The History of Austrian Economics & The Major Schools of Economics

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To: Dr. Palano
From: John Roberts III
Date: March 18, 2011
Subject: Austrian Economics CourseComprehensiveEssay
Introduction
This paper will address the history of economics and will explain how Austrian
economics contributed to the development of economic intellectualization. The essay will also
explain the most popular and important schools of economics, like Keynesian, Heterodox,
Mainstream, Classical, Neoclassical, and Austrian economics. This paper will elucidate the
major economic theories and concepts associated with these six different economic schools.
Finally, the essay will address the market niche concepts and theories of Austrian economics
and will examine the defining characteristics of Austrian economics such as subjectivismand
marginalism.
The Historical Setting of Economics and How Austrian Economics Contributed to
the Development of Economic Intellectualization
Aristotle’s Influence
The word economics is derived from the Latin word Oeconomica, which is a concept
attributed to Aristotle. He wrote three short books involving economics that strongly parallel
Austrian economic concepts. In his first book Aristotle discusses ethics, which relates to the
condition of trust for spontaneous order to prevail in reference to Jane Jacob’s city theory in

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the academic journal, Urban Intervention and Local Knowledge. His second book addresses
methods of generating revenue, which relates to the Austrian concept of trust for spontaneous
order (profit opportunities will emerge spontaneously) and entrepreneurship, as also explained
in the Urban Intervention and Local Knowledge. Aristotle’s third book on economics deals with
the relationship between husbands and wives, which involves economics; however, because of
the complex dynamics associated with this subject, for the sake of page length and time, no
further description will be given.1 Indeed, looking at the key economic contributions of
Aristotle, the emanation of economics began around 300 B.C.
Cato’s & Brutus’s Influence 90 B.C
Porcius Cato and Marcus Junius Brutus, two of the most prominent and historical
Roman senators during the time of Caser Augustus, were regarded as the forefathers of the
Republic. The concept of a Republic was rooted in the idea of liberalism, which in the context
of economics gave people more economic freedom, such as exploitation of opportunities (e.g.
entrepreneurship), and a voice in the Senate to address their economic needs.2 The political
system of a Republic brought safety and security to cities under Roman rule, which allowed
them to conduct business and trade more freely.
1700 to 1800
Adam Smith's book, The Wealth of Nations written in 1776, is generally considered to
mark the beginning of Classical economics. Classical economics has been regarded as the first
modern school of economic thought. Its major inventors include Adam Smith, Jean-Baptiste
1 Oeconomicus: A Social and Historical Commentary
2 Rome Series

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Say, David Ricardo, Thomas Malthus and John Stuart Mills. Classical economics originated in
Britain, eventually becoming the economic theory upon which the British government modeled
itself. Capitalists can thank Adam Smith and Classical economics for influencing the idea of a
free market without government intervention, which Austrian economics unequivocally agree
with.3
1800 to 1900
From the early to the mid-1800s economics was not permitted to be taught and sadly
disappeared entirely from the universities of the German Empire. Even more morose was that
most university professors readily enjoyed ridiculing economics and economists. The problem
during this time period was that universities, under the control of the German Empire, were
owned and operated by various kingdoms and grand duchies that formed the Reich. Professors
were civil servants expected to strictly obey the dictums issued by their aristocratic superiors,
the bureaucrats of the ministries of public institutions, which disapproved the inculcation or
lecturing of students about economics. In 1837, professors began to secretly disregard these
imposed restrictions on teaching economics, so the government resorted to more subtle and
efficacious methods to make the professors loyal supporters of the official policy. They
scrupulously sifted through the candidates before appointing them, ensuring only reliable men,
those who opposed studying and inculcating students about economics, obtained the university
3
Does the invisiblehand hold or lead? Market adjustment in an entrepreneurial economy

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chairs. Ergo academic freedom and economics receded into the background during most of the
19th century.4
Due to the prejudicial restrictions and academic limitations placed on economic analysis
in the German Empire, many economists moved to Austria in the mid-1800s. Inciting their
move to Austria was liberalism(an economic philosophy that supports and promotes laissez-
faire economics and private property in the means of production), which removed the chains
that previously prevented any intellectual effort to teach economics in Austria. This could be
the inherent reason why Austrian economics agrees with liberalism.5 Additionally, this
explicates why many of the founding fathers of Austrian economics were actually German –
Ludwig von Mises, Carl Menger, Eurgen von Böhm-Bawerk, and the Nobel laureate Friedrich
Hayek. This German economists’ migration to Austria has become the commonly accepted
explanation as to how Austrian economics acquired its name. Austrian economics derives from
the German identity of these four founders and early supporters, who fled the old
Habsburg/German Empire for the economic freedom to teach and lecture in Austria.6
In the 3rd and 4th quarters of the 19th century, Austrian economists began to study the
works of British Classical economics, because they accepted the assumption that economic
theory is derived from experience. This intrigue with British Classical economics led to the
Austrian school of economics supporting Utilitarianism, which was procured from British
economists like Jeremy Bentham and John Stuart Mills.7 Utilitarianismis the ethical theory
4 The Historical Settingof the Austrian School of Economics
6 Austrian School of Economics

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holding that the proper course of action is one that maximizes the overall happiness, by
whatever means necessary. It holds that the morality of an action is determined only by its
resulting outcomes. Austrian economists agreed with Utilitarianism, because of its emphasis on
maximizing utility and minimizing negative utility, in which British economics base utility on
preference satisfaction (Austrian core belief of subjectivism) and knowledge (Austrian core
belief of imperfect and specialized knowledge).8
The inauguration of the Austrian school of economics occurred in 1871 with the help of
Carl Menger, who is often thought of as the original and most prominent founding father of
Austrian economics. Menger additionally developed the two most influential and fundamental
concepts of Austrian economics, marginalism and subjectivism. Marginalism’s central concept
concedes that the marginal utility of a good or service is the utility gained or lost from an
increase or decrease in the consumption of that good or service.9 Subjectivism identifies worth
as being based on the wants and needs of the members of a society, as opposed to value being
inherent to an object. To put it simply, subjectivismimplies that individuals place different
monetary values on goods and services, so goods and services are in fact subjective not
objective. 10
1900s to Present Day
Economics significantly influenced historical events during the early 1900s until the end
of the Nazi regime in 1945. The aggressive imperialism, that twice ended in war and defeat,
and the limitless and escalating inflation of the 1920s were both horrors of the Nazi regime
8 Classical UtilitarianismfromHume to Mill
10 Why Subjectivism?

