Unfortunately,
not very many people consider themselves to be Austrian economists.
Equally unfortunate is the fact that a large proportion of those who do so
consider themselves are unaware of an essential aspect of what Austrian
economics teaches. This is the case in regard to the vital subject of cost
of production and its relationship to the prices of products. It is
mistakenly assumed that Austrian economics categorically denies all
possibility of cost of production being a determinant of price and that
any claim of such determination is incompatible with it--that such a claim
belongs exclusively to an entirely different system of thought, namely,
classical economics, to which Austrian economics is allegedly
irreconcilably opposed on this subject.
The truth is that Austrian economics fully recognizes cases in which
product values and prices are determined in the first instance by cost of
production, and that such cases are, indeed, commonplace. For example,
Friedrich von Wieser, the second most important Austrian economist of the
generation that followed that of Carl Menger, flatly declares
". . . on the whole, the cases where costs directly
determine value predominate."1 What is much more significant is
that a painstakingly careful development of the reasons for this
phenomenon was provided by no less than Eugen von Böhm-Bawerk, the
most important Austrian economist of that era, and the leading theorist of
marginal utility bar none. Böhm-Bawerk was also the teacher of Ludwig von
Mises, who alone surpasses him in importance in the Austrian school. What
follows is an extensive quotation from Capital and Interest,
Böhm-Bawerk's most important work.2
Böhm-Bawerk's Demonstration That Cost of Production Often
Directly Determines Price, and, in So Doing, Operates as the Transmitter
of Marginal Utility*
*Copyright © 1959 by Libertarian Press. All
rights reserved. Reproduced by permission of
Libertarian
Press.
"Up to this point in our discussion the law of the value of production
goods was developed subject to the simplifying hypothesis that every group
of means of production admits of utilization only to one very definite
purpose. That hypothesis is in real life only very rarely in agreement
with the facts. It is preeminently production goods, far more than
consumption goods, which are characterized by egregious heterogeneity. The
overwhelming majority of them will be capable of service in several
productive fields, some are adaptable to thousands of such productive
services. Examples are iron, coal, and above all, human labor. Of course,
we have to take these factual circumstances into account in conducting our
theoretical investigation. We must observe what modifications, if any,
affect the law that the value of a group of goods occupying remote orders
is governed by the value of their product.
"Let us alter the order of the presuppositions of our typical example
accordingly. Someone possesses a rather large supply of means of
production of second order (G2). From each of these groups he
can produce at will a consumption good of the category A, or one of
category B or finally, of category C. He desires, of course, to take
advance measures toward balanced provision for his various wants, and will
therefore draw simultaneously on various parts of his supply of means of
production to produce consumption goods of all three categories. And he
will produce amounts in each in accordance with his needs. If there is
genuinely balanced provision, the quantities produced will be so regulated
that needs of approximately equal importance depend upon the last specimen
in each category, and that thus the marginal utilities are approximately
equal. In spite of that it is not impossible that there will be
differences--possibly even quite considerable differences--in the marginal
utilities because, as we already know, the gradation of concrete wants
occurring in any one category is not always either uniform or continuous.
The first stove in my room will afford me a very considerable utility, say
one we might designate with an index of 200. A second stove will afford no
utility at all. I shall most emphatically call a halt in providing stoves
when I have a single specimen with its marginal utility of 200, even
though in other areas provision for needs may see a dropping off of the
average of marginal utility to as little as 120 or even 100. And so it is
permissible and necessary, if our example is to be true to nature, to
assume that the marginal utility of a specimen will be different in each
of the categories A, B and C. Let us call it 100 for A, 120 for B and 200
for C.
"Now the question arises, "What is the value, under these
circumstances, of a group of means of production, G2?"
"We have had so much practice with selective decisions of a similar
nature that we can give the answer without hesitation. The value will be
equal to 100. For if one of the available groups of means of production
should be lost, the owner would naturally shift the loss to the least
sensitive area. He would not curtail production in category B where he
would be sacrificing a marginal utility of 120, and certainly not in
category C where the sacrifice would go as high as 200. He would quite
simply produce one specimen fewer of category A where the reduction in
well-being is only 100. Let us express it in general terms. The value
of a unit of means of production is governed by the marginal utility and
the value of that product which has the least marginal utility among all
those products for the making of which the unit means of production could
have justifiably been used.
