Opportunity cost: a Fabian idea?

Bruce Caldwell has a lot of useful and interesting information on von Wieser in his *Hayek’s Challenge*. (Wieser was one of Hayek’s teachers.) Also, Caldwell has good footnotes to follow up on for more sources on von Wieser. Also, fun side note. Von Wieser said this of the theory of marginal utility in 1891: “The most momentous consequence of the theory is, I take it, that it is false, with the socialists, to impute to labor alone the entire productive return.”

For basic bibliography in English on Friedrich von Wieser, see:

Hülsmann, J. G. 2007. Mises: The Last Knight of Liberalism, Ludwig von Mises Institute, Auburn, Ala.

Schumpeter, J. and J. B. Achille Loria, 1927. “Obituary: Friedrich von Wieser,” Economic Journal 37.146: 328–335.

I’ve written more on Friedrich von Wieser here:
http://socialdemocracy21stcentury.blogspot.com/2013/07/friedrich-von-wieser-on-progressive.html

http://socialdemocracy21stcentury.blogspot.com/2010/10/friedrich-von-wieser-and-eugen-von.html

There is a chapter on Wieser in George Stigler’s early book “Production and Distribution Theories”, and also a number of references to Wieser in Schumpeter’s History of Economic Analysis. Both books also discuss opportunity / alternative cost.

For Val 1, you might find the chapter on “costs and production” in Stigler’s Theory of Price worth looking at: Stigler writes very well, he had an atypical interest in the history of economic thought, and he usually tried to find real-world instances of abstract economic concepts.

I think of Philip Wicksteed’s “The Common Sense of Political Economy” as compatible with Austrian economics because of its emphasis on opportunity cost. I forget why I am of this view.

William Smart’s, “An Introduction to the Theory of Value” is another early book introducing the British to the Austrian school of economics. One aspect of their thought I had trouble absorbing was early Austrian views on utility theory. It seems like they have an extra layer of abstraction, not present in mid 20th century utility theory. One ranks ultimate goals. Then one ranks goods based on which goals they contribute to. And then that second ranking is the basis for prices. And the goals and goods being ranked are measured in a discrete space, such that prices are only found up to an interval.

By the way, G. B. Shaw and Wicksteed argued over Marx’s theory of value, with both thinking of themselves as progressive at the time. Shaw championed Marx’s theory against the new-fangled marginal theory, but realized he did not have the math to make his case. Wicksteed rejected the labor theory of value.

Sorry “rino” – small print, bad light, spell check etc

JQ,

Regarding your OP. I, too, am amazed by that statement by von Wieser. It’s spot on, and I just wouldn’t have thought the Austrians capable of that. Good catch.

I really like the idea of having “skip over” sections that, hopefully, few will skip over. In them, I would love to see you detail alternative criticisms of your main sections, from previously marginalized economists/economic schools. In a recent book, Richard Wolff shows, for example, side by side, Marxist, Keynesian and Neoclassical models in theory and to some degree practice . . . in his Contending Economic Theories. Given this is (obviously) not the intention of your book, perhaps you could do a far more selective juxtaposition toward the end of it?

The quote was surprising to me as well, especially since Wieser seemed to have prided himself for using marginal utility to justify the institution of state-administered progressive taxation while at the same time ensuring inequalities would remain untouched.

But surely WWI and the Russian Revolution are the elephants in the room here, in terms of ideological evolution, so it is perhaps not surprising that someone convinced that inequalities were wasteful in 1914 would see the preservation of “historically transmitted inequalit[ies]” as a desirable feature of socio-economical institutions in 1927.

A brief passage in Schumpeter’s History of Economic Analysis pp. 913-917 details the Austrian development of marginal analysis, which they understood to explain distribution too. However, the Austrians did not use the price of the product, they used the consumer’s marginal utility, which came out of their barter theory. (Remember that in those days people thought that utility might be a measurable psychic quantity.) They solved the fundamental problems of allocation and distribution, but via a problematic theory of the “imputation” (Wieser’s word) of the consumer’s satisfaction to choices in production. But it had an interesting fall out:

“Discussion of the marginal utilities of means of production in the spirit of the theory of imputation easily leads to the recognition of the relevance to these marginal utilities of the elements of complementarity and substitutability of factors and of their alternative uses. By this route the Austrian [Menger?] arrived at what has been called the alternative-use or opportunity theory of cost–the philosophy of the cost phenomenon that may be expressed by the adage: What a thing really costs is the sacrifice of the utility of those other things which we could have had from the resources that went into the one we did produce.

