Principles of Economics — The (Economic) Good and Economy

This is the first part of a new series in which I try to summarize Carl Menger’s ‘Principles of Economics’. The goal is to make the important work slightly more digestible for segments of people with perhaps less time on their hands, but not necessarily less will to learn about economics. This first part captures the first two chapters in the book, and builds the theoretic framework of the economic and non-economic good, requirements, property, and of wealth.

Chapter I — The General Theory of the Good

1. The General Theory of the Good

Menger starts with listing four prerequisites that simultaneously must be present if a thing is to become a good, or in other words something which we can direct to satisfy our needs:

1. A human need. Example: satisfy immediate hunger.
2. Such properties as render the thing capable of being brought into a causal connection with the satisfaction of this need. Example: containing nutrients.
3. Human knowledge of this causal connection. Example: knowledge of nutrition, simply through tradition or through more scientific methods.
4. Command of the thing sufficient to direct it to the satisfaction of the need. Example: command over the thing containing nutrients.

Only when all four of these prerequisites are present simultaneously can a thing become a good. Let’s see what role a piece of meat would have in the above example. (1) will naturally be valid if an individual has not eaten anything for some time. (2) is also valid in the case of the meat, since it does contain various nutrients that the human digestive system can use to satisfy the hunger. (3) is valid if an individual has the knowledge that meat actually satisfies hunger. (4) is valid if an individual has command over the piece of meat.

It is easy to see where this prerequisites list could break down and where the meat good becomes, in this precise scenario, merely a thing or an object. The need to satisfy hunger might have vanished after a hearty meal. The piece of meat might be rotten enough for any nutrients to have little, if any positive, effect. An individual might lack the knowledge that the specific kind of meat is edible in the first place. And finally, the piece of meat might still belong to the animal not yet caught. Not only can prerequisites lack in the manner described above. As is the case with magical charms, snake oil and various other items, individuals may believe in causal connections not present in physical reality, causing the items to appear as goods when they are not. Such goods, Menger call imaginary goods.

2. The Causal Connections Between Goods

Goods vary somewhat according to their inherent characteristics. Some of them can satisfy a need directly, which causes Menger to name them goods of first order. A piece of meat is arguably such a good, since it satisfies hunger — a need if ever there was one. There are however a large number of things in the world that cannot be put in direct causal connection with the satisfaction of our needs, but which anyway must be considered goods. A pear tree, as an example, does not satisfy hunger in and of itself, but is a prerequisite for any pears to be accessible for that causal connection in the first place. The pear tree is then arguably a good of second order, while the pear in that scenario is a good of first order. The plot of land that houses the pear tree is arguably a good of third order. You can see how the plot of land, the pear tree as well as the pear all have a causal connection to the satisfaction of a need. There is in theory no end to the number of orders, and with the progress of civilization, we may expect production processes to become ever “deeper”.

It is important to understand that goods-character is not inherent in the goods themselves. Oil is today highly valuable, while for a couple of centuries ago it had no market price whatsoever. Despite having the exact same chemical composition, it is only due to changes in human understanding of oil and how it can be utilized, that it accrued goods-characters. Since knowledge can be lost as well as found, it becomes even easier to see how goods-character is never something inherent in a thing. It should also be noted that a good can occupy a different order or place in the causal nexus of goods, when observed with different satisfaction of needs in mind. A pear may be a good of first order for the hungry child, but a good of second order for the pear jam manufacturer. A pear may lose a specific place in a causal nexus of goods if the skill of jam manufacturing ever were lost.

