Lecture 2: Freedom in the Market: Ludwig von Mises (1881-1973)

Freedom and Society: Classical Liberalism in the Twentieth Century

A Course with Professor Thomas Patrick Burke
Spring 2007

We pointed out in the last lecture that although the earlier arguments for the free society were made on moral or philosophical grounds, once the science of economics developed sufficiently the role of defending liberty was largely taken over in the twentieth century by economists. Ludwig von Mises is one of those economists who delivered a fatal blow both to Marxism and to certain conservative views of the economy (the Prussian Nationalist school) that were opposed both to Marxism and to liberty. To understand Mises, it will be helpful to begin with Marx.

Karl Marx

Marx’s criticism of capitalism hinged on the concept of exploitation. Employers, he maintained, exploited their workers by appropriating to themselves the product of the workers’ labor. Capitalists were guilty of theft. This accusation was supported by two theories he held: the labor theory of value and the theory of surplus value. To understand these theories and their eventual rebuttal by Mises and other economists, we need to examine something of the history of economic thought.

As soon as thinkers began to reflect on the system of exchanges that we call the market, they asked themselves the question: what is it that determines the price of an item? It was generally agreed that the price of an item was a reflection of its value. But what was meant by its value, what was the source of that value, and how could the value be known? For prices often fluctuate significantly, but they tend to fluctuate around a basic or stable mean. So the price is clearly not the same as the value, which must be something fixed and stable, yet it must be related to it.

Aristotle argued that when two different kinds of item which have nothing in common are exchanged for one another, for example (a slightly grotesque example, but his) a certain number of shoes for a certain number of houses, this can only happen because each of them is equal to a third thing which acts as the measure of value. X number of shoes must have the value V, and Y number of houses must also have the value V. Only this equality makes the exchange possible. But where did this value V come from? Aristotle says it comes from demand. (Nicomachean Ethics, Book V, Ch. 5)

In traditional societies the person who produces an item will typically attempt to sell it at a price based on the cost of producing it. One assigns a certain cost to the raw material, say the leather of the shoe, a certain cost to the labor of making the shoe, and one adds a certain percentage for profit. During the middle ages this was often referred to as the fair or just price, provided the percentage for profit was not too high, and to charge a price significantly higher was condemned by the church as immoral. (The idea of a just price is exemplified also in the idea of a just wage, which was to play an equally prominent role in modern Catholic social teaching.) Eventually it was pointed out that the cost of the raw material was actually just the cost of the labor of producing the raw material, so that the price of the finished item consisted only of the cost of labor plus the percentage for profit. This is known as the labor theory of value. It was explained vividly and persuasively by Locke:

“…it is labour indeed that puts the difference of value on every thing; and let any one consider what the difference is between an acre of land planted with tobacco or sugar, sown with wheat or barley, and an acre of the same land lying in common, without any husbandry upon it, and he will find that the improvement of labour makes the far greater part of the value. I think it will be but a very modest computation to say, that of the products of the earth useful to the life of man nine tenths are the effects of labour: nay, if we will rightly estimate things as they come to our use, and cast up the several expenses about them, what in them is purely owing to nature and what to labour, we shall find that in most of them ninety-nine hundredths are wholly to be put on the account of labour. (Second Treatise, par. 40)

A society’s standard of living depends far more on its labor than on its natural resources, he points out.

“There cannot be a clearer demonstration of anything, than several nations of the Americans are of this, who are rich in land, and poor in all the comforts of life; whom nature having furnished as liberally as any other people, with the materials of plenty, i.e. a fruitful soil, apt to produce in abundance, what might serve for food, raiment, and delight; yet for want of improving it by labour, have not one hundredth part of the conveniencies we enjoy; and a king of a large and fruitful territory there, feeds, lodges, and is clad worse than a day-labourer in England. (Par. 41)

It is labor that converts resources into wealth.

