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• Foreword
• Preface
• Acknowlegments
• Cost and Choice
• 1.: Cost In Economic Theory
• Classical Economics
• Marginal-utility Economics
• The Marshallian Synthesis
• Frank Knight and American Neoclassical Paradigms
• 2.: The Origins and Development of a London Tradition
• Wicksteed and the Calculus of Choice
• H. J. Davenport
• Knight On Cost As Valuation
• Robbins, 1934
• Mises, Robbins, and Hayek On Calculation In a Socialist Economy
• Hayek, Mises, and Subjectivist Economics
• The Practical Relevance of Opportunity Cost: Coase, 1938
• G. F. Thirlby and “the Ruler”
• Mises’ Human Action
• The Death of a Tradition?
• Appendix to Chapter 2: Shackle On Decision
• 3.: Cost and Choice
• The Predictive Science of Economics
• Cost In the Predictive Theory
• Cost In a Theory of Choice
• Choice-influencing and Choice-influenced Cost
• Opportunity Cost and Real Cost
• The Subjectivity of Sunk Costs
• Cost and Equilibrium
• 4.: The Cost of Public Goods
• The Theory of Tax Incidence
• Costs and Fiscal Decision-making: the Democratic Model
• Costs and Decision-making: the Authoritarian Model
• Costs and Decision-making: Mixed Models
• The Choice Among Projects
• The Costs of Debt-financed Public Goods
• Ricardo’s Equivalence Theorem
• Tax Capitalization
• 5.: Private and Social Cost
• Summary Analysis
• A Closer Look
• Internal Costs, Equilibrium, and Quasi-rents
• An Illustrative Example
• Pigovian Economics and Christian Ethics
• Narrow Self-interest and Alternative-opportunity Quasi-rents
• Conclusion
• 6.: Cost Without Markets
• Prices, Costs, and Market Equilibrium
• Resource-service Prices As Final-product Costs
• Market Equilibrium, Costs, and Quasi-rents
• The Cost of Military Manpower: an Example
• The Cost of Crime: Another Example
• Artificial Choice-making
• Socialist Calculation and Socialist Choice
• Costs In Bureaucratic Choice

Hayek, Mises, and Subjectivist Economics

F. A. Hayek was appointed Tooke Professor of Economic Science and Statistics at the London School of Economics in 1931 and held this chair until 1950. Along with Robbins, he must be credited with providing the source of much of the LSE tradition in cost theory, a tradition that seems to have emerged gradually over these two decades. As suggested above, Hayek’s contribution was primarily that of providing the underlying methodological basis for the more explicit works on cost by others. He presented the methodology of subjectivist economics with convincing authority; his essays remain recommended reading almost thirty years after their initial publication. And economic theory, generally, should certainly have avoided some major modern confusions if Hayek’s essays had been more widely read and understood.

A distinction must be made between the orthodox neoclassical economics which incorporates the subjective-value or marginal-utility revolution in value theory and the subjectivist economics of the latter-day Austrians, notably Mises and Hayek. The dependence of price (value) on marginal utility, subjectively determined, can be fully recognized, while essentially an objective theory of cost is retained. In Jevons’ famous statement, marginal utility depends on supply which, in its turn, depends on cost of production. As stated, this theory is wholly objectivist in character, although, of course, the valuation of buyers and sellers is incorporated as a part of the objective data. Costs are objectively determinable, although the theory does not say that costs alone determine value. As contrasted with classical theory, one-way causality is missing, but not the objectivity of the explanation. It is this latter objectivity that is jettisoned, wholly and completely, by both Mises and Hayek. In this respect, they differ sharply with earlier Austrians, although they do not seem fully to sense the distinction. In many respects, they seem much closer to Wicksteed than to Wieser.

