods that have a smaller value to him than other goods at the command of another economizing individual who values the two goods in reverse fashion. The mere statement of this condition, however, strongly implies the existence of limits within which price formation must, in any given instance, take place.

Upper price limit (from A's perspective) set by A's relative values.

(5.i.2) By way of illustration, we will suppose that 100 units of A's grain have the same value to him as 40 units of wine...He will be willing to exchange his grain for wine only if he has to give less than 100 units of grain for 40 units of wine.

Lower price limit (from A's perspective) set by B's relative values.

(5.i.3) f A does find a second economizing individual, B, to whom only 80 units of grain, for example, have a value equal to 40 units of wine, the prerequisites for an economic exchange between A and B are certainly present...and at the same time a second limit is set to price formation. If it follows from the economic situation of A that the price of 40 units of wine must be below 100 units of grain (since he would otherwise derive no economic gain from the transaction), it follows from the economic situation of B that a greater quantity than 80 units of grain must be offered for his 40 units of wine.

Bargaining determines the final price.

(5.i.4) It is easily seen that A could provide better for the satisfaction of his needs even if he should have to give 99 units of grain for the 40 units of wine, and that B would be acting economically on the other side if he were to accept as little as 81 units of grain in exchange for his 40 units of wine. But since there is an opportunity for both economizing individuals to exploit a much larger economic advantage, each of them will direct his efforts to turning as large a share as possible of the economic gain to himself. The result is the phenomenon which, in ordinary life, we call bargaining.

Theory operates behind a veil of ignorance as to who will get the better deal. The expected value is simply the mean of the possible outcomes.

(5.i.6) [T]he outcome of the exchange will prove sometimes more favorable to one and sometimes more favorable to the other of the two bargainers, depending upon their various individualities and upon their greater or smaller knowledge of business life and, in each case, of the situation of the other bargainer. In the formulation of general principles, however, there is no reason for assuming that one or the other of the two bargainers will have an overwhelming economic talent, or that other circumstances will operate more in the favor of one than the other. Under the assumption of economically equally capable individuals and equality of other circumstances, therefore, I venture to state, as a general rule, that the efforts of the two bargainers to obtain the maximum possible gain will be mutually paralyzing, and that the price will therefore be equally far from the two extremes between which it can be established.

(5.i.7) In our case, the price for a quantity of wine Of 40 units upon which the two bargainers will finally agree will lie within the limits of 80 and 100 units of grain...As concerns its position between these limits, if the two bargainers are otherwise equally situated, it will be equal to 90 units of grain.




2. Price Formation Under Monopoly
The key results of Menger's analysis of monopoly markets are: (1) a monopolist can set price, or he can set quantity, but he cannot set both; and (2) the monopolist has market power.
A. Price formation and the distribution of goods when there is competition between several persons for a single indivisible monopolized good
For a monopolist selling a single unit of an economic good to several persons, the price formation mechanism is identical to the previous example of two bilateral monopolists. All competitors who have lower values for the good will be priced out of the market by the single competitor who values it most highly.
(5.ii.a.2) If, for example, an economizing individual, A, has a horse that has a value to him no higher than 10 bushels of grain if he were to acquire them, while to B, who has had a rich harvest of grain, 80 bushels have a value equal to a horse if lie were to acquire one...the price of the horse can be formed between the wide limits of 10 and 80 bushels of grain and can approach either of the two extremes without causing the economic character of the exchange to disappear.

(5.ii.a.3) But suppose that B1 does have a competitor, B2, who either does not have as great an abundance of grain as B1 or requires a horse less urgently. Still, B2 values a horse as highly as 30 bushels of grain, and could thus provide better for the satisfaction of his needs if he were to give 29 bushels of grain for A's horse. It is clear that the foundations for an economic exchange of a horse for some quantity of grain exist between B2 and A as well as between B1 and A. But since only one of the two competitors for A's horse can actually acquire it, two questions arise: (a) With which of the two competitors will the monopolist A conclude the exchange transaction? and (b) What will be the limits within which price formation will take place?

