Austrian Economics Reading Group Session 2 Spring 2010

An Austrian Forum has started in Raleigh, NC. The selection is "The Foundations of Modern Austrian Economics." By "Modern" we mean 1976. :-) This week we are to read the second 2 chapters. The book is here.

This past week we had a good showing at the NC State University Austrian Forum. While, there were a few more students this time, I think that a couple of students did not return for this second meeting. I don’t know if they couldn’t make it or if they simply were not interested in the Austrian perspective. On the plus-side, Karen Palasek joined us. She is usually a quiet participant, but when she does make a point, it is something that one should pay heed to.

The two readings for this week in the Dolan book, The Foundations of Modern Austrian Economics were: Kirzner’s “On the Method of Austrian Economics” and Rothbard’s “New Light on the Prehistory of the Austrian School.” Unbeknownst to me, there was a change in the readings this week. The group decided to skip the Rothbard reading and instead extend a point that we covered in the last session.

In the last session we were talking about the differences between the Austrian foundation and that of the Neo-Classicals. A difference is that in the construction of the demand curve, the Neo-Classicals say that Giffen goods are a possibility, while in the Austrian formulation, they are not.

Thus, we had a short reading by Peter Klein called, “A Note of Giffen Goods,” which can be found here. or try http://web.missouri.edu/~kleinp/misc/giffen.pdf

The reading is only 2 ½ pages long (which is why I read it before the session started), and is very powerful. There are several points in it that I simply have not thought of before. Klein points out that Menger and the Austrians look at discrete units and apply the logic of action, which allows us to derive the Law of Diminishing Marginal Returns. From this law, we can derive the Law of Demand.

From the Neo-Classical perspective, they start with bundles and not goods. The bundles are infinitely divisible and can be mapped on to a set of indifference curves and constrained by budgets. The Neo-Classical will place a single good on the horizontal axis and “all other goods” on the vertical. Then by changing the price of the single good, they can derive a demand curve in a separate (but connected) graph. Using this analysis, the Neo-Classical can decompose the effect of the price change into a substitution effect and an income effect. An inferior good yields a negative income effect, and a sufficiently strong negative income effect is the sign of a Giffen good.

One of the most interesting points that Klein makes is that Neo-Classicals are not actually using marginal utility in their analysis. They are actually comparing different levels of total utility (different indifference curves) and looking at the marginal rate of substitution of the respective bundles. Klein points out that “the adjective ‘marginal’ refers to the units, not the ‘utilities.’”

Brilliant!

The second reading was Kirzner’s “On the Method of Austrian Economics.” I think that this article is interesting, but is in desperate need of context. This essay was written in the early 1970s. At this time NYU was one of the last bastions of Austrian Economics, at least at the graduate level. During this time, there were few professors in the Austrian tradition and so their opinions, I think, were magnified. I don’t mean to belittle the ideas, but I think that if an Austrian professor embarked upon a discourse of economic kaleidics today, it would have less influence because the profession is so much larger.

Anyway, Kirzner separates the Austrian School into two basic “tenants.” The two sides are represented by Hayek and Lachmann. In a nut shell, Hayek argues that markets coordinate the actions and plans of individuals and that the market process moves us toward “equilibrium.” (There was some discussion about using the word, “equilibrium.” Cordato and I don’t really like to use it. I prefer Bastiat’s notion of Harmony, while Cordato prefers the use of error reduction.) On the other hand, Lachmann argues, “How can we know that markets equilibrate?” For Lachmann, the actions of one person discoordinate the plans of another person. The result of which might not be a movement toward anything like an equilibrium. As a result, while there are patterns, they are not something that we can use for prediction, hence, the use of the term “economic kaleidics.”

While the Austrian profession has never definitively answered Lachmann’s challenge, most modern Austrians (35 years later) have decided not to follow in his footsteps. This point, to me, says volumes about the over-emphasis of Lachmann’s position. Nevertheless, perhaps it is also high time that an answer be made to Lachmann’s challenge once and for all. The only question is: “Who’s up for it? “