“To make this a little clearer, let us but trace some of the ordinary provisions of life through their several progresses, before they come to our use, and see how much they receive of their value from human industry. Bread, wine and cloth are things of daily use and great plenty; yet notwithstanding, acorns, water and leaves or skins, must be our bread, drink and clothing, did not labour furnish us with these more useful commodities; for whatever bread is more worth than acorns, wine than water, and cloth or silk than leaves, skins or moss, that is wholly owing to labour and industry; the one of these being the food and raiment which unassisted nature furnishes us with; the other, provisions which our industry and pains prepare for us, which how much they exceed the other in value, when any one hath computed, he will then see how much labour makes the far greatest part of the value of things we enjoy in this world; and the ground which produces the materials is scarce to be reckoned in as any, or at most but a very small part of it; so little, that even amongst us, land that is left wholly to nature, that hath no improvement of pasturage, tillage or planting is called, as indeed it is, waste; and we shall find the benefit of it amount to little more than nothing. (Par. 42)

This fact suggests that the secret of achieving a wealthy society is to have a large population rather than extensive territory.

“This shows how much numbers of men are to be preferred to largeness of dominions; and that the increase of lands, and the right employing of them, is the great art of government; and that prince who shall be so wise and godlike as by established laws of liberty to secure protection and encouragement to the honest industry of mankind, against the oppression of power and narrowness of party, will quickly be too hard for his neighbours… (Par. 42)

“An acre of land, that bears here twenty bushels of wheat, and another in America, which, with the same husbandry, would do the like, are, without doubt, of the same natural intrinsic value; but yet the benefit mankind receives from the one in a year, is worth 5 pounds and from the other possibly not worth a penny, if all the profit an Indian received from it were to be valued, and sold here; at least, I may truly say, not one thousandth. It is labour then which puts the greatest part of value upon land, without which it would scarcely be worth anything: it is to that we owe the greatest part of all its useful products; for all that the straw, bran, bread, of that acre of wheat is more worth than the product of an acre of as good land, which lies waste, is all the effect of labour; for it is not barely the ploughman’s pains, the reaper’s and thresher’s toil, and baker’s sweat, is to be counted into the bread we eat; the labour of those who broke the oxen, who digged and wrought the iron and stones, who felled and framed the timer employed about the plough, mill, oven, or any other utensils, which are a vast number, requisite to this corn, from its being feed to be sown to its being made bread, must all be charged on the account of labour, and received as an effect of that: nature and the earth furnished only the almost worthless materials, as in themselves… ” (Par. 43)

I have quoted Locke at length here so that you can see this theory was not some passing whim or idle supposition for him but had a solid foundation, and because this passage is relevant not only to his labor theory of value but also to his famous argument for private property, to which we will eventually return.

This labor theory of value was also accepted by Adam Smith.

“Every man is rich or poor according to the degree in which he can afford to enjoy the necessaries, conveniences, and amusements of human life. But after the division of labour has once thoroughly taken place (the subject of Smith’s first chapters), it is but a very small part of these with which a man’s own labour can supply him. The far greater part of them he must derive from the labour of other people, and he must be rich or poor according to the quantity of that labour which he can command, or which he can afford to purchase. The value of any commodity, therefore, to the person who possesses it, and who means not to use or consume it himself, but to exchange it for other commodities, is equal to the quantity of labour which it enables him to purchase or command. Labour, therefore, is the real measure of the exchangeable value of all commodities.

“The real price of everything, what everything really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. What everything is really worth to the man who has acquired it, and who wants to dispose of it or exchange it for something else, is the toil and trouble which it can save to himself, and which it can impose upon other people. What is bought with money or with goods is purchased by labour as much as what we acquire by the toil of our own body. That money or those goods indeed save us this toil. They contain the value of a certain quantity of labour which we exchange for what is supposed at the time to contain the value of an equal quantity. Labour was the first price, the original purchase-money that was paid for all things. It was not by gold or by silver, but by labour, that all the wealth of the world was originally purchased; and its value, to those who possess it, and who want to exchange it for some new productions, is precisely equal to the quantity of labour which it can enable them to purchase or command.

