Carl Menger (1840-1921) addressed the "diamond-water paradox" that had been puzzling classical economists: the fact that humanity finds diamonds more valuable than water although water is far more important. Like the philosopher Schopenhauer, Menger concluded that people followed impulses more than reason. Menger focused on the uncertainties in human behavior. He asserted that complete knowledge of what is going to happen economically does not exist and that decisions based on expectations of what will happen involve risk. Producers take a risk because they cannot predict with certainty that what they receive in sales will be greater than their production costs. As obvious as this is to people today, it was not the economic model that was standard before Menger. With these observations Menger began what became known as the Austrian School of Economics. Menger believed that it was for entrepreneurs to collect and evaluate information as best they could and to take calculated risks – a view that more than a century later would appear as platitude.
Carl Menger. He introduced into pricing theory the public acting other than with logic.
A fellow Austrian, Eugen von Böhm-Bawerk (1851-1914), read Carl Menger's "Principles of Economics," became an adherent of his theories and wrote criticisms of Marx's economics, describing capitalists as helping rather than exploiting their employees. Böhm-Bawerk taught courses at the University of Vienna, and among his students were those who would become well-known as associates of the Austrian School of Economics: Joseph Schumpeter, Ludwig von Mises and Henryk Grossman.
Schumpeter taught at Harvard beginning in 1932 and was most influential. He described capitalism as in a failure-success continuum rather than just headed for failure as Marx had described. Schumpeter claimed that socialistic creations would hamper the beneficence of the individualist entrepreneur hero. Among his students was Alan Greenspan, chairman of the US Board of Governors of the Federal Reserve, 1987-2006, who shared with Ayn Rand a belief in the individualist enterpreneur hero.
Ludwig von Mises and Friedrich von Hayek were also from Europe. They ran from Hitler, von Mises to New York and Hayek to London. Hayek was responding to European fascism and to economic policies in the Soviet Union. He claimed that government guided by majority opinion made sense only if that opinion was independent of government. Hayek believed it best to leave a free play of ideas among the masses in economic matters. He and von Mises believed that people following their own innovations and doing what they see as in their interest is better than a few bureaucrats trying to constrict economic development into a plan of their making – no matter how bright the planners. Hayek won the Nobel Memorial Prize in Economic Sciences in 1974.
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