Praxeology is the distinctive method of the Austrian School of Economics. This term, first coined by Ludwig von Mises, means “the science of action”. Praxeology takes as its starting-point the action axiom, which says, simply, that man acts. Acting implies choosing a goal and employing the means considered suitable to the achievement of such goal. Acting means trying to exchange a less satisfactory state of affairs for a more satisfactory one. This axiom is self-evident and it does not need to be demonstrated through experience. It is not self-evident in a psychological sense, i. e. evident to everyone, but in the sense that any attempt at refutation leads to its confirmation. Thus, the critic trying to refute the action axiom is himself performing an action: he has a goal and employs certain means to achieve it (time to think, certain arguments, his own body to express those arguments, etc.).
Praxeology builds from the intellectual principles included in the category of human action through logical deductions and equips us with the theoretical knowledge necessary for the interpretation of reality.
One of the key elements of praxeology is methodological individualism, i.e. the fact that only individual human beings act. Through methodological individualism, we can grasp the subjective nature of economic phenomena such as value or utility. By acting, a person is trying to achieve certain goals considered important for some reason. The word “value” refers to the subjective appraisal of his goal by the actor, with an intensity that varies according to different people, goals, and points in time. Means are anything that the actor considers suitable to help him reach his goal. The word “utility” refers to the subjective appraisal of means by the actor and it depends on the value assigned to the desired goal. Value and utility are two sides of the same coin, since the subjective value assigned by the actor to his goal, is projected onto the means considered suitable to achieve it.
Another key feature of the Austrian school is its reliance on the logical method in contrast with the mathematical method used by most of the mainstream economists. As Huerta de Soto has explained, verbal language is more suitable to economic analysis than mathematics because it allows us to capture more perfectly the essence of economic phenomena. Mathematical formalism cannot incorporate the subjective reality of time or human creativity.[i]
The study of nature, as it has been developed by the natural sciences, is based on the regularity of the concatenation of phenomena. Non-human entities react following regular patterns. Natural sciences assume an invariable uniformity in the concatenation and sequence of phenomena and, through induction, they infer from the regularity of past events the same regularity in future events. This assumption is necessary for the predictive capacity of natural sciences. The ideal research method would consist in the formulation of hypothesis that could be corroborated by the elaboration of experiments where one element is isolated and modified while the rest remain unchanged. This could lead to the formation of theories subject to verification, according to the positivism of the Vienna Circle, or to Popperian falsification. The existence of constant relations between different mechanical elements that can be established trough experiments is what allows the use of mathematical equations for the resolution of definite problems. However, in the field of human action, there are not such constant relations since man presents a purposeful behavior, i.e. man chooses his desired ends and the means to attain them. Therefore, as Mises stated, “the equations formulated by mathematical economics remain a useless piece of mental gymnastics”.[ii]
The praxeological analysis accomplished through logical deductions from the action axiom helps us to clarify and understand important economic phenomena. We will show four significant examples.
1) THE LAW OF DIMINISHING MARGINAL UTILITY.
The law of diminishing marginal utility states that the greater the supply of a good, the lower the utility of a unit of that good; the smaller the supply, the higher the utility of a unit.[iii]
As we have seen, human action implies the use of means for the achievement of ends. From this, we deduce that means are scarce since they wouldn’t be taken into account for the achievement of ends if they weren’t and, therefore, they wouldn’t be objects of action. Since means are scarce, there is the need to economize them, i. e. to allocate them in such a way that they serve to the achievement of the most desired ends. From this, we can deduce that the larger the supply of means available, the larger the number of ends that can be satisfied.
The scarcity of means implies that not every end can be achieved. Action takes place by choosing which ends shall be satisfied by the employment of means. Acting man must rank his ends hierarchically in a scale of values and his action demonstrates this hierarchy.
The actor evaluates only those physical units of a means that enter into his concrete action, he chooses and evaluates specific units of a means. For example, he may evaluate units of cows or units of horses, but he does not evaluate “cows” or “horses” in general. The actor does not choose between classes of means, but between specific units of them. Each unit that enters into his concrete action is graded and evaluated separately. Only when several units together enter into human action are all of them evaluated together. This process of evaluation according to the specific units involved provided the solution for the famous “value paradox”. Classical economists were unable to explain why people valued platinum highly than bread when it was evident that bread was more useful. However, as Rothbard has explained, acting man does not evaluate goods according to abstract classes but in terms of specific units available. Man does not care whether “bread in general” has more or less value than “platinum in general”, but whether, given the presently available stock of bread and platinum, a loaf of bread is more or less valuable to him than an ounce of platinum.
People value goods at the margin. If an individual has a definite supply of a good and must give up one unit, he must renounce the satisfaction provided by that unit, which will be the lowest ranked satisfaction that can be attained with that supply. This least important end fulfilled by the stock is known as the “marginal utility”, and this is the utility with wich is valued each unit of a supply of a good. The satisfaction provided by the unit which the actor would have to give up is at the margin. That is the reason why it is called marginal utility.
The marginal analysis can also be applied to production through the value of marginal productivity, which consists of the contribution to the production process, expressed in monetary terms, of a unit of a factor of production. Marginal productivity depends on the physical product produced by a unit of a factor and the valuation of the product by the consumer, i.e. is determined by the marginal physical productivity (the physical quantity that can be imputed to an unit of a factor or, in other words, the quantity of a product that would be foregone with the loss of a unit of a factor of production) times the price of the product.
