Austrian School of Economics

What is the Austrian School of Economics?

If you generally believe that economists who need data are always busy with complex formulas rather than out-of-the-box thinking, then you should look at the Austrian school. Just like the monks living in the monastery, the economists of this school strive to solve a complex problem-economic problems by conducting “thought experiments”.

The Austrian school believes that the truth can be discovered by thinking aloud. Interestingly, this group does have unique insights into some of the most important economic issues of our time. Read on to understand how the Austrian School of Economics developed and its place in the world of economic thought.

Key points

  • Austrian economist Carl Menger Principles of Economics In 1871, he was considered by many to be the founder of the Austrian School of Economics.
  • Over the years, the main ideas of the Austrian School have been continuously developed through the input of various economists.
  • In addition to Karl Menger, the Austrian school also includes names such as Ludwig von Mises, Eugen von Bohm-Bawerk, and Friedrich Hayek.
  • The Austrian school uses transcendental thinking logic to discover universally applicable economic laws, while other mainstream economic schools use data and mathematical models.
  • The early concepts of the Austrian school made a significant contribution to the theory of diminishing marginal utility.

Learn about the Austrian School of Economics

The Austrian School of Economics as we know it today was not built in a day. This school has undergone many years of evolution, and the wisdom of one generation has been passed on to the next. Although the school has made progress and absorbed external knowledge, the core principles remain the same.

Austrian economist Carl Menger Principles of Economics In 1871, it is considered by many to be the founder of the Austrian school. The title of Menger’s book is nothing special, but its content has become one of the pillars of the marginalist revolution.

Menger explained in his book that the economic value of goods and services is inherently subjective, so what is valuable to you may not be valuable to your neighbors. Menger further explained that as the number of goods increases, their subjective value to individuals will decrease. Behind this valuable insight is the so-called concept of diminishing marginal utility.

Later, another great thinker of the Austrian school, Ludwig von Mises, applied the theory of marginal utility to money in his book. Money and credit theory (1912). In fact, the theory of diminishing marginal utility of money may help us find the answer to one of the most basic questions in economics: how much is too much? Here, the answer is also subjective. An extra dollar in the hands of a billionaire will hardly make any difference, even though the same dollar is priceless in the hands of the poor.

In addition to Karl Menger and Ludwig von Mises, this Austrian school also includes other big names such as Eugen von Bohm-Bawerk, Friedrich Hayek and many others. Today’s Austrian school is not limited to Vienna; its influence spreads all over the world.

Over the years, the basic principles of the Austrian School have provided valuable insights into many economic issues, such as the law of supply and demand, the causes of inflation, the theory of money creation, and the operation of foreign exchange rates. On each issue, the Austrian school’s views are often different from other schools of economics.

In the following section, you can explore some of the main ideas of the Austrian School and how they differ from other schools of economics.

Universally applicable economic laws

The Austrian school uses transcendental thinking logic—things that a person can think about without relying on the outside world—to discover universally applicable economic laws, while other mainstream economic schools, such as the neoclassical school, the new Keynesian school, and the Others use data and mathematical models to objectively prove their views. In this regard, the Austrian school can be compared more specifically with the German historical school, which rejects any economic theorem in general.

Price determination

The Austrian school believes that prices are determined by subjective factors such as personal preference for buying or not purchasing specific goods, while the classical economics school believes that the objective cost of production determines the price, and the neoclassical school believes that the price is determined by the following factors. Balance of supply and demand.

The Austrian school opposes the views of classicism and neoclassicism and believes that production costs are also determined by subjective factors based on the value of alternative uses of scarce resources, and the balance of supply and demand is also determined by subjective personal preferences.

Capital goods

The core view of the Austrian school is that capital goods are not homogeneous. In other words, hammers, nails, wood, bricks, and machines are all different and cannot be perfectly substituted for each other. This may seem obvious, but it has practical implications for convergent economic models. Capital is heterogeneous.

Keynes’ treatment of capital ignored this. Output is an important mathematical function in both the micro and macro formulas, but it is obtained by multiplying labor and capital. Therefore, in the Keynesian model, a nail that produces $10,000 is exactly the same as a tractor that produces $10,000. The Austrian school believes that the creation of wrong capital goods leads to real economic waste and requires (and sometimes painful) readjustment.

interest rate

The Austrian school opposes the classic view of capital that interest rates are determined by the supply and demand of capital. The Austrian school believes that the interest rate is determined by the subjective decision of the individual to spend money now or in the future. In other words, the interest rate is determined by the time preference of the borrower and the lender. For example, an increase in the savings rate indicates that consumers are delaying current consumption, and more resources (and money) will be available in the future.

The impact of inflation

The Austrian school believes that any increase in the money supply that is not supported by the increase in the production of goods and services will lead to an increase in prices, but the prices of all goods will not increase at the same time. The prices of certain commodities may rise faster than others, resulting in greater differences in the relative prices of commodities. For example, Peter the plumber may find that his work makes the same money, but when buying the same bread, he must pay more money to the baker Paul.

2.24%

The estimated inflation rate for the United States in 2021.

Changes in relative prices will make Paul rich at the expense of Peter. But why is it so? If the prices of all goods and services rise at the same time, it doesn’t matter. However, the prices of those commodities for which funds are injected into the system will be adjusted before other prices. For example, if the government injects capital through the purchase of corn, the price of corn will rise ahead of other commodities, leaving traces of price distortions.

Business cycle

The Austrian school believes that the economic cycle is caused by the distortion of interest rates caused by the government’s attempts to control the currency. If the government intervenes to artificially keep interest rates low or high, improper capital allocation will occur. Eventually, the economy will experience a recession.

Why must there be a recession? Labor and investment used in inappropriate industries (such as construction and renovation during the 2008 financial crisis) need to be redeployed to practical economically viable purposes. This short-term business adjustment has led to a decline in real investment and an increase in unemployment.

The government or central bank may try to avoid a recession by lowering interest rates or supporting failed industries. Austrian theorists believe that this will only lead to further improper investment and make the recession worse when it does strike.

Market creation

The Austrian school regarded the market mechanism as a process, not as a result of design. People create markets to improve their lives, not to make any conscious decision. So, if you leave a group of amateurs on a desert island, their interaction will sooner or later lead to the creation of a market mechanism.

Bottom line

The Austrian school’s economic theory is based on language logic, which provides relief to the technical clumsiness of mainstream economics. It is quite different from other schools, but by providing unique insights into some of the most complex economic issues, the Austrian School has won a permanent place in the complex world of economic theory.

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