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caused by politicians who economically acted as they had been taught. These politicians were
educated by the champions of the Historical school of economics. When I say champions, I
mean pushovers or pseudo intellectuals who derived their economic ideas from anti-liberal and
anti-Austrian economics. Earlier I discussed how in the mid-1800s German universities did not
permit the teaching of economics and how economics disappeared entirely from the
universities of the German Empire. The Historical school of economics dominated German
university economic departments during the early to the mid-1800s. The government advisors
and officials who were the students of the Historical school were never taught the economic
theorems and logical concepts of the time proven Austrian school. Consequently, their
historical approach supplied faulty judgment or lack of economical discernment and knowledge
needed during the Great Depression of the 1920s, WWI, and WWII, because these German
political leaders lacked the economic analysis skills to solve these important events. The
Historical school of economics was to blame for these failures because in rejecting the
deductive approach they likewise dismissed the great economic insight from Austrian
economists such as Ludwig von Mises, Carl Menger, Eurgen von Böhm-Bawerk, and the Nobel
laureate Friedrich Hayek, who taught in Austria. Instead, German political leaders and other
advisors looked to the wrong economists, if you would even call them that; they look to
Schmoller who eventually conceded to Karl Marx’s socialism. If Germany had instead relied
upon a priori reasoning and adopted the Austrian school of economics that emphasized the
impracticability of socialism and the success of liberalism, they presumably could have been
able to make a quicker recovery from the Great Depression and quite possibly avoided WWI
and WWII. Because the German people trusted individuals like Marx, Schmoller, and Hitler to

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make their country economically efficient through the use of socialismit is evident why they
were destined to fail.11
These persuasive statements and factual evidence illustrates why the German Empire
should have listened to Austrian economists. Mises considered socialismwas impractical.
Austrians knew that socialismwould fail due to four emphatically lucid and logical obstacles
impeding socialism. The first obstacle was private property and incentive, second, monetary
prices and the economizing role they play, third, profit and loss accounting, and fourth, the
political environment. By looking at these four empirical problems amalgamated with socialism
one can synthesize that without a political environment that protects and encourages private
property people’s incentive/motivation to work wanes, thus, monetary prices become
obsolete, which subsequently eliminates profit and induces loss accounting. When analyzing
these destructive socialist effects, one can deduce that advanced economic process is
unobtainable when a country adopts socialism. A socialism institutional regime attempts to
abolish private ownership in the means of production, which causes advanced industrial
production to be reduced to the point that decision makers are left in the dark when denied the
necessary compass to resolve a problem. Mises warns that the abolishment of private property
leads to political control over individual decisions and thus the eventual suppression of political
liberties to the concerns for the collective.12
According to Hayek, who was Menger’s mentee, he believed that socialismis a problem
of ethics and psychology because of socialism’s issue with human motivation. Under the
12 Economic Calculation:The Austrian Contribution to Political Economy

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socialist systemthe decision of alternatives cannot be rationally made due to the lack of human
motivation. Hayek also believed that socialismwas impossible because the institution
configuration of socialismprecludes economic calculation by eliminating the emergence of the
specific knowledge that is necessary for calculations to be made by economic actors. Hayek
states that the aims and programs of socialism are factually impossible to achieve and execute.
Overall, the collapse of socialist states in countries of the East, Central Europe (Germany), Cuba,
and the Soviet Union has hurt the longevity of socialist economics. Over the past century these
country collapses have turned many once inspired socialist supporters to abandon this
economic theory and move towards liberalism, which hails and helps to galvanize the Austrian
Economic School.13
To reaffirm the point I expressed above, considering how Schmoller contributed to the
anti-liberal realization. I would like to add that it was Schmoller’s debate with Menger over
Methodenstreit (1880-1890s) that compellingly induced German’s animosity towards liberalism
by the end of 19th century. Methodenstreit is a German term referring to an intellectual
controversy or debate over epistemology, which is a branch of philosophy concerned with the
nature and scope/limitations of knowledge. This controversy was between the supporters of
the Austrian School of economics, led by Carl Menger and the proponents of the German
Historical School, led by Gustav Schmoller. It was Schmoller’s fault that the German Historical
School felt animosity towards liberalism because he defended an untenable position and did
not realize what the Methodenstreit controversy was about. The matter in dispute was
whether there could be such a thing as a science, other than history, that could deal with the
13 Economic Calculation:The Austrian Contribution to Political Economy

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aspects of human action. At this time radical materialist determinism was a philosophy
universally accepted in Germany. Radical material determinist thought that human ideas,
volitions, and actions were produced by physical and chemical events. They also believed that
the natural sciences will one day describe in the same way in which today they describe the
emergence of a chemical compound out of the combination of several ingredients.14
Schmoller and his disciples rejected this philosophy because it was incompatible with
the religious tenets of the Prussian Government. He repeatedly blamed the economists for
prematurely making inferences from quantitatively insufficient material. In his opinion, more
statistics, history, and the collection of more “material” was needed to substitute a realistic
science of economics for the hasty generalizations of the British “armchair” economists. He did
not realize the gulf that separated his view from those of the German philosophers who
demolished positivism’s ideas about the use and treatment of history. Positivismasserts that
only authentic knowledge is that which is based on sense, experience, and positive verification.
Schmoller did not see that the tenor of Dilthey’s doctrine (which is a theory of knowledge that
asserts that knowledge comes primarily via sensory and historical experience) was the
annihilation of the fundamental thesis of his own epistemology - that some laws of social
development could be distilled from historical experience. In the end, Schmoller embarrassed
himself and drove Germans further away from him and closer towards the socialism that
inevitably lead to Germany’s demise in WWI and WWII.15