(5.ii.a.4) B1 would obviously be acting uneconomically if, in the competition for A's horse, he were to permit B2 to acquire it for the price of 29 bushels of grain, since the economic gain of B1 would still be considerable if he were to give 30 bushels of grain or more for the horse and thereby economically exclude B2 from the exchange transaction.

(5.ii.a.6) Since A would certainly be acting uneconomically if he did not transfer his monopolized good to the competitor who is in a position to offer him the highest price for it, nothing is more certain than that the exchange transaction will, in this particular economic situation, take place between A and B1.

The price may still be indeterminate (it will fall within some range) if there are two potential buyers. The price would be determinate (at the lowest price possible) only if there were an auction held between the buyers.

(5.ii.a.7) As concerns the second question (the limits within which price formation will take place), it is certain that the price that B1 will give A cannot reach 80 bushels of grain since at this price the transaction would lose its economic character for B1. Nor can the price fall below 30 bushels of grain. For price formation would then fall within the limits where the exchange transaction would still be advantageous for B2, who would therefore have an economic interest in competing until the price should again reach the limit of 30 bushels. In our case therefore, the price must, of necessity, be formed between the limits of 30 and 80 bushels of grain. The opinion could arise that instead of the price in the case we have been discussing being formed between 30 and 80 bushels of grain it will be established at exactly 30 units. This conclusion would be correct if we were dealing with an auction sale in which no minimum price had been set in advance or if it had been set below 30 bushels of grain...But if economizing individual A does not bind himself from the beginning with an auction contract and can pursue his interest with complete freedom, there is no economic reason why the price of a horse should not reach 79 bushels of grain in an exchange between A and B, just as there is no reason why it should not be set at 30 bushels.

(5.ii.a.9) Suppose now that the two previous competitors for A's horse, B1 and B2, are joined by a third competitor, B3. If the value of the horse to this third individual would be equal to 50 bushels of grain, it is clear from what has just been said that the transaction again will take place between A and B1, but the price will be formed between the limits Of 50 and 80 bushels. If a fourth competitor, B4, appears, to whom A's horse would have a value equal to 70 bushels of grain, the transaction will still take place between A and B1, but the price will be formed between the limits of 70 and 80 bushels.

(5.ii.a.10) Only when a competitor, for instance the economizing individual B5, appears on the scene, to whom the monopolized good has a value of as much as 90 bushels of grain, will the transaction take place between A and this last competitor and the price of the horse be fixed between 80 and 90 bushels of grain.

(5.ii.a.11) What has been said is valid for every other case in which the foundations for exchange operations exist between a monopolist exchanging an indivisible good for some other good offered by several other economizing individuals. Summarizing, we obtain the following principles: (1) When several economizing individuals, for each of whom the foundations for an economic exchange are present, compete for a single indivisible monopolized good, the competitor who will obtain the good will be the one for whom it is the equivalent of the largest quantity of the good offered for it in exchange. (2) Price formation takes place between limits that are set by the equivalents of the monopolized good in question for the two competitors who are most eager, or who are in the strongest competitive position, to perform the exchange. (3) Within these limits, the price is fixed according to the principles of price formation already demonstrated for isolated exchange.


B. Price formation and the distribution of goods when there is competition for several units of a monopolized good
For a monopolist selling more than one unit of an economic good to several persons, the result is similar. Price falls in a range set, on the high side, by a successful buyer who has the least value for the good among the successful buyers and, on the low side, by the unsuccessful buyer who values it most highly among the unsuccessful buyers.
Moreover, there is an inverse relationship between quantity and price.

(5.ii.b.2) The more complex case that I wish to discuss now is one in which the foundations for economic exchange operations exist simultaneously between a monopolist who has command of a quantity of a monopolized good on the one hand and several economizing individuals on the other hand who have quantities of some other good at their disposal.

