 He's the director of the Mises University, and he's the editor of the quarterly journal of Austrian economics. He's kind of like the godfather of the Austrian school. His subject of his lecture this morning is the origins of the Austrian school, Joe. Thank you. Thank you. I'm really honored to be here to talk to you about the birth of the Austrian school, which, without which, we would not have this institute, obviously. So the Austrian school has a single founding father. His name is Carl Menger. He wrote in the 1870s. And what we'll do is we'll go through the background in which Menger initially learned economics and which he wrote, and then I'll go through his doctrines. The Austrian school was founded during a period called the Marginalist Revolution, which is sort of a misnamed event in the history of economics. It would be better named the subjectivist revolution or the subjective value revolution. But to begin with, what does a Marginalist revolution mean? What is it? What is the significance of the participants and so on? Let me just give you an outline of how it's generally defined in the history of economic thought books. The Marginalist Revolution is the simultaneous and independent discovery of the principle of margin utility by three different economists, sort of like the discovery by two different people of Newton and Leibniz of calculus. They did not communicate before discovering this principle. But as I'll show you, the principle was stated by Carl Menger, which was much different than the way it was conceived by the other two participants in the revolution. Who were they? They lived in different countries. Carl Menger lived in Austria, hence the name the Austrian school. He published the book, The Principles of Economics in 1871. William Stanley Jevons was a British economist. In the same year, he published The Theory of Political Economy. And three years later, a French economist that had more or less been exiled by other French economists because he was a mathematical economist to Switzerland, Leon Ball Ross, published his book. Now, not all of them use the term marginal. In fact, Menger didn't have any term for the concept he was setting out. It was Menger's student, Friedrich von Wieser, who used the term Grungsnurzen, which means marginal utility. And I'll get to the meaning of the word marginal utility in a moment. Jevons used the term final utility. And Ball Ross used the term rarité. As I said, on the surface, superficially, they seem to be the same concept. But when you went a little bit more deeply into the different doctrines, Menger's was much different than the doctrines of the other two. Actually, let me give you a picture so you can bear in mind what they look like. While Ross is on the left, and the seeming villain in a Batman movie is Jevons on the right, the great Austrian founder. Oh, I'm sorry. I got it. Delusions of grandeur. Here's Menger, a picture and a portrait. Now let me just talk about the subtle differences in the doctrines as they were presented. Jevons and Ball Ross were both mathematical economists. Ball Ross wasn't a very good mathematician, as it turns out, as later economists pointed out. And they conceived of marginal utility as a quantity of satisfaction, an actual quantity that it could be measured. It could be added up. It could be compared between individuals. Unfortunately, their vision infuses economics today. But Menger conceived it as something much different. He thought it was, he looked at it as sort of the outcome of an individual actor's judgment about the importance of concrete wants and satisfying his, of concrete goods and satisfying his wants. So Menger's focus was on human wants. And this was the beginning of Austrian economics. But he discovered much more than the principle of marginal utility. Actually, he created a whole theory of price based on individual human wants. That is, he put human beings at the center of economics. And in so doing, he did found the Austrian School of Economics. He was a genius in a certain sense. Now, he was a genius in the sense that he created something new under the sun. The French economist J.B. Sey corrected economists in 1802 when they said that production was the creation of goods. He said, well, nobody could produce anything in the world. Everything in the world is always in the world. You could only transform it. You can transform matter into different forms. So since Sey, we talk about production as being a transformation of things into other things that are more useful to human beings. But the only thing that human beings can create, they can create something new under the sun. And that is ideas. And what Menger did, even though he had many, many influences, he put together a system of ideas that gave us an overall economic theory. And this was new. Many economists, prior to Menger, had seen that, in fact, human wants, subjective value were the most important causes in economic phenomena. But they did not weren't able to construct the theory of price, of how things were priced, based on these insights. And that's where Menger's genius lay. Now, he was recognized by some of the greatest economists and historians of thought, that is his contribution. I'll just put up a few quotes. Joseph Schumpeter, who was an Austrian by birth, but was not really a follower of Menger, but was a great historian of thought, wrote that, nobody's principal is nobody's pupil, excuse me, and what he created stands. Menger's theory of value, price, and distribution is the best we have up to now. And now he's writing in the mid-1920s. Ludovan Mises, who was a Mengerian, and was taught by Menger's student, Bumbaver, wrote, what is known as the Austrian School of Economics started in 1871, when Karl Menger published a slender volume under the title, that's the German title, Principles of Economics, until the end of the 70s, there was no Austrian school. There was only