Abstract
This chapter reviews Wicksteed’s, Davenport’s and F Knight’s subjective theory of opportunity cost, and the ways in which this theory offered a superior explanation of the relationship between cost, price and utility to the mainstream neoclassical conception. Conventional Marshallian microeconomics regresses back to the “cost of production” theories of the classical school, by splintering the price theory into two unrelated subfields: consumer behaviour/demand explaining the “short-run” and the theory of the costs of production, explaining the “long-run”. Wicksteed, Knight and Davenport, in line with radically subjectivist views of marginalism, wanted to unify these two fields on subjectivist foundations. Wicksteed derived both consumer and producer behaviours from individual utility, and reduced the cost and supply to preferences by using the ‘total demand-stock’ analysis of price determination (instead of conventional supply-demand analysis). Davenport corrects the mistaken view by Bohm-Bawerk who admitted the Marshallian double standard of value (utility and disutility/cost), and insists that utility and scarcity together determine value, both of consumer and producer goods. The theory of entrepreneurship as forward-looking price speculation, and of costs as “objectified” entrepreneurial assessment by Knight and Davenport are contrasted with the Marshallian “real cost” theory, that leaves little room for the entrepreneur.
This is a preview of subscription content, log in via an institution to check access.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Notes
- 1.
See James Buchanan (1999). Cost and Choice. Indianapolis: Liberty Fund.
- 2.
Frank Knight is in many respects an idiosyncratic thinker who is difficult to classify because of the vast bread of his interests and eclectic nature of his results and views. However, in this book he will be classified as a member of the Austrian or psychological school, based on his methodological views, his emphatic subjectivist reductionism and his emphasis on general equilibrium framework of analysis. Interestingly enough, Knight’s famed views of uncertainty and entrepreneurship that are nowadays most highly esteemed in the Austrian school are viewed much more skeptically. For a strong appreciation of Knight’s theory of entrepreneurship the biggest merit goes to Ludwig von Mises who applied the Knightean views to great effect in his Human Action, as well as to a large number of Mises’ students and later followers in America, studying entrepreneurship, theory of the firm and their relationship to central planning see eg (Rothbard 2007; Foss and Klein 2012)
- 3.
This is one of the unrealistic assumptions that will be criticized by later economists, including Wicksteed, Haberler and others. If the constancy assumption is dropped then the relative significances of supply and demand converge but the same principle of demand-drive nature of both remains.
- 4.
Moreover, Knight emphasized that the very notions of irksomeness and effort are subjectively constituted, see op cit.
- 5.
Actually, Marshall himself was the originator of the concept of external economy, but Pigou was responsible for the most influential application see esp. Marshall (1890: 158–250).
- 6.
Pigou develops his theory of externality most thoroughly in the book A.C. Pigou (1912). Wealth and Welfare. London: Macmillan.
- 7.
A good recent appreciation of Knight’s contribution to the debate about Pigou effects is Harold Demsetz (2012), “The Problem of Social Cost: What Problem? A Critique of the Reasoning of A.C. Pigou and R.H. Coase”. Review of Law and Economics, Vol 7 no 1. In it Demsetz challenges the usual interpretation of Ronald Coase as a radical critic of Pigou and demonstrates that they share a similar misconception about the nature of cost and praises Knight for correctly demonstrating that in the presence of private property rights the problem of externalities will disappear.
- 8.
The absurd lengths to which the economists are ready to go in pushing the Marshallian view of the market equilibrium is nicely illustrated in a popular textbook “Principles of Economics” written by Tyler Cowen and Alex Tabarrok. In a section covering the famous Vernon Smith’s laboratory experiment with two group of students who trade the pieces of paper with assigned reservation prices, they pretend one group are “buyers” and the other are “producers”. Buyers have “consumer surplus”, seller have “producer surplus”. Buyers have “preferences”, sellers have “costs”. On the market buyers with strongest preferences will buy from “lowest cost” sellers. The absurdity of this producer-consumer dichotomizing was obvious: nobody was “producing” anything, people are trading stuff they’ve got for free. “Costs” of production for “sellers” were exactly zero. Yet Cowen and Tabarrok this way describe the conditions of the equilibrium: “…in the entire experiment only once was a seller with a cost greater than equilibrium price able to sell and only once was a buyer with a willingness to pay less than the equilibrium price able to buy—so total surplus was very close to being maximized throughout the experiment” (Cowen and Tabarrok 2018: 58).