“Sporadically, this theory of cost had turned up in the past, especially in J. S. Mill’s Principles, but only to explain special cases which failed to fit into the older schemata. As a general theory and as an explanation of the fundamental social meaning of cost–both in capitalist and in socialist society–it was NEW. There should be no doubt that it makes a much better theory of distribution…” (History of Economic Analysis, p. 917)

Schumpeter locates the origination of the term in a footnote:

“The…term is due to D.I. Green, ‘Pain Cost and Opportunity Cost,’ Quarterly Journal of Economics, January 1894, and has gained wide currency in the United States owing to the vigorous sponsorship of Professor Knight. The most exhaustive treatment of this whole set of problems is to be found in H.J. Davenport’s Value and Distribution (1908), who preferred the equivalent term Displacement Cost.” (p. 917)

I fixed the book title on wikipedia (Der natürliche Werth). Apparently, according to wikipedia, Wieser coined not only the term “opportunity cost” but also “marginal utility”. Maybe there’s a reason why he’s almost forgotten in the profession despite these fundamental contributions?

Well, Leon Walras was himself a “socialist” of sorts. The main strain of Austrian socialism, before and after the war, were the Austro-Marxists, who were largely Kantian in orientation and lodged between the reformist social democratic and revolutionary wings, somewhat along the lines of what would come to be called “Eurocommunism”.

To repeat, Schumpeter wrote that the term “opportunity cost” was coined in 1894 by D.I. Green in the Quarterly Journal of Economics. (History of Economic Analysis, p. 917 footnote).

A few pages before that, Schumpeter describes the Austrian development of value theory and its incorporation of distribution, and immediately follows with some idea of Wieser’s contribution, and of the fate of that contribution among the others:

“…Menger went on to say that means of production–or, as he called them, ‘goods of higher order’–come within the concept of economic goods by virtue of the fact that they also yield consumers’ satisfaction, though only indirectly, through helping to produce things that do satisfy consumers’ wants directly. Let us pause for a moment to consider the meaning of this analytic device that looks so simple or even trite and was nevertheless a genuine stroke of genius. [Footnote here: In embryonic form this device had already been used by Gossen.] It enables us to treat such things as iron or cement or fertilizers–and also all services of natural agents and labor that are not directly consumed–as incomplete consumable goods, and thereby extends the range of the principle of marginal utility over the whole area of production and ‘distribution’. The requisites or factors or agents of production are assigned use values: they acquire their INDICES OF ECONOMIC SIGNIFICANCE [J.A.S. uses italics] and hence their exchange values, from the same marginal utility principle that provides the indices of economic significance and hence explains the exchange values of consumable goods. But those exchange vales or relative prices of the factors constitute the costs of production for the producing firms. This means, on the one hand, that the marginal utility principle now covers the cost phenomenon and in consequence also the logic of the allocation of resources (structure of production), hence the ‘supply side’ of the economic problem SO FAR AS ALL THIS IS DETERMINED BY ECONOMIC CONSIDERATIONS. And it means, on the other hand, in as much as costs to firms are incomes to households, the same marginal principle, with the same proviso, automatically covers the phenomena of income formation or of ‘distribution’, which really ceases to be a distinct topic, though it may, of course, still be treated separately for the sake of exposition. The whole of the organon of pure economics thus finds itself unified in the light of a single principle–in a sense in which it had never been before.

