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This is going to be a tough lesson. We need to dive into what Austrian Economics Theory is, what are their key tenets, their main insights, critiques and why those critiques are incorrect.

We did not want to tackle this subject before showing you what Austrian Economics can do for you. Now that you have seen it with your own eyes in Austrian Economics In Pictures, we can move forward into Austrian Economics in theory.

 

WHY AUSTRIAN ECONOMICS

We do not mean why the name of Austrian Economics. What we mean is why Austrian Economics is so special.

The answer is quite simple. All the other economic theories have two parts, one part describing how the economy works and the second part describing what should a government do to so-call “manage” this economy.

Austrian Economics is different. At its core, Austrian Economics only describes the mechanics of a market, its inner workings. It does not provide any specific advice or suggestion to “manage” the economy simply because its main conclusion is that the economy works just fine without the need for any “management”.  In other words, no Central Bank is necessary, actually, it is counterproductive.

Of course, a small percentage of economists try to use it to explain how to do just that, but the vast majority have reached the same conclusion: no management is necessary.

 

AUSTRIAN ECONOMICS IS MAINSTREAM

For those of you out there, who feel uncomfortable with a strange theory, you don’t need to. Austrian Economics is mainstream, although most economists choose not to recognize it.

As a matter of fact, is it so mainstream that several of its postulates have been “borrowed” by other mainstream theories! For example, the subjective theory of value, marginalism in price theory and the formulation of the economic calculation problem.

It is so mainstream that even Nobel prize winners felt threatened by it and felt the need to attack it ruthlessly and consistently. They failed, of course. But what this is telling us is that Austrian Economics is considered a large threat to other economic theories. You do not fight mosquitoes with cannons!

 

THE PRINCIPLES OF AUSTRIAN ECONOMICS

This theory was developed over many years and it continues to be developed today. It is an unfinished work. Nevertheless, it is more than powerful enough to provide a shining light of hope and its main conclusion, that economy does not require management, holds stong. We will now take a look at its main ideas.

Before we do so, a word of caution. Economics has its own language, which is very specific. We will not attempt to duplicate said language because it is technical in nature. Our objective if for you to understand the main concepts, not to obtain a degree of economics. So, to the purists we say this: this is not for you, it is intended for the rest of the people.

Economic Individuality: economic processes can only be explained by the action or inaction of individuals. The concept that a “group” or “society” has a mind of its own and acts as a separate entity is incorrect.  Groups of people can only act through the actions of their individuals.

Economic Subjectivity: because individuals act to create an economy, in order to explain economic processes we need to go back to those very same individuals. When we do so, we discover that people are not objective calculators but subjective beings influenced by their beliefs, knowledge, experience and expectations. There is no such thing as a fully objective, fully rational person. We are all subjective in our judgments and decisions.

Prices: because people act individually and have subjective judgments, how much a person is willing to pay for something is also a subjective value. There is no such thing as an objective price or value of anything. All prices are determined by the subjective beliefs of people. It is not possible to determine a “fair” price or a “market value” of anything. The only way to find out those number is to actually sell those things in a market and find out the price that was paid for them.

Costs of Opportunity: is the calculation that producers make when determining how much capital (money, time, labor, properties, etc.) will be used to create a good or service for sale. When they make this calculation, they full understand that once used, this capital will not be available for use in something else. For example, if they decide to buy a machine to automate production, this money cannot be spent on wages to manufacture something else. The cost of opportunity is simply the cost of producing product A versus the cost of producing product B. This is important because when they make this choice, they assume that A will give them a higher profit, and therefore they won’t be getting any profit from B since they are not producing it. This mechanism is what makes production efficient in a free market.

Utility Variations: Utility is the perceived usefulness of something. This something could be a value, a cost, revenue, productivity or anything else. Usefulness changes with the last item we add or subtract from the total. The general idea is that how useful something is, depends of how many of these we already have. For example, if we are thirsty, a glass of water will be very useful, but after the first glass, the second one would be less useful and the third even less and so on. In economics, this is called marginalism, because the amount of those “things” we already own is seen as border or margin to which we add or subtract.

Time Preferences for Production and Consumption: the idea is that people are not always impulsive when it comes to manufacture products or consume those products. Most companies invest now (spending money) for a larger profit in the future. Many people save now (depriving themselves from a product today) in order to purchase a better product tomorrow. This is the mechanism that describes why savings and investment happens.

Consumer Sovereignty: consumers, acting individually and subjectively, determine product preferences through prices. If a product sells, it is an endorsement of the product at that price. If a product does not sell, it is a rejection of that product at that price. These preferences determine the direction in which producers must go in order to make a profit through satisfying people’s preferences. This is what makes a free market efficient. However, when governments interfere, this process is disrupted. Preferences are artificially twisted and producers are no longer influenced solely by people’s preferences but by bureaucratic rules and regulations. This removes freedom from markets which makes producers manufacture products that nobody wants. This makes markets inefficient. Consumer sovereignty is an absolute necessity for free markets.

Political Freedom: economic freedom is linked to political freedom. When people are fully economically free, they are also politically free. The reason is simple, in a free market, politicians have no economic power because they don’t make the decisions, people do. No economic power means that people cannot be coerced. However, as soon as politicians begin to restrict economic freedom, they begin to restrict options for consumers. They can coerce people into product A against product B or no product A at all! Eventually, politicians begin to coerce people into other things which in the end leads to the complete destruction of individual liberties.

Note: please see the Glossary if you are unfamiliar with certain words.

Continue to Austrian Economics In Theory - Part 2

 

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