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It was not until the 20th century, pending the postwar period, that economists began to
realize the importance of the entrepreneur as the driver of economic progress. Several
decades later, from the 1960’s through the 1970’s, economists began to focus on institutions in
their analysis of economic growth (Kasper & Streit, 1998). Once this occurred, Neoclassical
economics began to fade away. As Stiglits writes, “the neoclassical view prevailed until 30–40
years ago, when people became convinced that the laws of supply and demand did not explain
everything about economic equilibria. The breakthrough came when people began to
recognize that economic theory ought to be able to explain the reason for institutions in a
society”.16
Institutions are one of the fundamental concepts of the Austrian school of economics
and without institutions entrepreneurship could not exist. Hayek also mentions institutions and
went so far as to develop a theory of the evolution of democratic political and legal institutions
responding to historical influences without the intelligent design of an authoritative legislator,
which he promulgated in his copious articles published in 1960, 1973, 1976, and 1979. The
final Austrian economic contribution to the 20th century was economic calculation to the
discipline of the political economy, which is something I think is so significant I will address the
subject later in this paper.17
16 Entrepreneurship and Development: Causeor Consequences
17 Entrepreneurship and Development: Causeor Consequences

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The Different Economic Schools
In this section I will briefly describe the six different economic schools of thought that
are the most globally prominent and frequently discussed. These include Austrian economics,
Classicaleconomics, Neoclassical economics, Keynesian economics, Heterodox economics, and
Mainstream economics. Classical economics and Keynesian economics are two of the most
commonly compared economic schools of thought in the topography of economics. All other
economics base their theories in correlation to either the Classicalor Keynesian approach to
economics. The two major conceptual differences between the two schools involve equilibrium
and price flexibility. Price flexibility proposes that prices adjust in the long run in response to
market shortages or surpluses. Also, it states that changes in the price level are met by equal
change in resource prices, especially wages. Keynesian economics believes in market
disequilibrium (the amount of goods or services sought by buyers/demand is not equal to the
amount of goods or services produced by sellers/supply) and that prices are imperfectly
flexible. The Classicalschool concludes that the market is at equilibrium and prices are
perfectly flexible as long as supply and demand are unequal. To put this into the context of
Austrian economics, the Austrian school shares more similarities and agrees with Classical
economics more than the Keynesian school. The one theory that the Austrian School does not
agree with the ClassicalSchool on is the concept of the market being at equilibrium - Austrians
believe that the market is at disequilibrium. The concept of market disequilibrium is, however,
one of the few theories upon which the Austrians and the Keynesians agree. Overall, Austrian
economics agrees more with the theories of Classical economics than the theories associated
with the other economic schools.

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Mainstream Economics
Mainstream economics is a loose term referring to the non-heterodox economics taught
in most prominent universities. They agree with the relatively new concept of applying
mathematic modeling to solve and make predictions about economic situations and human
actions. This especially aggravates Austrians because one of their fundamental concepts is that
models, particularly in the case of human actions, are not accurate extrapolations that apply to
the real world. Mainstream economics is largely dominated by the resulting synthesis, being
largely Keynesian in macroeconomics and Neoclassical in microeconomics. The
microeconomics of Mainstream economics can be defined in terms of optimization and
equilibrium. There are four assumptions to which Mainstream economics are committed. The
first assumption is maximizing behavior satisfies models and behavioral theories. The second
assumes stable preferences, which suggests there exists models of endogenous preferences.
The third assumes equilibrium, which Mainstream economics suggests that game theory has
transformed concepts of market equilibrium to the extent that it is not clear what it means to
say that economists are, in general, committed to assuming equilibrium. The fourth, and last,
assumption is perfect knowledge and they argue that countless economists have explored ways
of modeling imperfect knowledge, even where probabilities cannot be attached to outcomes.
What holds Mainstream economics together is positive methodology, which explains why
Mainstream economists believe the assumptions that everyone in the market has perfect
knowledge and that the economy is always in long-run equilibrium. One of the major
differences between Mainstream economics and Austrian economics is that explanatory axioms
underlie Austrian economics and a set of empirical laws underlie Mainstream economics.

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Austrian economics and Mainstream economics do have many theory differences; however,
Austrian economics has contributed to Mainstream economics adoption of marginalism and the
subjective theory, the two bedrock concepts of Austrian economics developed by Carl
Menger.18 Thanks to the Austrian school, marginalismhas now become an integral part of
Mainstream economic theory.19
Problems with Mainstream Economics According to Austrian Economics
The most interesting controversy between the two economic schools involves empirical
laws. According to Rothbard, the set of empirical laws that underlies Mainstream economics is
flawed for at least three reasons. First, no one has discovered any empirically robust law.
Secondly, theories can never be tested because it is impossible to undertake controlled
experiments where all relevant variables are held constant and hence ceteris paribus clauses
will never be satisfied. Finally, and thirdly, is the act of making a prediction may change the
forces at work. Mainstream economics most distinctive distinguishing feature is model-building
and Austrian economics suggest models are not a real world representation and only cause
further confusion. Austrian economists believe in universal economic theorems like market
disequilibrium and perfectly flexible prices, however, Mainstream economists deny there are
economic theorems of universal validity that can apply to any city or person.20
Classical Economics
Classicaleconomics is widely regarded as the first modern school of economic thought,
which originated in Britain. Its major developers were Adam Smith, Jean-Baptiste Say, David
18 The Austrian Theory of the Marginal Useand of Ordinal Marginal Utility
19 Austrian Economics and the Mainstream:View from the Boundary

