Ask Mint | Austrian school: it doesn’t rely on complex mathematical models

Ask Mint | Austrian school: it doesn’t rely on complex mathematical models
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First Published: Mon, Aug 17 2009. 12 14 AM IST

Updated: Mon, Aug 17 2009. 12 14 AM IST
The most common belief is that economists never speak in plain language, no matter what you do with them. Lay all of them end-to-end or lock them in a cage or leave them on a deserted island—they would never speak without using mathematical equations.
With so many economic schools of thought, looking for simple economic truths of life is really a tough job. But don’t be disappointed. There is one school—the Austrian school of economics—that provides valuable insight into some of the most important issues of our times without using complex formulas.
Johnny: That’s interesting. But first, can you provide a brief introduction to the Austrian school?
Jinny: The Austrian school is one which believes that you can understand complex economic issues without going to any laboratory, by simply using your own thinking power. This school has evolved through the years; however, its line of thinking remains the same. Carl Menger, an Austrian economist, is considered by many as the founder of the Austrian school.
Other than Menger, this school also includes other big names such as Ludwig von Mises, Eugen von Böhm-Bawerk, Friedrich Hayek and many others. Today, the influence of the Austrian school extends far beyond the boundaries of Austria and you could find its disciples across the world.
Illustration: Jayachandran / Mint
The Austrian school is different from other schools of economics because it does not rely on complex mathematical models to prove its point. The economists of the Austrian school derive their understanding by using what is called a priori thinking—something which appeals to our logic on its own without any support of a mathematical model.
Johnny: Can you talk about any economic issue from the side of the Austrian school, so that I can know how these economists think?
Jinny: Okay, let’s talk about inflation, a favourite topic of discussion among economists. You might have heard about disequilibrium of demand and supply causing inflation. If demand for goods and services exceeds supply, their prices increase until the demand and supply are again in equilibrium. The rise in prices is called inflation.
Mainstream economists go to great lengths to find out how money supply is mathematically linked with the equilibrium of demand and supply. Mainstream economists try to understand everything about price rise with mathematical precision.
They fail to understand anything which can’t be captured in their mathematical models. For instance, there is no mathematical model which could precisely explain how and why inflation affects different people differently. To understand some of these real-life issues, you need to set aside your complex mathematical models and think like an economist of the Austrian school.
The Austrian school would explain the whole process as follows: Inflation affects different people differently because prices of all goods and services do not increase simultaneously. This sounds logical even without mathematical proof. Prices of some goods may increase faster than others, leading to greater disparity in the relative income of people. For instance, the price of a loaf of bread may increase faster than the price of a bottle of milk.
A milkman may be earning the same amount of money by selling a bottle of milk but he has to pay more to buy the same loaf of bread. In other words, the baker is becoming richer and the milkman is becoming poorer because the price of bread has risen faster than the price of milk.
Johnny: Can the Austrian school explain why it happens like that?
Jinny: Now, that’s something which we need to understand. If the prices of all goods and services were to increase uniformly, then inflation would hardly have mattered. The milkman can earn more by selling a bottle of milk at a higher price and use the extra earning to buy a loaf of bread at a higher price. No gain, no loss.
But the Austrian school believes that prices of goods and services increase in a non-uniform manner only when the government or central bank increases money supply without any commensurate increase in the production of goods and services. The prices of those goods and services through which the money is injected into the system would increase before the prices of other goods and services. Say, for instance, if the central bank decides to inject money by purchasing scrap metal, then the price of scrap metal would start rising faster than the prices of other goods and services.
The prices of other goods and services would increase only when the extra money introduced into the system starts moving around. For instance, the dealer of scrap metal may use his extra money to buy more corn, which would push the price of corn upwards. Increase in money supply has a ripple effect in an economy.
Johnny: Well, this may not be the last word on inflation, but we should surely ponder upon what the Austrian school has to say on different economic issues.
Many things in life can’t be stated in terms of mathematical equations.
What:The Austrian school of economics provides unique insights into some of the most complex economic issues.
How: The economists of the Austrian school derive their understanding by using a priori thinking.
Who: Carl Menger is considered to be the father of the Austrian school. Other big names such as Ludwig von Mises, Eugen von Böhm-Bawerk and Friedrich Hayek also belong to this school.
Shailaja and Manoj K. Singh have important day jobs with an important bank. But Jinny and Johnny have plenty of time for your suggestions and ideas for their weekly chat. You can write to both of them at realsimple@livemint.com
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First Published: Mon, Aug 17 2009. 12 14 AM IST