Karl Menger. And he influenced a number of brilliant minds, two in particular, who were quite brilliant. But his influence spread over the world. By the 1880s, he had many, many followers in Austria and German-speaking countries. And then by the 1890s, the Austrian school was known internationally. And the Austrian school was built on Menger's foundations. In fact, that's what Hayek tells us. Hayek, who also is no mean historian of thought, says that the Austrian school's fundamental ideas belong fully and wholly to Karl Menger. What is common to the members of the Austrian school what constitutes their peculiarity and provided the foundations for their later contributions is their acceptance of the teaching of Karl Menger. So we can't emphasize Menger's brilliance too much. Can't be overstated. But prior to Menger's writing, the most popular school or the school that was the most influential in the world was the British, what was called the British Classical School. And they said some very good things, but they also made some very profound errors in their reasoning. The British Classical School consisted of three men, David Hume, Scottish philosopher Adam Smith, the so-called founder of economics, though he certainly was not, and David Ricardo, who systematized Smith's system and made it more abstract in a bad way, made it bloodless in some sense. But they were all very brilliant men. How did they see the price system? What did they say about prices and values and so on? Well, let me tell you some of the good things they said. They said, you know what, prices are not random. They're not determined by power. They're not determined by whim or historical accident. In fact, they are a regular phenomena. Prices that we see are determined. Not only are they determined, and we'll see just how in a moment, but they also regulate all production and decisions and how resources are allocated. In the short run, that's through supply and demand. And in the long run, it's because of cost of production. It's the cause of value. So for example, if we take a quick look at how they thought prices regulated production was fairly straightforward, they point out, look, if demand goes up, now they never explain what demand was. But if there's an increase in demand, prices will go up above average cost. So if there's an increase in demand for, let's say, smaller hybrid automobiles, then suddenly the price of those things will rise above their average cost. That will drive up the profits. Above some normal level, that is, everyone is earning some normal level of 5% or 10% in the economy as it's going along. And now suddenly, in this one industry, you have huge profits. And that will inspire entrepreneurs who know their costs of production and see that prices are rising to increase supply in response to the higher profits. But over the longer run, when supply increases, then the price will begin to fall back towards the natural or long run price. So for example, as the price of oil has gone up because of greater demand on the part of China and India and other developing countries, and because of supply side problems with the US Sabre rattling at Iran and so on, we find that suddenly we have this new phenomenon of fracking. That is, of using a new technology to determine or to produce more of a substitute for oil as natural gas. So that was an accidental, that was a result, or that was a response to the profits, as a classical school would say, that are above normal in the area of fuels and so on. And on the other hand, if the demand for product collapses, if the demand for large gas guzzling automobiles collapse, then the prices will fall below average cost. And suddenly you'll have losses in that industry, and related industries. Supply will fall. And as supply falls, then prices will go back up toward some normal level that keeps some people in the industry. Though some of the resources have moved out into the production of hybrid autos. So that sequence of events shows that really the classical school had what was called the theory of calculable action. That is, they believe that resources were allocated by the conscious calculations and decisions of businessmen. They also, in the short run, held that supply and demand was a principle that held not only in England or Scotland, but all over the world. It was an immutable principle, and it was a universal principle. And finally, actually, Menger agreed with all of this. Menger thought that all of this was correct. But he did find some problems with the classical school. And in fact, there were a number of flaws. So let me just quickly go over the flaws. Then we'll talk about how Menger addressed these flaws. The first and greatest flaw was that the classical school reasoned in terms of abstract classes of goods, not in concrete units, but abstract classes. They would ask the question, why is it that diamonds are more expensive than bread? Why is it that coal has a certain price, and that price might be less than the price of diamonds? So they talked about goods as abstract classes. When you talk about goods as abstract classes, you suddenly lose the human being involved. So the result of all this, the upshot, was the so-called paradox of value. The paradox of value, which we'll talk about more when we come to Menger, was the puzzle that, look, something like diamonds, which is really just a good that allows people to conspicuously express how wealthy they are, or it's used for mere ornamentation. But yet, it has a much higher exchange value than bread. Bread is a staff of life. Bread is what, back in certainly England of that era, kept the bulk of the population alive. Why is it then, if bread has such greater use value than diamonds, its price per unit of weight, let's say, is so much less than that of diamonds? That's the paradox of value. And the classical economists never really resolved it. They did an end run around