Liberty Matters

Eugen von Böhm-Bawerk: Pioneer of Causal-Realist Price Theory


In his contribution, Richard Ebeling briefly notes that Böhm-Bawerk developed a theory of price formation that was based exclusively on the subjective valuations of buyers and sellers.  In Böhm-Bawerk’s theory, prices are determined within the limits set by the “the marginal pairs” of buyers and sellers.    Unfortunately Böhm-Bawerk’s pioneering work in price theory has been overshadowed by his brilliant contributions to capital and interest theory.  I shall therefore focus my comment on delineating the key features of Böhm-Bawerk’s price theory.[24]
The importance and originality of Böhm-Bawerk’s work in this area were recognized by three eminent historians of thought intimately familiar with the Austrian tradition.  Mises considered Böhm-Bawerk’s three-volume Capital and Interest to be “no doubt … the most eminent contribution to modern economic theory.” [25]  “Especially important,” according to Mises, is the third book of the second volume, which contains Böhm-Bawerk’s exposition of value and price theory.[26]  Schumpeter also very favorably appraised Böhm-Bawerk’s contribution: “His theory of price is still the best we possess [as of 1914], the one that best answers all fundamental problems and all basic difficulties.”[27]  And Hayek maintained that the Austrian formulation of the subjective value doctrine “… including the theory of cost, was largely the result of Böhm-Bawerk’s brilliant exposition,” which went beyond Menger and Wieser “in matters relating to price.”[28]
The foregoing are not just antiquarian tributes to Böhm-Bawerk’s theoretical acumen, but a testimony to the influence of his price theory that continues to live on today.  Indeed, in the chapter on “Prices” in Human Action, Mises treated the basic theory of price formation as a closed chapter in economic theory.  He summed up in a single paragraph Böhm-Bawerk’s analysis of the marginal pairs as the essence of the “pricing process” before moving on to a discussion of the complications introduced by entrepreneurship, factor pricing, monopoly, and other “microeconomic” topics.[29]  Rothbard devoted three full chapters in Man, Economy, and State to a modern elaboration of Böhm-Bawerk’s price theory, which undergirds the analysis in the rest of the treatise.[30] 
Indeed, Böhm-Bawerk is the originator of the causal-realist price theory that has seen a renaissance in Austrian economics in the past fifteen years.[31] While Carl Menger must be credited with the original conception of the general causal-realist approach to economic phenomena, Menger never elaborated a complete theory of price.[32] For this achievement the palm goes to Böhm-Bawerk, who heeded Menger’s dictum to devote “special attention to the investigation of causal connections between economic phenomena involving products and the corresponding agents of production . . . for the purpose of establishing a price theory based upon reality and placing all price phenomena . . . together under one unified point of view. . . .”  (Emphases are mine.)[33]
In his analysis of price formation, Böhm-Bawerk developed four key features of modern causal-realist price theory.  First, he sought to explain prices actually paid on markets, not hypothetical equilibrium prices.  After elaborating the “basic law of the determination of price,” he concluded that “price is completely and entirely the product of men’s subjective valuations.”[34]1 Böhm-Bawerk emphasized that this explains actual prices.  He referred to “the pricing process as a resultant that is derived from all valuations that are present in society” and declared, “I do not advance this as a metaphorical analogy, but as living reality.”[35]
This is not to deny that Böhm-Bawerk used notions of equilibrium and the state of rest in formulating his price theory.  He did so, but he distinguished between those that actually described the market situation at any point in time and those that were purely fictional and served an instrumental function.  Recognition of this distinction is the second key feature of causal-realist price theory.   
In Böhm-Bawerk’s view, actual prices are the consequence of “a momentary market situation” determined by “the magnitude of the valuations by ‘the marginal pairs.’”[36] He used the term “momentary equilibrium” to denote this situation, which comes into being when all opportunities for mutually beneficial exchange in a market are completely exhausted.[37]  When analyzing the pricing and allocation of productive factors, however, Böhm-Bawerk employed a very different,  long-run  concept of equilibrium in which future wants are known with certainty, factor supplies are constant and instantly mobile, and technological change is absent.  This construct allowed him to deduce actual tendencies for product prices to equal costs of production, all laborers and capital goods to be allocated to their highest valued uses, and the wage rate of labor to equal the value of its marginal product.  He recognized, however, that an economy operating under such conditions was a pure fiction:  “It is inconceivable that in actual practice production should pursue an ideally perfect course, untrammeled by limitations of time or space, free of any friction, with perfect foreknowledge of future wants, without any disturbing dislocations in demand, supply and the technique of production.”[38]
This brings us to the third essential feature of causal-realist price theory stressed by Böhm-Bawerk: the central role of the capitalist-entrepreneur in the economic process.[39] The insight that motivated all of Böhm-Bawerk’s work was that “production takes time.”  But as time elapses, according to Böhm-Bawerk, things change unpredictably: “People and things can change. . . . Wants can alter, so can the relations between wants and coverage and . . . the insight into those relations can change.”[40]  Thus when the capitalist commits his property to production for an uncertain future, he at the same moment assumes the role of the entrepreneur.  In planning production, the capitalist-entrepreneur therefore “anticipates” how much of his product he can profitably sell at the market price which he “estimates” will prevail in the future.[41]
The fourth crucial element of causal-realist price theory present in Böhm-Bawerk’s work is the focus on explaining money prices, not merely the relative prices of a barter economy.  In discussing the “individual determinants of price,” Böhm-Bawerk included “the subjective value of the good of exchange [i.e., money]” to both buyers and the sellers.   This analytical breakthrough permitted him to explain how money facilitates the transformation of individual subjective valuations into a socially meaningful, objective structure of prices used by capitalist-entrepreneurs for economic calculation.  According to Böhm-Bawerk, if the law of marginal utility
. . . is worked out within the broad framework of the market, then it  is no longer a matter of direct relation to individual subjective wants, but of relation through them, by indirection, to money.  Money furnishes, as it were, the neutral common denominator for the otherwise noncomparable needs and emotions of different individuals.[42] (250) 
Anticipating Mises, Böhm-Bawerk went on to show how the subjective marginal valuations of consumers mediated by the monetary calculations of capitalist-entrepreneurs ultimately direct resources to their “best paid uses.”[43]
Since price theory is the core of any system of theoretical economics, contemporary Austrian economists do well to heed Mises’s counsel:  “A man not perfectly familiar with all the ideas advanced in these three volumes [of Capital and Interest] has no claim whatever to the appellation of an economist.”
