Carl Menger

Menger used this insight to resolve the diamond-water paradox that had baffled Adam Smith (see Marginalism). He also used it to refute the labor theory of value. Goods acquired their value, he showed, not because of the amount of labor used in producing them, but because of their ability to satisfy people's wants. Indeed, Menger turned the labor theory of value on its head. If the value of goods is determined by the importance of the wants they satisfy, then the value of labor and other inputs of production (he called them "goods of a higher order") derived from their ability to produce these goods. Mainstream economists still accept this theory.

Menger used his "subjective theory of value" to arrive at one of the most powerful insights in economics: both sides gain from exchange, or in modern jargon, exchange is a positive-sum game. People will exchange something that they value less for something they value more. Because both trading partners do this, both gain. This insight led him to see that middlemen are highly productive: they facilitate transactions that benefit those they buy from and those they sell to. Without the middlemen these transactions either would not have taken place or would have been more costly.

Menger also came up with an explanation of how money develops that is still accepted today. If people barter, he pointed out, then they can rarely get what they want in one or two transactions. If they have lamps and want chairs, for example, they will not necessarily be able to trade lamps for chairs but must instead make a few intermediate trades. This is a hassle. But people notice that the hassle is much less when they trade what they have for some good that is widely accepted, and then use this good to buy what they want. The good that is widely accepted eventually becomes money. Indeed, the word pecuniary derives from the Latin pecus, meaning cattle, which in some societies served as money. Other societies have used cigarettes, cognac, salt, furs, or stones as money. As economies became more complex and wealthier, they began to use precious metals (gold, silver, and so on) as money.

Menger extended his analysis to other institutions. He argued that language, for example, developed for the same reason money developed—to make interaction between people easier. He noted that neither language nor money was developed by government. He called such developments "organic."

The Austrian school of economic thought first coalesced from Menger's writings and those of two young disciples, Eugen von Böhm-Bawerk and Friedrich von Wieser. Later Austrian economists Ludwig von Mises and Friedrich Hayek, used Menger's insights as a starting point, Mises with his work on money and Hayek with his idea of "spontaneous order."

Carl Menger was born in Galicia, part of Austro-Hungary (now southern Poland), to a prosperous family. He was one of three talented brothers; Anton was a legal philosopher and socialist historian, and Karl was a prominent mathematician. Carl earned his doctorate in law from the University of Krakow in 1867. As a result of publishing his Principles of Economics in 1871, he was given a lectureship and then a professorship at the University of Vienna, which he held until 1903. In 1876 he took a tutoring post for the Crown Prince Rudolf of Austria. In that capacity he traveled throughout Germany, France, Switzerland, and England.