At the root of economic reasoning lies the question of value. How do we determine the value of something? Is value an inherent property of things? Or is it, on the contrary, a subjective phenomenon? How do we compare the value of two things? Where does value come from?

Such questions have occupied economists and philosophers for many centuries and have received numerous different answers. In many ways, the epistemological evolution of economics has been punctuated by the evolution of theories of value.

After the physiocrats' theory of land value, positing that all value come from land, had been refuted by the classical economists' labor theory of value, postulating that the value of a good stems from the amount of labor going into its production, it was the turn of the marginal theory of value to supplant the latter. In the 1870s, following Marx, the last of the classical economists, three new schools of economic thought emerged almost simultaneously around a marginal theory of value: the Lausanne school with Léon Walras, the modern or neoclassical school with William Stanley Jevons, and the Austrian school with Carl Menger. This revolution in the theory of value constituted a significant renewal of economic thought.

From Left to Right: William Stanley Jevons, Carl Menger, Léon Walras

The marginal theory of value holds that economic value corresponds to what an economic agent willingly pays for the next unit of a good or service. As this theory emphasizes the fact that prices are formed at the margin, i.e. for the next unit of a given good, it was termed “marginalism”.

It is common to present the marginalism of these three schools as similar. Indeed, Walras and Jevons are highly compatible, but Menger’s theorization diverges from the others in profound ways. In his work, now considered foundational to Austrian economic theory, titled "Grundsätze des Volkswirtschaftlehre" (Principles of Political Economy), published in 1874, Menger, offers a marginal, but primarily subjective, explanation of value, unlike Walras and Jevons, who consider value to be an objective and measurable phenomenon.

The Austrian economist refutes the conception of Adam Smith's successors and abandons the idea that the value of a good comes from the amount of labor used in its production, in favor of the notion that its value is determined by the individual, who, in each context, performs a mental act of valuation regarding a specific quantity of a good or service. This intellectual leap made by Menger challenges the objectivity of value: for him, value is not an objective property of goods; it is merely the result of the relationship that the individual has with that thing: "value does not exist outside of human consciousness."

In other words, Menger invites us to consider that value exists only as a subjective psychological phenomenon within the individual, that value is not an inherent property of goods, but rather stems from the individual's opinion about the utility they can derive from those goods.

According to this view, a liter of drinking water has no objective value. Someone who has access to a modern system of drinking water and is not currently thirsty would probably assign very little value to that additional liter of water, whereas an individual who is thirsty in the middle of the desert, seeing it as the difference between life and death, would certainly be willing to attribute almost infinite value to that liter of water.

In summary, Menger noticed that the value of an economic good is nothing more than the subjective valuation that an individual assigns to an additional unit of that good or service.

From this point, Menger deduces that voluntary exchange between two individuals takes place because each party believes it will increase their subjective utility. For him, exchange does not presuppose any equivalence of value, contrary to what the classical economists believed. According to the Austrian thinker, if there were equivalence of utility between the exchanged goods, there would be no reason for the parties to bother exchanging in the first place. If there is an exchange, it is because each party finds it in their (subjective) interest, and consequently, each voluntary exchange produces a social benefit.

However, such a social benefit, or the subjective value attributed to a good, cannot be measured. For Menger, value is a cognitive phenomenon of comparison (ordinal) rather than measurement (cardinal). It is not, as the neoclassical economists have thought since Walras and Jevons, the assignment by the individual of a numerical value that reflects the utility they derive from it, but rather an act of ordering human desires by which an individual expresses that they desire a quantity of good A more intensely than a quantity of good B.

Any agent can say whether they prefer 2 bananas to an economics course, but no one can reasonably say that they value 2 bananas at 3.1416 utils, while valuing an economics course at 3 utils, and therefore, they prefer to have the bananas. Such a description of human preferences, based on continuous real functions, does not correspond to the reality of the cognitive processes we experience in our daily lives. An individual never evaluates goods presented to them by comparing them to an abstract standard of utility. Instead, he subjectively compares different courses of action, which he cannot judge in absolute terms but can nonetheless rank based on their relative desirability.