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Ricardo, Thomas Malthus and John Stuart Mills. One can infer by their last names that most of
the Classical economic founders were British. According to most economic historians, Adam
Smith's The Wealth of Nations published in 1776 “marked the beginning of classical
economics”.21 Adam Smith identified the wealth of a nation with the yearly national income,
instead of the king's treasury. Smith saw this income as produced by labor, land, and capital.
With property rights to land and capital held by individuals, the national income is divided up
between laborers, landlords, and capitalists in the form of wages, rent, and interest or profits.
The Classical political economy is popularly associated with the idea that free markets can
regulate themselves. “The classical school was followed by Neoclassical economics in Britain
beginning around 1870”.22 Classical economics is similar to Austrian economics because they
both emphasize the essential elements of economics such as private property,
entrepreneurship, division of labor and institutions.23
Neoclassical Economics
The Neoclassical school of economics believes in stable preference like Mainstream
economics and market equilibrium like Keynesian and Austrian economics. Additionally,
Neoclassical economists are avid supporters of the price mechanism (refers to a wide variety of
ways to match up buyers and sellers through price rationing), which is one of the major
concepts emphasized by Austrian economics. A core concept of neoclassical economics
involves model building, for they have a hankering to create models for every conceivable
21 Does the InvisibleHand Hold or Lead? Market Adjustment in an Entrepreneurial Economy

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economic situation just like Mainstream economics.24 Because of this compulsive dedication to
model building Neoclassical economics dominates microeconomics. One of the assumptions
underlying the Neoclassical model of perfect competition is that everyone in the economy has
perfect knowledge about every economic opportunity. This assumption rules out the possibility
that any unrecognized proﬁt opportunities could exist in the economy, which means with
perfect knowledge there are no entrepreneurial opportunities.25 The rational choice theory is
another important staple concept of Neoclassical economics that uses a narrower definition of
rationality than the Austrians. Neoclassical economists perceive rationality to simply mean that
an individual acts in a way that balances costs against benefits to arrive at an action that
maximizes personal advantage (Milton Friedman 1953).26
Problems with Neoclassical Economics According toAustrian Economics
The fundamental problem Austrian economists have with Neoclassical economics is they
heavily rely on and endorse mathematical modeling. The root of this problem is that Austrian
economists comprehend that the complexity of human behavior makes mathematical modeling
of an evolving market extremely difficult and inconclusive to indubitably affirm it portrays a
valid reality. Instead, Austrians advocate explanatory axioms and a laissez faire approach to the
economy.27 Laissez faire describes an environment in which transactions between private
parties are free from state intervention, including restrictive regulations, taxes, tariffs, and
enforced monopolies. Austrians strongly believe the Neoclassical growth theory is ill-equipped
to deal with the time and institutional aspects that are critical for a firm understanding of
25 The Origins of Entrepreneurial Opportunities
26 On Rationality,Ideal Types and Economics:Alfred Schutz and the Austrian School
27Austrian Economics and the Mainstream:View from the Boundary

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economic development. The Neoclassical formalized model overlooks the deeper issues that
irrefutably influence entrepreneurship, such as institutional evolution, politics, legislation, and
sociology. To put it simply, in the view of the Austrian school of economics, Neoclassical
economic theory is an inappropriate and unrealistic tool to analyze and prescribe policies that
will induce economic development. Neoclassical economics concerns itself with the operation
of markets, not with how markets develop. When applying Neoclassical theory to economic
history and development, it ignores the incentive structure that is embodied in institutions and
entrepreneurship. The Neoclassical analysis of economic performance through time contains
two erroneous assumptions, that institutions do not matter and that time does not matter,
both of which are extremely important to Austrian economic theory.28
Keynesian Economics
The two basic concepts that Keynesian economics supports includes price is imperfectly
flexible and the market will be at disequilibrium. John Keynes, the founder of Keynesian
economics believed that if price is imperfectly flexible this would ultimately lead to full
employment of labor; however, other economic schools denied this. Keynesian economics
advocates a mixed economy chiefly the private sector, but with a large role of government and
the public sector.29 They put a major emphasis on macroeconomics and informally have the
reputation as the school of economics that dominates the macro-level of economics.30 During
the later part of the Great Depression, World War II, and the post-war economic expansion
between 1945 and 1973, Keynesian economics served as the economic model for several
28 Entrepreneurship and Development: Causeor Consequence?
29 The Collected Works of F.A. Hayek
30 Spotlight on Keynesian Economics

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countries. Its popularity could not last forever, for it began to lose favor and influence
following the stagflation of the 1970s and the recent stagflation in 2007 and 2008.31 The one
major problem Austrian economics associate with Keynesian economics is their concept of
price being imperfectly flexible, because according to Austrians the price mechanism of supply
and demand causes price to be perfectly flexible, thus pulling the market back towards
equilibrium.
Heterodox Economics
Heterodox economics generally refers to theories or to schools of economic
thought that are considered outside of Mainstream economics. This form of economics is
viewed as an umbrella term that covers multifarious economic approaches, schools, and
traditions. These include institutional, post-Keynesian, socialist, Marxian, feminist, ecological,
social, and the most significant Austrian economics.32
The Affinity between Heterodox and Austrian Economics
Austrian economics is thought of as a Heterodox school of economics because they both
emphatically accentuate the spontaneous organizing power of the price mechanism. The five
leading characteristics of the emerging new orthodoxy of Heterodox economics are bounded
rationality, rule following, institutions, cognition, and evolution. When listed in order these
characteristics of Heterodox economics create the acronym BRICE. The interesting fact about
31 Economics:Principles in action
32 The Nature of Heterodox Economics