There seems no doubt that subjectivist economics was explicitly introduced at LSE by Hayek. In a paper of major importance, published in 1937,18 he laid down the central features of the subjectivist methodology, features that he elaborated in considerably more detail in later works.19 In his 1937 paper, Hayek gives credit to Mises for the latter’s background work,20 published in German in 1933, but made available only much later (1960) to English-language scholars. Hayek’s initial paper provides, in one sense, the “classical” methodology of the subjectivists, a methodology which is central to a theory of cost that is related directly to choice and that is to be contrasted with the theory of cost embodied in neoclassical orthodoxy.

The subtle distinction between the economics of subjective value and the subjectivist economics espoused by Hayek and Mises was quite naturally obscured so long as the task of economic theory was largely limited to the explanation of market interactions. The famous Jevons statement about supply serves as an illustration. So long as individual producers, responding to the demands of consumers, are the actors whose behavior we seek to explain, there is really no need of inquiring as to whether the costs of production are subjective or objective. Costs are obstacles to the choices of producers, and economists can discuss “laws of cost” in this context without presuming that objective measurement is possible.

With the advent of “welfare economics,” regardless of how this might be defined, such previously admissible methodological fuzziness no longer passes muster. If idealized market interaction process—pure or perfect competition—is used as the standard for deriving conditions which are then to be employed as norms for interference with actual market process, the question of objective measurement must be squarely faced. If prices “should” be brought into equality with costs of production, as a policy norm, costs must be presumed objective, in the sense that they can be measured by others than the direct decision-maker.

Only Hayek and Mises seemed to be completely aware of this problem and of its major importance, although many other economists seem to have been vaguely disturbed by it. Subjectivist economics, for Hayek and Mises, amounts to an explicit denial of the objectivity of the data that informs economic choice. The acting subject, the chooser, selects certain preferred alternatives according to his own criteria, and in the absence of external change he attains economic equilibrium. This personalized or Crusoe equilibrium is, however, wholly different from that which describes the interactions among many actors, many choosers. In the latter case, the actions of all others become necessary data for the choices of the single decision-maker. Equilibrium is described not in terms of objectively determined “conditions” or relationships among specific magnitudes, e.g., prices and costs, but in terms of the realization of mutually reinforcing and consistent expectations. The difference between these two approaches, the objectivist and the subjectivist, is profound, but it continues to be slurred over in the neoclassical concentration on the idealized market interaction process in which all individuals behave economically. In an unchanging economic environment populated by purely economic men, the two approaches become identical in a superficial sense. In a universe where all behavior is not purely economic, where genuine choice takes place, the important differences emerge with clarity.

At this juncture in the development of economic theory, we must, I think, ask why the convincing arguments of Hayek exerted so little weight. Without question, objectivist economics continues to carry the day, and few of its practitioners pause to examine critically its methodological foundations. There are, no doubt, several reasons for this failure, but undue attention paid to the definition of equilibrium, although of immense importance in itself, may have retarded acceptance of the more general subjectivist notions. Neutral readers of the impassioned debates on socialist calculation might have been led to think that the central issue was really one that involved the possibly erroneous derivation of policy criteria from stationary equilibrium settings. Indeed this is an issue, but the subjectivist critique is obscured here. As noted earlier, this concentration on equilibrium, of which Hayek, Robbins, and to a lesser extent Mises, all are guilty, left the way open for Lerner to drop all references to general equilibrium in his derivation of the policy rules that explicitly require the introduction of objectively measurable costs.

[18. ]F. A. Hayek, “Economics and Knowledge,” Economica, IV (1937), 33-54, reprinted in Hayek, Individualism and Economic Order (Chicago: University of Chicago Press, 1948), pp. 33-56.

[19. ]Additional essays that appeared in 1940, 1941, 1942, and 1943 are included in the two volumes, Individualism and Economic Order, op. cit., and The Counter-Revolution of Science (Glencoe, Ill.: The Free Press, 1952).

[20. ]Ludwig von Mises, Grundprobleme der Nationalökonomie (Jena, Germany: Gustav Fischer, 1933), translated by George Reisman as Epistemological Problems of Economics (New York: Van Nostrand, 1960).