"All the relations which we had declared to be plainly in force with
regard to the value of means of production and their products under the
simplifying assumption of only a single possible disposition, are
therefore generally valid as between the value of means of production and
value of its least valuable product.
"And what is the situation with respect to the other categories of
products, B and C? That question brings us to the origin of the `law of
costs.'
"If under all circumstances the marginal utility attainable by a good
within its own category were determinative, then the categories B and C
would have to receive a value divergent not only from that of category A,
but also from the value of its costs G2. B would then have a
value of 120, C a value of 200. But here we are confronted with one of the
cases where, through substitution, a possible loss in one category is
transferred to another, and as a result, the marginal utility of the
latter becomes determinative for the other as well. Thus, if a specimen of
category C is lost, it is not necessary to forgo the marginal utility of
200 which the specimen would have delivered directly. Instead, it is
possible to convert one unit of the means of production G2 into
a new specimen C, and in its place rather produce one specimen fewer in
that category in which the marginal utility, and hence the loss in utility
is least. And indeed that possibility becomes a reality. The category in
question in our example is the category A. Because of the opportunity
which production offers for substitution, a specimen C is therefore not
valued in accordance with its own marginal utility of 200, but in
accordance with the marginal utility of the least valuable related
product, the product A; its value is therefore 100. The same applies,
naturally, to the value of category B, and would apply generally to every
category of good which is `productionally related' to A, and of which the
direct marginal utility is also greater than that of category A.
"This leads to some important consequences. The first is that in this
way the value of goods having a higher individual marginal utility
occupies the same rank as the value of the `marginal product';3
and hence also the same rank as the means of production from which both
emanate. The identity which exists in principle between "value" and
"costs" therefore obtains in this instance as well. But it is to be
carefully noted that here the coinciding is brought about in quite a
different way from that which was followed in the case of costs and
marginal product. In the latter instance the two coincide because the
value of the means of production accommodates itself to the value of the
product. The value of the product is the determinant factor, the means of
production is the factor that is determined. In our present case it is the
other way around, and it is the value of the product that must do
the accommodating. Ultimately it accommodates only to the value of another
product. But initially it accommodates also to the value of the means of
production from which it emanates and which brings about its
substitutional connection with the marginal product. The transmission of
value proceeds, so to speak, along a broken line. First it goes from the
marginal product to the means of production, fixes the value of the
latter, and then ascends in the opposite direction from the means of
production to the other products which it is possible to produce from
them. In the end product, then, the products of higher immediate marginal
utility derive their value from their means of production. Let us
translate the abstract formula into terms of concrete practice. Good B or
good C is, in general, a product of higher immediate marginal utility. If
now we consider what good B or C is worth to us our first response is,
"Just exactly as much as the means of production are worth to us from
which we can at any moment replace the product." If we then inquire
further and ask how much the means of production themselves are worth, we
arrive at the marginal utility of the marginal product A. But on
innumerable occasions we can spare ourselves this further inquiry. Time
and again we already know the value of the goods that comprise the cost,
without any necessity for working it out from its foundation and
proceeding onward from case to case. And on all these occasions we simply
determine the value of products by their costs, and in doing so we are
taking advantage of an abbreviation which is as accurate as it is
convenient.
"And now the whole truth about the celebrated law of costs is revealed.
It is indeed quite correct to say that costs govern value. Only it is
imperative to remain aware of the limits within which this `law' is valid
and of the source from which it derives its virtues. In the first
place it is only a particular law. It is valid only so long as
the possibility is present of furnishing, through production, substitute
specimens in any quantity and at any time they are desired.4 If
there is no possibility of substitution, then in the case of each product,
value must be determined by its immediate marginal utility in its own
category. In that case its value no longer coincides with that of the
marginal product and of the intermediate means of production. Therein lies
the explanation of the empirically established principle that the law of
costs is valid only for the goods that are "reproducible at will," and
that it is a law of only approximate validity. For it does not bind the
goods over which it holds sway to slavishly meticulous adherence to costs.
On the contrary, it permits fluctuations above and below such costs,
depending on whether production at the moment lags behind demand or
outstrips it.
"A second and still more important consideration is that
even where the law of costs is valid, those costs are not the final, but
only an intermediate cause of the value of goods. In the last analysis,
they do not give value to their products, but receive it from them.