the paradox of value. What they did was to say, well, economics is about exchange value. Economics is about prices on the market, explaining prices on the market. We'll just put use value over to the side. They didn't make that, yes, anything that has a price has use value, but they didn't treat use value in any greater depth than that. So subjective use value, and therefore, the important role of consumers in price determination just dropped out. Now, this also led them to focus on the businessman. The businessman then was the central character in economics. He was the one who paid the costs and responded to the prices in allocating resources. So their explanation then of price, at least in the long run, was that prices were determined by their costs of production. The higher the costs of production that businesses had to pay, the higher the price would be. One variant of the theory was called the labor theory of value, which was put forth by David Ricardo. And basically what he said was that, really it's the ratio of the amount of labor in a good to another good that determines value. So for example, if a plasma TV has embodies five times the amount of labor, then let's say an older generation television, then its price is gonna be five times as high. Others stuck to a money cost of production. And they didn't just focus on labor. Okay, now, what was the problem with this theory? One problem was, well, for example, the song I Am the Walrus, the lyrics to that song sold on eBay for $40,000 a few years back. Did that cost $40,000 for John Lennon to produce that? Another example is that there was one of the biggest diamonds in the world, the most expensive diamond that ever sold at auction. It's called the graph pink. It's a pink diamond, a 25 carat diamond. It sold for $46 million. Did it cost that much to produce that diamond? In fact, no one probably even knows. It may have been picked up somewhere at very little effort or it could have cost something to go down and mine it. But that's irrelevant from the point of view of modern Austrian economics. So how did, or by the way, famous paintings, the Mona Lisa and so on, which would have a huge price was ever auctioned off, those things, the price of those things could not be explained by the classical school. So what did they do? They said, well, those are monopoly goods. They're scarcity goods. It's just the scarcity of those things that determine their price. So what they did was they had a bifurcated or two-part value theory. Reproducible goods like coal, bread, diamonds, the cost of production determined their prices. And other goods, collectibles and so on, goods that could not be reproduced, their prices were determined by scarcity. And now, of course, land, since land is not produced, though it's a very important factor of production, cannot be explained by the cost theory. It can only be explained by a scarcity theory. So they came up with a monopoly theory of land. Land is inherently a monopoly, because it cannot be reproduced. So these are all the problems with the classical school. What these propositions implied was first that value is inherent in goods. In some sense, the more the laborer sweats overproducing a good, the higher its value is. So one historian of thought, Whittly, called it the embodied sweat theory of value. Or to think of it another way, at some point a price is stamped on the good when you produce it, and that's the price. That's the price that's sold to consumers at and so on. And when goods are exchanged for money, so for example, this bottle of water exchange is for $2, and that implies that this bottle of water has a value equal to the $2. Or if this is $2 and this case of pens up here are $2, well then they were produced at equal costs. So exchange, according to the classical economist, shows inequality of value. And as we'll see, that is wholly rejected by menger. And also the cost of production theory of value does not explain really, cannot accommodate huge losses that firms suffer. For example, GM lost $6 billion in the first quarter of 2009. For all of 2008, for example, lost $30 billion. Lost $37 billion in 2007. That's very difficult to explain from the cost of production theory of value standpoint, right? Because why don't they just raise the price so that's higher than the cost? Shouldn't the cost determine the price? AIG, the big insurance company, lost $62 billion in one quarter in 2008, okay? And 99 billion for all of 2008. And that's inexplicable by the classical theory. Now they could say, well, it's a short run and so on, but the point is that this takes a long period of time. These firms were losing money. And finally, what tended to happen was that they focused on the long run. The long run in which there were no profits and losses. And in which cost of production dominated. They thought that the cost of production was the main determinant of prices. Okay, so now let's talk a little bit about menger. How do you react to all of this? He was an economic journalist in the late 1860s before he wrote his book. He did cover the markets. He did see that prices were changing on commodities markets and other markets day-to-day or even hour-to-hour. So in his notebooks, he wrote to himself that he didn't say the classical theory, but the classical theory or the prevailing theory does not explain prices. And so he set himself the task of explaining prices in a way that takes into account human wants. Now he was very comfortable with saying that prices are determinant, that we could explain how prices are determined, and that prices indeed do guide production and allocation of resources. He was very, very happy with all of that. Now in his notebooks, prior to writing his book, he wrote some notes to himself. And in those notes, he said the following. So he's writing these notes to himself. As men himself is the beginning and the end of every economy, beginning