The Austrian School and Its Neighbourhood
The founder of the Austrian school was born in Poland, then part of the Austro-Hungarian Empire, in 1840. He attended university in Vienna and Prague and went on to take his doctorate in Krakow. His first job was as a journalist, and by 1871, when he published the Principles of Political Economy, he had become a civil servant. Thanks to this book he had a rapid academic career: by 1873 he was professor; in 1876-78 he was made tutor to Crown Prince Rudolf of Austria, and from 1878 to 1903 he held the chair of political economy at the University of Vienna.
The Principles of Political Economy are hardly what a modern reader would expect of a key text for the marginalist approach. Menger had studied law, which, in the continental European tradition, implied an approach with a strong emphasis on history and illustration of concepts, often prolix. Menger appeared distant from the project - shared by Jevons and Walras - to construct economic theory as a quantitative science to be developed in mathematical terms. His text was devoid of mathematical formulas, and on various occasions Menger made no secret of his profound scepticism regarding the use of mathematical tools. His aim was, rather, to construct a theory transcending simple description of economic phenomena while retaining strong links with empirical reality. Moreover, Menger’s subjectivism in the field of value theory, unlike Jevons’s, owed little or nothing to utilitarian concepts.
A subjective approach to a theory of value based on comparison between supply and demand, value in use and scarcity was very much the rule in the tradition of Austro-German universities. This tradition had its roots in medieval Scholastic doctrines and implied systematic rejection of Ricardian labour-value theory but not of the theory of differential rent or the Smithian theory of the growth of the wealth of nations associated with the division of labour.
Menger’s Principles thus followed the structure of the great German textbooks: extensive discussion of goods and needs led up to the theory of value, exchange and price, after which attention turned to distribution, development and money. The objective of economic theory was, Menger asserted, to analyse the causal relations between goods and human values; significantly, while Jevons stated his concern for a specific aspect of human activity, relating to the satisfaction of needs of the lowest level, Menger defined economic activity as a search for knowledge and power.
This was in fact one of the most innovative aspects of Menger’s text. Another significant element was his interest in the interrelations between the different goods within the economic system, which saw Menger advancing beyond the traditional tendency (again dating back to Scholastic thought) to consider the formation of value, or price, of each good in isolation.
Menger’s subjectivism was indeed radical, his analysis starting from the evaluation that each individual makes of his own situation - hence also his methodological individualism. Thus, value is given by the way human beings assess the varying importance of the various needs and the suitability of the different goods to satisfy such needs.1 More precisely, the different needs were classified in order of importance, and it was assumed that the intensity of each progressively decreased when it was satisfied; a certain degree of satisfaction had to be reached for the most pressing need before tackling the immediately successive one in order of importance.  The determination of value then required that, along with the value in use of the goods, their scarcity be taken into account; their evaluation therefore concerned not the absolute importance of each need but its importance ‘at the margin’. This evaluation was made directly in the case of consumption goods (goods of the first order) and indirectly in the case of production goods (goods of the second, third, etc. order). In the latter case, the means of production was imputed with part of the value that the good produced held for the consumer, this portion being computed in proportion to the contribution made by the good or service to the productive process (hence the name imputation theory). The role of
primum movens of the economic system is thus attributed to the consumer. The idea of the consumer as sovereign had at the same time a normative and a descriptive content, thus implying a justification for economic liberalism, in the sense of ‘leaving it to the market’.
The subjective view of value in use proposed by Menger departed from the dominant line followed by German economists of the time, seeking objective foundations for the measurement of use values. To use Bernardine of Siena’s (1380-1444) terminology, we might say that Menger focused on the goods’ complacibilitas (that is, on their correspondence to the individual users’ preferences), while the German tradition of the time looked to their virtuositas (capacity to satisfy human needs). Finally, we should stress that, possibly in order to mark his distancing from utilitarianism, Menger avoided the term ‘utility’, preferring to speak of the ‘importance of satisfactions’.
In his analysis of exchange value Menger started from the case of two goods and two parties to the exchange, or bilateral monopoly. In this case there is a range of values compatible with realisation of the act of exchange coming between the two extremes at which one of the two parties loses interest in the exchange. In general, then, Menger saw the exchange as a matter of unequal values implying an advantage for both participants.
Menger outlined, but did not fully develop, generalisation of this analysis to cases of more than two goods and two parties to the exchange: as a consequence of his refusal to apply mathematical tools his analysis fell short of the analyses produced by other authors of the time, or even of earlier times. His original contribution is to be found elsewhere, in the attempt to delineate a conceptual framework such as would allow the theoretician to keep account of crucial aspects of the real world, such as the limits of human knowledge and the uncertainty surrounding the decisions of economic agents. Moreover, Menger stressed the role of the market in favouring the diffusion of information. However, it proved difficult to relate these data to mathematical analyses of value within the subjective approach; as a consequence, they were tacitly disregarded in the canonical version of the marginalist theory.
Unlike Jevons or Walras, Menger did not assume utility functions to be maximised under budget constraints; value depended on the subjective evaluations people made of their needs and the way to satisfy them, and such evaluations could change in unexpected ways. Menger appeared interested in dynamic aspects, such as the study of how goods tout court become economic goods, the issue of the original development of private property and the active way economic agents set out to increase their knowledge and consequently modify their preferences. In this context, Menger stressed the elements of inequality, irreversibility and gains from exchange. The notion of equilibrium was applied to the choices of the individual economic agent, but much less to the economic system as a whole, due to the difficulty of coordinating such choices (limited knowledge, importance of learning).
Similarly, Menger stressed the existence of transaction costs and thus the theoretical and not only practical importance of elements such as knowledge and distance. Hence the role attributed to the intermediaries, who help the economic agents towards fuller knowledge and better organisation of the market and the role attributed to money. This brings us to Menger’s conception of the process of civilisation itself, identified with the reduction of ignorance and development of institutions that help human beings get to grips with an uncertain future. Institutions such as money, the market and the division of labour were explained - in accordance with methodological individualism - as unintentional effects of individual uncoordinated choices, modified in the course of time as a consequence of learning processes in response to the experience gradually acquired. On the whole, Menger had an optimistic view of economic progress, decidedly closer to Smith than to Malthus’s Essay on Population; as in Smith, progress was related to improvements in the division of labour and to capital accumulation.
-  Let us recall that according to Menger value had to do with the essence, and price with thephenomenic manifestation, of economic activity: a distinction that had some affinity withMarx’s and was conversely absent from Walras’s French approach or the Anglo-Saxonline followed by Jevons or Marshall.
-  In contrast to the canonical marginalist theory of the consumer, where substitutabilityamong goods plays a central role, Menger did not admit substitutability among needs(that is, the possibility that a lower degree of satisfaction of a need be compensated bya higher degree of satisfaction of some other need, leaving the situation of the consumerunchanged).
-  The role Menger attributed to the monopolistic market form in his analysis contrasts withthe dominance of perfect competition in the analyses by his pupils, Wieser and Bohm-Bawerk, who came closer in this respect to the approaches of the French and Anglo-Saxonmarginalist theoreticians.