3. The Laws Governing Goods-Character

A. The goods-character of goods of higher order is dependent on command of corresponding complementary goods.

With goods of first order, it is in our power to use them directly to satisfy our needs. We can eat the pear or apple to satisfy hunger. Only with the complete set of goods of second order can we transform those into goods of first order. Bread, as another example of a common good of first order, can be created with flour, water, yeast, salt and energy — all of which in this case are goods of second order. Flour itself is created from wheat, which in this case is a good of third order. Wheat grows on fields that in this example may be considered goods of fourth order. It should be evident then, that the satisfaction of needs may only be accomplished if we command the good of first order, or if we command all goods of second order and transform those into the good of first order, or if we command all goods of third order and transform those into the goods of second order, and then transform the goods of second order into the good of first order, etc. We must command all complementary goods of a higher order for any of them to have that specific goods-character. If we lack flour, for example, the water, yeast, salt and energy do us no good for the purpose of making bread in attempt to satisfy a specific need.

It must be added, however, that lacking flour in the above example does not necessarily rob the complementary goods of second order of all of the goods-character. The water, now having no goods-character for the purpose of making bread from wheat flour, can have goods-character due to being part of the causal nexus of other goods. The obvious example is that water is a good of first order for the purpose of quenching thirst. While lacking flour from wheat, a baker might also have flour from other types of grain, causing water to acquire goods-character of second order when in other causal nexuses.

Not only is the goods-character of goods of higher order dependent on command of corresponding complementary goods of the same order. Unless we command also all the complementary goods of a lower order, the specific goods-character of the goods of the higher order is lost. For the purpose of satisfying a need to eat bread, as an example, a plot of land — a good of fourth order — on which we grow wheat — a good of third order — will lose its goods-character if we lack yeast, a good of second order. In conclusion:

B. The goods-character of goods of higher order is derived from that of the corresponding goods of lower order.

4. Time and Error

In this section, Menger introduces time as a relevant factor in the transformation of goods of a higher order to that of a good of lower order. He points out that while the required time between transforming goods into a good of lower order may diminish due to for example technological advances, the time component may not disappear completely. As a clear example, Menger takes an oak forest. All higher order goods might be used extremely efficiently, but there is no way around the fact that one has to wait decades after planting for the goods of lower order (fully grown trees, wood) to be readily commanded by its owner.

The implication here is that human foresight is added to the equation since the time component often makes it impossible to satisfy an immediate need. This tangents Menger’s second point, that the time component introduces uncertainty, or error. A person commanding a good of first order may be sure of its quality and quantity, while a person commanding all goods of second order cannot be as certain of the quality and quantity of the good of first order that will only later be at disposal. A good example is the command over a certain number of bushels of wheat, as opposed to the command of all such goods of higher order, like seeds, water, land, fertilizer and labor services. Like that of time, uncertainty can decrease with better knowledge of the nature of the causal nexus, meaning the production process.

5. The Causes of Progress in Human Welfare

In this section, Menger starts off with making an important distinction between his economic theories and that of Adam Smith. Smith attributes the division of labor to be the central factor in the economic progress of mankind. This at first seems entirely logical, but misses the time aspect brought up just recently. To make his point, Menger describes a primitive society with entirely divided labor (hunters, gatherers, cooks etc). This division is very efficient, but has a myopic focus on short-term consumption which leaves them all in relative poverty. So there must be another factor that helps distinguish poor societies with a division of labor, from rich societies with a division of labor.

This second factor is of course the transformation of goods of higher orders, to goods of lower orders — a process that takes time. The poorer society may collect goods of first order to satisfy immediate needs, while leaving goods of higher order unused. The richer society can transform goods of higher orders to goods of first order and achieves a more plentiful total outcome. A primitive collecting economy naturally has a lower output than an economy that utilizes goods of higher orders to create even more goods of first order. One good example is a fisherman that instead of fishing with his hands, makes use of goods of higher order to create a boat and fishing nets. The end goal is the same — the capture of as much fish as possible. It should now be clear that time, or more specifically the transformation of goods from higher to lower order in the causal nexus, plays a crucial part in the progress of human welfare. There is a strict trade-off between immediate but relatively low consumption, and delayed but relatively high consumption.