“Wealth, as Mr. Hobbes says, is power. But the person who either acquires or succeeds to a great fortune does not necessarily acquire or succeed to any political power, either civil or military. His fortune may, perhaps, afford him the means of acquiring both, but the mere possession of that fortune does not necessarily convey to him either. The power which that possession immediately and directly conveys to him is the power of purchasing a certain command over all the labour, or over all the produce of labour, which is then in the market. His fortune is greater or less, precisely in proportion to the extent of this power; or to the quantity either of other men’s labour, or, what is the same thing, of he produce of other men’s labour, which it enables him to purchase or command. The exchangeable value of everything must always be precisely equal to the extent of this power which it conveys to its owner.” (Wealth, Ch. 5)

Smith sees, however, that it is not easy to calculate how much labor an item contains, and so the exact relationship between the price of an item and the quantity of labor it contains must be uncertain.

“But although labour be the real measure of the exchangeable value of all commodities, it is not that by which their value is commonly estimated. It is often difficult to ascertain the proportion between two different quantities of labour. The time spent in two different sorts of work will not always alone determine this proportion. The different degrees of hardship endured, and of ingenuity exercised, must likewise be taken into account. There may be more labour in an hour’s hard work than in two hours’ easy business; or in an hour’s application to a trade which it cost ten years’ labour to learn, than in a month’s industry at an ordinary and obvious employment. But it is not easy to find any accurate measure either of hardship or ingenuity. In exchanging, indeed, the different productions of different sorts of labour for one another, some allowance is commonly made for both. It is adjusted, however, not by any accurate measure, but by the higgling and bargaining of the market, according to that sort of rough equality which, though not exact, is sufficient for carrying on the business of common life.

“Every commodity, besides, is more frequently exchanged for, and thereby compared with, other commodities than with labour. It is more natural, therefore, to estimate its exchangeable value by the quantity of some other commodity than by that of the labour which it can purchase.” (Ch. 5)

This other commodity is gold or silver: money.

Marx is in good company, therefore, when he accepts the same labor theory of value. He not only accepts it, but proposes a method of calculating the quantity of labor in any item and so of comparing the values of two different items. The aim of his analysis, however, is very different from that of Locke or Adam Smith: it is to undermine the very concept of exchange, of a commodity, and so of the market.

First, Marx affirms the traditional Aristotelian concept of value:

“Let us take two commodities, e.g., corn and iron. The proportions in which they are exchangeable, whatever those proportions may be, can always be represented by an equation in which a given quantity of corn is equated to some quantity of iron: e.g. 1 quarter corn = x cwt. (hundredweight) iron. What does this equation tell us? It tells us that in two different things, — in 1 quarter of corn and x cwt of iron, there exists in equal quantities something common to both. The two things must therefore be equal to a third, which in itself is neither the one nor the other. Each of them, so far as it is exchange value, must therefore be reducible to this third.”

This third is labor. Marx distinguishes between the utility or use-value of an item and its exchange value. In exchanges, he believes, the utility of the item plays no role.

“If then we leave out of consideration the use-value of commodities, they have only one common property left, that of being products of labour.”

In the process of exchange, the different kinds of labor become homogenized. We abstract from the particular kind of labor used to produce the item. It cannot

“…be regarded as the product of the labour of the joiner, the mason, the spinner, or of any other definite kind of productive labour. Along with the useful qualities of the products themselves, we put out of sight both the useful character of the various kinds of labour embodied in them, and the concrete forms of that labour; there is nothing left but what is common to them all; all are reduced to one and the same sort of labour, human labour in the abstract.”

This abstract, homogeneous labor-value of an item can be measured by the labour-time required to produce it in that particular society, “the labour-time socially necessary for its production.” The unit of homogeneous labour-time is arrived at by totalling up the entire labor-time of the society and averaging it out.

The utility of an item, in Marx’s analysis, functions only as a precondition for the exchange to take place. He concedes that “nothing can have value, without being an object of utility.” But “if the thing is useless, so is the labour contained in it; the labour does not count as labour, and therefore creates no value.”

Up to this point it must be conceded that Marx has said little that is truly new. But now he takes a further step, to create the concept of “surplus value.” This arises, on his account, from the simple fact that the laborer can produce more than he costs his employer in wages. The exchange value of labor (reflected in what it costs the employer) is something entirely distinct from its use-value (what it is capable of producing), Marx states. Let us assume that a day’s labor by the workman costs the employer $100. This will represent (according to the “Iron Law of Wages” popularized by Lassalle) the minimum wage necessary to keep the workman and his family alive. And let us suppose that all the other costs of the employer for this day’s work — furnishing the tools, renting the building, etc. — come to $50. But during this day the laborer can produce goods that his employer can sell for perhaps $200. This extra $50 represents “surplus value.” “Our capitalist foresaw this state of things, and that was the cause of his laughter.” This surplus value is what makes capital.