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BRICE is that the Austrian school of economics believes in and emphasizes all the characteristics
within the acronym BRICE.33
BRICE - Bounded Rationality
Austrian economists, Mises and Hayek, assumed bounded rationality; even Adam Smith
presumed this as well. People are expected to have only bounded rationality, meaning people
are rational but not perfect. In Hayek’s theory of bounded rationality, the bounds to human
rationality have a logical and meta-mathematical dimension, and are not merely a contingent
empirical fact about limited power of cognition.34
BRICE - Rule Following
In the emerging new orthodoxy of Heterodox, people are modeled as rule followers.
Rule following can be defined objectively with the aid of information theory, in particular the
concept of mutual information. Economists have discovered that generally individuals and
institutions work best when they are governed by relatively simple rules rather than complex
rules in which they must use discretion. The conclusion is that in order for people and
institutions to prevail in a harmonious and prolific environment there needs to be a set of
simple and lucid rules they will follow.35
BRICE - Institutions
From the beginning, Austrian economists recognized that institutions matter and
included close institutional analysis in their work. Carl Menger’s theory of the evolution of
money is the standard example of the Austrian theory of institutions. The importance of
33 Austrian Economics atthe Cutting Edge

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institutional analysis in the Austrian theory led Mises and Hayek to a definitive position in the
socialist calculation debate. This position concluded that socialismcould not work because of
its many conflicting issues with the core concepts of Austrian economics, such as private
property and incentives.36
BRICE - Cognition
When it comes to cognition, Austrian economics has been devoted to cognition since
Hayek became infatuated with the economical influences of cognition. The activity of the mind
is typically defined as cognition and Hayek believed that a person’s cognition was particularly
important for an individual’s ability to adapt to any environment. Hayek, as well as many other
Austrian economists like Mises, believed cognition allowed people to make piecemeal
adjustments to their environment, especially in the case of exploitation, because exploitation is
the driving force behind the idea of entrepreneurship. As for subjectivism, one of the core
concepts of Austrian economics, Austrian’s view subjectivismof expectations as a species/type
of cognitive economics.37
BRICE - Evolution
In the case of evolution, it was one of the standard defenses of rational maximizing; and
Milton Friedan’s essay on positive economics relies on evolution. Austrian economics is notable
for its evolutionary theory of institutions, which explicates the negative ramifications that result
from socialism. Recent Austrian economists like Ulrich Witt have worked on theories that
emphasize social evolution. Michael Wohlgemuth in 2002 made an innovative application of

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Austrian evolutionary reasoning regarding politics. Evolution is thought to sometimes
approximate an optimal solution and thus should be utilized by not just Austrian and Heterodox
economists, but by all economists who seek economic improvement.38
Concluding the Similarities that Austrian and Heterodox Economic Share with BRICE
Looking at all the examples and illustrations presented in the previous paragraphs about
BRICE, one realizes the influential implications of each characteristic. By the Austrians agreeing
with and emphasizing the five Heterodox characteristics of bounded rationality, rule following,
institutions, cognition, and evolution, they have enhanced the economic significance of the new
orthodoxy, Heterodox economics. Seeing that these two economic schools believe in many of
the same theories and concepts, one becomes optimistic about the possibility of new economic
developments emerging in the near future. A world in which two economic schools work on a
problem or solution together is far better and more efficient than one school pitted against the
other, which has usually been the case throughout the history of economics.
Austrian Economics
The name, Austrian economics, derives from the identity of its founders and early
supporters, who were citizens of the old Austrian Habsburg Empire, including Carl Menger,
Eugen von Böhm-Bawerk, Ludwig von Mises, and Nobel laureate Friedrich Hayek. These
economists left Germany to teach economics in Austrian universities, because during the early
to mid-1800s economics were not allowed to be taught in German universities. This is another
theory how Austrian economics acquired its name. The Austrian school believes that price is
perfectly flexible because people value choices. They also believe that all markets are at

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disequilibrium. The Classicalschool believes in perfectly flexible prices just like the Austrians,
however, unlike the Classicalschool, Austrian economics do not agree with the Classical theory
that the market is at equilibrium. According to Peter Boettke, there are three defining
characteristics of Austrian economics which consists of: first, methodological individualismand
subjectivism, the second, analytical focus on the agent of change (e.g. the entrepreneur) and
market processes of adjustment to change, and third, an examination of the institutional
conditions required for spontaneous order. The market niche concepts and theories associated
with Austrian Economics include the price mechanism, subjectivism, marginalism,
entrepreneurship, institutions, and economic calculation.39
Market Niche Concepts and Theories Associated with Austrian Economic
Price Mechanism
The price mechanism, one of the core concepts of Austrian economics, is based on
supply and demand. The price mechanism or market-based mechanism refers to a wide
variety of ways to match up buyers and sellers through price rationing. It also describes the
price of goods and services based on demand and supply. An example of the price mechanism
is through the use of announcing bids and asking prices. Generally speaking, when two parties
wish to engage in a trade, the purchaser will announce a price they are willing to pay, the bid
price, and the seller will announce a price they are willing to accept, the asking price.40

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Subjectivism
Subjectivism is one of the fundamental concepts of Austrian economics that Carl Menger
developed. The subjective theory of value is an economic theory of value that identifies worth
as being based on the wants and needs of the members of a society, as opposed to value being
inherent to an object. It holds that to possess value an object must be both useful and scarce,
with the extent of that value dependent upon the ability of an object to satisfy the wants of any
given individual, thus products and services are subjective not objective. The economic theory
of subjectivismpoints out what is lost when legislators make simplistic distinctions between
necessities and luxuries or when, unlike voluntary transactions, legislative policy fails to take
account of subtle differences between the circumstances and tastes of different people. It is
impossible to make and implement a clear distinction between luxuries and essentials. The
government cannot make this distinction as well as a consumer can. It is dubious for the
government or policymakers to try and distinguish between essential and frivolous imports
according to whether they serve production or economic growth or mere consumption.
Policymakers do not understand how the price system brings into play the dispersed knowledge
that people have about their own tastes and circumstances. Some consumers choose to buy
extraordinary things and deliberately deprive themselves of the other things generally counted
as necessities. Subjectivist economists believe that consumers are the only ones able to
appraise essential and frivolous products and services, not the government.41
41 Why Subjectivism?

