The Austrian Way – Part 2

An Introduction to Austrian Economics

Part 2 – by Aaron Koenig

Read: Part 4 | Part 3 | Part 1


Human Action

Stages of human behavior
Stages of human behavior

The individual and its actions are at the center of Austrian Economics. Austrians frown upon the habit of economic schools to squeeze human action into abstract mathematical models. Austrians always start at the needs and desires of real people, and do not accept the concept of a “homo economics,” whose behavior is simplified to fit into the artificial models of economists. In contrast, mainstream economists work with abstract terms and formulas, mimicking the precision of natural sciences. But economic processes are much more complex than scientific experiments in a laboratory, which can be repeated at will. In contrast, the economy is influenced by many factors, which work together differently in every situation. 

The Austrian School therefore instead focuses on understanding the actions of human beings. It is no coincidence that Ludwig von Mises’ magnum opus is called Human Action. In its early days, the Austrian School was sometimes referred to as the “Psychological School,” because of its human-centered approach. Mises rejected this name, as he did not care about the psychological motives of human behavior, but only about its practical consequences for the economy. He preferred to call his approach Praxeology: the science of human action.

Where Do Prices Come From?

Market Price
Market Price

A good starting point to understanding Austrian economic thinking is to look at its explanation of how prices arise in a free market. While earlier economists argued the price of a product is mainly derived from the costs of its production, Carl Menger and his successors claim that prices are solely defined by the subjective value that a user assigns to a product in a specific situation. For this, he coined the term “marginal utility.” The marginal utility of a product is the additional benefit you get from consuming an additional unit. This can differ significantly depending on the situation, even for the same good. 

Someone who is nearly dying of thirst in the desert would be willing to pay more money for a bottle of water than he would at his hometown supermarket. For him, the value of this life-saving bottle of water is much higher than the 100 dollars a greedy seller would charge. His willingness to pay will be significantly lower for a second bottle because its marginal utility is much lower after his thirst has been quenched. The seller, on the other hand, will value the 100 dollars higher than the bottle of water – if he disposes of enough water not to die of thirst himself. Otherwise, he would not sell his last bottle for any amount of money.

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Value is Subjective

Value in Clothes line
Value in Clothes line

We see that the buyer and the seller do not assign the same value to a product. Quite the contrary: a transaction will only take place if for the buyer the product has a higher value than the money he pays for it, while the seller appreciates the money more. Therefore, a “fair price” or an “intrinsic value” of a product does not exist. Prices always arise from individual decisions in specific situations. If a central authority fixes prices, distortions and unwanted aftereffects will inevitably follow. 

The higher price of the Blue Dollar in Argentina is a natural consequence of the capital controls by the Argentinian government. Their efforts to prevent Argentinians from buying dollars are in vain. Argentinians need dollars, so they are willing to pay a price that is much higher than the “official” rate as defined by the government. Price controls always lead to “black,” or to be precise, free markets. Another example from Argentina: when the government limited the price of beef to maintain its affordability (eating immense amounts of beef at a barbecue is an essential part of Argentinian culture), many cattle ranchers went out of business and started to grow soybeans instead. This leads to a scarcity of beef, eventually forcing the government to suspend the price controls.

To be continued…

Aaron Koenig’s book cover page

This is an excerpt of Aaron’s book A Beginner’s Guide to Bitcoin and Austrian Economics

Aaron Koenig is a contributor to the Census Blog. He is an entrepreneur, consultant, writer and film producer, specialized in Bitcoin and Blockchain technology. Aaron is the author of the books A Beginner’s Guide to Bitcoin and Austrian Economics, Cryptocoins – Investing in Digital Currencies and The Decentral Revolution

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