(5.ii.b.3) Suppose that a newly acquired horse would have a value to farmer B1, who has a large quantity of grain but no horses, equal to 80 bushels of his grain. To farmer B2 a newly acquired horse would have a value equal to 70 bushels of grain, to B., 60, to B4 50, to B5 40, to B6 30, to B7 20, and to B8 only 10 bushels of grain. A second horse would have a value, to each of these farmers of 10 bushels less than the value of the first, a third a value of 10 bushels less than the second, and so on, each additional horse having a value of 10 bushels less than the preceding one (provided in each case that an additional horse is needed at all). The essential features of this economic situation can be presented in a table.

Number of Bushels of Grain that are Equal in Value to an Additional Horse Acquired by Trade  1st
horse
2nd
horse
3rd
horse
4th
horse
5th
horse
6th
horse
7th
horse
8th
horse

To B1 80 70 60 50 40 30 20 10
To B2 70 60 50 40 30 20 10
To B3 60 50 40 30 20 10
To B4 50 40 30 20 10
To B5 40 30 20 10
To B6 30 20 10
To B7 20 10
To B8 10


(5.ii.b.5) But suppose that the monopolist brings not merely one but three horses to market...[W]hich one (or which ones) of the eight farmers will acquire the horses brought to market by the monopolist and what price will be charged?

(5.ii.b.6) B1 would be acting economically if he were to acquire one horse at a price between 70 and 80 bushels, thereby economically excluding all his competitors from the exchange. But he would act uneconomically with respect to the second horse if he were to offer 70 bushels or more for it, since by such an exchange the satisfaction of his needs would not be better provided for than before. With the third horse, at a price that would exclude B2 from the transaction and which must therefore be at least equal to 70 bushels of grain, the economic disadvantage to B1, and hence the non-economic character of such an exchange, would become still more obvious.

(5.ii.b.8) Since we are assuming that B1 is an individual behaving economically, he will not exclude his competitors from the exchange purposelessly or to his own detriment. He will exclude them from acquiring quantities of the monopolized good only if, and to the extent to which, he can thereby obtain for himself an economic advantage he would have to forgo if he were to permit the other competitors to purchase quantities of the monopolized good. In our case, therefore, where an exclusion of all competitors for the monopolized good is rendered economically impossible for B1 by the economic situation, he will find himself in the position of being obliged to let B2 participate in the purchase of quantities of the monopolized good. He will even have a common interest with B2 in establishing the price of a unit of the monopolized good, in this case the price of a horse, at as low a level as possible under the existing circumstances. Far from driving the price of a horse to 70 bushels of grain or more, B1 as well as B2 will therefore have an interest in seeing that the price is fixed as much below 70 bushels of grain as is possible in the given economic situation.

(5.ii.b.9) In these efforts, B1 and B2 will be limited by the competition of the other competitors, above all by that of B3. They will have to agree to a price at which the other competitors for the monopolized good (including B3) will be economically excluded from the transaction. Thus, in the case of three horses, the price will be formed between 60 and 70 bushels of grain. At a price fixed between these limits, B1 could acquire two horses and B2 could acquire one, in each case economically, while all other competitors would, at the same time, be excluded from acquiring quantities of the monopolized good.

(5.ii.b.10) Price formation between these limits is the only possible result. If the price were less than 60 bushels, B3 would not be excluded from the transaction, and would therefore attempt to obtain for himself the gain that would result from the exploitation of the opportunity confronting him. But since B1 and B2 are economizing individuals, and since they are in a position to gain a considerable economic advantage at an even higher price, they will not allow this to happen. If the price were, on the other hand, to reach or to exceed the limit of 70 bushels of grain, B1 would be able to purchase only one horse and B2 none at all, and only one of the horses offered for sale would therefore actually be sold. In the case of three horses, therefore, price formation outside the limits of 60 and 70 bushels of grain is economically impossible.

(5.ii.b.11) If A were to bring 6 horses to market, we could show by similar reasoning that B1 would acquire 3 horses, that B2 would acquire 2 horses, that B3 would acquire one horse, and that the price of a horse would be formed between 50 and 60 bushels of grain.