Consumption goods (goods of first order), from being an accidental concurrence of nature, now become the product of human will, within the limits set by natural law. The immediate collecting of wild pears will naturally, over time, yield smaller pear outputs than the careful planting and nurturing of pear trees on fertile land under your command. The delayed gratification combined with division of labor is, according to Menger, what has taken humans from barbarism and misery, to a state of civilization. It is only possible if humans have obtained the knowledge needed to transform goods of higher orders to lower orders, and if they also have the foresight to plan ahead with the causal process in mind.

6. Property

To wrap up the general theory of the good, Menger describes property as: The entire sum of goods at an economizing individual’s command for the satisfaction of his needs. This is not to be confused with wealth, a concept discussed later on. Menger finally points out that man has to try to satisfy his needs for shelter as well as food, and that not even the most complete satisfaction of a single need can maintain life and welfare. The implication is that an economizing individual’s property will always consist of a number of, for him, useful goods.

Chapter II — Economy and Economic Goods

The quantities of consumption goods a person must have to satisfy his needs may be termed his requirements. Only with these goods can a man be said to be able to maintain his life and well-being. As humans have certain foresight, there is naturally an attempt to provide in advance for meeting such requirements in the future. Menger takes the production of winter clothes as one example, before the winter has arrived. In order to provide in advance, Menger lists two kinds of knowledge that men must possess as a prerequisite. They must (a) know their requirements — that is, the quantities of goods they will need to satisfy their needs during the time period over which their plans extend, and (b) know the quantities of goods at their disposal for the purpose of meeting these requirements.

1. Human Requirements

A. Requirements for goods of first order (consumption goods).

Menger notes that human beings experience directly and immediately only needs for goods of first order — that is, for goods that can be used directly for the satisfaction of their needs. If no requirements for these goods existed, none for goods of higher order could arise. Requirements for goods of higher orders are in other words dependent upon requirements for goods of first order. If, for example, firewood ceases to be a requirement due to migration to a warmer climate, trees would cease to be a requirement for the specific purpose of satisfying the need to stay warm.

Uncertainty plays a role role here as well, since humans have to try to command the appropriate quantity of consumption goods that is required over the time period for which their plans extend.

B. Requirements for goods of higher order (means of production)

If requirements for goods of first order for a coming time period are already met by current quantities, there can be no need for the provision of these same requirements by means of goods of higher order. If, however, the quantities of goods of first order are not enough, a need arises for goods of higher order, as a means to produce consumption goods required in the future.

Menger defines full requirement as the unfulfilled required quantity for a future period. Effective requirement, on the other hand, is the part of the full requirement that can be transformed from goods of higher order. The difference between the full requirement and the effective requirement is termed latent requirement, and would only become effective if the higher order goods currently lacking suddenly became available. And so, with respect to a given future time period, our effective requirements for particular goods of higher order are dependent upon the availability of complementary quantities of the corresponding goods of higher order. Menger uses the American Civil War as a good example. The export of raw cotton to Europe declined considerably, while the full requirement for cotton piece goods due to cold weather remained the same. This resulted in the requirement of complementary goods of second order like machinery and labor services suddenly becoming latent, meaning the effective requirement of goods of second order was lower than the full requirement of goods of second order. Unless a situation improves, latent requirement always becomes a problem over time, resulting in unsatisfied needs due to the lack of goods of first order.

C. The time limits within which human needs are felt.

Here Menger discusses how requirements of future time periods are related to a current transformation of higher order goods to lower order goods. Since this process has an inherent time component, it is for example too late to plant wheat in the autumn to satisfy bread needs arising during the winter of the same year. The wheat, limited by laws of nature, would not have the required conditions to grow before deadly snow arrived.

2. The Available Quantities

Knowledge of requirements for goods in future time periods is the first prerequisite for planning of all human activity directed to the satisfaction of needs. Clear foresight of these quantities thus becomes important. As long as there is no considerable trade between men, knowing the quantities commanded by others is of little importance, but as soon as trade emerges (chiefly as a result of division of labor), this piece of information naturally becomes highly advantageous for the purpose of planning. A professional class which operates as an intermediary in exchanges to facilitate trade will emerge, and a crucial role of this class is to also compile data over stockpiles. Periodically published stockpile reports of commodities is a good example of data that emerges out of the need to plan ahead combined with accessible trading activities.

