Carl Menger Explains the Nature of Goods

With the publication of his Principles of Economics in 1871, Carl Menger (1840–1921) laid the groundwork for the Austrian school. His contribution is famous beyond Austrian economics, because it was one of the fundamental works of the subjective value theory and of marginal analysis. Yet the content of Menger’s book goes much further. It has lost none of its appeal, as it is still one of the best books to learn how the market economy works. The present article is the first in a series that covers Menger’s seminal contribution. Following the German original closely, the following text provides interpretations and newly translated quotes that make the work accessible to the modern reader. The first installment of the series treats the concept of “goods.”

What Is a “Good”?

The totality of goods falls into two categories: material goods (including natural forces, insofar as they are goods) and useful human actions (or omissions), the most important of which is labor. In order to qualify as a good, a thing under consideration must be able to satisfy a human need but also be available and the connection between the properties of this thing and the satisfaction of human needs must be known. “Good” in this sense also includes useful actions and omissions. To qualify as a “good,” things and actions must relate to human beings. “The quality of a good is not something that adheres to the goods, it is not their property, but only presents itself to us as a relationship in which certain things are for humans, and with the disappearance from this relationship, things cease to be goods” (p. 3n).

Yet this relationship is not free of errors. In fact, a peculiar relationship can be observed where things that have no causal connection with the satisfaction of human needs are treated as goods. “This result occurs when properties, and therefore effects, are mistakenly assigned to things that don’t really belong to them, or human needs are mistakenly assumed and are not really there” (p. 4).

Menger calls those goods “imaginary goods” that are causal by valuation, but not in reality. These are things, which derive their quality as a good only from their imagined properties, or from people’s imagined needs. Examples of this are drugs that do not cure existing diseases and drugs for diseases that do not exist.

In any case, it is our judgment or rather opinion that establishes the quality of a good in a thing.

First- and Second-Order Goods

Menger defines as “first-order goods” those goods that can immediately satisfy our desires. These are goods which are capable of increasing our well-being and whose properties have a known causality with our well-being.

“Second-order goods” are those things which cannot be used in a direct causal connection with the satisfaction of our needs. Nevertheless, they possess the quality of good because they have an “indirect causal relation” to the satisfaction of human needs. While second-order goods are incapable of directly satisfying our wants, they are useful to produce first-order goods. First-order goods are in a direct causal relationship with human wants, second-order goods stand in an indirect causal relationship to them.

Inherent to the ensemble of goods, there is a structure depending on their distance from final consumption. Thus, it is theoretically possible to categorize second-, third-, or fourth-order goods, etc., starting, for example, with bread as the first-order good, which is capable of immediately satisfying human needs, with flour as the second-order good, wheat as the third-order good, and the field as the fourth-order good, with labor included in these orders.

What matters here is not the numbering of orders, but the causal connection between the good and the satisfaction of human desires. What matters are their degrees of transmission of causality.

Complementary Goods

In order for a higher-order good to have the quality of a good, the corresponding complementary goods must be at our disposal. In order to fulfill the categorical requirement of being a higher-order good, the necessary complementary good must be available, otherwise this thing or service loses its quality as a good.

First-order goods serve our satisfaction immediately. Second-order goods require transformation. All production is transformation and the whole economy can be imagined as a system of transformations wherein higher-order goods are modified for the purpose of becoming first-order goods.

“If we have first-order goods, it is in our power to use them directly to satisfy our needs. If we have the corresponding goods of the second order, it is in our power to transform them into goods of the first order and in this way to supply them to the satisfaction of our needs. If we only have third-order goods, we have it in our power to transform them into the corresponding second-order goods, and these again into the corresponding first-order goods” (p. 11). The quality of higher-order goods depends on our ability to transform them into the satisfaction of human needs, wants, and desires.

Higher-order goods (greater than the first order) require the use of higher-order complementary goods. This is a restriction of great importance, “because it lies by no means in our power to use a single good of a higher order to satisfy our needs unless we also have the other (complementary) goods of a higher order at our disposal” (p. 11).

If an existing second-order good can no longer be used because there is a lack of one or more of its complementary goods, this specific second-order good loses its quality as a good. When there is a lack of complementary goods, the corresponding good no longer possesses the power to satisfy human needs and thereby one of the essential prerequisites for the quality of goods is eliminated. From this it follows that the quality of a second-order good is subject to the availability of the necessary complementary goods of the same order in respect to the production of the first-order good.

Law of the Mutual Dependence of Goods

Summarizing these considerations, one can formulate the “law of mutual dependence of goods,” which says that the qualification of being a good of a higher order depends on the availability of complementary goods of a higher order necessary to generate the good of the first order. Higher-order goods comprise the totality of goods which are necessary for the production of a good of the first order, and complementary goods comprise the totality of goods that are necessary to produce a good of higher order for the purpose of producing a good of the first order (p. 15).

Menger illustrates this argument with a series of examples from the American War of Secession, when the lack of cotton from the Southern states caused a temporary supply shortage. This cotton shortage made the specialized textile machines in Europe along with the qualified labor in this industry useless, and they lost their quality of being goods. The interruption of supply chains affects the goods beyond those that are lacking. Although the machinery was physically the same as before and the workers in this area did not lose any of their qualifications, their good quality diminished or vanished.

These considerations lead to the principle that the quality of being a good of higher order is conditioned by the corresponding goods of lower order (p. 17). With the change in the satisfaction of desires for goods of the first order, goods of the higher order vary in their quality of being goods. Goods of higher orders lose immediately their good quality when the needs that they previously served to satisfy disappear. With the disappearance of the corresponding needs, the whole basis of the relationship between the goods crumbles and what constitutes the quality of being a good disappears.

From these considerations follow the law that “the goods of higher order concerning their quality as goods are conditioned by the quality of being a good of the goods of the lower order for whose production these goods of higher order are to serve” (p. 21).

Wealth Creation

Although the causal relations of the narrow production process may be clear, they do not represent the totality of the transformation process. In addition to the factors that belong to the world of the goods, the production process contains elements whose causal connection with human welfare may not yet be recognized or whose control may not already be understood.

This results from the fact that goods of a higher order acquire and maintain their good quality not with regard to the needs of the immediate present, but only with regard to human needs in the future. These values can only be anticipated by human foresight but not known, as they will only become valid at the time when the production process has been completed (p. 23).

The transformation process of goods from the higher to the lower order follows strictly the laws of causality and happens in time. According to the laws of causality, the goods of higher order become those of the next lower order and so on until they become goods of the first order and finally serve for the satisfaction of human needs.

Menger supplements Adam Smith’s theory of wealth creation. Besides occupational activity and commerce, the key to wealth creation is the transformation of goods to higher orders. Economic progress is linked to insight into causalities. This way, economic development and the accumulation of knowledge go hand in hand. Human development reaches out to extend production step by step into the realm of the higher-order goods. Menger makes it clear that besides commerce, the most important aspect of economic growth and development is knowledge about the connection between things and human welfare. Wealth creation is intimately connected with the expansion of knowledge.

Concluding Remarks

The structure of Principles of Economics begins with the analysis of goods. This analysis lays the foundation for the subsequent chapters that deal with time and error, the role of property, value, prices, exchange, and, finally, money. Future contributions will address these items.