(5.ii.b.14) Summarizing what has been said, we obtain the following principles: (1) The quantity of a monopolized good offered for sale by a monopolist is acquired by those competitors for it to whom the largest quantities of the good offered in exchange for it are the equivalents of the units of the monopolized good. The monopolized good is distributed in such a way that the quantity of the good given in exchange that is the equivalent of one unit of the monopolized good is equal for each of the purchasers of portions of the monopolized good (50 bushels of grain equal to one horse, for example).

(5.ii.b.15) (2) Price formation takes place between limits that are set by the equivalent of one unit of the monopolized good to the individual least eager and least able to compete who still participates in the exchange and the equivalent of one unit of the monopolized good to the individual most eager and best able to compete of the competitors who are economically excluded from the exchange.

(5.ii.b.16) (3) The larger the quantity of the monopolized good offered for sale by the monopolist, the fewer will be the competitors for it who will be economically excluded from acquiring portions of it, and the more completely will those economizing individuals be provided with it who would have been in a position to acquire portions even if smaller quantities of it had been offered for sale.

(5.ii.b.17) (4) The larger the quantity of a monopolized good offered for sale by the monopolist, the lower in terms of purchasing power and eagerness to trade will he have to descend among the classes of competitors for the monopolized good in order to sell the whole quantity, and hence the lower also will be the price of one unit of the monopolized good.


C. The influence of the price fixed by a monopolist on the quantity of a monopolized good that can be sold and on the distribution of the good among the competitors for it
Nothing really new in this section, except that the monopolist is setting the price rather than quantity. The monopolist establishes a price (the usual market practice and, as described in the previous section, some are willing to pay the price and others aren't.
(5.ii.c.1) As a rule, a monopolist does not bring given quantities of a monopolized good to market with the intention of selling the whole amount under all circumstances, and of awaiting the result of competition in the determination of the price, as at an auction. His usual procedure is rather to bring a quantity of his monopolized good to market or keep it ready for sale, and to ask a fixed per unit price for it.

(5.ii.c.6) The higher the price, the more numerous will be the individuals, or classes of individuals, who are excluded completely from consuming the monopolized good, the scantier will be the provisioning of the other classes of the population who are not completely excluded, and the smaller will be the quantities of the monopolized good that the monopolist can sell. With reductions in price, on the other hand, progressively fewer economizing individuals, or classes of individuals, will be excluded completely from acquiring any quantities of the monopolized good, the provisioning of individuals who were already participating in the trade at higher prices will be more complete, and the sales of the monopolist will progressively increase.


D. The principles of monopoly trading (the policy of a monopolist)
The significant observations arising from Menger's analysis are that (1) a monopolist can set the price, or the quantity, but not both; and (2) the unique position of the monopolist is that he has market power
(5.ii.d.1) In the two previous sections, I have explained the influence of a larger or smaller quantity of a monopolized good offered for sale on the determination of its price, and the influence of a higher or lower price set by the monopolist on the quantity of a monopolized good that will be sold.

(5.ii.d.2) As we have seen, if the monopolist wishes to sell a particular quantity of the monopolized good, he cannot fix the price at will. And if he fixes the price, he cannot, at the same time, determine the quantity that will be sold at the price he has set...But what does give him an exceptional position in economic life is the fact that he has, in any given instance, a choice between determining the quantity of a monopolized good to be traded or its price. He makes this choice by himself and without regard to other economizing individuals, considering only his economic advantage. It is thus in his power to regulate price by offering smaller or larger quantities of the monopolized good for sale, or to regulate the quantity of the monopolized good traded by raising or lowering the price, always in accordance with his economic interest.

(5.ii.d.3) Under some circumstances, [the monopolist] may even have occasion to abandon part of the quantity of the monopolized good at his disposal to destruction instead of bringing it to market, or, with the same result, to leave unused or to destroy part of the corresponding means of production at his command instead of employing them for the production of the monopolized good. He would adopt this policy if...the resultant price would be so low that he would have a smaller profit than could be obtained by destroying a portion of the quantity of the monopolized good at his command and selling only the remainder, at a higher price, to classes of the population having greater purchasing power.

Menger briefly considers the issue of revenue, though he doesn't hit on the concept of revenue maximization.

