Question

Explain the implications of Menger’s theory of imputation of value with regard to capital investments and the opportunity for profit.

Answer 1

While there is no dispute regarding Menger's role as creator of the defining principles of Austrian economics, there does exist some confusion regarding the precise nature of his contribution. It is not always fully recognized that Menger's endeavor to radically reconstruct the theory of price on the basis of the law of marginal utility was not inspired by a vague subjectivism in outlook. Rather, Menger was motivated by the specific and overarching aim of establishing a causal link between the subjective values underlying the choices of consumers and the objective market prices used in the economic calculations of businessmen. The Classical economists had formulated a theory attempting to explain market prices as the outcome of the operation of the law of supply and demand. Yet, these economists were compelled to restrict their analysis to the monetary calculations and choices of businessmen while neglecting consumer choice for the lack of a satisfactory theory of value. Their theory of "calculated action" was correct as far as it went, and was used in demolishing the protectionist and interventionist schemes of sixteenth- and seventeenth-century mercantilists and the statist fantasies of nineteenth-century Utopian socialists. Thus, Menger's ultimate goal was not to destroy Classical economics, as has sometimes been suggested, but to complete and firm up the Classical project by grounding the theory of price determination and monetary calculation in a general theory of human action.

In the Classical view, then, both prices and production behaved according to definite laws of cause and effect. Prices were determined by the interaction of all market participants, so that the actual price of any good reflected the momentary equilibrium of supply and demand; the allocation of resources to the various processes of production was governed by the calculations and choices of profit-seeking (and loss-avoiding) businessmen, which meant that, in the long run, resources were allocated among the various branches of production so as to ensure a tendency to equalize at some normal or natural level the "rate of profit" or rate of return on all capital investment. Classical economics, therefore, did indeed contain an embryonic theory of human action, but their theory was incomplete because it focused narrowly on the calculating businessman, the proverbial "economic man", who "bought in the cheapest and sold in the dearest markets." In other words, the Classical theory of prices and production was a theory of calculable action only, i.e., of action in the marketplace, a realm where all means and ends, costs and benefits, and profits and losses could be calculated in terms of money. While this was a great achievement and a bold step forward in economic science, it left out of account the subjective and nonquantifiable valuations and preferences of the consumer, the raison d'être of all economic activity.

When Menger seriously turned his attention to economic theory in 1867, there existed a mighty though deeply flawed system of economic theory that had been constructed mainly by the British Classical School, namely David Hume, Adam Smith, and David Ricardo. To their undying credit, the Classical economists were successful in demonstrating that price phenomena--product prices, wages, and interest rates-- were not the product of historical accident or the arbitrary whim of sellers but were determined by universal and immutable economic law, viz., the law of supply and demand. They also showed how prices, through the calculations and actions of profit-seeking businessmen, effectively regulated the production process. They concluded that, in those industries where the selling price exceeded the average cost of the product by a greater than normal margin, business owners were motivated by prospective profits to expand their output from existing enterprises, while additional output was forthcoming from new enterprises initiated by capitalist-investors eager to share in the supranormal profits. Conversely, in those industries where product prices failed to cover per unit costs, the universal quest for profit and aversion to loss among businessmen led existing firms to contract their output or discontinue production altogether, while discouraging entry by new competitors into the industry. Moreover, as the production of goods expanded in those industries where higher-than-normal profits were being reaped, supply increased relative to demand and the profit rate tended to diminish back to a normal level as prices declined toward their "natural" level in relation to production costs. In the case of industries where production was shrinking due to losses, the decrease in supply relative to demand drove prices up toward (and beyond) average costs to their natural level, causing losses to disappear and a normal level of profit to emerge in the process.

The four functions Menger describes as the core of entrepreneurship are simply the praxeological implications of property in higher-order goods. This explains why, in Menger's view, the knowledge an actor acquires and the expectations he forms are not autonomous but are strictly governed by the structure of goods constituting his property and his chosen ends. As an "economizing man" who actuates and guides an uncertain causal process, Menger's entrepreneur is a dynamic actor who profits by actively seeking out the most valuable uses for his property and is not merely a passive "risk-bearer" whose profits represent a reward for investing in risky ventur es.