and the end. So economics is about man, about human beings. He then said, in another note, our science is the theory of a human being's ability to deal with his wants. And finally he said, all things are subject to the law of cause and effect. That's actually the very first line of his book. Now, that meant something, very specific to Mender. What Menger saw, and again, this is from his notebooks, was that human beings were involved at two ends of the economic process. They're involved at the beginning, if you look at these trinities that he's written down here. He says that ends, human ends, cause means, cause the production of means, and the means that satisfy ends, we call goods in economics. And then the means themselves cause the realization of the ends. So there's double causality there. Human wants cause economic production, and production of ultimately of consumer goods satisfies human wants. So causality runs throughout his system. He also said, man, external world subsistence. In other words, human beings have wants, they look to the external world for things that can satisfy those wants, they transform those things, and then from those things, they get their subsistence, that is the things that satisfy their wants. And finally, wants, goods, satisfaction, that's clear. Wants cause goods, that is cause the economic activities that bring about goods, which in turn brings about the satisfaction of the wants. So causality and human centeredness is the gist of his system. And this actually comes from many older economists that did recognize the central importance of human being. Those we'll see, they did not have the marginal concept. So the mid-19th century French economist, great free market economist, Frederick Bastiat, entitled the chapters to one of his treatise, one of the chapters to his treatise, wants, efforts, and satisfaction. And Menger was very, very familiar with this tradition because Bastiat had an influence all over the continent, including in Germany. There were subjective value theorists in Germany that believed that subjective value was the most important determinant in determining prices. So what did Menger set out to do? What he did was, he wrote this in the preface, he says, I have devoted special attention to the investigation of the causal connections between economic phenomena involving products and the corresponding agents of production, okay. Not for the purpose of establishing a price theory, not only for the purpose of establishing a price theory based upon reality and placing all price phenomenon, and includes interest, wages, ground rents, okay. All of these are gonna be unified. There wasn't gonna be different value theories. Let's place them all together under one unified point of view, okay. But also because of the important insights we thereby gained into many other economic processes here to for completely misunderstood. He believed that all of economics could be reduced to the human striving to satisfy their wants. So that's what Menger was all about. That's what his book was all about, and now we'll get to some of the doctrines in his book. Okay, so one of the first doctrines that Menger talked about was the theory of goods. And what he said was that to have goods, you need a certain things that exist in the real world. The first is that there should be a human need, and I have this written out someplace to show you. I'll just go through it. There has to be a human need. There has to be such properties as render the thing capable of being brought into causal connection with the satisfaction of this need. Meaning simply that the thing must be able to satisfy that need. In other words, if you make a ham sandwich, then that ham sandwich, you have to have in mind that that can satisfy your hunger, okay? That is the want for satisfying hunger. And then there has to be a human knowledge of this causal connection. And finally, let me just push this up for people in the back. There has to be a command of the thing sufficient to direct it to the satisfaction of the need. So those were the four properties or preconditions of a good. And now, that's not completely correct, okay? Mengu is later corrected by Mises because if you take these as the preconditions, then things like psychics get paid a lot of money or goods that are sold just for vanity and so on, and that really don't satisfy a need in some absolute sense, in some objective sense. The price of those things cannot be explained. So Mengu said that those things are just imaginary goods, but he admitted they were goods. So Mises replaced numbers two and three by saying that there must be an opinion by human being that this thing is capable of being into causal connection with the satisfaction of this need. In this case, you can explain people going to quacks, you can explain people going to consulting psychics, you can explain people purchasing goods that make them look ridiculous rather than make, you know, improve their appearance. You can, in other words, subjective value must be actually pervades the preconditions. So we could also point out that number four, if you don't have control of a thing, that thing's not a good, okay? For example, the sun. The sun might satisfy a need for a nice day at, let's say, a baseball game, but you have no control over whether the sun is going to be out. In other words, the weather, let's say, whether you're gonna have some sort of a sunny day or not, if it's gonna be pleasant or it's not gonna be pleasant, that can't be controlled. So in that case, we don't consider that a good. All of these preconditions must be present. Now, Manger then wasn't just satisfied with talking about a good, because Manger considered a good something like air, okay? Air is a good in Manger's view because it satisfies the human need to stay alive, to keep one's vital organs working. So he went a step further and he said that he wanted to talk