Austrian theory of Economics

October 18, 2015
ANSWER: The Keynesians are not

If you carry the popular impression that data-hungry economists are always busy with complex formulas and not with outside-the-box thinking then you should take a look at the Austrian school. Just like monks living in their monastery, the economists of this school strive to solve complex economic issues by conducting "thought experiments." The Austrian school believes that it is possible to discover the truth simply by thinking aloud. Interestingly, this group does have unique insights into some of the most important economic issues of our times. Read on to find out how the Austrian school of economics has evolved and where the Austrian school stands in the world or economic thought.

An Overview of the Austrian School
What we know today as the Austrian school of economics was not made in a day. This school has gone through years of evolution in which the wisdom of one generation was passed on to the next. Though the school has progressed, and incorporated knowledge from outside sources, the core principles remain the same.

Carl Menger, an Austrian economist, who wrote "Principles of Economics" in 1871, is considered by many to be the founder of the Austrian School. The title of Menger's book suggests nothing extraordinary, but its contents became one of the pillars of marginalist revolution. Menger explained in his book that the economic values of goods and services are subjective in nature. That is: what is valuable for you may not be valuable for your neighbor. Menger further explained that with an increase in the number of goods, their subjective value for an individual diminishes. This valuable insight lies behind the concept of what is called diminishing marginal utility.

Later on, Ludwig von Mises, another great thinker of the Austrian School, applied the theory of marginal utility to money in his book "Theory of Money and Credit" (1912). The theory of diminishing marginal utility of money may in fact help us in finding an answer to one of the most basic questions of economics: how much money is too much? Here also, the answer would be subjective. One more extra dollar in the hands of a billionaire would hardly make any difference although the same dollar would be invaluable in the hands of a pauper.

Over the years, the basic principles of the Austrian school have given rise to valuable insights into numerous economic issues like the laws of supply and demand, the cause of inflation, theory of money creation, and operation of foreign exchange rates. On each of the issues, the views of Austrian school tend to differ from other schools of economics.

Main Ideas and Key Differences
Some of the main ideas of the Austrian school and their differences with other schools of economics are examined below:

  • Methodology
    The Austrian school uses logic of a priori thinking - something that a person can think on his/her own without relying on the outside world - to find out economic laws of universal application, whereas other mainstream schools of economics, like the neoclassical school, the new Keynesians and others, make use of data and mathematical models to prove their point objectively. In this respect, the Austrian school can be more specifically contrasted with the German historical school that rejects universal application of any economic theorem.
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