That is clear as crystal in the case of production goods for which there
is only one productive use. Surely no one will wish to deny that it would
be erroneous to assert that Tokay wine is valuable because Tokay vineyards
possess value; everyone will concede that the truth is the other way
around, and those vineyards have a high value because their product is
highly valued. It is just as hopeless to deny that the value of a
quicksilver mine depends on that of the quicksilver, the value of a
wheatfield on that of wheat, the value of a brickkiln on that of brick,
and not vice versa. Only because of the manysidedness of most cost goods
is it possible for the situation to present the opposite appearance. As
the moon reflects the light of the sun upon the earth, so do the manysided
cost goods reflect the value which they receive from their marginal
product on their other products."5
Concluding Comment
(The following two paragraphs are from
George Reisman, Capitalism: A Treatise on Economics (Ottawa,
Illinois: Jameson Books, 1996), p. 416. Consequently, they are to be
understood as designated as: Copyright © 1996 by George Reisman. All
Rights Reserved.)
What Böhm-Bawerk has shown in these passages is that when the price of
goods such as [automobile] fan belts, or anything else whose own, direct
marginal utility is extremely high, is determined on the basis of cost of
production, precisely then is its value determined on the basis of
marginal utility--the marginal utility of the means of production used to
produce it, as determined in other, less important employments. The buyer
of a fan belt, or whatever, does not pay a price corresponding to the
value he attaches to his car, but a much lower price corresponding to the
marginal utility of the materials and labor required to produce fan belts
or whatever--a marginal utility that in turn is determined by the marginal
utility of products other than fan belts or whatever. As Böhm-Bawerk
develops the law of diminishing marginal utility, it is no more surprising
that the price of vital components and parts, or any necessity, is in
conformity with its cost of production rather than its own direct marginal
utility than it is that the marginal utility of the water on which our
physical survival depends is no greater than the utility of the marginal
quantity of water we use. Determination of price by cost is merely a
mechanism by means of which the value of supramarginal products is reduced
to the value of marginal products. The only complication is that the
marginal products in this case are physically different and lie in other
lines of production. . . .
It should be clear that the notion that cost of production has no
significant explanatory role in economics does not come from Böhm-Bawerk
and Wieser. It comes from Jevons. It was Jevons who held that the only
possible connection between cost of production and price was through the
intermediary of variations in supply and that every price is actually
determined by the specific demand for and supply of the individual good in
question.6
Notes (Supplied by
George Reisman)
1. Friedrich von Wieser, Natural Value (London and New York: The
Macmillan Company, 1893), p. 181n. See also Wieser's Ursprung und
Hauptgesetze des Wirtschaftlichen Werthes (Vienna: 1884), pp.
15051.)
2. Eugen von Böhm-Bawerk, Capital and Interest, trans. George D.
Huncke and Hans F. Sennholz (South Holland, Illinois: Libertarian Press,
1959), vol. 2, pp. 173-76. The identical quotation appears in my book
Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson
Books, 1996), pp. 414416. The previous and remaining four notes are
reproduced unchanged from that source.
3. Böhm-Bawerk uses the term "marginal product" here to refer to a
distinct product of a different type, not, as is the practice in
contemporary economics, to the gain or loss of a product of a given type
attributable to the presence or absence of a unit of a factor of
production.
4. It must be pointed out that the existence of inventories, which can
be drawn down in response to an increase in demand, before additional
production succeeds in increasing supplies, and which can be temporarily
built up in response to a decrease in demand, before production is cut
back, makes it unnecessary that production be adjusted instantaneously to
changes in demand. The extent to which demand is postponable also
introduces a measure of flexibility in how quickly production must be
adjusted to changes in demand in order to maintain a connection between
prices and costs.
5. Along the same lines as this long quotation, see also Böhm-Bawerk,
Capital and Interest, vol. 3: Excursus 8, and Böhm-Bawerk's
untranslated article "Wert, Kosten, und Grenznutzen," Jarhbuch für
Nationalökonomie und Statistik, Dritte Folge, 3:328.
6. See W. S. Jevons, The Theory of Political Economy, 4th ed.
(London: Macmillan and Co., 1924), p. 165.
Addendum: A Note to
Readers (2/16/97)
The above material appears in Chapter 10 of my book
Capitalism. If
you found it surprising and to be worthwhile reading, then there is a good
chance that you will find the material equally surprising and worthwhile
if you read my section "The
Conceptual Framework of the Exploitation Theory" (pp. 476-479, in Chapter 11 of my book),
and the section "The Role of Saving and Productive
Expenditure in Aggregate Demand" (pp. 682-685, in
Chapter 15).
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