“By turning his money into commodities that serve as the material elements of a new product, and as factors in the labour process, by incorporating living labour with their dead substance, the capitalist at the same time converts value, i.e. past, materialized, and dead labour into capital, into value big with value, a live monster that is fruitful and multiplies.” (Marx, Ch. 7, sec. 2)

Ludwig von Mises

Let us now investigate Mises’ analysis of this. He states several theses, which we can summarize as follows:

— Although there are valuations, there is no such thing as exchange “value.” There are only prices.

— Valuations are not objective but subjective.

— There is no tertium quid , no third thing that the object bought and the object sold are equal in value to.

— The object of the exchange is always not a class but an item — this is the concept of the “margin.”

Let us take the case where I am buying a book from you for $20. This means that I prefer the book to the $20, while you prefer the $20 to the book. Each of us has a different preference. This preference is a valuation: a valuation is always relative, it means the act of preferring one thing over another. If our valuations were the same, no exchange would take place. If we want to use the language of values, the book has two different values to each of us, and the $20 also has two different values. But it is better to speak of valuations, because these “values” are entirely subjective.

When I make the decision to buy your book for $20, the amount of labor that has gone into making the book is completely irrelevant. The figure of $20 reflects relative demand, or demand relative to supply. Initially, in order to arrive at the price you desire, you may have added up the total cost of producing the book and added a percentage for profit. But if no one wants to buy it, your calculations are in vain. On the other hand, if there is only this one copy of the book and thousands of people want to buy it, they may be willing to give you far more than you initially asked; in this case your calculations are also in vain. The figure of $20 will be realistic if other people have bought this or similar books for similar figures.

The price of the book is always the price of this particular volume. Let us suppose that 5,000 copies of it were printed, and the first 4,000 sold in one day at $20. On the second day people might be willing to pay more than $20 to make sure they bought one. If all 4,999 have been sold, and still 1,000 people want to buy the remaining one, its price might well go up to $1,000. This is the idea of the “margin.” We shall return to it below.

Mises writes:

“An inveterate fallacy asserted that things and services exchanged are of equal value. Value was considered as objective, as an intrinsic quality inherent in things and not merely as the expression of various people’s eagerness to acquire them. People, it was assumed, first established the magnitude of value proper to goods and services by an act of measurement and then proceeded to barter them against quantities of goods and services of the same amount of value. This fallacy frustrated Aristotle’s approach to economic problems and, for almost two thousand years, the reasoning of all those for whom Aristotle’s opinions were authoritative. It seriously vitiated the marvelous achievements of the classical economists and rendered the writings of their epigones, especially of Marx and the Marxian school, entirely futile. The basis of modern economics is the cognition that it is precisely the disparity in the value attached to the objects exchanged that results in their being exchanged. People buy and sell only because they appraise the things given up less than those received. Thus the notion of a measurement of value is vain. An act of exchange is neither preceded nor accompanied by any process which could be called a measurement of value. An individual may attach the same value to two things; but then no exchange can result. But if there is a diversity in valuation, all that can be asserted with regard to it is that one is valued higher, that it is preferred to one .” ( Human Action, Ch. XI, p. 203f.)

It follows from Mises’ analysis that there is no such thing as a “just price” or a “just wage,” since both concepts presuppose that economic value is an objective rather than a subjective reality. (This was a conclusion that the philosopher Thomas Hobbes had already arrived at in the seventeenth century: “The value of all things contracted for is measured by the appetite of the contractors, and therefore the just value is that which they be contented to give.”)

Having explained something of Mises’ rebuttal of Marxism, and thus shown, as I hope, his immense relevance today, I wish to turn to a few aspects of his overall system of thought as explained in Human Action.