about economic goods and he added something for economic goods, okay? So another precondition that's necessary to be added to these preconditions in order to get an economic good is that they have to be scarce in relation to human wants. That is, there can't be enough to satisfy all human wants for the good. So that was Manger's analysis of economic goods and it was economic goods that was the subject of economics and this is where he brought in the law of marginal utility, which I promised before I would explain and explain it in a way that does not look on utility as a quantity that can be added up, compared and so on. So what Manger did was to set out, to solve the so-called paradox of value and he did so by setting up an example, example of something like what I'm gonna give you. He assumed an unrealistic situation in which there's only one human being and you can think of Robinson Crusoe on an island, shipwrecked, with only his own labor power and the natural resources available on the island. Now, Robinson Crusoe has many wants, one of which is for food and for food products to satisfy various ends, he has many different ends. So let's assume that he can eke out some sort of a harvest from the grain on the island. He finds that there's land there that grain is growing wild and that he can harvest that grain. So he must use it to serve his most important wants and to determine which wants are more important, he ranks them, okay? You can, there are many, many wants for grain so in order to use it for the highest ranked ends, there has to be a choice and in order for there to be a choice, there has to be a ranking. So he ranks them as follows, assuming we the external observers know this. The first is for bread for sustaining life. The first sack of grain will sustain his life, will allow him to live for another year, okay? Then the second would be for maintaining health and vitality. If he has a second batch of bread produced from this grain, then that will enable him to satisfy other ends. He won't just have to lie around in a very weakened state, he'll be healthy and he'll be able to achieve other ends. The third is seed for the next harvest, for next year's harvest, that is that will keep him alive and healthy for another year. And let's say there's a fourth one available, that would be for, may use whiskey, I prefer vodka. So he would produce a beverage to go along with his meals. The fifth would be for feeding farm animals, let's say there's chickens and there's let's say other types of cows or goats or whatever yield milk and meat and so on. He's lonely, so he needs a parrot to talk to him, at least it can repeat words. There's some sort of companionship there. And so let's say if he had 20, he could use up to 20 sacks. Beyond that, it would be no longer an economic good. And let's assume that he initially has only five sacks. So Menger then asks the question and he was very insightful in asking certain questions, questions that would lead to advances in economic theory. So the question he asked is, let's assume that this guy has five sacks of grain. What is their value to him? What is the value of each sack? Are they all different? But then how could that be? Each sack is exactly like every other sack. Each sack is interchangeable, can be used for all the same ends. So the fifth can be used for all the same ends as the first sack, for example. Are they equal in value to some average of those five? And then how do you average out the importance of those sacks? There is no unit of measurement. So Menger said, imagine the following situation. Imagine that there's some rodents that burrow into the barn and eat the second sack. Okay, they devour the second sack. So the next morning when the farmer, when Ramta Crusoe enters the barn, he finds only his four sacks. Does he give up the second end? Okay, does he use the sacks for his first, third, fourth, and fifth end? Well, of course not. They're interchangeable. What he will do is reallocate sack number five to the use that would satisfy the second one. The second ranked one. So no matter which sack is lost, the end that's not fulfilled is the fifth end. Therefore, every sack is valued at the importance or value of the fifth end. Now, this is where margin utility comes in. Utilities, in other words, for satisfaction. Marginal to Menger means dependent or relevant. What is the relevant end that is lost no matter which one of those sacks is destroyed? You lose the satisfaction utility from the fifth end. From the lowest ranked end that can be supplied or that can be satisfied by the given supply of the good. So Menger came up with the rule that the law, that the value of a unit of a good is always equal to its margin utility. So every single one of those sacks is equal to, is equal in value, that is attached to the satisfaction of the fifth ranked end. Now, if he fortuitously comes upon a sixth sack, okay, he's able to harvest a sixth sack of grain, then what happens? Well, now he can satisfy a lower ranked end, the sixth end, and that means that the margin utility has dropped. So the more you have, so the corollary law is that as the supply of a good that an individual possesses increases the margin utility and therefore the value of the good falls. On the other hand, if he were to lose the fifth or one of those sacks, then the margin utility rises. So the smaller the supply, the greater the value of each unit. So that was Menger's derivation of the law of margin utility. Notice, it doesn't talk about quantities of anything, it doesn't add anything up. It focuses on human wants. So how did he solve the paradox of value with that? Well, what Menger pointed out then was, very simply, in a normal situation, diamonds are very, very scarce in relation to human wants. Water is not very scarce. So if we're talking about the water diamond, the diamond water paradox is sometimes cold. So the margin utility