The economic theory of costs foundations and new directions

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The Economic Theory of Costs

The theory of costs is a cornerstone of economic thinking, and figures crucially
in the study of human action and society. From the first day of a principles-level
course to the most advanced academic literature, costs play a vital role in virtually
all behaviors and economic outcomes. How we make choices, why we trade, and
how we build institutions and social orders are all problems that can be explained
in light of the costs we face.
This volume explores, develops, and critiques the rich literature on costs,
examining some of the many ways cost remains relevant in economic theory and
practice. The book especially studies costs from the perspective of the Austrian
or “causal-realist” approach to economics. The chapters integrate the history
of economic thought with contemporary research, finding valuable crossroads
between numerous traditions in economics. They examine the role of costs in
theories of choice and opportunity costs; demand and income effects; production
and distribution; risk and interest rates; uncertainty and production; monopsony;
Post-Keynesianism; transaction costs; socialism and management; and social
entrepreneurship.
Together, these papers represent an update and restatement of a central element
in the economic way of thinking. Each chapter reveals how the Austrian, causalrealist approach to costs can be used to solve an important problem or debate in
economics. These chapters are not only useful for students learning these concepts
for the first time: they are also valuable for researchers seeking to understand the
unique Austrian perspective and those who want to apply it to new problems.
Matthew McCaffrey is Assistant Professor of Enterprise in the Alliance Manchester Business School, University of Manchester, UK. His research focuses on
entrepreneurial decision making, the role of entrepreneurship in social and economic development, and the institutional conditions in which enterprise thrives.


Routledge Frontiers of Political Economy

For a full list of titles in this series please visit www.routledge.com/books/series/
SE0345

228 The Social Construction of Rationality
Policy Debates and the Power of Good Reasons
Onno Bouwmeester
229 Varieties of Alternative Economic Systems
Practical Utopias for an Age of Global Crisis and Austerity
Edited by Richard Westra, Robert Albritton and Seongjin Jeong
230 Money as a Social Institution
The Institutional Development of Capitalism
Ann E. Davis
231 Remaking Market Society
A Critique of Social Theory and Political Economy in Neoliberal Times
Antonino Palumbo and Alan Scott
232 Political Economy as Natural Theology
Smith, Malthus and their Followers
Paul Oslington
233 Sharing Economies in Times of Crisis
Practices, Politics and Possibilities
Edited by Anthony Ince and Sarah Marie Hall
234 Philosophy in the Time of Economic Crisis
Pragmatism and Economy
Edited by Kenneth W. Stikkers and Krzysztof Piotr Skowroński
235 Public Policy and the Neo-Weberian State
Edited by Stanisław Mazur and Piotr Kopyciński
236 The Economic Theory of Costs
Foundations and New Directions
Edited by Matthew McCaffrey

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The Economic Theory
of Costs

Foundations and New Directions
Edited by Matthew McCaffrey


First published 2018
by Routledge
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© 2018 selection and editorial matter, Matthew McCaffrey; individual
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The right of the Matthew McCaffrey to be identified as the author of the
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without intent to infringe.

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Contents

List of figures
vii
List of tablesix
List of contributors
xi
Acknowledgements
xiii