(5.ii.d.4) It would be entirely erroneous to assume that the price of a monopolized good always, or even usually, rises or falls in an exactly inverse proportion to the quantities marketed by the monopolist, or that a similar proportionality exists between the price set by the monopolist and the quantity of the monopolized good that can be sold. If, for example, the monopolist brings 2,000 instead of 1,000 units of the monopolized good to market, the price of one unit will not necessarily fall from 6 florins, for example, to 3 florins. On the contrary, depending upon the economic situation, it may in one case fall only to 5 florins, for example, but in another to as little as 2 florins. Under some circumstances, therefore, the total receipts that the monopolist obtains from the sale of a larger quantity of the monopolized good may be exactly the same as the total receipts yielded by the sale of a smaller quantity. Under other circumstances, however, they may be greater or less. If the monopolist in our example, were to sell 1,000 units of the monopolized good, his total receipts would be 6,000 florins. For 2,000 units he would not, however, necessarily receive 6,000 florins also, but perhaps as much as 10,000 or as little as 4,000 florins, according to the circumstances of the case. The reason for this lies ultimately in the fact that there are very great differences in the scales of equivalents for the various individuals with respect to different goods.

There is implicitly a loss in individual and social welfare when there is monopoly power.

(5.ii.d.5) If it is assumed that all monopolists are economizing individuals aware of their advantage, then their policy is directed naturally neither to fixing the lowest possible price, nor to selling the largest possible quantity of a monopolized good. It is directed neither to making the monopolized good available to the largest possible number of economizing individuals, or groups of individuals, nor to providing each individual with the monopolized good to the fullest extent possible. The monopolist has no interest in all this. His economic policy is directed to making a maximum profit from the quantity of the monopolized good available to him.




3. Price Formation and the Distribution of Goods Under Bilateral Competition

A. The origin of competition
The origin of competition here is very vague. Apparently, as the market increases (due to population growth, increase in wealth, etc.), and monopoly profits increase, the incentive for competitive supply also increases.
(5.iii.a.1) Monopoly, interpreted as an actual condition and not as a social restriction on free competition, is therefore, as a rule, the earlier and more primitive phenomenon, and competition the phenomenon coming later in time.

(5.iii.a.2) The manner in which competition develops from monopoly is closely connected with the economic progress of civilization. The increase of population, the increased needs of the various economizing individuals, and their growing wealth, drive the monopolist, in many instances even while increasing production, to exclude progressively larger classes of the population from consuming the monopolized good, and permit him at the same time to drive his prices higher and higher....The monopolist cannot always comply with the growing requirements of society for his commodities (or labor services), and if he could comply, a corresponding increase of his sales is not always in his economic interest. In most cases, therefore, he will be driven to make a choice between his clients, and some of the competitors for his monopolized good will either get nothing or will be supplied with it only reluctantly and inadequately.

(5.iii.a.3) The economic situation just described is usually such that the need for competition itself calls forth competition, provided there are no social or other barriers in the way.


B. The effect of the quantities of a commodity supplied by competitors on price formation; the effect of given prices set by them on sales; and in both cases the effect on the distribution of the commodity among the competing buyers?
When a fixed quantity of goods are brought to market, the analysis is of the formation of price is unaffected as to whether there is one or more sellers.
(5.iii.b.1) To facilitate comprehension, I shall utilize the case with which I illustrated my explanation of the principles of monopoly trade as the basis of the present investigation. In the [previous] table, B1, B2, B3, etc., represent individual farmers or groups of farmers. To each farmer a first newly acquired horse is the equivalent of the quantity of grain appearing in the first column, and each additional horse is the equivalent of a quantity of grain 10 bushels less. The question before us is: what will be the influence of larger or smaller quantities of a commodity offered for sale by several competing sellers on the price and on the distribution of the commodity among the competitors for it?