of diamonds on someone's value scale is much higher than the margin utility of the last gallon of water. If you wanna compare a diamond to a gallon of water. And that's why it's much more valuable and that's reflected in a market economy in which you have exchange in the much higher price of the diamonds. It has nothing to do with their costs, okay? Diamonds could be just as scarce as they are today, they could have all been found at little cost on beaches and so on, and their price would be the same. The cost is totally irrelevant to diamonds, and to the price of diamonds. Now, change all that around. Imagine a situation in which someone has that $46 million pink graph diamond that I was talking about in their pocket and they're in the middle of the desert and they haven't had water in three days. Would they trade that diamond for a gallon of water? What does it matter? They paid $46 million for that diamond, of course they would. At that point, after the third day, their organs begin to shrivel and their vitals begin to deteriorate and they die. So basically they're comparing their life, okay? Which gallon of water will allow them to sustain with the best use of that diamond and the diamond has a little margin utility in that case. Because now water is more scarce. So it's a question of how scarce the good is. The same thing is true in a normal situation. Air is not a free good, okay? Or air is a free good. Today we would say following Von Mises that it's a general condition of human welfare. It's not a good, we don't think about producing it and so on. However, if you're a deep sea diver or if you're in a space capsule, you certainly do attach a high utility to air and therefore the air that's produced for deep sea diving and for taking off and going into space does have a price on the market, okay? To go back to what determines the good, the preconditions and so on. Certain things such as the malaria fungus are very, very rare, okay? But they're not goods, okay? They're not even scarce because there are no human wants for them. So no matter how rare something is, if there's no want for it, then there's no value to it. So let me just see if you get the idea of margin utility and how it determines value. Let's say there's a farmer who has a supply of three horses and a supply of two cows and they are not interchangeable. Horses can only be used for certain ends and the cows can be used for other ends. And so let's say the farmer would use the first horse for plowing his field and the second most pressing use of a horse is also to hook them up as and make the plowing more productive and then the third end is milk that the first cow can give. The fourth end is the cheese and butter that can be made from the milk that the second cow produces and then the third horse would be for pleasure riding. So in this situation, which animal would be more valuable? Well, when I give this to undergraduates, they always pull out the horses. The horse would be more valuable because it's plowing the fields higher end. No, that's absolutely wrong, okay? If, again, we can use a mangarian experiment. You have these horses and cows in a barn together. The barn catches fire. You can only save four out of the five animals. Which four do you save? Obviously two horses and two cows. What animal do you leave in there? You leave the horse in there, okay? So the horse has, because the horse has the lower margin utility. So with this situation of supply, then the value of cows are higher. However, once that changes, once, let's say, the animal is destroyed, the horse is destroyed in the fire, then what happens? The values are reversed. It's a question of the supplies in relation to the wants. The horse now has the second end as its margin utility whereas the cow has the fourth end. Okay, so the cow becomes a less valuable animal, okay? And in real life, you have this situation where, let's say, there are three cars in a family. They're pretty interchangeable. And let's say one is for the primary breadwinner, the other is for the spouse who may have a part-time job in due errands. So the car is allocated to that. And then the third end is a junior can drive the car. Okay, it's just got his license, a hard license. So what happens if the old man cracks up his car? Does he go out without the car? Of course not, okay? It's reallocated from junior, okay? Now, junior has to ask for the keys. The point is then, now with two remaining cars, the margin utility is higher and the car has a higher value to the family. So that's how Manger solved that problem. Now, he addressed another problem that we wanna talk about. And that is weird, once you get in, this is just talking about really consumer's goods. Once we get into production, how are the value of goods or factors of production determined? And remember the dual causality. What the classical school said was that if you're gonna produce bread, let's say you must first grow the wheat, then you mill the wheat into flour, then you bake the flour into bread, then you send the bread to the retailer and the retailer sends it. So production definitely moves from what we call the higher stage, the stage further away from consumers, to the lower stage. The classical school would have put a second arrow along on that side going in the same direction on the value side, okay? Where I have value written on the right side. That is, it's because the wheat is expensive or because the wheat costs something that the flour which is made out of the wheat has a price and so on. So the price of bread depends on the price of wheat, okay? Manger said, no, that's not true, okay? In fact, the bread causes the satisfaction or provides services to satisfy human wants. The ultimate cause of any value lies in the human wants being satisfied. So value travels up from the consumer to the wheat. So the bread is only valuable, okay? It's not value, even as a consumer's