Human Action

1. Although this work bears the subtitle “A Treatise on Economics,” it is actually rather more. For Mises, the laws of economics are exemplifications of broader basic principles governing human action in general, and the study of these broader principles, to which the book is devoted, he terms “praxeology.” The subtitle would be more accurate, then, if it read “A Treatise on Praxeology,” though it would also certainly be more obscure. While we are on the subject of terminology, we mention in passing his frequent use of “catallactics,” a word taken from the Greek word for an exchange, and used by Mises for a branch of praxeology which provides “the analysis of those actions which are conducted on the basis of monetary calculation,” “the elucidation of a system in which there are money prices and economic calculation.” This is the economics of a market society or “economics in the narrower sense,” as opposed to the broader questions that economics, and with it praxeology, must investigate. For “in order to conceive the market fully one is forced to study the action of hypothetical isolated individuals on one hand and to contrast the market system with an imaginary socialist commonwealth on the other hand.”

2. The laws of praxeology, or human action in general, are not summations of experience, but are known a priori, that is, independently of experience. This is a term that in the history of modern philosophy is associated especially with the name of Emmanuel Kant, who considered that the basic rules of morality are of such a nature. An example in the realm of economics is the proposition that if the supply of an item increases its price will fall, all things else being equal. We usually believe this as soon as we know what is meant by the words in the sentence, such as “supply,” “price,” and perhaps others relevant to them such as “demand.” We do not have to wait until we have had years of experience of the market: it is a matter of logic. This is true, says Mises, of all the fundamental principles of economics. If they do not require experience to confirm them, they also cannot be disproven by experience.

He writes:

“Praxeology is a theoretical and systematic, not a historical, science. Its scope is human action as such, irrespective of all environmental, accidental, and individual circumstances of the concrete acts. Its cognition is purely formal and general without reference to the material content and the particular features of the actual case. It aims at knowledge valid for all instances in which the conditions exactly correspond to those implied in its assumptions and inferences. Its statements and propositions are not derived from experience. They are, like those of logic and mathematics, a priori. They are not subject to verification or falsification on the ground of experience and facts. They are both logically and temporally antecedent to any comprehension of historical facts. They are a necessary requirement of any intellectual grasp of historical events. Without them we should not be able to see in the course of events anything else than kaleidoscopic change and chaotic muddle.”

The fundamental principles of economics are known, like the theorem of Pythagoras in geometry (in a triangle, the square of the hypoteneuse is equal to the sum of the squares of the other two sides), by thoroughly examining their terms. It is sometimes maintained that any proposition whose truth is known from an examination of its terms is a mere tautology and can add nothing to our knowledge. Yet it would be hard to deny that the theorem of Pythagoras was an addition to our knowledge.

One of the important consequences of the a priori character of the laws of economics is that it is foolish and self-defeating to deny the validity of economics, as some social activists do who find its conclusions out of harmony with their worldview. While any particular theory in economics is open to being disproved by a more thorough examination of its logic, the science as a whole cannot be rejected rationally, any more than logic can be.

3. The Austrian School

Human Action is one of the books most representative of the Austrian School. This term stands more for a viewpoint than a geographical entity. Its best-known exponents have been Carl Menger, generally thought of as its founder, Ludwig von Mises, Friedrich (von) Hayek and Joseph Schumpeter, but there have been several others not so well known in the English-speaking world. Not all of them have come from Austria, and not all economists who come from Austria have belonged to this school. More recent American representatives have been Murray Rothbard, Israel Kirzner and Henry Hazlitt. The school has been distinguished by several features:

— Within the discipline of economics, it has been economists associated with this school who have spearheaded the attack on Marxism and socialism. By contrast, many economists belonging to the mainstream, usually termed neoclassical, have been rather relaxed about these movements, or have even sympathized with them to some extent. Something similar applies to Keynesianism. The Austrians typically argue that useful economic calculation is impossible without private property and without the distributional system of the market.

We mentioned in the first lecture that there are two basic kinds of argument for the free society, one based on utility, the other on morality. The Austrian case against Marxism and all forms of collectivism is based entirely on utility. Some of these writers, such as Hayek, have made a moral case, but with a utilitarian conception of morality.

— By the same token, it is the Austrian economists who have done the most to defend the ideal of a laissez-faire economy. The mainstream neoclassical majority often have no particular conception of an ideal economy beyond a few basic principles, but tend to take particular questions as they arise.