(5.iii.b.2) To begin with, assume that there are two competitors in supply, A1 and A2, and that together they have 3 horses for sale, A1 having two horses and A2 one. From what was said earlier, it is clear that in this case farmer B1 will buy 2 horses and farmer B2 one horse. The price will be between 60 and 70 bushels of grain, a higher price being impossible because of the economic interest of the two farmers B1 and B2, and a lower price because of the competition of B3. If A1 and A2 have six horses for sale, it is no less certain that B1 will purchase three of them, B2 two, and B3 one, and that the price will be between 50 and 60 bushels of grain, etc.

As a footnote Menger observes that high search costs (sellers finding buyers and vice versa) inhibit efficient price formation. I wouldn't view this as a defense of merchants who act as agents for sellers.

From this it is at once evident that the great importance to human economy of markets, fairs, exchanges, and all points of concentration of trade in general, is due to the fact that as trading relationships become more complex the formation of economic prices becomes virtually impossible without these institutions. The speculation that develops on these markets has the effect of impeding uneconomic price formation from whatever causes it may arise, or of mitigating at least its harmful effects on the economy of men.

(5.iii.b.3) If we compare the price and the distribution of goods resulting from the sale of a given quantity of a commodity by several competing sellers with the situation observed under monopoly, we find a complete analogy. Whether a given quantity of a commodity is sold by a monopolist or by several competitors in supply, and independent of the way in which the commodity was originally distributed among the competing sellers, the effect on price formation and on the resultant distribution of the commodity among the competing buyers is exactly the same.

(5.iii.b.4) Although the larger or smaller quantity of a good sold has a very decisive influence on its price and distribution under monopoly as well as competitive trade, the fact that a particular quantity of a commodity is supplied by a monopolist alone or by several competitors in supply has no influence on the phenomena of economic life just mentioned.


C. The effect of competition in the supply of a good on the quantity sold and on the price at which it is offered (the policies of competitors)
We finally are presented with the traditional competitive market situation where a variable (an unrestricted) quantity of goods may be offered for sale by more than 1 person. While the propositions he derives are correct and insightful, they lack the support of the deductive analysis he provides to the monopoly markets.
Surprisingly, Menger does not use a numerical example to describe this competitive market. A two dimensional table representing several sellers and buyers is impractical. Consequently, some of his observation do not hold strictly.

Note that a small contradiction is present here. Menger claims that, for a given quantity offered for market, a "definite price is established." However, he earlier observed that a price is established between two limits (5.ii.b.15).

(5.iii.c.1) I have just explained that, for each particular quantity of a good offered for sale, a definite price is established, that at any set price there is a definite amount of sales, that in both cases there is also a definite distribution of the goods sold, and that it is irrelevant in these respects whether the quantity involved is marketed by a monopolist or by several competitors in supply.

First, Menger first examines the case where there is a ceiling on total potential supply, and observes that sellers have much less incentive to act unilaterally to influence market price. The conclusion is that a larger quantity comes to market at a lower price, than under a monopoly.

Here Menger takes some liberties. While it is not "economically impossible" (5.iii.c.7) for a duopolist to assert market power, the incentive to do so is certainly less.

(5.iii.c.4) To set the economic phenomena involved clearly before us, let us consider the simple case in which the quantity of a monopolized good available to a monopolist suddenly comes into the hands of two competitors.

(5.iii.c.5) A monopolist has died, and has left his holdings of the monopolized good and means of production to two heirs in equal shares. This is an instance of the simple case just posited...f we suppose each of the two heirs to be determined to pursue the sale of the previously monopolized good independently, we have a case of real competition before us, and the questions to be considered are: what quantities of the previously monopolized good will now, in contrast to the previous situation, be offered for sale, and what supply prices will be set by the two competitors?

(5.iii.c.6) In the previous section, we saw that it is frequently in the economic interest of the monopolist to abstain from marketing portions of the whole quantity of the monopolized good available to him, and to destroy them or let them spoil, since he can often obtain a larger profit from a smaller quantity of his goods than he would if he were to sell the entire available quantity at lower prices. Assume that a monopolist has 1,000 pounds of a monopolized commodity and that he can...either sell 800 pounds at 9 ounces of silver per pound or dispose of the whole available quantity at 6 ounces of silver per pound. It is thus in his power to take 6,000 ounces of silver for the entire quantity of the monopolized commodity at his command, or to take 7,200 ounces of silver for 800 pounds of it...He will destroy 200 pounds of his monopolized commodity, permit them to spoil, or otherwise withdraw them from trade, and will offer only the remaining 800 pounds for sale-or, which amounts to the same thing, he will set his price at such a level that the same result will obtain.