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Marginalism
Marginalismis another key concept that Carl Merger developed for Austrian economics.
Marginalism’s central concept is the marginal utility of a good or service. Marginal utility is the
utility gained/lost from an increase/decrease in the consumption of that good or service.42 A
simple definition of marginalismis that the relationship between cost and quantity should be
taken at the margin. Austrian economists believes in the law of diminishing marginal utility,
meaning that the first unit of consumption of a good or service yields more utility than the
second and subsequent units. The Austrian school also talks about marginal cost which is the
change in total cost that arises when the quantity produced changes by one unit. This is the
cost of producing one more unit of a good. If the good being produced is infinitely divisible, so
the size of a "unit" is infinitesimal, then assuming the cost function is differentiable the
marginal cost function is the first derivative of the total cost function with respect to quantity.43
Entrepreneurship/Innovation
This fundamental concept is at the heart of the Austrian economic spirit.
Entrepreneurship occurs when an individual acts to take advantage of a profit opportunity that
presents itself in the economy. In its simplest form, the entrepreneur might notice that one
person is willing to sell something for less than someone else is willing to pay for it, so the
entrepreneur can act as a middle man, profiting from buying at the lower price and selling for
more. The profit, which is the return to the entrepreneur’s alertness to the opportunity, was
created entirely by the entrepreneur’s activity, because the sale would not have taken place
42
“Austrian School of Economics”The ConciseEncyclopedia of Economics
43
The Austrian Theory of the Marginal Useand of Ordinal Marginal Utility

24
without someone having noticed the proﬁt opportunity. The simplest definition of
entrepreneurship involves noticing previously unexploited proﬁt opportunities.44
Economic Calculation
Economic calculation of the political economy is Austrian economics contribution to the
20th century. The simple definition of economic calculation refers to the decision-making ability
to allocate scarce capital resources among competing uses. Mises wrote economic calculation
is either an estimate of the expected outcome of future action or the establishment of the
outcome of past action. Its most practical meaning is to show how much one is free to
consume without impairing the future capacity to produce. Economic calculation provides the
foundation for the main contributions of the Austrian school in monetary theory, capital theory,
business cycle theory, the entrepreneurial theory of the market process, and the examination
of interventionism. This means that all the unique contributions of Austrian economics to
substantive economics can be traced back to the central importance of economic calculation
for human cooperation. Mises states that socialismis not a reliable system of society’s
economic organization because it lacks any method of economic calculation. Mises’s great
contribution to economic science was to establish that this (man must mentally process the
alternatives placed before him, and to do so he must have some “aid to the human mind” for
comparing inputs and outputs) decision-making ability is dependent on the institutional context
of private property. Mises argument for the need for economic calculation concluded that
without private property in the means of production, there will be no market for the means of
production. Without a market for a means of production, there will be no monetary prices
44 The Originalsof Entrepreneurial Opportunities

25
established for the means of production. And without monetary prices, reflecting the relative
scarcity of capital goods, economic decision makers will be unable to rationally calculate the
alternative use of capital goods. To sum up Mises argument, simply without private property in
the means of production, rational economic calculation is not possible.45
The Defining Characteristics of Austrian Economic
Methodological Individualism
Methodological individualismis a widely-used term in the social sciences. Its advocates
see it as a philosophical method aimed at explaining and understanding broad societies-wide
developments as the aggregation of decisions by individuals. The term was originally coined by
Joseph Schumpeter in 1908. Methodological individualism does not imply political
individualism, although methodological individualists like Friedrich Hayek and Karl Popper were
opponents of collectivism. Collectivismviews the whole as being greater than the sum of its
individual parts, and gives priority to group rights over individual rights; this is the bases for
socialismand communism. Detaching methodological individualismfrom political
individualism, Max Weber's position, argued at the start of the twentieth century that if a
properly-functioning communist regime were to arise, it too would have to be sociologically
understood on methodological individualist principles.46
45
Economic Calculation:The Austrian Contribution to Political Economy
46 Is There an Intellectual Market Niche for Austrian Economics?

26
Entrepreneurship
Austrians stress that entrepreneurship does not describe a distinct group of individuals,
but rather, is an omnipresent aspect of human action. When the market is not in equilibrium,
profit opportunities exist, and entrepreneurs discover and act on these profit opportunities to
equilibrate the market. The taxonomy of the origins of entrepreneurial opportunities includes
factors that disequilibrate the market, factors that enhance production possibilities and most
notably, opportunities created from previous acts of entrepreneurship. Entrepreneurship
creates the opportunity for more entrepreneurs, which leads to economic progress.
Entrepreneurship activity benefits the buyer, the seller, and more generally, the entire
economy. In 1973, Kirzner emphasized the role of entrepreneurship in equilibrating an
economy, which would lead to a more efficient allocation of resources. He identifies three
major categories of factors that create profit opportunities: (1) Factors that disequilibrate the
market; (2) Factors that enhance production possibilities; and (3) Entrepreneurial activity that
creates additional entrepreneurial possibilities. When production possibilities increase,
entrepreneurial opportunities are created in several ways. More inputs, including increases in
the quality of physical and human capital, allow inputs to be combined in new ways. Income
growth opens the possibility of marketing new goods, or expanding the market for goods that
are income-elastic. Undertaking such activities requires the entrepreneurial insight to see that
there are profits to be made from changing the way one does business.47
The two most important core institutions for encouraging entrepreneurship are well-
defined property rights and the rule of law. Examples of institutions that stunt economic
47 The Originalsof Entrepreneurial Opportunities

