What is Austrian Economics?

This study note for A-Level and IB economics looks at some of the key ideas and theorists from the Austrian School.

The Austrian School of Economics is a heterodox school of economic thought that emphasizes the spontaneous organizing power of the price mechanism, the importance of individual choice, and the limitations of central planning. It originated in late 19th-century Vienna and has been influential in critiquing mainstream economic theories and advocating for free markets.

Key Principles

1. Subjectivism:
   • Economic value is subjective and varies from person to person.
   • Example: The value of a glass of water can vary greatly depending on whether a person is in a desert or near a river.
2. Methodological Individualism:
   • Economic analysis should focus on individual actions and decisions.
   • Example: Market outcomes are the result of individual decisions and cannot be fully understood by looking at aggregate data alone.
3. Marginalism:
   • Emphasizes the importance of marginal utility in determining value.
   • Example: The additional satisfaction from consuming one more unit of a good diminishes as consumption increases.
4. Opportunity Cost:
   • The cost of any action is the next best alternative forgone.
   • Example: Choosing to spend time studying economics means giving up the opportunity to work or engage in leisure activities.
5. Time Preference:
   • Individuals value present goods more than future goods, leading to the concept of interest.
   • Example: People prefer to have money now rather than later, which is why they are willing to pay interest on loans.
6. Capital Structure and Investment:
   • Capital is heterogeneous and its structure is crucial for economic growth and development.
   • Example: Different types of capital goods (machinery, buildings) play specific roles in the production process and are not easily interchangeable.
7. Entrepreneurship:
   • Entrepreneurs play a key role in driving economic progress through innovation and risk-taking.
   • Example: Successful entrepreneurs like Steve Jobs have transformed industries through innovation and strategic risk-taking.
8. Critique of Central Planning:
   • Argues that central planning is inefficient due to the knowledge problem and lack of price signals.
   • Example: The collapse of the Soviet Union is often cited as an example of the failure of central planning.

Key Theories

1. Business Cycle Theory:
   • Austrian economists argue that business cycles are caused by artificial manipulation of interest rates and credit expansion by central banks.
   • Example: The housing bubble and subsequent financial crisis of 2008 were fueled by low interest rates and excessive credit growth.
2. Price Signals and Market Coordination:
   • Prices communicate information and help coordinate economic activity without central direction.
   • Example: A sudden increase in the price of oil signals scarcity and prompts consumers to reduce usage and producers to find new sources.

Key Economists and Contributions

• Carl Menger: Founder of the Austrian School, known for his work on the theory of value and marginal utility.
• Ludwig von Mises: Developed praxeology, the study of human action, and critiqued socialism in his work "Human Action."
• Friedrich Hayek: Advanced the idea of spontaneous order and the importance of knowledge in economics, Nobel Prize winner in 1974.
• Murray Rothbard: Expanded on Mises’ work, known for his writings on economic history and anarcho-capitalism.
• Isabel Paterson: Contributed to the discussion on individualism and free markets in her book "The God of the Machine."
• Emily Chamlee-Wright: Focuses on cultural economics and the role of institutions in economic development.

Real-World Applications

• Free Market Advocacy: Austrian economists advocate for minimal government intervention and free markets.
  • Example: Policies promoting deregulation and tax cuts are often influenced by Austrian economic principles.
• Critique of Monetary Policy: Argue that central bank policies can lead to economic distortions and cycles.
  • Example: The criticism of the Federal Reserve’s role in the housing bubble leading to the 2008 financial crisis.

Different Economic Perspectives

• Neo-Classical Economics: Focuses on mathematical models and equilibrium, often criticized by Austrians for ignoring the dynamic and subjective nature of human action.
• Keynesian Economics: Advocates for government intervention to manage economic cycles, which Austrians argue leads to inefficiencies and distortions.
• Marxist Economics: Emphasizes class struggle and government control of resources, which Austrians critique for ignoring the importance of individual choice and market mechanisms.

Timeline of Key Dates and Policy Responses

• 1871: Carl Menger publishes "Principles of Economics," founding the Austrian School.
• 1920: Ludwig von Mises publishes "Economic Calculation in the Socialist Commonwealth," critiquing socialism.
• 1944: Friedrich Hayek publishes "The Road to Serfdom," arguing against central planning.
• 1974: Friedrich Hayek is awarded the Nobel Prize in Economics.
• 2008: Financial crisis prompts renewed interest in Austrian critiques of central banking and monetary policy.

Glossary

• Capital Structure: The arrangement of capital goods in an economy.
• Entrepreneurship: The act of starting new businesses, introducing new products, and improving processes.
• Marginal Utility: The additional satisfaction gained from consuming one more unit of a good.
• Methodological Individualism: Analyzing economic phenomena by focusing on individual actions.
• Opportunity Cost: The cost of the next best alternative forgone.
• Praxeology: The study of human action and conduct.
• Spontaneous Order: The self-organizing nature of markets without central direction.
• Subjectivism: The idea that value is determined by individual preferences and circumstances.

Essay Questions

1. Discuss the Austrian School’s critique of central planning and its implications for economic policy.
2. How does the Austrian concept of entrepreneurship differ from the neo-classical view of firms?
3. Analyze the Austrian Business Cycle Theory and its relevance to modern economic crises.
4. Compare and contrast the Austrian School’s views on market coordination with those of Keynesian economics.
5. Evaluate the strengths and weaknesses of the Austrian School’s emphasis on methodological individualism.

Suggested Books, Articles, and Papers

1. "Principles of Economics" by Carl Menger - http://b-ok.cc/book/1818286/cd...
2. "Human Action" by Ludwig von Mises - http://b-ok.cc/book/1722228/9a...
3. "The Road to Serfdom" by Friedrich Hayek - http://b-ok.cc/book/1882043/40...
4. "Man, Economy, and State" by Murray Rothbard - http://b-ok.cc/book/707274/0d8...
5. "The God of the Machine" by Isabel Paterson - http://b-ok.cc/book/2809365/8b...
6. "The Cultural and Political Economy of Recovery: Social Learning in a Post-Disaster Environment" by Emily Chamlee-Wright - http://b-ok.cc/book/2770801/11...

These study notes provide a comprehensive overview of the Austrian School in Economics, incorporating theoretical foundations, real-world examples, and different economic perspectives to aid students' understanding of this influential economic thought.