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Böhm-Bawerk Speaks Again

Mises Daily: Thursday, January 19, 2006 by

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Review of Basic Principles of Economic Value, by Eugen von Böhm-Bawerk (2005), Grove City: Libertarian Press. $12

The book under review contains the Hans F. Sennholz translation of Böhm-Bawerk's essay Grundzüge der Theorie des Wirtschaftlichen Güterwerts which was originally published, in 1886, in the most important economic journal of its time, Conrad's Jahrbücher für Nationalökonomie und Statistik, and later, in 1932, reprinted in German, in the London School of Economics Series of Scarce Tracts in Economic and Political Science. It presents Böhm-Bawerk's basic thesis that all economic knowledge must build on a thorough inquiry into the nature of subjective value. The author states his aims clearly in the Introduction:

" (. . .) there is unanimous agreement that it is one of the most important tasks of economic theory to clarify the exchange relations of goods or, what is called, the objective exchange value, and to develop its laws. But there is less agreement on the need today to develop a comprehensive theory for subjective value. To set forth not only this theory but also its indispensability and scientific benefit is one of the most important tasks of the following pages." (p. 5)

In fact, it is the task of the theory of value and prices to show how the choices of individuals result, in the sphere of interpersonal exchange, in the emergence of market prices. As would be highlighted more emphatically in the later writings of Ludwig von Mises, the monetary, private property market system provides the basis for economic calculation by transforming the ordinal preference rankings of different individuals, which are impossible to compare, into a quantity of common, cardinal units. Ordinal utility can thus become the basis for socially-meaningful cardinal comparisons of value. Money prices, only possible in a monetary, private property market system, provide a common cardinal unit in which different factors can be compared in social value.

Accordingly the theory of subjective value is treated in Part I of the essay (pp. 9–90) whereas Part II treats the theory of objective exchange value (pp. 91–167).

One might wonder whether this publication event presents any scientific interest except from the particular perspective of historians of economic thought with a very special interest in the history of the Austrian School.

There may seem to be several reasons for raising such doubts. The analysis presented in the essay Basic Principles of Economic Value was further elaborated in Book III of Böhm-Bawerk's Positive Theory of Capital. An English translation of this work had already appeared in 1959 as the second volume of Capital and Interest (Böhm-Bawerk 1959). It is the latter work that established Böhm-Bawerk's reputation as one of the great economists of the 19th century.

Furthermore, according to one view of the matter, common among many contemporary economists, any important contributions of the Austrian School in the field of value and price theory have already been absorbed by and incorporated into the accepted body of mainstream economic thought.

According to the point of view adopted here, this view is questionable. Arguably a better acquaintance with Eugen von Böhm-Bawerk's theses and writings might enlighten economic thinking even today.

One illustration is provided by Böhm-Bawerk's treatment of the law of costs (ibid. passim). It is part of the neoclassical theory of the firm that entrepreneurs are assumed to be profit maximizers and that profit is maximized if marginal revenue and marginal cost are equal. Certain empirical findings had shown, however, that entrepreneurs do not adopt such a price and output policy based on marginalist deliberations.1Business men appear not to think of their pricing decisions in terms of marginal revenue and marginal cost. Economists had thus found themselves in the embarrassing position of having to try to reconcile the neoclassical theory of the firm, dependent on the concept of marginal revenue, with the actual facts of pricing observed in the real world. Corporations often follow the practice of quoting prices on a "cost-and-markup" basis. It even seems that markup pricing is now rather generally considered to be the norm in imperfectly competitive markets. Böhm-Bawerk's insights, even if they have largely gone unnoticed in this context,2 shed a different light on this controversy, and suggest a different conclusion.

Böhm-Bawerk's treatment of the law of costs is consistent with the view that there are numerous cases in which cost of production is in fact the immediate determinant of the price of a good and, furthermore, that cases in which prices are determined by cost of production actually represent a special application of the law of diminishing marginal utility.3 Whereas contemporary economic theory has largely lost sight of the role of cost of production as the direct determinant of prices of most manufactured or processed goods, Böhm-Bawerk shows that the value of all the products of the same factors of production, however high their own, direct marginal utility, is reduced to the marginal utility and value of the marginal product of those factors of production, precisely under normal conditions of free competition. If a firm can assume that its own costs of production are no higher than its competitors' or potential competitors', then in setting its prices in conformity with its costs—that is, above its costs only by enough to earn the going rate of profit—it ensures that it is not likely to be undersold to any great extent, or to attract newcomers to its field.4

Böhm-Bawerk constructs an example assuming that someone owns a large supply of second order producers' goods (G2) which he can use to manufacture at random either a consumers' good from category A (marginal utility of 100 per unit), category B (marginal utility of 120 per unit) or category C (marginal utility of 200 per unit). The following figure is provided (p. 76):

       

Since, on Böhm-Bawerk's account, and because of the possibility of substitution, "the value of a producers' good unit is determined by the marginal utility and value of that product which (. . .) has the lowest marginal utility" (p. 75), Böhm-Bawerk concludes as follows:

"To translate this abstract formula into practical terms: reflecting on the value of good B or C, in general, a good of higher direct marginal utility, we must conclude that it is worth as much as the means of production from which the product can be made at any time. If we inquire further into the value of the means of production, we arrive at the marginal utility of marginal product A. But we usually omit this further investigation because we know the value of the cost items without having to develop them every time from the beginning. In all such cases, we arrive at the value of goods simply by using their costs." (p. 77)

In the last chapter of the book (pp. 161–67), Böhm-Bawerk then argues that, in the case of market interaction and with respect to goods that can be reproduced at will, and just as the subjective value of producers' goods depends on the value of the least valuable or marginal product, so the price of the marginal product, that is, the least valuable product for which the producers' good can be economically employed, rules the price of the means of production.