27
growth include government, police and/or court corruption, excessive taxation and/or
regulation, unstable and/or inconsistent monetary and fiscal policy (Frye and Shleifer, 1997).
The lack of institutions in countries like post-communist Russia and the Ukraine with their
unofficial economic activities is the cause of their lack of economic growth. Historically,
countries that have well-defined property rights and a strong rule of law have a high growth
rate. When analyzing developing countries, those that have adopted these core institutions as
well as others that stem from them, such as freedom of choice, predictable government
activity, rules conducive to increase market and firm development, freedom of contract and
exchange, have grown at a faster rate compared to their counterparts which have adopted
different institutions. Property rights and entrepreneurship are critical in encouraging capital
flow and economic development into a country. It is widely agreed that the entrepreneur is
the catalyst of economic progress.48
The Institutional Conditions Required for Spontaneous Order
The third defining characteristic at the heart of Austrian economics is an examination of
the institutional conditions required for spontaneous order. This question stimulates the
economic senses for the gravity of this inquiry is indubitably hard to swallow not due to the
nature of the answers complexity. We, however, can thank the author Peter Boettke, for his
ambiguous and reserved explanation of the institutional conditions required for spontaneous
order. Since the authors had the audacity to pose such an inquisition and offer no explanation
to elucidate his own challenging question, the reader is left to seek out an answer that is more
convoluted and multifarious than the explanation of the Holy trinity. The author goes a step
48 Entrepreneurship and Development: Causeor Consequence?

28
further to add abounded impendence of confusion upon an already flustered reader by pitting
the four most prominent patriarchs of the Austrian school of economics against each other.
When Peter Boettke states “The Philosophical justifications provided for this research program
differ among Austrian economists – such as Mises, Hayek, Rothbard, and Menger”, this allows
the author to divert the ominous perplexity of the question of institutional conditions back to
the original economists who constructed Austrian economics. In my opinion, the author is too
confounded about how to answer the question that he is surely intimidated that his
explanation would cause him to be unmitigatedly assailed by the entire economic community.
Due to the author’s inability of elucidating the necessary institutional conditions required for
spontaneous order to prevail, it seems that I must muster the fortitude to translucently
explicate the necessary conditions for spontaneous order to succeed.49
The only way to achieve an accurate definition that describes the institutional
conditions required for spontaneous order (self-ordering, self-sustaining, and self-regulation
economics) to prevail is to read another academic journal entitled Austrian Economics and
Game Theory: A Stocktaking and an Evaluation. The only conclusive definition I was able to
derive from this source about institutional conditions that related to spontaneous order was a
vague but insightful sentences that offered a more informational description involving
institutions and spontaneous order. The text stated “Game theory ideas have been used in a
number of attempts during the last 10-15 years to address Austrian and Classical liberal ideas
on the spontaneous emergence of beneficial institutions. The Game Theory is a mathematical
method for analyzing calculated circumstances, such as games, where a person’s success is
49 Is There an Intellectual Market Niche for Austrian Economics>

29
based upon choices of others. Indeed, game theory appears ideally suited to deal with issues
that have traditionally been a major concern to Hayekian Austrians, such as the formation of
conventions and other spontaneous orders. A number of non-Austrian but clearly sympathetic
to Austrian economics (Langlois 1986, Witt 1986, Buchanan 1997, Klein 1997) have utilized
game theory to analyze institutions, in some cases extensively.”50 Regarding the question
involving the institutional conditions required for spontaneous order, I can induce from reading
these few sentences that the conditions involved with the game theory may help address many
Austrian ideas about the many beneficial institutions that derive from spontaneous order.
Later in the article the reader is able to see how economists have begun to utilize the game
theory to analyze institutions. When one analyzes the game theory one realizes that this
theory appears ideally suited to deal with some of the fundamental issues, such as the
formation of conventions and other spontaneous orders, which have been the major concerns
to Hayekian Austrians. The game theory has also been able to address the significant Austrian
explananda, such as spontaneous emerged rules, which Neoclassical economists do not agree
with. To finally conclusively answer the 3rd defining characteristic of Austrian economics, an
examination of the institutional conditions required for spontaneous order, it seems like the
main condition that needs to be met is there must be institutions that promote the
sustainability of spontaneous order. From the past few sentences, it seems like the game
theory is progressively becoming a condition that will promote spontaneous order, with its
influence of Oskar Morgenstern who characterizes himself as an Austrian supporter and his
50 Austrian Economics and Game Theory: A Stocktaking and an Evaluation

30
utilization of the game theory to analyze institutions, and its dedication to address Austrian
explananda like spontaneous emerged rules.51
The last academic journal that addressed the 3rd defining characteristic of Austrian
economics - examining the institutional conditions required for spontaneous order, was Urban
Interventionism and Local Knowledge. This article gives the most accurate and definitive
definition that describes the institutional conditions required for spontaneous order to prevail.
In this journal the author explained that trust and security in a city and local knowledge are
conditions for spontaneous order. According to Jane Jacobs, and Austrians economists, a city is
a spontaneous order because of its abilities of self-ordering, self-sustaining, and self-regulating.
For a city to have this order trust must be apparent. Trust is the expectation that one’s physical
safety and security in public spaces will not be endangered. This expectation of safety and
security is a bedrock condition for spontaneous order. A degree of social cooperation can be
achieved, in the last resort, through government coercion. The challenge for social theory is to
explain whether and under what conditions such cooperation can emerge spontaneously. One
of Jacob’s principal contributions to our understanding of cities as spontaneous orders is her
insight that safety and ultimately trust depends on a surprisingly high degree of the structure
and location of public spaces, and that the relations that emerge spontaneously from a secure
foundation of trust essentially supports self-ordering processes of discovery and economic
growth.52
51 Austrian Economics and Game Theory: A Stocktaking and an Evaluation
52 Urban Interventionismand Local Knowledge