Introduction: the economic theory of costs in perspective

1

MATTHEW M c CAFFREY

PART 1

Cost and choice
  1 Contemporary debates on opportunity cost theory
and pedagogy

9
11

JONATHAN NEWMAN

  2 The “income effect” in causal-realist price theory

27

JOSEPH T. SALERNO

PART 2

The evolution of causal-realist production theory

49

  3 From Marshallian partial equilibrium to Austrian general
equilibrium: the evolution of Rothbard’s production theory

51

PATRICK NEWMAN

 4 Man, economy, and state, original chapter 5:

producer’s activity
MURRAY N. ROTHBARD

73


vi  Contents
PART 3

Risk, uncertainty, and cost

131

  5 The myth of the risk premium

133

JÖRG GUIDO HÜLSMANN

  6 Time and the theory of cost

147

JEFFREY M. HERBENER

PART 4

Causal-realist price theory: debate and synthesis

167

  7 Monopsony theory revisited

169

XAVIER MÉRA

  8 Costs and pricing: an Austro-Post-Keynesian synthesis?

191

MATEUSZ MACHAJ

PART 5

Economic organization, entrepreneurship, and the firm

205

  9 Austrian economics and transaction cost economics:
notes on a doubtful compatibility

207

MIHAI-VLADIMIR TOPAN

10 Management is what’s wrong with socialism: cost
at the expense of value

225

PER L. BYLUND

11 Economic calculation and the limits of social
entrepreneurship243
MATTHEW M c CAFFREY

Index

265

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Figures

2.1
2.2
2.3
3.1
3.2
3.3
3.4
4.1
4.2
4.3
4.4
4.5
4.6
4.7

4.8
4.9
4.10
4.11
4.12
4.13
4.14
4.15
6.1
6.2
6.3
6.4
6.5

Individual labor supply curve
Individual demand curve for money assets in terms of labor
Reciprocal demand curve for money assets in terms of labor
Market demand curve and the demand curve faced by an
individual firm
Optimal production with various constant outlay and
product curves
Derivation of a firm’s demand curve for a factor of production
Graphical illustration of money revenue and outlay from
production of Product P
Graphical illustration of Case (b1)
Graphical illustration of Case (c)
Constant outlay curves with given factor prices
Production of output with various factor combinations
Constant product curves with various factor combinations
Constant outlay and constant product curves

Possible production of output with given constant outlay
Optimal production with various constant outlay and
product curves
Possible production of output with constant money outlay
Maximum production of output at various money outlays
Product outlay curve
Total product outlay curve
Graphical illustration of production of Product P for various
money outlays
Graphical illustration of money revenue and outlay from
production of Product P
Final supply curve of the producer
Short-run costs of production
Marginal unit of output in production
Long-run costs of production
Immediate-run price of a good
Immediate-run price of a good

39
40
41
57
60
61
65
80
82
98
99
100

102
102
104
105
106
106
107
112
112
125
149
151
153
154
155


viii  Figures
6.6
6.7
6.8
6.9
6.10
6.11
6.12
6.13

Immediate-run price of a factor of production
Production costs and the interest rate in the ERE
Production costs with different techniques in the ERE

Falling demand and cost structure in the FSR
Time – sequence and uncertainty
Immediate-run price of a good under uncertainty
Immediate-run price of a factor of production under uncertainty
Production decisions by entrepreneurs under uncertainty

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156
157
158
159
160
161
163
164


Tables







2.1
2.2
4.1
4.2

4.3







4.4
4.5
4.6
4.7
4.8









4.9
4.10
4.11
4.12
4.13
4.14
4.15

4.16
4.17
11.1

Individual labor supply schedule
Individual demand for money assets in terms of labor
Jones’ money returns
Factor combinations for the production of Good A
Factor combinations and output for the production
of Good A
Gross revenue in the production of Good A, Case (a)
Gross revenue in the production of Good A, Case (b1)
Gross revenue in the production of Good A, Case (b2)
Gross revenue in the production of Good A, Case (c)
Extended factor combinations and output for the
production of Good A
Factor combinations for constant output
Production costs for constant output
Smith’s production decisions for Product P
Smith’s money returns for various money outlays
Smith’s money returns for various outlays, continued
Smith’s money returns for various outlays, total
Smith’s money outlays for producing Products P, Q,
and R
Maximum net income of Smith for various
investment decisions
Smith’s money returns for various investment decisions
Types of entrepreneurship by income and organizational
method

39
40
77
78
78
79
79
79
82
91
92
93
110
111
117
118
122
123
123
251


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Contributors

Per L. Bylund is Assistant Professor of Entrepreneurship and Records-Johnston
Professor of Free Enterprise in the School of Entrepreneurship at Oklahoma
State University. He is the author of two books, The Problem of Production:

A New Theory of the Firm (Routledge, 2016) and The Seen, the Unseen, and
the Unrealized: How Regulations Affect Our Everyday Lives (Lexington,
2016). His areas of research are entrepreneurship, strategic management, and
economic organization.
Jeffrey M. Herbener is Chairman of the Department and Professor of Economics
at Grove City College. He serves as Associate Editor of the Quarterly Journal of Austrian Economics and is a Senior Fellow of the Ludwig von Mises
Institute.
Jörg Guido Hülsmann is Professor of Economics at the University of Angers, a
Senior Fellow of the Ludwig von Mises Institute, and a member of the European Academy of Sciences and Arts. He is the author of Krise der Inflationskultur (2013), The Ethics of Money Production (2008), and five other books.
He has also edited The Theory of Money and Fiduciary Media (2012) and five
other books. His writings have been translated into twenty languages. His current research focuses on the political economy of financial markets, and on
monetary theory.
Mateusz Machaj is an Assistant Professor at the Institute of Economic Sciences
at the University of Wroclaw, and a Researcher at the Faculty of Social and
Economic Studies, Jan Evangelista Purkyně University in Ústí nad Labem.
Xavier Méra holds a PhD in Economics from the University of Angers, France.
He is a Teaching and Research Assistant at Université Rennes 2 and an Associated Scholar of the Ludwig von Mises Institute.
Matthew McCaffrey is Assistant Professor of Enterprise in the Alliance Manchester Business School at the University of Manchester. His research focuses
on entrepreneurial decision making, the role of entrepreneurship in social and
economic development, and the institutional conditions in which enterprise
thrives.


xii  Contributors
Jonathan Newman received his PhD in Economics from Auburn University in
2016. He is a Fellow of the Ludwig von Mises Institute and the Online Course
Manager for the Foundation for Economic Education. He currently teaches
economics at Auburn University.
Patrick Newman is an Assistant Professor of Economics at Florida Southern
College.

Murray N. Rothbard (1926–1995) was a leading economist of the Austrian
school and the author of dozens of books and scholarly research articles. His
treatise on economic principles, Man, Economy, and State, played a major role
in the revival of the Austrian tradition in the United States.
Joseph T. Salerno is Professor of Economics at Pace University and Academic
Vice President of the Ludwig von Mises Institute. He is the Editor of the Quarterly Journal of Austrian Economics and the author of Money: Sound and
Unsound (2010) as well as of numerous articles in peer-reviewed economics
journals and scholarly books.
Mihai-Vladimir Topan is Associate Professor in the Department of International
Business and Economics at the Bucharest University of Economic Studies. He
is also President of the Ludwig von Mises Institute Romania and Founder of
the Academia Privată.

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Acknowledgements

Chapter 1: Contemporary debates on opportunity cost theory and pedagogy
Jonathan Newman
I appreciate the discussions with the 2016 Mises Institute Research Fellows
on this topic. I would also like to thank Randy Beard, Joseph Salerno, and
Michael Stern for discussing opportunity costs and other esoteric economic
riddles with me. Matthew McCaffrey is an excellent editor and I thank him
for his great advice and his patience. Of course, I take full responsibility for
any remaining errors.
Chapter 3: From Marshallian partial equilibrium to Austrian general
equilibrium: the evolution of Rothbard’s production theory
Patrick Newman
The author would like to thank Peter Boettke, Peter Klein, Matthew McCaffrey, Ennio Piano, Joseph Salerno, and an anonymous referee for helpful

comments. In addition, he thanks the Ludwig von Mises Institute for the use
of the Murray N. Rothbard archives, as well as Barbara Pickard for archival
assistance. Any remaining errors are the author’s.
Chapter 5: The myth of the risk premium
Jörg Guido Hülsmann
Comments from Mr Maximilien Lambert and Mr Tom Cleverly are gratefully
acknowledged.
Chapter 7: Monopsony theory revisited
Xavier Méra
The author wishes to thank Renaud Fillieule, Guido Hülsmann, Tudor Smirna,
and Georges Lane for their comments on an earlier version of this chapter.
Any remaining errors are the author’s.
Chapter 9: Austrian economics and transaction cost economics: notes on
a doubtful compatibility
Mihai-Vladimir Topan
The author would like to thank Radu Muşetescu, with whom he has discussed
transaction cost economics ad nauseam. Any remaining errors are the
author’s.