This subjective conception of value, understood as a psychological relationship that the individual entertains with his goals and the means relevant to achieve them, also allows Austrian economists to explain the phenomenon of the division of labor.

Visiting a Nail Factory, Léonard Defrance (18th century)

Everyone is unique and has a particular personal situation. Therefore, everyone possesses a superior ability to perform certain tasks than his peers (absolute advantage) or a superior ability to perform certain tasks than other ones (comparative advantage). It cannot be otherwise; to deny this elementary fact would be to claim that all humans are equal in all aspects.

In the case where an individual has a superior ability compared to their peers in the production of a given good (absolute advantage), they have an interest in specializing in the production of that good and then exchanging the surplus obtained for the goods they desire. By doing so, they satisfy their subjective utility more economically than if they were to engage in the production of all the goods they desire.

But it may also be the case that the individual does not have an absolute advantage in the production of any good. In this case, there will still be types of production for which the individual is better than in others (comparative advantage), and for this reason, they still have an interest in specializing.

Certainly, there are individuals who could produce that given good more productively than him, but since these individuals are probably more productive in another task than in this one, and since they cannot perform both tasks simultaneously, it is unproductive for them to work on this task rather than another for which they are more productive. By specializing in the task for which they are most productive, they will obtain a surplus greater than if they had not specialized, and therefore, through exchange, they could obtain an increased quantity of those other goods, even if the goods obtained would have been produced more efficiently by themselves than by the producers from whom they obtained them.

Take the example of a physician. He might be better at writing emails and scheduling appointments than his secretary (relative advantage). But any time spent at doing those tasks is time he does not employ curing patients. Hence, as he is more productive curing people, it is in his interest to delegate administrative duties to another person even if he is better at such task than his deputy, because it allows him to maximize the value generated for others, and thus its own wealth.

In essence, there is a benefit to specialization, even for individuals who do not have absolute advantages, because time is a scarce and rival resource: each unit of time spent on an activity other than the one for which an individual is most productive implies a cost represented by the foregone production they renounced (opportunity cost).

Once the individual is specialized in a particular production, they can then reserve the quantity of products they consider necessary for their personal consumption and exchange the surplus for other desired goods. In doing so, they satisfy their desire for the goods they produce themselves, which means that the remaining units of their production have little value to them. It is what economists call decreasing marginal utility: each additional unit of a good is less desired than the preceding. For others lacking such goods, it's a different story: for the same reasons, they tend to desire the goods they do not produce more intensely than those they do. This leads to a situation where there is a strong asymmetry between the various subjective valuations of individuals, which is highly conducive to exchanges: each party has an interest in exchanging their surplus production because they thereby increase their subjective utility.

The result of the preceding analysis is that individuals are always better off when they specialize in their work and engage in exchanges. Therefore, Austrian economists, especially Ludwig Von Mises, conclude that the productive advantage arising from the division of labor is the driving force behind the process of social cooperation. Here, it may be useful to quote him directly:

"The fundamental facts that brought about cooperation, society, and civilization and transformed the animal man into a human being are the facts that work performed under the division of labor is more productive than isolated work and that man’s reason is capable of recognizing this truth. […] People do not cooperate under the division of labor because they love or should love one another. They cooperate because this best serves their own interests."

1871-1874 are the wonderful years of modern economics: this period witnessed the works of three independent thinkers foundational to modern economics. With their emphasis on subjective ordinal value Austrian economists will develop a whole body of economic thought setting them apart from their homologues. The work of Austrian economists reasoning about human action in the context of scarcity will forever stand in stark contrast with the economic doctrines initiated by Jevons and Walras heavily relying on mathematics standing on the back of the idea that value can be objectively measured and derived as a continuous function.

Building on the insights of subjective ordinal value Menger explained the emergence of the division of labor and voluntary exchange. Yet as we will see in the next chapter, direct exchange is a poor strategy for economic agents seeking to maximize their subjective utility. The father of the Austrian School has thus further developed his reasoning to explained why money emerged as a social institution.

The following chapters will be dedicated to the emergence of money as a social institution, the theory of capital and interest, which will serve as the basis for the Theory of the Business Cycle, and lastly the role of prices for economic calculation.