31
There are four conditions that help to generate the spontaneous formation of these
social phenomena. Frist, public spaces should have mixed primary uses that attract people to
particular districts so that people use them in large numbers at different times. Secondly, short
blocks with frequent opportunities for people to turn corners and vary their routes make
streets more interesting. They multiply the number of potential meeting points, increase one’s
exposure to more of the intricacies of the local environment, and increase the chances of
seeing the unexpected and making unexpected connections. Third, interspersed with newer
buildings should be old ones that have lower property values, so that new ideas have less costly
way to become established. Fourth and final, there needs to be a sufficiently dense
concentration of people, for whatever purpose they may be there, in order to promote both
safety and a high demand for an array of uses, including residential, recreational, and work
related. There should be “the almost unconscious reassurance of general street support in
upholding civilization”.53 Any breakdown in these support structures ultimately reduces the
overall security of the street and beyond. Much of this knowledge is called “local knowledge,”
which consists of knowing how to get things done, but also of knowing whom to trust and
under what circumstances. In the end trust feeds back into and reinforces the expectation of
safety and security, for when people can expect strangers to help them uphold community
norms, norms are when there is trust, they also feel safe and more secure in public spaces.
Local knowledge of time and place for maintaining a healthy community of strangers in safety
and security takes time, but then communication between strangers and trust networks, will

32
thus support the more formal business practices in a successful district, indirectly but critically,
and in this way promote the more extensive use of markets and the price system.54
The trust that evolves in such a city that has been so elaborately described serves as a
foundation for dynamic economic processes. It encourages a mixture of primary and
supporting secondary uses of public spaces within a given district like industries, schools,
homes, government and business offices, grocery stores, gas stations, restaurants, bars, and
churches. All these forms of capital attract a growing number of people at different times of
the day and night. This type of environment attracts further diversity in the use of public
spaces and networks of what, Jacob, calls “codevelopment,” which is a type of interdependence
and complementarity among primary and supporting activities like the synergy among
investment banks, insurance firms, and law offices on Wall Street, that especially thrive in large
settlements. Like trust, “codevelopment”, is an outcome of a successful neighborhood district
as well as a basis for future economic growth and adjustment. When the elements of
“codevelopment” are in place, cities can become “the natural generators of diversity and
prolific incubators of new enterprises and ideas”.55 The opportunities for chance meetings,
serendipitous connections, and accidental discoveries are tremendously multiplied in such an
affluent and economically growing environment. In this type of environment people and
business thrive because in great cities public and semi-public meeting and gathering places like
coffee houses, restaurants, bookstores, university seminars, specialty shops, unusual
neighborhoods, theaters, museums, and parks and plazas are so high in number and variety
55 Jacobs 1961

33
compared to those found in smaller settlements that they really constitute a difference in
opportunities and exploitation. In this way, great cities serve as the primary incubators of new
ideas and entrepreneurship, and there is in them a strong tendency to be not only the ﬁnancial
and political centers of the regions in which they reside but the creative centers as well. They
are thus the engines of economic and cultural change, and dominate the political landscape of
modern society.56
When you look at the simple fact that trust leads to local knowledge that leads to
business that leads to production that leads to new ideas that leads to entrepreneurship, one
realizes that if you can create a city or community that is based on trust were the citizens feel
safe and secure everything else will follow. So in the end, if everyone adopts Jane Jacob’s four
conditions that help to generate the spontaneous formation of these social phenomena, than
your communities, cities, countries, or the world will have spontaneous order – self-ordering,
self-sustaining, self-regulating, which ultimately leads to economic growth. With the
enlightenment of the propitious and opulent Austrian economics spontaneous order it is our
duty, no, our obligation as rational and perspicacious individuals to inspire and encourage the
utilization of spontaneous order. We should endorse this because we desire cities with great
grandeur and great cities are part of Hayekian spontaneous order and they stimulate copious
institutions and informal networks that characterize a mature market process.57
Out of all the three academic journals I referenced to explain and inform the reader
about institution conditions required for spontaneous order the best of the three academic

34
journals that analyzed, rationalized, and illustrated in perfect detail was, Urban Interventionism
and Local Knowledge. If this ideal economic theory could work world-wide than there would be
no longer any 2nd or 3rd world countries, with spontaneous order it sounds like a utopia.
Because Austrian economics’ spontaneous order stimulates efficiency and prolific
societies/cities, spontaneous order is the central concern to the theory of interventionism.
Conclusion
When considering all the different schools of economics, the Austrian school of
economics contains the best principles and concepts to stimulate economic growth. The
market niches for Austrian economics include the price mechanism, subjectivism, marginalism,
entrepreneurship, institutions and institutional conditions necessary for spontaneous order,
disequilibrium, perfectly flexible prices, and economic calculation. Austrian economics stress
the need for private property and how private property affects production, monetary prices,
and economic calculation. Mises, one of the most prominent Austrian economists, explains the
need for private property by stating without private property in the means of production, there
will be no market for the means of production, and without a market for a means of
production, there will be no monetary prices established for the means of production, and
without monetary prices reflecting the relative scarcity of capital goods, economic decision
makers will be unable to rationally calculate the alternative use of capital goods. In conclusion,
without private property in the means of production, rational economic calculation and
economic growth is not possible. One of the most important core concepts of Austrian

35
economists is institutions. Austrian economics emphasize that the lack of institutions in
countries like post-communist Russia and the Ukraine with their unofficial economic activities is
the cause of their lack of economic growth. When considering developing countries, those that
have adopted core institutions like private property rights and rule of law as well as others that
stem from it - freedom of choice, predictable government activity, rules conducive to market
and firm development, freedom of contract and exchange - have also grown at a faster rate as
compared to their counterparts, which have adopted non-Austrian economic institutions. In
the end for a country to have the most effective and efficient economic growth they need to
follow and encourage the core economic theories of Austrian economics like entrepreneurship,
private property rights, rule of law, subjectivism, and marginalism. By adopting the concepts of
Austrian economics communities, cities, and countries will be able to achieve sustainable
economic growth.

36
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