good, it's value lies in the fact that it can satisfy human wants. The value of the bread at the wholesaler is only valuable because the bread is valuable at retail. And the bread at the wholesaler bestows or imputes, it's called the fear of imputation, it imputes value back to the flour. The only reason why the flour is valuable is because it causes the production of the bread, okay? So value causality travels upward, production causality travels downward toward the consumer, but what precipitates the whole process? What precipitates the whole process is human wants. That causes the value of the various stages of production. So for Manger then, this was the ultimate refutation of the cost of production theory of value. Because if you have land up there, okay, the only reason when I put that stage up there, the only reason why the land is valuable is because it can cause the production of wheat. So one example I give, it's kind of dated now to drive this point home, is the case in which, well actually, if you've seen the movie Witness starring Harrison Ford, which takes place in the Amish country, the Amish people are sometimes called the plain folks. They don't wear any sort of ornamentation. They don't even have buttons on their clothes, they just use sort of hooks and hoops to fasten their clothing. So needless to say, they don't wear any diamond jewelry. Now let's assume that all Americans adopt that moral code, that type of value system. What happens to the price of diamonds? Assuming they don't have an industrial use for the moment, fold to zero. What happens to the high wages, the high salaries of expert appraisers of gems? And to the craftsmen who fashion fine jewelry? Those wages fall to zero. What happens to the value of diamond mines? Zero. Manger used a similar example, he used tobacco products. So if people suddenly feared for their health and stopped smoking cigars, cigarettes, chewing tobacco and so on completely, what would happen to the value of prices of cigarettes and cigars and so on? They would fall to zero. The prices of specific cigar and cigarette rolling machines would fall to zero. And if it didn't have any other use, the price of, or in rent, of land on which tobacco is grown would fall to zero, okay? So prices determine cost and values determine prices, subjective values. In 1776, a great economist, not Adam Smith, Kandiyak, made the following observation. He said that men, pearls are not expensive because men spend a lot of time and effort diving for them. But rather, men spend a lot of time and effort diving for pearls because they are valuable, okay? So they incur those costs because of the high value. So there's an imputation backwards from consumers. So the paradox of value is completely resolved by Menger. He also shows the correct way which the value of the factors of production are determined, including labor, including land. He has one theory of price for everything. Now, he's repaired that bifurcation of the dichotomy and value that the classical school has. Also, he's gotten rid of the cost of production doctrine so that even in the long run, prices determine costs, okay? In the long run, when profits are wiped out, and that will be another topic this week, prices are equal to costs in the long run. But not because, in some sense, costs determine prices, but because prices will determine costs throughout the economy, okay? But there was another thing to settle. And that was, and that is, look, okay, so I've explained why the price of, let's say, flour and ovens and so on, why they have prices, okay? But Menger went a little bit further and he said, is there a way to separate out the value of each specific factor of production? Because remember, at every stage, there's many different factors of production, not just one, as I put there, okay? There's labor of various different kinds. At the lower stage, at the intermediate stages, there's a lot of capital goods, all different from one another. How do we explain the value of any of these things? And there, Menger came up with what was later to be called the law of margin of utility. He didn't do it in quite a definitive manner, but he suggested the solution. And again, it was by asking an important question. And then answering the question. And let's take the following. Let's say that if I had 90 units of labor, two horses, one plow, piece for plow, 40 acres of land and 500, let's say, pounds of fertilizer, okay? That's called a production function. If I can combine all those things, remember, man can't create anything. We can only transform some things into more useful forms. I can transform all of those things under the direction of the entrepreneur, under my direction, let's say I'm the owner and the entrepreneur, into 1,000 horses of wheat, okay? 1,000 W. So there's all these different factors of production involved in this production process. How do we determine the value of any of them? That is, what's one pound of fertilizer worth? What's one acre worth? Now, Mayer did not go into a fully developed economy with a price system. He was still talking on the level sort of of a single individual. But you can see the solution that he suggested. He said let's, so those are all those 500, those are units of fertilizer or 100 sacks of fertilizer, 100 pound sacks. So it's 500, 100 pound sacks of fertilizer. So let's ask the question then. What is the value of a 100 pound sack of fertilizer? And so he said how much would the total product decrease? This is the question. How much would the total product decrease if a unit of the factor of production was subtracted from the process of production? Again, just like subtracting one animal or subtracting one sack of wheat, he posed the question in a manner that was easy to see the problem and to solve the problem. He said, well, let's say that if we changed fertilizer, if we subtracted from the process, 100 pounds of