2)THE LAW OF DIMINISHING RETURNS.
The law of diminishing returns states that in a process of production where the quantity of one of the factors varies while the quantity of the other factors is held constant, there always exists some optimum amount of the varying factor. If one deviates from this optimum, the quantity produced does not increase at all or at least not in the ratio of the increased factor.
This law has a praxeological foundation. The factors of production used in the production of a consumer good are means to the satisfaction of a need. In a production process is always necessary the cooperation of more than one factor of production, since, at least, labor and time are always necessary. Otherwise the good would have appeared magically and instantaneously. The necessity of the existence of an optimum is deduced from the necessity of the cooperation of more than one factor of production. If there were no optimum, the average product would increase indefinitely as the quantity of the varying factor increased. This would mean that any desired quantity of the product could be secured by merely increasing the supply of the varying factor. It would also mean that the scarcity of the other factors would not matter since any quantity of the product could be obtained by increasing the quantity of the varying factor. Therefore, the other factors would not be means for the action, since their scarcity would not matter and, as we have seen, means are necessarily scarce. However, in a production process is always necessary more than one factor of production.
As Jeffery Herbener has explained, man, as a temporal being, distinguishes between sooner and later. He can, therefore, judge the value of attaining an end sooner differently than attaining it later, and he will prefer the satisfaction of an end sooner to the same satisfaction later.[iv] Temporality is deduced from the action axiom, since the establishment of the desired goal and the use of means to achieve it must precede the attainment of the goal. Temporal beings prefer the attainment of a goal sooner than later: time is scarce, therefore, is a means to economize. A man places a premium on present satisfaction over future satisfaction and places a discount on the satisfaction in the future. This discount, which consists in the lesser valuation of the satisfaction of needs in the future, will be uniform across all actions within the same intertemporal structure and will affect all actions regardless of when a person chooses to undertake any one of them. In choosing to take an action later, a person is demonstrating that the value of the action in the future exceeds its value in the present, even when the discount of the future is applied. This is consistent with the action axiom: acting man chooses a more highly valued alternative and foregoes a less highly valued one.
Acting man economizes his actions across all aspects of action subject to choice: ends, means, place, and time. The market economy performs this integration for society. Prices are determined by the underlying preferences of buyers and sellers. Prices of consumer goods are directly determined by the preferences consumers have for them as expressed in their demands for the goods. Prices of intermediate goods used to produce each consumer good are indirectly determined by consumer preferences as they generate revenue for entrepreneurs to justify the demand entrepreneurs express for them. Entrepreneurs pay each factor of production the monetary value of its contribution to production. If the factor payment is made sooner than the revenue is received from the sale of the output produced, then the payment is discounted because of time preference. This discount of future money relative to present money is interest and determines the pure, or time preference, rate of interest. Because all exchange of present money for future money of the same time structure involves time preference, the pure rate of interest is uniform across all such intertemporal exchange. It follows that all present goods that generate future money will have their prices determined by discounting the future money by the rate of interest to obtain the equivalent amount of present money. This process of capitalization results in a uniform rate of interest as the difference between the present money spent to acquire factors of production and the future money obtained from selling the output produced. Prices, so determined, are the basis for economic calculation which permits entrepreneurs to appraise the lines of production and investment that people find most valuable.
In short, the law of time preference states that people prefer “present goods” (goods available for use at present) to “future goods” (present expectations of goods becoming available at some date in the future), and that the social rate of time preference, the result of the interactions of individual time-preference schedules, will determine and be equal to the pure rate of interest in a society.
4)THE LAW OF COMPARATIVE ADVANTAGE.
This important principle is also known as the law of association or the law of comparative costs. David Ricardo, one of the classical economists, was the first author to formulate this law for a specific case, that of two countries engaged in international trade but for whom capital and labor were not free to move. However, only the Austrian School has been able to realize the universal nature and consequences of the law of association.[v]
If we imagine two individuals, each one better suited for the production of a specific good, it is obvious that the total production of both goods will increase if each individual specializes in the production of that good for which he is more productive and does not waste time in the production of that good for which he is less productive. Both individuals benefit from cooperation, specialization and the exchange of the product of their labor. However, what if one of the individuals is superior in the production of both goods? In this case, they would also benefit from cooperation if the superior person specializes in the production process in which he has the higher relative superiority and leaves the production process in which he has the lower relative superiority to the other person.
Manuel F. Ayau has explained this principle with the imaginary case of two individuals called SuperJoe and InferJack. SuperJoe produces 12 pieces of bread and 6 garments in a 12-hour shift. InferJack produces 6 pieces of bread and 2 garments. The total for both products is 18 pieces of bread and 8 garments. If SuperJoe spends, instead of 12 hours for each product, 16 hours to the production of garments and 8 hours to the production of bread, and InferJack spends the 24 hours to the production of bread, they will produce, respectively, 8 breads/8 garments and 12 pieces of bread. Total production will have increased to 20 pieces of bread and 8 garments with no increase in total time worked. The only thing that has changed is that SuperJack and InferJoe have allocated their time according to comparative advantage,with Joe spending more time in the activity in which he has a higher relative superiority and with Jack spending more time in the activity in which he is relatively less inferior. Both benefit from specialization and exchange.[vi]
The only case where specialization and the division of labor would not suppose any advantage would be the extremely improbable case of a world inhabited by people endowed with the same productive capabilities in all aspects.