(5.iii.c.7) But if the 1,000 pounds of the previously monopolized commodity are divided between two competitors, this policy immediately becomes economically impossible for each of them. If one of the two were to destroy part of the quantity available to him, or if he were to withdraw it from trade in some other way, he would of course elicit a definite increase in the price of a unit of his commodity. But never, or only in very rare instances, would he able to obtain a greater profit by so doing. If A1, for instance, the first of the two competitors, were to destroy 200 of the 500 pounds of the previously monopolized commodity at his command or otherwise withdraw them from trade, he would doubtless cause the price of the good to rise from 6 to 9 ounces of silver per pound, for example. But he would not cause a greater total profit to accrue to himself. The consequence of his action would be that A2 would obtain 4,500 instead of 3,000 ounces of silver, while he himself would obtain only 2,700 ounces of silver (instead of 3,000) in exchange for the other 300 units sold. The intended gain would accrue solely to his competitor, and he himself would suffer a substantial loss.

(5.iii.c.8) The first effect, therefore, of the appearance of competition in supply is that none of the competitors selling a commodity can derive an economic advantage from destroying or withdrawing from exchange a part of the available quantity of the commodity-or, which amounts to the same thing, from leaving the means of production available for its production unused.

Finally, Menger takes an even more drastic shortcut in considering the situation where quantity of potential supply is not restricted. Our duopolists may be able to supply some quantity above 1,000 pounds. The problem, of course, is there is no theory of production here.

The earlier conclusion was that the quantity of some given amount of supply that is offered for sale will increase with competition. The (again unsupported but insightful) conclusion here is that the available quantity will also be larger with competition. The justification for this proposition appears to be that even the smallest potential profit will be pursued (economic profits = 0 under competition) and output will expand in order to capture those profits.

(5.iii.c.11) But competition has still another, much more important, consequence for the economic life of men. I refer to the increase of the quantities of a previously monopolized commodity that become available to economizing men. Monopoly usually causes only part of the quantity of the goods at the command of the monopolist to be offered for sale, or only a part of the available means of production to be put to use. True competition always puts this malpractice to an end immediately. But competition usually has the further effect of increasing the available quantity of a previously monopolized commodity. It is a very rare occurrence, at any rate, for the means of production collectively at the command of two or more competing sellers to be as narrowly limited as those at the command of a monopolist. In the great majority of cases, therefore, several competitors will market a greater quantity of a commodity than a monopolist. Thus the existence of true competition not only causes the entire quantity of a commodity actually available to be offered for sale, but also has the further and much more important result of increasing significantly the quantity that becomes available. When there is no natural limitation to the means of production, this means that more and more classes of society are able to consume the commodity at falling prices, and that the provisioning of society in general becomes ever more complete.

(5.iii.c.13) [C]ompetition, which concerns itself with the exploitation of even the smallest economic gain wherever possible, tends to descend with its goods to the lowest social classes that the economic situation at any time permits. The monopolist has the power to regulate, within certain limits, either the price or the quantity of a monopolized good coming upon the market. He readily renounces the small profit that can be made on goods destined to be consumed by the poorest social classes in order to be able to exploit the classes of greater purchasing power more effectively. But under competition, where no single competitor has the power to regulate by himself either the price or the quantity of a good traded, each individual competitor desires even the smallest profit, and the exploitation of existing possibilities of making such profits is no longer neglected. Competition leads therefore to large-scale production with its tendency to make many small profits and with its high degree of economy, since the smaller the profit on each unit the more dangerous becomes every uneconomic waste, and the brisker the competition the less possible becomes an unthinking continuation of business according to old-established methods.



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