xiv  Acknowledgements
Chapter 11: Economic calculation and the limits of social entrepreneurship
Matthew McCaffrey
The author would like to thank Carmen-Elena Dorobăţ and Patrick Newman
for helpful comments on the earlier drafts of this chapter. Any remaining
errors are the author’s.

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Introduction
The economic theory of costs in perspective
Matthew McCaffrey

At first glance, the “economic theory of costs” seems like a mundane topic, even
for the dismal science. The term does not call to mind fashionable research trends
in economics, nor does it clearly hint at pressing problems in the global economy.
In fact, if anything, questions about “the theory of costs” recall the years of “high
theory” in the early twentieth century  – and rightly so. At that time, economics was still carving out its niche in the social sciences, and therefore welcomed
deep and wide-ranging discussion of its fundamental problems. It was thus a
very different discipline from the narrowly empirical and formal profession it has
become, in which “big” questions, and earlier chapters in the history of thought
in general, are mostly irrelevant. However, although they represent a road not
taken (or, rather, a road discontinued), the years of high theory are in many ways
exemplary. They witnessed many vigorous exchanges of ideas between major
economists, debates that laid foundations for modern work that have only partly
been exploited.
For reasons that will become clear, many of the vital problems of this era, and
of economics in general, can be grouped under the heading “the economic theory
of costs.” The present book draws together several new and valuable contributions
to this literature. Before outlining its contents, however, I would like to explain
further what is meant by “the economic theory of costs,” as well as clarify how
the topic fits within economics in general, and why it is worth studying. Doing so
will also help to describe the scope and purpose of the individual chapters, and of
the collection as a whole.
Despite appearances, the theory of costs is neither an obscure nor an uninteresting strand of economic research. In fact, it is a cornerstone of economic thinking
that can profoundly influence fundamental theory, its countless modern branches
and applications, and even other social sciences and management disciplines. Far
from being a relic of a forgotten era, then, the study of costs lies at the center of a
vibrant and ongoing research agenda in and around all fields of human action and

social relations.
The concept of cost has played a prominent role in economics for more than
two centuries. Most importantly, in the classical era, costs – specifically, the
long-run costs of production – were often given pride of place as the ultimate


2  Matthew McCaffrey
explanation prices (Klein, 2007, p.  8; Buchanan, 1969, pp.  1–7). They were
thus inextricable from any discussion of the essential theorems of economics.
Nevertheless, the exact relevance of costs for value and prices was fiercely
debated, resulting eventually in the overturn of the classical approach by the
marginalist revolution that began in 1871. This sea change in economics thoroughly revised the theory of costs. Today, costs remain inextricable from the
theory of value, but for the opposite reason than the one imagined by the classical economists.
The rise of marginalism is mainly associated with the work of Carl Menger,
William Stanley Jevons, and Léon Walras. However, it was Menger who most
fully realized the potential of the subjective theory of value that lies at the heart
of marginalism (Menger, 2007 [1871]). Like his contemporaries, Menger helped
revolutionize the theory of cost by explaining that the value of any good is ultimately determined by its marginal utility to consumers. Yet he went a step further
in his explanation of the pricing process by showing that costs of production are
not an independent cause of value; on the contrary, the prices of the factors of
production (which together form the costs of production) are determined by the
value consumers assign to the finished goods the factors produce. The subjective
valuations of consumers thus stand in a causal relation to the objective prices that
appear on real-world markets (Salerno, 1999a).
In elaborating this theory, Menger thus identified two traits of sound economic
reasoning: first, it seeks to understand economic phenomena – e.g. prices, wages,
and interest rates – as they appear in the real world, and second, it investigates
causal relationships between these phenomena. These characteristics have led
some economists to describe Menger’s unique approach as “causal-realist.”
Menger’s ideas are usually associated with the geographical Austrian school, but

