Carl Menger (1840–1921) was the founder of the Austrian School of Economics. This school of economics is most noted for the development of the theory of marginal utility that contested the cost-of-production theories. Menger's first work, Principles of Economics (Grundsätze der Volkswirtschaftslehre), printed in 1871, was the first expression of his unique theories.
Menger's investigations in his book The Method of the Social Sciences with Special Reference to Economics (Untersuchungen über die Methode der Socialwissenschaften und der politischen Oekonomie insbesondere), redefined and defended his positions. This book generated much debate and controversy. Menger's school of thought was derisively termed the Austrian School, since its early proponents were faculty members at the University of Vienna. However, since its first creators, no other economists from the Austrian School have held positions at Austrian universities.
Menger's ideas appealed to many other economists who further refined and propagated his ideas. Notable economists from the Austrian School include Eugen von Bohm Bawerk, Friedrich von Wieser, Ludwig Heinrich Edler von Mises and Friedrich August von Hayek.
Much of the Austrian School's theories are based on the idea that the economy is based on the decisions of individuals. This theory contends that economy is built on practices that are not consciously designed or put into place but rather are byproducts of actions taken by people to achieve their personal goals.
Von Hayek believed that the economy is the "product of human action, but not of human design." A person cutting across a snow-covered lawn to reach his destination leaves footprints behind him. Other people follow these footsteps, making the path bigger and wider. Although the leader and all the followers are only interested in reaching their destination as quickly as possible, they create a path in the snow that helps other people. Von Hayek believes that the ups and downs of economy follow the same "path in the snow" design. People do not consciously create a system of prices and exchanges; they wish to benefit themselves. However, their behaviors create a market system.
The implication of this theory is that official or government intervention in the economic system is not usually effective. The theory emphasizes the central role that individual entrepreneurs have in directing the economy. Von Hayek's view and that of the Austrian School clearly opposed the socialist and fascist views popular at the time.
Von Mises clearly argued that socialism is doomed to economic failure. He based his views on the contention that without a market economy, there would be no way of designating prices or value and, therefore, there would be no rational way to allocate capital goods in a productive manner. Without an exchange of money or barter for goods, as per private ownership, there would no logical allocation of raw materials necessary for the production of consumer goods, and producers would eventually lose incentive to produce at all.
The Austrian School proposes that economic policies cannot predict human behavior since consumer goods are not inherently valuable. Rather, value is attached to goods by individual desires. For instance, though economists might base their policies on the assumption that human beings value commodities that prolong human life, they may fail to take into account human foibles. The robust sale of alcohol and cigarettes proves that people attach great value to alcohol and cigarettes even though they curtail the projected human life span.
The Austrian School also generated the economic law of diminishing marginal utility. This law states that a person receives the most satisfaction from the first unit of a product that he consumes. This can be illustrated with a thirsty person reaching for a bottle of water. The first drink that he swallows will be immensely enjoyed. The second cup will be less important and the third cup even less so. He may down the fourth and fifth cup without any enjoyment at all.
At the end of the 20th century, the status of the Austrian School of Economics could be summarized in five points: 1. In a historical perspective, many of the Austrian School's theories were absorbed into mainstream microeconomics.
2. The von Bohm-Bawerk capital and interest theory had been revived.
3. Politically and socially, the free-market favoritism espoused by the Austrian School has been widely accepted. 4. Proponents of the Austrian School refuse to adopt modern mathematical techniques, used by standard economics.
5. The Austrian School emphasizes the radical uncertainty that surrounds all decision-making in the realm of economics.