— Austrian economics emphasizes the significance of the individual and of individual choice. It is only individuals who act. A science of human action must therefore in the first place be a study of individual action. There is no such thing as an action of “society” or of any group or collectivity that is not an action of one or more individuals.

— Related to this, Austrian economics emphasizes, as we have seen in Mises, that exchange value is not something objective but is purely subjective.

— In particular, it has been the Austrian economists who have been most responsible for developing marginalism. If there is one feature that separates modern economics from the classical economics that preceded it, it is the concept of “marginal utility.” This concept was largely developed by Carl Menger, the founder of Austrian economics, but it has been accepted far beyond the limits of that school. There seems reason to believe that it was when Marx discovered that this idea had been developed that he ceased work on Das Kapital , which was never finished. And indeed among modern economists it is widely given credit for having exploded Marx’s theory.

The classical economists (Adam Smith, David Ricardo) had encountered the following stumbling block in their theory of value. This theory explained the prices of items by their underlying value, as we saw above. But in the market, things that have a high value for human life often have a low market value or price, whereas things that have a low value for human life can have a high market value and price. A common example given was the contrast between water and diamonds. Water is indispensable for life, yet is sold cheap on the market, while diamonds are a superfluous luxury we can well live without, yet they are extremely costly.

The French writer Turgot put forward the suggestion that market value, instead of being objective, as generally assumed, was in fact purely subjective, a reflection of the desires of the individuals involved. This thesis was developed further by Carl Menger into the full theory of marginalism. The solution grasped by Menger was that the object of a purchase or sale is not water as such or diamonds as such, but this particular bucket of water and this particular diamond. Now the price of this particular bucket of water depends not only on the value of water as such for human life, but above all on the abundance or scarcity of water at that location; and similarly with the diamond. If the individual already has plenty of water, one more bucket of it will be worth little if anything to him, but if he has none, it will be worth a great deal. Similarly, the price of diamonds is high, not because they are indispensable for human life, but simply because, while being beautiful, they are also very scarce. If diamonds lay everywhere around, their price would be no higher than that of water. Marginal utility is the utility of this last bucket of water or this last diamond.

The concept of the margin can also be used with other concepts, such as productivity. An employer contemplating hiring an additional employee will make a rational decision, not necessarily by hiring the most talented person, but by discovering how much additional income this particular person will bring in over and above the additional cost of his wages.

The concept of marginal utility destroys the idea of intrinsic or objective market value. It makes plain that market value is entirely a function of the subjective desires of buyers and sellers, and has nothing to do with any quality inherent in the object.

To return to some further distinctive features of the Austrian school of economists:

— They have been more skeptical about empirical observation and experiment in economics than their neoclassical colleagues. The Austrian approach is more philosophical. Preferences for one item over another can be expressed, but the intensity of preference or desire cannot be measured, they assert. This has been one of the chief differences separating them from the more mainstream neoclassical theory, and after the Second World War it resulted in their being largely marginalized by mainstream economists.

— The Austrians have emphasized the role of the entrepreneur, as the initiator of new forces in the economy. Related to this, they give special importance to the uncertainty of the market and to risk. An entrepreneur is one who acts in the midst of uncertainty and who therefore shoulders risk.

— Neoclassical economics centers its calculations on the concept of “equilibrium,” where demand and supply balance one another. By contrast, the Austrians argue that the true state of a living economy is always disequilibrium.

— The Austrians emphasize the dispersal of knowledge. The knowledge needed to run an economy is dispersed among all the participants in it, and it is impossible for government to possess this knowledge.

Mises’s books are:

The Theory of Money and Credit,

Nation, State, and Economy,

Socialism: An Economic and Sociological Analysis,

Critique of Interventionism,


Epistemological Problems of Economics,

Omnipotent Government: The Rise of Total State and Total War,


Human Action: A Treatise on Economics,

preceded by National?konomie in 1940

Theory and History: An Interpretation of Social and Economic Evolution,

The Anti-Capitalistic Mentality,

The Ultimate Foundation of Economic Science.

Terms for discussion

Opportunity cost


Austrian Economics



action and choice


classical economics: explaining prices, objective value

subjective value

marginal value

a priori