his writings inspired many economists outside the narrow confines of Vienna,
including Philip Wicksteed, Lionel Robbins, John Bates Clark, Frank A. Fetter,
and Herbert J. Davenport, each of whom contributed to the larger Mengerian,
Austrian, causal-realist tradition (Salerno, 1999a, 1999b; Klein, 2008).
Menger’s insights into value and price were most notably developed by Eugen
von Böhm-Bawerk and Friedrich von Wieser. Wieser is remembered mostly
for elaborating the opportunity cost concept, but Böhm-Bawerk also played a
formative part in early Austrian research, much of which involved clarifying and
defending Menger’s subjectivist approach to value theory (e.g. Böhm-Bawerk,
1962a [1891a], 1962b [1894], 2002 [1892]). In particular, Böhm-Bawerk repeatedly debated the role of costs in determining prices, and one of the crowning
achievements of early Austrian economics was to show, contra Marshall and the
classicals, that all prices are ultimately determined by subjective values, rather
than being determined by consumer values on the demand side and costs on the
supply side (Böhm-Bawerk, 1962b [1894]). Unlike value, which is a starting
point of economic theory, cost is a dependent concept. As Böhm-Bawerk put it,
The question of the relation of cost to value is properly only a concrete
form of a much more general question – the question of the regular relations

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Introduction  3
between the values of such goods as in causal interdependence contribute to
one and the same utility for our well-being.
(Böhm-Bawerk, 1962a, p. 14)
Nevertheless, costs are connected in various ways to virtually every fundamental concept in economics, including value, choice, utility, exchange, money,
profit, loss, and entrepreneurship (cf. for example, Böhm-Bawerk, 1962a, p. 13).
Böhm-Bawerk even remarked that in regard to “the interaction of price, value and
costs . . . it is in my opinion no exaggeration to state that to understand their connection is to understand a good half of economics” (Böhm-Bawerk, 1959, p. 249).
The present book offers a path toward the understanding to which BöhmBawerk alluded. Exploring the theory of costs was instrumental in the early

development of Menger’s subjective value theory, and it is no less important for
contemporary economists who hope to advance Menger’s causal-realist approach
through their own work. That is the purpose of this collection: to showcase a variety of research strands within the modern Mengerian tradition that relate in some
way to the theory of cost. The organization of the topics follows a logical progression, beginning from the fundamental concept of choice – where the idea of cost
also begins  – and building up to discussions of pricing, production, economic
organization, and comparative economic systems.
In Chapter  1, Jonathan Newman surveys a recent controversy over the idea
of opportunity cost. Contemporary mainstream economists are divided about the
exact meaning of this vital concept, as well as the question of how it should be
taught to students. In particular, competing definitions of opportunity costs have
sown confusion in both economic research and teaching. Newman explains that
this confusion can be resolved by appealing to the thoroughly subjectivist view
of opportunity cost developed in the causal-realist tradition. If we recognize that
opportunity costs refer to a subjective and ordinal preference ranking, the tension
between different views of opportunity cost evaporates. However, some critics
close to the Austrian school have disputed whether the idea of opportunity cost is
valuable at all. Newman also shows why these views are mistaken, and he defends
the continued use of opportunity cost as a foundational concept in economics.
Specifically, he argues that criticisms of opportunity cost depend on assuming
away the forward-looking nature of action and cost and also on falsely conflating
different kinds of choices that actors make.
The concepts of action, preference, and choice lead naturally to a discussion of
the formation of individual demand curves. In Chapter 2, Joseph Salerno outlines
a causal-realist method for deriving the key principles of demand analysis using
the individual’s ordinal scale of values. Value scales provide the basis for deriving
the law of marginal utility – which requires the assumption of the constancy of
money’s purchasing power – and in turn allow us to deduce individual demand
curves. Unlike mainstream economic theory, the demand curve in causal-realist
analysis is a temporal construct that refers to the individual’s personal economic
situation at the moment of his purchases. This implies that income, as a flow of

