Montreal, April 30, 2006 • No 177




Gennady Stolyarov II is a science fiction novelist and philosophical essayist, and is Editor-in-Chief of The Rational Argumentator. He lives in Chicago.




by Gennady Stolyarov II


          Carl Menger (1840-1921), professor of economics at the University of Vienna, brought about major progress in economic understanding and analysis during the latter half of the nineteenth century. His two chief works, Principles of Economics (1871) and Investigations into the Method of the Social Sciences with Special Reference to Economics (1883), provide a superior alternative to the classical economists' failed labor theory of value.


          Menger's methodological individualism pointed out defects in classical economists' treatment of collectives as economic units and insisted on tracing economic value to its root: the valuing individual. His methodological subjectivism refuted the labor theory of value and showed that economic value is formed on the basis of acting subjects' needs and preferences. Menger's view of value itself as contextually objective for particular individuals firmly grounded economic value in the requirements of individual survival and flourishing.

          Using these methodological and philosophical innovations, Menger arrived at the concept of marginal utility, which resolved a theoretical inconsistency that had plagued classical economists: the water-diamond paradox. His work – the inauguration of the Austrian School of Economics – enabled economic science to progress beyond the internal contradictions of classical theory and discover a more realistic understanding of values and market processes.

Irresolvable contradictions

          By 1871, classical economic analysis – following in the tradition of Adam Smith's Wealth of Nations (1776) – was beset by apparently irresolvable contradictions. These difficulties stemmed from Smith's labor of theory of value, which posited that the costs of a good's production fully determine its economic value (Younkins, p. 29). Smith and his followers held that an object's economic value is intrinsic to it and is determined externally to the considerations, valuations, and expectations of economically acting subjects: purchasers and sellers. Rather than focus on individuals as the basic units of economic analysis, the classical economists emphasized fictitious collectives – nations and groups whose members were interchangeable parts and whose economies could be analyzed as if they were single entities.

          As a result, instead of considering why given units of a good have value, the classical economists wanted to find out why certain goods as a whole have value within a given nation or group. This methodologically collectivist view led classical economists into a paradox in their attempt to answer "why diamonds are more valuable than water" (Johnsson, p. 243). The classical economists recognized that water is much more important to human survival than diamonds – yet diamonds fetch a far higher price on the market. This empirically evident truth showed a clear deficiency in the classical theory of value; after all, a view of value as intrinsic suggested that water should have a far higher market price than diamonds. A new theory was needed to account for this fact.

          The marginalist revolution in economics during the 1870s provided a solution to the water-diamond paradox and an entirely new theory of economic value based on the concept of marginal utility. Economists William Stanley Jevons, Leon Walras, and Carl Menger originated and described marginal utility theory independently of one another (Younkins, p. 16). Of these three formulations, Menger's 1871 work – Principles of Economics – distinguished itself by its greater adherence to reality, theoretical precision, and concern with the valuations of individual economic agents.

          Jevons and Walras viewed marginal utility mathematically – as the derivative of an individual's utility function – a mathematical measurement of his "preferences," assigned to him by the economist. They sought to "map" individual preferences using continuous curves that could then be analyzed via the tools of calculus. Menger emphasized a more realistic view of marginal utility, based on an ordinal ranking of an individual's preferences: "Menger does not attempt to mathematically simplify by assuming continuity, divisibility, or a perfect market" (Younkins, p. 16). For Menger, quantifying value mathematically is nonsensical; saying that good X is worth five units of value while good Y is worth twenty is an arbitrary construction. All one can say legitimately is that good Y is valued above good X – based on the individual's actual economic activity. One can assign ordinal rankings to an individual's economic values, but not cardinal magnitudes.

          Menger departed from classical economics in his insistence on methodological individualism. In Investigations into the Method of the Social Sciences with Special Reference to Economics (1883), he heavily critiqued the classical view that economic activity and value were the result of the actions of fictitious collectives, such as nations and groups: "Adam Smith and his school… have neglected to teach us to understand [economic phenomena] theoretically as the result of individual efforts. Their endeavors have been aimed… at making us understand them… from the point of view of the 'national economy' fiction" (Menger, p. 195-96).