3. The Origin of Human Economy and Economic Goods

A. Economic goods.

An investigation of the requirements for, and the available quantities of, a good may establish the existence of any one of the three following relationships:

(a) that requirements are larger than the available quantity.
(b) that requirements are smaller than the available quantity.
(c) that requirements and the available quantity are equal.

The first state is what we are mostly used to when we think about various goods. Wherever men recognize that the requirement for a good are greater than its available quantity, they achieve the further insight that no part of the available quantity may lose its useful properties or be removed from human control without causing these needs now to be satisfied less completely than before. A good example would be various food products, in a place where it is not abundant. The first effect of this insight is for men to (1) maintain at their disposal every unit of a good standing in this quantitative relationship, and (2) to conserve its useful properties. If starvation threatens, maintaining ownership of food and keeping this food from rotting is of utmost importance.

So, with respect to the above, men endeavor to (3) make a choice between their more important needs and needs that they must leave unsatisfied, and (4) to obtain the greatest possible result with a given quantity of the good or a given result with the smallest possible quantity — or in other words, to direct the quantities of consumers’ goods available to them, and particularly the available quantities of the means of production, to the satisfaction of their needs in the most appropriate manner. The complex of human activities directed to these four objectives is called economizing, and the goods involved are economic goods. It is important to realize that the act of economizing differs between individuals, since each individual have needs that are not identical. This undoubtedly complicates aggregated measuring of economizing individuals.

In the struggle for economic goods in a state of nature where human requirements so often are larger than available consumption good quantities, individuals will attain very different degrees of success. Whatever the division, it is evident that some members of a society will be unable to meet their full requirements, creating an opposition of interest between possessors of economic goods and those wanting of such goods. It therefore becomes necessary for society to protect the various individuals in the possession of economic goods. This is the economic origin of our present legal order, and is called protection of ownership, the basis of property. Property is thus not an arbitrary invention but rather the only practically possible solution of the problem of a requirement- and availability disparity.

B. Non-economic goods.

Menger has a great example, of a society close to a mountain river with enough water flow, both during rainfall and during periods of drought, to satisfy the needs for water for all members of that society. Since all current and future requirements are assured to be met, water will not be an object of human economy, and for this reason Menger calls it, in this specific example, a non-economic good. For non-economic goods, no economic struggle or competition can by definition occur.

C. The relationship between economic and non-economic goods.

It is important to realize that the economic or non-economic character of a good is nothing inherent in it, nor a property of it. A good can attain an economic or non-economic character, depending on the quantitative relationship between requirement and availability. A good can be an economic good at one point in time, and a non-economic good at another point in time. A good can be an economic good in one part of the world, and a non-economic good in another. Firewood is one example of what could often be a non-economic good in small forest societies, while in a society far from forests, firewood naturally could attain an economic character. Ice, from attaining an economic character in summer, may have no such character in winter.

There can be only two kinds of reasons why a non-economic good becomes an economic good: an increase in human requirements or a reduction of the available quantity. An increase in requirement can stem from (1) growth in the population, (2) growth of human needs, and (3) advances in the knowledge men have of the causal connection between things and their welfare.

D. The laws governing the economic character of goods.

With respect to prior discussions, Menger concludes that the existence of requirements for goods of higher order is dependent upon the corresponding goods of lower order having economic character. Similarly, the economic character of goods of higher order depends upon the economic character of the goods of lower order for whose production they serve.

4. Wealth

The entire sum of goods at a person’s command can be termed his property. The entire sum of economic goods at an economizing individual’s command can on the other hand be called his wealth. This distinction comes from the fact that non-economic goods in his command are not objects of his economy since they are abundant. Wealth can therefore also be defined as the entire sum of goods at an economizing individual’s command, the quantities of which are smaller than the requirements for them. Menger points out that if there were a society where all goods were available in amounts exceeding the requirements for them, there would be no wealth as there would be no economic goods.