[24.] For Böhm-Bawerk’s value and price theory, see Bohm-Bawerk, Capital and Interest, vol. 2, Positive Theory of Capital, George D. Huncke, trans. (Spring Mills, PA: Libertarian Press, 1959), pp. 121-256; and idem, Basic Principles of Economic Value, trans. Hans F. Sennholz (Grove City, PA: Libertarian Press, 2005).
[25.] Ludwig von Mises, “Capital and Interest: Eugen von Böhm-Bawerk and the Discriminating Reader.”  In idem, Economic Freedom and Interventionism: An Anthology of Articles and Essays, Bettina Bien Greaves, ed. (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1990), p. 134.
[26.] Ibid., p. 133.
[27.] Joseph A. Schumpeter, “Eugen von Böhm-Bawerk: 1851–1914.” In idem, Ten Great Economists:From Marx to Keynes, H.K. Zassenhaus, trans., (New York: Oxford University Press, 1965), p. 159.
[28.] F.A. Hayek, “Hayek on Wieser,” in The Development of Economic Thought: Great Economists in Perspective, ed. H.W. Spiegel (New York: John Wiley and Sons, 1952), p. 558.
[29.] Ludwig von Mises, Human Action: A Treatise on Economics. Scholar’s Ed. (Auburn, AL: Mises Institute, 2008), p. 324. Mises on the "Pricing Process" in Ludwig von Mises, Human Action: A Treatise on Economics, in 4 vols., ed. Bettina Bien Greaves (Indianapolis: Liberty Fund, 2007). Vol. 2. Part 4, Chap. 16 "Prices" </titles/1894#lf3843-02_label_357>. For a recent exposition of the theory of marginal pairs, see John B. Egger, Clarifying and Teaching Böhm-Bawerk’s “Marginal Pairs,” The Journal of Economic Education, 27:1 (1997): 32-40.
[30.] Murray N. Rothbard, Man, Economy, and State: A Treatise on Economic Principles, with Power and Market: Government and the Economy, Scholar’s Edition, 2nd ed.  (Auburn, AL.: Mises Institute, 2009), pp. 79-317.
[31.] See, for example:  Joseph T. Salerno,  “The Place of Mises’s Human Action in the Development of Modern Economic Thought,” Quarterly Journal of Austrian Economics,  2:1  (1999): 35–65; Salerno, “Menger’s Causal-Realist Analysis in Modern Economics,” Review of Austrian Economics, 23: 1 (2010):  1–16; Peter G. Klein, “The Mundane Economics of the Austrian School,” Quarterly Journal of Austrian Economics 11 (2008): 165–87;  Nicolai Foss and Peter G. Klein,  Organizing Entrepreneurial Judgment: A New Approach to the Firm (New York: Cambridge University Press, 2012); Per Bylund, “Division of Labor and the Firm: An Austrian Attempt at Explaining the Firm in the Market,” Quarterly Journal of Austrian Economics, 14:2 (2011): 188-215; G.P. Manish,   “Error, Equilibrium, and Equilibration in Austrian Price Theory,” Quarterly Journal of Austrian Economics 17:2 (2014), pp. 127-53; Matthew McCaffrey, “Economic Policy and Entrepreneurship: Alertness or Judgment?” in Per Bylund and David Howden, eds., The Next Generation of Austrian Economics: Essays in Honor of Joseph T. Salerno (Auburn, AL: Mises Institute, 2015), pp. 183-99.
[32.] Joseph T. Salerno, “Carl Menger: The Founding of the Austrian School,” in Randall Holcombe, ed., 15 Great Austrian Economists (Auburn, AL: Mises Institute, 1999), pp. 71-100.
[33.] Carl Menger, Principles of Economics, James Dingwall and Bert F. Hoselitz, trans., 2nd ed. (Grove City, PA: Libertarian Press, 1994), p. 49.
[34.] Bohm-Bawerk, Positive Theory, p. 234.
[35.] Ibid., p. 229.
[36.] Ibid., p. 249.
[37.] Ibid., p. 231.
[38.] Ibid., p. 255.
[39.] For an exposition of Böhm-Bawerk’s neglected insights into entrepreneurship, see Matthew McCaffrey and Joseph T. Salerno, “Böhm-Bawerk’s Approach to Entrepreneurship,” The Journal of the History of Economic Thought, 36:4 (December 2014), pp. 435-54.
[40.] Ibid., p. 172.
[41.] Ibid., pp. 249-50.
[42.] Ibid., p. 250.
[43.] Ibid., pp. 251-56.