          To Menger, collectives qua collectives do not exist; only individuals exist and are motivated by ideas they hold individually – which might include their allegiance to groups of other individuals: "For Menger, the individual is the unit of analysis because it is only at the individual level that meaning can be assigned to actions" (Younkins, p. 17). Every thought, every valuation, every action is a fundamentally individual endeavor. Thus, to analyze the root of economic value, Menger saw fit to examine the valuing individual.

          To extend his innovative methodological individualism, Menger abandoned the classical economists' intrinsic view of value and instead focused on the valuing subject and the way in which he determines the worth of economic goods. He emphasized not the equilibrium state toward which market prices tend but rather the more realistic question of how market prices get there: "Menger stressed the role of subjective evaluation with respect to the principle of marginal utility. Whereas Jevons and Walras were concerned with equilibrium, Menger was interested in process." (Younkins, p. 16)

"To Menger, collectives qua collectives do not exist; only individuals exist and are motivated by ideas they hold individually – which might include their allegiance to groups of other individuals."

          Menger derived the nature and origin of economic values through a methodological subjectivism – but not a metaphysical, moral, or psychological one. For Menger, economic values may be subjective, but they are not arbitrary: "Menger taught that there are objective laws of nature and that goods had objective properties that made them capable of fulfilling men's needs" (Younkins, p. 3).

          For Menger, the fundamental root of value is the need to sustain and enhance the valuer's biological life. Menger realized that the material world must be employed in a specific way to sustain human life and that "the value of goods is… nothing arbitrary, but always the necessary consequence of human knowledge that the maintenance of life, of well-being, or of some ever so insignificant part of them, depends upon control of a good or quantity of goods" (Menger, p. 120).

          Menger posited a sophisticated alternative to the conventional dichotomy that value is either wholly external to the mind or wholly created by it. Menger rejects both of these options and shows that value is formed subjectively on the basis of inescapable objective requirements: "While most accounts reduce value either to the mind or to some intrinsic property of things, Menger demonstrated that all social phenomena [were] composed of varying combinations of beliefs and entities, judgments and facts, mind and matter" (Zϊρiga, p. 134).

          Many later economists have realized that calling Menger's theory of value "subjective" is a gross oversimplification; the theory can be better described in Richard C.B. Johnsson's words as "contextually individually objective" (Johnsson, p. 246). Individuals differ from one another and exist in different contexts; it is thus possible for one individual to value things differently from another and for both individuals to still value and pursue their lives to the fullest. Johnsson argues that this recognition is essential to marginal utility theory, for "[w]ithout this idea, Menger would not have been able to solve the old 'value paradox' of the classical economists" (Johnsson, p. 243).

The water-diamond paradox

          Having illustrated the essential characteristics of Menger's methodological individualism, methodological subjectivism, and contextually objective view of values, we can now examine how Menger resolved the water-diamond paradox. Because values are not intrinsic to goods but rather contextual, "[a] person assigns value to a good based on the end it enables him to achieve" (Younkins, p. 30). Hence, a person cannot value the world's entire existing stock of a given good; it makes no sense to talk about the value of water in general or of diamonds in general, because no acting individual ever chooses between all the world's water and all the world's diamonds. For the achievement of specific ends, an individual uses specific units of water, diamonds, and any other relevant good. An individual will value water and diamonds not as grand totalities, but rather on the margin – hence the term "marginal utility."

          Menger understood that the less scarce a given good is, the less value an additional unit will confer upon the individual obtaining it; this follows from the logically deducible law of diminishing marginal utility: "A given unit, quantity, or amount of a particular good will satisfy a person's most intense need or desire. After each unit consumed or used, a man's need or desire may be less intense. Each increment of that specific good available to him will be less valuable in his eyes." (Younkins, p. 16-17) If an individual has only one unit of a good, he will use it to fulfill what he considers the most important end that can be met with that good. If he obtains a second unit, he will necessarily devote it to his second most valued end; this continues indefinitely for however many goods an individual might possess.