money, has no direct role in determining the demand curve, which is based solely


4  Matthew McCaffrey
on the individual’s value scale (a ranking of existing stocks of goods and money).
As a result, movements along the demand curve do not produce income effects,
which are a theoretical illusion. However, the causal-realist approach does shed
new light on the theory of substitution effects. That is, focusing on value scales
reveals that all goods are at least partial substitutes for each other. In fact, substitution is a necessary relationship that prevails among all goods. Finally, Salerno
argues that, even without the concept of the income effect, the causal-realist
approach still provides an explanation for the existence of a backward-bending
labor supply curve.
The causal-realist approach extends beyond the analysis of individual consumer behavior, however. In Chapter  3, Patrick Newman outlines some major
differences between the causal-realist and mainstream views of production
theory. His discussion relies on a proto-chapter  of Murray Rothbard’s treatise
Man, Economy, and State, which appears as Chapter 4 of this book. As Newman
explains, Rothbard’s early work relied on many conventional mainstream economic assumptions and concepts in order to explain producer’s activity, including
perfect competition and the isolated firm. Newman compares Rothbard’s earlier
chapter with his published work in order to chart the evolution of his thinking on
these vital economic topics. In particular, he shows that after drafting the original production theory that appears in Chapter 4, Rothbard became increasingly
aware of its theoretical shortcomings. He became especially critical of the Marshallian partial-equilibrium analysis he initially embraced. As a result, Rothbard
abandoned this analytical apparatus, choosing instead to use the works of earlier
writers in the causal-realist tradition to build a highly original “Austrian general
equilibrium” production theory that was eventually included in the final version
of Man, Economy, and State. However, although he eventually took a very different path in his theorizing, Rothbard’s proto-chapter – and Newman’s comparative
study of it – helps tease out several points of contrast between the causal-realist
and mainstream views of production, entrepreneurship, and the firm.
To take one example, a truly realist approach to economic theory cannot rely
excessively on equilibrium constructs that abstract from the passage of time, and
therefore assume away the problems of risk and uncertainty. In Chapter  5, Jörg

Guido Hülsmann revisits the theory of risk and questions the current role that risk
plays in economics, especially in the theory (and real-world formation) of interest
rates. He rejects the view that interest rates can be viewed as the arithmetic sum of
several separate, identifiable components. In contrast to this view, he argues that in
a free-market setting, all known risks either are accounted for through entrepreneurial judgment, or are irrelevant to acting individuals. As a result, observable interest
rates cannot contain a risk premium; instead, differences in prices that appear to
reflect compensation for increased risk are actually nothing more than reflections
of different subjective evaluations of available investment opportunities.
Importantly, the concept of uncertainty is far more challenging for economic
analysis than risk. In Chapter 6, Jeffrey Herbener uses this fact as a starting point
for integrating the element of time into causal-realist production theory. Time
brings with it the problem of uncertainty, which in turn has a profound influence

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Introduction  5
on the production process. In particular, uncertainty implies that capitalist-­
entrepreneurs must speculate about the future discounted marginal revenue products of the factors they employ. Their anticipations, and the interaction of the
anticipations of all entrepreneurs in the market, cause the costs of production
to conform to output prices regardless of the technical relationships that exist
in production. The spectrum of quality in entrepreneurial foresight determines
the speed and accuracy of this process, and also explains the profits earned by
entrepreneurs during the adjustment, profits that are missed by their less-astute
competitors.
As explained above, the theory of costs is inextricable from the body of price
theory, which in turn provides the basis for analyzing production in both free
and hampered market economies. In Chapter 7, Xavier Méra examines the latter
case, specifically, the problem of monopsony. Méra explains that although early
causal-realist writings hinted at the possibility of monopsony, later writers like