“Much of the problems that arise from this set-up can be discussed only on a level on which Walras rules supreme. But, though I believe that Jevons should be credited with a vision of the facts above and if so holds priority, the credit for having worked out that theory systematically, on the plane on which we are moving now, should go to the Austrians and particularly to Menger, whose Grundsätze contain all the details. Professor Stigler, indeed, pointed out many a ‘hiatus’ in Menger’s treatment, and rightly attributed them to his preoccupation with the threshold problems of the valuation of directly consumable goods. This accounts in fact for the impression that he was neglecting cost aspects. But on Stigler’s own showing, Menger had all the essential results. Nor must we forget that the Grundsätze was, in a sense quite different from that applicable to Marshall’s Principles, intended to be but an introduction. Actually, it was left for Wieser to work out the Austrian theory of cost and distribution explicitly. But he was the worst technician of the three great Austrians. And objections to methods that were peculiar to him crowded upon his readers–and especially Wicksell–as to impair the effect of what was really a great performance. Böhm-Bawerk expounded, developed, and defended the Mengerian theory of value. But in this field he neither had nor asserted claims to originality. The best formulation of the Austrian doctrine was presented later on by Wicksell.” (History of Economic Analysis, p. 912-913)

As a non-economist, and a not very knowledgeable one, I get lost in the thicket of terminology. Something that jumped out at me was the comment the “free markets”
outperform central planning. I am a great believer in asking the right question (almost always, the correct question is why, though “what do you mean by that” is also a good question). What is meant by “outperform”? Also what is meant by “free market” and
“central planning”. But then, I tend to think of “free markets” as a chimera.

john c. halasz

I have my doubts. Walras understood profit as the extra cash a entrepreneur received after materials, overheads and labour were paid. This is covered in “Elements of Pure Economy”, 1977 Reprint, 232.

He relies on wages “remaining substantially unchanged” (Walras 391) even as earnings of capital vary. For Walras wages are determined by a labour market (Walras 223).

However he does state that in a state of equilibrium, “entrepreneurs make neither profit nor loss” which is a socialist principle. But he immediately confuses this with his “opinion” that an entrepreneur should receive income based on fees for his capital plus fees for his work (Walras 225f).

Has anyone really argued that Walras was a socialist?

Chris Warren @ 29:

[Opportunity cost] seems to be a plastic concept that can be adapted according to circumstances assuming a general understanding that you have to give up something in order to gain something.

It does not matter if academic economists offer one particular definition if the rest of humanity uses another.

Yes, indeed.

Real people have to be practically good economists just to navigate daily life; academic economists do not have to be practical in their ideas at all — pleasing the prejudices of the very rich may be enough.

A practical person has to trade off against an uncertain future, so that money spent today may be money unavailable to spend tomorrow, with no necessary correspondence to actual resources put to use, now or in the future. The economist may choose to abstract away from uncertainty or money as anything more than a mere numéraire. That reasoning in the abstract satisfies some need of ideological propaganda is virtue enough for an academic scribbler, the contradictions inherent in the practical situation can be disregarded. That uncertainty and money turn all the Panglossian conclusions of an economic theory positing general market equilibrium upside down outlines the schizophrenia of neoclassical economics.

@29
Yes indeed about the “kerfuffle”. It would be interesting if JQ would provide us with some clarity on how he understands the concept of opportunity cost, in plain language. At present people on his home blog seem to be switching back and forth between the ‘common-sense’ concept of opportunity costs, as you describe, and an a somewhat obscure and counter-intuitive academic definition provided in a confusing (and possibly confused) academic paper someone linked to.

I for one am beginning to feel like I am in quicksand, or a desolate marsh as described in Lord of the Rings, with this opportunity cost concept.

I also question the concept’s reliance on what I think JQ has previously described as “methodological individualism” but I don’t know if I am going to get any answers there. However maybe another commenter here can help me. The concept of utility is fundamental to mainstream (or orthodox) economics, is that right? And utility as a concept is based on individual choices, right?

I’ve done quite a lot of reading in basic economics (including a very large text for undergraduates which I worked all the way through), and my main supervisor has a background in economic history so gives me a fair bit of guidance, but I still get confused as to what economists are actually talking about, quite frequently. I do suspect the problem isn’t just me :)

Quiggin’s bloggers miss the point.

Opportunity cost is the fundamental ideological basis of capitalism.

Owners of capital expect a return on their capital at least equal to that obtained if their funds were placed in a low-risk bank account.

They then deduct this from any accounting profits and declare they are making zero “economic” profits.

So if all capitalists adopt the same logic (which they must) no one will loose market share.

If you get rid of opportunity costs – you get rid of capitalism.