The main problem here is why is it not enough to say that if buyer’s reservation prices are determined by his “willingness to buy”, then the seller’s reservation prices should be determined by his “willingness to sell”? What’s the purpose of inserting “costs” into the whole thing? What if sellers are not producers of anything but say people who are selling land, or inherited piece of real estate or an automobile received as a gift, or a painting bought 20 years ago for a trifle sum? What is the meaning of “seller’s cost” in these types of situations? It’s the same type of fallacy that Bohm Bawerk and Wicksteed found in Marxian labor theory of value. There are expensive goods that are not produced and that do not involve any labor at all, and worthless things that are produced with a great amount of labor. Similarly to Marxism, the Marshallian supply and demand, cost and preference model, allows only for the trades that involve goods you personally produced at “exertion costs” to you.
- 9.
This aspect of Wicksteed’s theory will become increasingly influential with the passage of time. Lionel Robbins famous essay “On the Nature and Method of Economic Science” generalizes Wicksteedean approach into a definition of economics as a science of human action with scarce goods (Robbins 1932). See Chap. 7 for a more detailed elaboration.
- 10.
One of the classical economics textbooks that consistently uses Wicksteedean total demand fixed stock model at the expense of supply-demand framework is famous “University Economics” by Allen and Allchian. It uses Wicksteedean graphs to illustrate all important microeconomic phenomena; not only the equilibrium analysis and price determination, but also applied topics like price controls, see Alchian and Allen (1972).
- 11.
The history of how this doctrine came to be accepted is discussed more in detail in Chap. 7.
- 12.
The next chapter explores the economic and ethical ramifications of the marginal productivity theory in greater detail. Here it is just hinted at as much as it is necessary to illuminate the notion of cost, but for a more detailed analysis I refer the reader to Chap. 4.
- 13.
Mises’ failure to realize this is clearly seen when he says: “Experience teaches that there is disutility of labor. But it does not teach it directly. There is no phenomenon that introduces itself as disutility of labor. There are only data of experience which are interpreted, on the ground of aprioristic knowledge, to mean that men consider leisure-i.e., the absence of labor-other things being equal, as a more desirable condition than the expenditure of labor.” Mises (1998: 65). What he calls disutility of labor is a utility foregone of leisure. Or perhaps utility foregone of other things that could be achieved with different kinds of labor.
- 14.
In his “History of Economic Analysis” Joseph Schumpeter confirms this by writing: “Discussion of the marginal utilities of means of production in the spirit of the theory of imputation easily leads to the recognition of the relevance to these marginal utilities of the elements of complementarity and substitutability of factors and of their alternative uses. By this route this Austrian arrived at what has been called the alternative use of opportunity theory of cost—the philosophy of the cost phenomenon that may be expressed by the adage: what a thing really costs us is the sacrifice of the utility of those other things which we could have had from the resources that went into the one we did produce…The most exhaustive treatment of this whole set of problems is to be found in H.J. Davenport’s Value and Distribution (1908), who preferred the equivalent term Displacement Cost (Schumpeter 1954: 917, 917f29)
- 15.
Frank Knight does the exact same thing in his study “Risk, Uncertainty and Profit”, i.e. identifies sacrifice and opportunity cost: “Cost is…“pain cost” or “opportunity cost”, as one prefers; there is no real difference in meaning between the two” (Knight 1921: 73f)
- 16.
The third part of Frank Knight’s great book “Risk, Uncertainty and Profit” is devoted to the problem of uncertainty and in Human Action Mises makes the same problem one of the central pillars of analysis. Modern “Austrian” theory of the firm and entrepreneurship is predominantly under the influence of Knight, see Foss and Klein (2012). Problem of entrepreneurship in the psychological school, particularly its non Knight-Davenport branch (Clark, Wicksteed, Fetter) is discussed here in Chap. 6. For a Misesian appreciation of Davenport’s theory of entrepreneurship see Richard Ebbeling (2013), “Herbert Davenport’s Economics of Enterprise and Entrepreneurship: A Centenary Appreciation,” Procesos de Marcado: Revista Europea de Economica Politica [The Market Process: A Review of European Political Economy], Vol. X, No. 2 (Autumn, 2013).
- 17.
In his book “Cost and Choice” Buchanan (1999) analyzes the history of the alternative cost doctrine, but he puts the main emphasis to the English LSE contribution, while neglecting the American contribution: Fetter, Clark and Knight are barely mentioned in his analysis.