          For example, one's first unit of water will be used to prevent one from dying of thirst. One's second unit might be used to nourish one's pet dog. The third unit might be allocated to watering one's plants. The fourth unit might be used in a decorative fountain outside one's house. If an accident spills the water one uses to sustain oneself, one will reallocate one's resources to serve one's most urgent priorities; the water originally intended for the fountain will instead be used to alleviate thirst.

          But in an advanced economy where water is abundant, one possesses so many units of it that the marginal utility of each additional unit would be relatively insignificant. In contrast, diamonds are extremely scarce relative to water; one is likely to have either no diamonds at all or only a few. Thus, each additional diamond will be put to one of the most highly-valued uses that can be found for diamonds. Of course, the most important use for a diamond – for example, using it in a ring or a highly precise diamond-edged saw – is far more valuable than the ten-thousandth most important use for a unit of water – hence the higher market price for a given diamond than for a given unit of water.

          Using this logic, Menger resolved the classical economists' paradox of value; he showed that value is an outlook of individuals toward individual units of goods and is determined in accordance with the law of diminishing marginal utility. The less of a given good an individual has, the more each additional unit of that good will benefit him. The market values of some economic goods in terms of other economic goods are thus determined by those goods' relative abundance in the possession of acting individuals. In a desert – where an individual is on the verge of dying from thirst – he might be willing to trade a million diamonds for a glass of water that would save his life.

Methodological subjectivism

          As a result of Menger's work, the field of economics was able to progress beyond the internal contradictions of the classical school's intrinsic labor theory of value. Through his methodological individualism, Menger showed the errors in the classical analysis of collectives as entities; he firmly grounded values in their source – valuing individuals.

          Through his methodological subjectivism, Menger refuted the notion that a product's value is determined by the labor invested in it; rather, value originates from the valuing subject's needs and preferences; "goods have no inherent or intrinsic value in themselves" (Younkins, p. 29). Through his contextually individually objective view of values, Menger grounded economic value in reality and showed that it is neither intrinsic nor arbitrary, but rather intimately connected to the objective advancement of the individual's life and flourishing.

          Menger applied these theoretical insights to solve the classical economists' water-diamond paradox – using the idea of valuation on the margin and the law of diminishing marginal utility to provide a logically sound case for why certain goods fetch higher market prices than others. Menger's work inaugurated an entire new economic paradigm – the Austrian School of Economics. The cornerstones of economic theory he discovered have strongly influenced economic giants such as Eugen von Bφhm-Bawerk, Ludwig von Mises, Friedrich Hayek, Murray Rothbard, and Israel Kirzner (Younkins, p. 2). Today, Menger's discoveries continue to fuel a wealth of economic progress and analysis.


Works Cited

• Johnsson, Richard C. B. "Austrian Subjectivism vs. Objectivism." Philosophers of Capitalism: Menger, Mises, Rand, and Beyond. Ed. Edward W. Younkins. Lanham, MD: Lexington Books, 2005. 239-252.
• Menger, Carl. Investigations into the Method of the Social Sciences with Special Reference to Economics. 1883. New York: New York University Press, 1985.
• Menger, Carl. Principles of Economics. 1871. Trans. James Dingwall and Bert F. Hoselitz. Grove City, PA: Libertarian Press, 1994.
• Younkins, Edward W. "Carl Menger's Austrian Aristotelianism." Philosophers of Capitalism: Menger, Mises, Rand, and Beyond. Ed. Edward W. Younkins. Lanham, MD: Lexington Books, 2005. 15-47.
• Younkins, Edward W. "Introduction." Philosophers of Capitalism: Menger, Mises, Rand, and Beyond. Ed. Edward W. Younkins. Lanham, MD: Lexington Books, 2005. 1-11.
• Zϊρiga, Gloria L. "Truth in Economic Subjectivism." Philosophers of Capitalism: Menger, Mises, Rand, and Beyond. Ed. Edward W. Younkins. Lanham, MD: Lexington Books, 2005. 133-141.