Thus, in instances like these, cost of production is a determinant of prices only in the first instance. When one investigates the nature of costs, they are always revealed as constituted by prices of factors of production, themselves determined by demand and supply, or on the basis of costs that reflect the operation of demand and supply at a further stage of removal.

Part II of the book is entitled The Theory of Objective Exchange Value. The central third chapter of this part, entitled The Basic Law of Price, contains in a section entitled Formation of Price with Two-sided Competition the well-known analysis of price formation in a horse-auction market, set in a bargaining context, in the manner familiar from the analogous treatment in Positive Theory of Capital. The numerical illustrations and conclusions are similar to those of the later elaboration. Consequently, similar caveats and reservations apply.   


  Wear the Structure: $11
Surely Böhm-Bawerk arrives at the basic law of price, namely that "the market price is limited and determined by the subjective value judgments of both marginal pairs of buyers and sellers" (p. 121), but at the same time he unintentionally illustrates the danger of reliance on concrete numerical examples by drawing an incorrect generalization(see Appendix).

In particular, if it is true that it is the valuations of the marginal pairs that determine the range of feasible prices, Böhm-Bawerk is wrong to suggest that the range is either from the last successful seller to the last successful buyer or from the first unsuccessful buyer to the first unsuccessful seller, whichever range is smaller.5 The lower limit is either the last successful seller or the first unsuccessful buyer (whichever is larger), and the upper limit is either the last successful buyer or the first unsuccessful seller (whichever is smaller). A modest change in Böhm-Bawerk's exposition (p. 120) can complete and clarify this outcome, however:

"Where there is two-sided competition, the market price will find its level at a point within a range having an upper and a lower limit. The upper limit is [determined] the smaller of the valuation by the last buyer to come to terms and the valuation by that excluded willing seller who has the greatest capacity for exchange. The lower limit is [determined] the greater of the valuation of the last seller among those coming to terms and the valuation of that excluded willing buyer who has the greatest capacity for exchange. This double limitation thus sets the narrow range."(pp. 120–21)

Böhm-Bawerk's original wording is bracketed; the suggested replacements are italicized.6 Böhm-Bawerk's presentation is thus characterized by a certain lack of precision and completeness which is nevertheless of minor significance.7

On the other hand, Böhm-Bawerk's Austrian approach allows for an interesting comparison of the research paradigms of the Austrian and the Chicago schools and clearly illustrates a number of remarkable attributes of the Austrian school: a preference for working with discrete units of indivisible goods, verbal rather than symbolic mathematical reasoning, cause-and-effect analysis rather than mutual determination, and imperfect markets with limited numbers of traders. It can thus be expected that the book will find a place on the reading lists accompanying standard intermediate price theory courses.


Ludwig van den Hauwe lives in Brussels, Belgium and holds a Ph.D. in Economics from the Université Paris-Dauphine. Send him e-mail at: ludwigvandenhauwe@yahoo.fr. Comment on the blog.

Appendix

The example provided by Böhm-Bawerk (p. 114) is the following:

In Böhm-Bawerk's example, the range of prices is between the valuations of the first unsuccessful buyer (A6) and the first unsuccessful seller (B6): between $210 and $215. This is indeed one possible set of boundaries for the price range, but it is only one of four.

Notes

1 These findings triggered the Marginalist Controversy in economics. Good summaries of this controversy are provided in Mongin (1998) and Vromen (1995, pp. 14–21).

2 An exception is provided by George Reisman (1998, p. 414 ff.).

3 The crucial passage can be found on pages 74–78 of the essay under review.

4 This view is elaborated further in Reisman (1998, pp. 52, 417).

5 The error is to be found in footnote 15 on page 121 of the essay.

6 For a similar suggestion with respect to the exposition in Positive Theory of Capital, see Egger (1998).

7 In this respect Mises's words can be reminded: "These masterful expositions are unsatisfactory in some minor points ands disfigured by unsuitable expressions. But they are essentially irrefutable. As far as they need to be amended, it must be done by a consistent elaboration of the fundamental thoughts of their authors rather than by a refutation of their reasoning" (Mises 1998, p. 202).

References

Böhm-Bawerk, E. von. 1959. Capital and Interest. Illinois: Libertarian Press.

Böhm-Bawerk, E. von. 2005. Basic Principles of Economic Value. Grove City: Libertarian Press.

Egger, J.B. (Winter) 1998. 'Clarifying and Teaching Böhm-Bawerk's "Marginal Pairs."' Journal of Economic Education. Pp. 32–40.

Mises, L. von. 1998. Human Action. Auburn: Ludwig von Mises Institute.

Mongin, P. 1998. ‘The Marginalist Controversy.' In: The Handbook of Economic Methodology.John B. Davis, D. Wade Hands and Uskali Mäki, eds. Cheltenham: Edward Elgar. Pp. 277–81.

Reisman, G. 1998. Capitalism. Illinois: Jameson Books.

Vromen, J.J. 1995. Economic Evolution. London: Routledge.