- 18.
The degree to which this debate was lost for the psychological school is best shown by the universal acceptance of empiricism and positivism in modern economics. The fact that Hayek’s Nobel Prize speech, defending the orthodox psychological view of the method of economics is such a clear outlier in this respect, best reflects this shift. Here is Hayek: “while in the physical sciences the investigator will be able to measure what, on the basis of a prima facie theory, he thinks important, in the social sciences often that is treated as important which happens to be accessible to measurement. This is sometimes carried to the point where it is demanded that our theories must be formulated in such terms that they refer only to measurable magnitudes….It can hardly be denied that such a demand quite arbitrarily limits the facts which are to be admitted as possible causes of the events which occur in the real world. This view, which is often quite naively accepted as required by scientific procedure, has some rather paradoxical consequences. We know, of course, with regard to the market and similar social structures, a great many facts which we cannot measure and on which indeed we have only some very imprecise and general information. And because the effects of these facts in any particular instance cannot be confirmed by quantitative evidence, they are simply disregarded by those sworn to admit only what they regard as scientific evidence: they thereupon happily proceed on the fiction that the factors which they can measure are the only ones that are relevant.” (Hayek, Pretense of Knowledge, Nobel Prize Speech, 1974)
References
Alchian, Armen, and William Allen. 1972. University Economics. 3rd ed. Wadsworth Pub. Co.
Buchanan, J.M. 1999. Choice and Cost: A Inquiry in Economic Theory. Chicago: Markham.
Cowen, Tyler and Tabarrok, Alex. 2018. Modern Principles of Economics. Macmillan: fourth edition.
Davenport, H.J. 1913. The Economics of Enterprise. New York.
Demsetz, Harold. 2012. The Problem of Social Cost: What Problem? A Critique of the Reasoning of A.C. Pigou and R.H. Coase. Review of Law and Economics 7 (1): 1–13.
Ebbeling, Richard 2013. Herbert Davenport’s Economics of Enterprise and Entrepreneurship: A Centenary Appreciation. Procesos de Marcado: Revista Europea de Economica Politica [The Market Process: A Review of European Political Economy] X (2) (Autumn 2013): 415–421.
Foss, Nicolai, and Peter Klein. 2012. Organizing Entrepreneurial Judgment. Cambridge University Press.
Knight, F.H. 1921. Risk, Uncertainty and Profit. 1933 reprint. London: L.S.E.
———. 1924. Some Fallacies in the Interpretation of Social Cost. The Quarterly Journal of Economics 38 (4): 582–606.
———. 1928. A Suggestion for Simplifying the Statement of the General Theory of Price. Journal of Political Economy 36 (3): 353–370.
Marshall, Alfred 1890. Principles of Economics: An Introductory Volume. 1990 reprint of 1920 edition. Philadelphia: Porcupine.
Mises, L.v. 1998. Human Action. Scholar’s ed. Auburn: Ludwig von Mises Institute.
Pigou, A.C. 1912. Wealth and Welfare. London: Macmillan.
Rothbard, Murray N. 2007. Man, Economy and State with Power and Market. Auburn: Ludwig von Mises Institute.
Smith, Adam 1776. An Inquiry into the Nature and Causes of the Wealth of Nations. Glasgow.
Wicksteed, P.H. [1910]1933a. The Common Sense of Political Economy, Volume I. London: Macmillan.
———. 1933b. The Common Sense of Political Economy, Volume II. London: Macmillan.
Robbins, Lionel. 1932. An Essay on the Nature and Significance of Economic Science. London: Macmillan.
Schumpeter, Joseph. 1954. History of Economic Analysis. New York: Oxford University Press.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
Copyright information
© 2020 The Author(s), under exclusive license to Springer Nature Switzerland AG
About this chapter
Cite this chapter
Jankovic, I. (2020). Opportunity Foregone: Ango-American Psychological Theory of Cost. In: Mengerian Microeconomics. Palgrave Studies in Classical Liberalism. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-57749-0_3
Download citation
DOI: https://doi.org/10.1007/978-3-030-57749-0_3
Published:
Publisher Name: Palgrave Macmillan, Cham
Print ISBN: 978-3-030-57748-3
Online ISBN: 978-3-030-57749-0
eBook Packages: Economics and FinanceEconomics and Finance (R0)