fertilizer left everything else alone, 100 of those 500 pounds, then what would happen to the wheat? So the delta sign is simply the change. Wheat would fall by 40 bushels, okay? So instead of 1000 bushels, if you took away 100 pounds of fertilizer, you would only get 960 bushels of wheat. So then what becomes the value of the fertilizer of 100 pounds of fertilizer? Well, the marginal product, meaning the amount that depends on the use of that extra 100 pounds is 40 bushels of wheat, and therefore the value of the marginal product of that 100 pounds of fertilizer is the value to the farmer of the 40 bushels of wheat. It's the marginal utility of the 40 bushels of wheat to the farmer, okay? And you can put prices in there and you can modernize the example. So he's still talking about a single person. So if you want to just stick value in there from Enger, then you would find that if each bushel of wheat was worth, it could be sold on a market of $5, then the marginal product of the 100 pounds of fertilizer was 40, then that 100 pound bag would cost $200. We'd have a price of $200. We'd tend to have that price, okay? So in any production process, factors of production tend to earn their marginal product, okay? And that marginal, or the value of their marginal product, all of that again depends on prices which depend ultimately on consumer demand. Finally, I think I have a few minutes. Yeah, how did Enger think of the theory of exchange that was proposed by the classical school? That is that things exchange were equal in value. Well, what Enger said was that in fact, that's completely wrong. In fact, he pointed out every exchange indicates or reveals a double inequality of value, okay? So let's just take a horse and a cow. A has a cow, B has a horse, okay? The animals that I put in parentheses represent what they don't have, what they would like to have. So if indeed this exchange takes place, that is what is revealed, okay? If A and B exchange a cow for the horse, then it must be the case, according to Enger, that the horse has a greater value to A than the cow did that he gave up, okay? What each individual gives has a greater value than what it's given up. So notice that neither value the cow or horse equally, and in fact, both of them value them in reverse order. That's called the reverse valuation of wants. So in fact, far from showing that exchange reveals equality between the goods exchanged, when you focus on human wants and human action, you find that there's a double inequality. Every time two parties make an exchange, and that includes a labor exchange, it includes consumer goods, capital goods, whatever's exchanged, the implication, the logical implication is that each party is getting what they value more and giving up what they value less. Otherwise the exchange would not take place, there'd be no rationale for the exchange. Does that mean that people are always happy after every exchange they make? Of course not. Enger in his book has a section on uncertainty, okay? And once you talk about uncertainty, as Van Mises shows, you talk about regret, because not all your expectations are gonna be fulfilled. So let's say somebody buys a motorcycle and initially, before the exchange, foresees himself riding along on this road and in the sunny road through the mountains and so on, and attracting women and so on and so forth. Well let's say two days after he gets the bike, he's caught in a rainstorm, he skids out, he's almost hit by a few large trucks and it's not such a pleasant experience. Well the point is, well he regrets that exchange, but that does not mean that at the moment of making the exchange, he didn't value what he was getting more than what he gave up, okay? We all have regrets in life. We all make mistakes in our market activities. In fact, entrepreneurship, people who are entrepreneurs are those people who, from very young ages, are ones that anticipate the future better than other people. That is, they themselves know what they want. I mean, we've heard that expression. He knows what he wants, but she knows what she wants. Those are the budding entrepreneurs. People who know what they want plan to get it and are happy when they get it, okay? Whereas many people can look on a menu and simple thing like picking a dish and then dislike the dish almost immediately. We all have friends like that. They're not good entrepreneurs in their own life and they probably would not be good entrepreneurs in the business world. So, just to one last point here. The sellers and the buyers, I mean, you can update this to a BMW 550 and again, there's an exchange that takes place. And that can come from Germany or it can come, this holds across borders, okay? So it's absurd to say, for example, that buying a good from a foreign country somehow hurts the American economy or has a negative impact on the American economy. The American economy are the individuals that compose that economy. Anybody who buys a foreign good is doing so because they anticipate that that would have a higher value than the money they're paying for it. So everybody wins in that situation, okay? The fact that some people that are producing goods that have higher prices or lower quality here in the US now don't get their business is just another component of entrepreneurship. I mean, it's just, that happens. That happens when somebody shifts from a barber to a hairstylist, okay? That happens domestically. It happens when a new technology comes in. A new technology destroys more jobs in industries than foreign trade ever did. But at every step of the way, the people involved in the exchanges are all gaining from those exchanges. The fact that you exchange with one seller and not another seller, whether or not that seller be located on one side or another side of some mythical border does not make any difference, okay? All right, I'll stop there. It's a long way to go, Manger, thank you.