Marginal utility, economic order and economic process

Prior to the 1870s, economists typically attributed differences in product prices to differences in the costs of producing those products. Products com­mand higher prices because they are more costly to produce, according to this line of explanation.

John Stuart Mill’s Principles of Political Economy, which was originally published in 1848, was probably still the most widely referenced statement of the economic principles of pricing and resource allocation when it appeared in a revised edition in 1871. Shortly after he remarked that ‘there is nothing in the laws of value which remain for the present or any future writer to clear up; the theory of the subject is complete’, Mill waded into a presentation of the diamond-water paradox, and in much the same fashion that Adam Smith had done nearly a century before. Diamonds are expensive, water is not. Yet people can live without diamonds, but not without water. This formulation appeared to present a paradox, which was resolved by invoking a distinction between use value and exchange value and by limiting the economic explana­tion to exchange value. Yet the paradox dissolves instantly under the neoclassical formulation. Market prices depend on the values that consumers place on one more diamond or one more bottle of water.

The marginal utility apparatus represents a clear advance over the cost of production approach for explaining prices and resource allocation. It is clear that Menger shared with his neoclassical brethren this focus on explaining variations in prices by variations in consumer valuation of the marginal unit. Yet it is also clear that he used his analytical apparatus differently than did the other neoclassicals. For those economists, economics was centrally con­cerned with the explanation of prices and resource allocation. To this day, this centrality is illustrated by a vocabulary that makes repeated references to economic theory as being price theory or price and allocation theory. For Menger, however, pricing and allocation were of only secondary interest, and for this reason Menger stands apart from his neoclassical brethren. For Menger, price and allocation theory was only a small part of economic theory.

In the Walrasian orientation that came to dominate neoclassicism, the central analytical problem is to explain the structure of relative prices and the allocation of resources among competing uses in a setting where knowledge is frozen and time is suspended. In this analytical schema, changes in knowl­edge are sources of exogenous shocks when time is allowed to elapse. In sharp contrast, Menger sought to develop an analytical framework where the passing of time and the development of knowledge, institutions and organiz­ations that accompanied the passing of time occupied the analytical foreground, and were not injected as exogenous shocks.

This point is illustrated nicely by Menger’s treatment of pricing, particu­larly his emphasis on price formation as opposed to price determination. Where Walras sought to explain some equilibrium pattern of prices in terms of a logic of marginal utility, Menger refused even to impose the requirement that the same product sell everywhere for the same price. Such price uniform­ity might arise in some historical settings, Menger would surely acknowledge, but the central analytical task would be to explain the formation of such uniformity, and not to impose it by assumption. Menger’s central concern lay with explaining the formation of actual prices, and not with expounding a logic of assumed equilibrium prices. This interest in a process of economic evolution through time led to a treatment where competition evolves from monopoly, and where one of the central features of the economic process is the generation of new knowledge and products, not as exogenous shocks to some logic of equilibrium, but as a natural feature of a scarcity-induced competition through time.