Mises and Rothbard largely dismissed the idea as unimportant. The reason is that
both older and newer monopsony theories fail to adequately distinguish between
monopsonistic and competitive prices. However, Méra argues that in their writings on monopoly the Austrian critics actually laid the foundation for a theory of
“monopoly price-gap” in which monopsony and monopoly prices are part of the
same phenomenon, namely, the hampered market economy.
Austrians are not alone in their criticisms of the mainstream economic approach
to costs. In Chapter 8, Mateusz Machaj surveys some common ground between
Austrian and Post-Keynesian theories of price formation. Like Austrians, PostKeynesians are critical of the conventional view that firms operate in practice by
equalizing marginal costs and marginal benefits. A  growing body of empirical
research suggests that real-world managers do not make decisions according to
this rule. Machaj argues that this “business practice” critique is nothing more than
an alternate way of expressing how the Austrian theory of “imputation” plays out
within the firm. This common ground means that some Post-Keynesian arguments
can strengthen Austrian critiques of mainstream price theory.
However, not all strands of economic thought are compatible with the causalrealist approach. Mihai-Vladimir Topan argues in Chapter 9 that the transaction
costs paradigm is one such. He examines the transaction costs literature, especially the work of Ronald Coase, in light of the two fields in which it is most
successful: the economic analysis of property rights, and the theory of the firm.
According to Topan, neither application of transaction costs is successful. The
reason is that the concept of transaction costs is both vague and based on a faulty
distinction between production and exchange, or between the firm and the market.
As a result, transaction costs are at best helpful as heuristic devices in those limited contexts where they can be defined clearly and unambiguously.
Topan’s critique of the transaction costs theory of the firm leads logically to
the question of economic organization. In this field, causal-realist price theory
provides a bridge between the theory of the firm and the study of comparative
economic systems. Specifically, Mises’s theory of economic calculation can be
used to explain the unhampered market economy and the firms within it as well as


6  Matthew McCaffrey
economic conditions under a system of socialist central planning. Mises’s famous

critique of socialism showed decisively that without genuine market prices based
on private property and the entrepreneurial division of labor, it is impossible for
central planners to accurately appraise the costs of their decisions, and therefore
to allocate resources to their most urgent uses (Mises, 1990).
In Chapter  10, Per Bylund returns to Mises’s argument and elaborates one of
its vital distinctions: the difference between entrepreneurs and managers. Entrepreneurs, in their capacity as owners and decision makers, bear the uncertainty of
investing in the market in order to create value. Managers, on the other hand, are
limited to adjusting the technological conditions of production in order to ensure the
physical efficiency of production methods that have already been tried and tested
by entrepreneurs. The implication is that although unhampered market economies
will tend toward constant improvement in consumer welfare, socialist societies
are managerial and lack the ability to revolutionize production in an innovative,
entrepreneurial way. Consequently, they will be at best static and at worst – and
more likely – will persistently decline in terms of their ability to improve consumer
welfare.
The problem of economic calculation also applies outside the extremes of
purely for-profit enterprise and socialist central planning: calculation is also a
vital lens through which to view alternative forms of economic organization in
the market economy. In Chapter  11, Matthew McCaffrey examines one such
example: the growing field of social entrepreneurship. Although it attracts major
interest in management studies, social entrepreneurship has received scant attention from economists. This chapter resolves this oversight by placing the theory
of social entrepreneurship on an economic foundation. McCaffrey outlines the
economic meaning of social behavior and shows that conventional market entrepreneurship is deeply social, while at the same time, social ventures are inevitably
bound up with some kind of profit motive. This implies that the line between
social and conventional entrepreneurship is not as clear as is sometimes thought.
Importantly, social enterprises must engage in economic calculation if they want
to survive in competitive markets. This means they must rely on external prices
for the goods and services they produce, as without them they cannot estimate the
social opportunity costs of their decisions.
It is not an accident that this book concludes with discussions of economic calculation; in many ways, Mises’s contributions in this field unify and complete

the work begun by Menger, Böhm-Bawerk, and many others who attempted to
explain the role of costs in individual action and in the social order. The following
chapters each attempt to develop a part of the systematic body of economic theory
built by these economists over the course of more than a century. By doing so, they
show clearly that the theory of costs in the causal-realist tradition is a valuable and
indeed a vital theoretical framework for understanding a wide range of economic
problems old and new. The tradition established by Menger thus continues to grow
and thrive through these and many other published works. However, only a tiny
portion of all potentially relevant writings can be discussed in these pages: due to
the limitations involved in assembling a collection such as this, and the enormous
scope of the theory of cost, some important topics have fallen by the wayside.
These include the law of comparative advantage and the theory of externalities, as

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Introduction 7
well as studies of specific works like James Buchanan’s Cost and Choice (1969)
and the many important papers included in his collection L.S.E. Essays on Cost
(1981 [1973]). These may seem like unforgivable omissions; however, we can satisfy ourselves with the knowledge that these works already receive attention from
scholars in and around the Mengerian tradition, and hope that this trend continues.
The chapters included here offer an antidote to some of the worries plaguing
mainstream economic thought. The causal-realist approach they embody is especially vital at a time when the economics profession is under attack for its lack of
realism and inability to address urgent problems at all levels of the economy, and
even to explain them to people outside its ranks. Fortunately, alternative frameworks
can and do encourage progress toward addressing each of these criticisms, and their
current success in doing so is a cause for optimism. To take only one example, it is
notable that in addition to their academic responsibilities, many of the contributors
to this book are also founders or leaders of thriving private organizations that take
the public teaching of economics as their mission, a task in which mainstream economics has little interest. In any case, it is our hope that this collection will further

develop research and teaching in the Austrian, causal-realist tradition, its engagement with other approaches to economics, and its relevance for other disciplines.
Matthew McCaffrey
University of Manchester
May, 2017

References
Böhm-Bawerk, Eugen von. 1959. Positive Theory of Capital. Trans. George D. Huncke
and Hans F. Sennholz. South Holland, IL: Libertarian Press.
———. 1962a [1891]. “The Austrian Economists.” In Shorter Classics of Böhm-Bawerk.
South Holland, IL: Libertarian Press, pp. 1–24.
———. 1962b [1894]. “The Ultimate Standard of Value.” In Shorter Classics of BöhmBawerk. South Holland, IL: Libertarian Press, pp. 303–370.
———. 2002 [1892]. “Value, Cost, and Marginal Utility.” Quarterly Journal of Austrian
Economics 5 (3): 37–79.
Buchanan, J. M. 1969. Cost and Choice: An Inquiry in Economic Theory. Chicago: University of Chicago Press.
———. 1981 [1973]. L.S.E. Essays on Cost. New York: New York University Press.
Klein, Peter G. 2007. “Foreword.” In Principles of Economics. Auburn, AL: Ludwig von
Mises Institute, pp. 7–10.
———. 2008. “The Mundane Economics of the Austrian School.” Quarterly Journal of
Austrian Economics 11 (3–4): 165–187.
Menger, Carl. 2007 [1871]. Principles of Economics. Auburn, AL: Ludwig von Mises
Institute.
Mises, Ludwig von. 1990. Economic Calculation in the Socialist Commonwealth. Auburn,
AL: Ludwig von Mises Institute.
Salerno, Joseph T. 1999a. “Carl Menger: The Founder of the Austrian School.” In Fifteen
Great Austrian Economists. Ed. Randall G. Holcombe. Auburn, AL: Ludwig von Mises
Institute, pp. 71–100.
———. 1999b. “The Place of Mises’s Human Action in the Development of Modern Economic Thought.” Quarterly Journal of Austrian Economics 2 (1): 35–65.


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Part 1

Cost and choice


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