An Introduction to Austrian Economics

This is the first part of my series where I examine Bitcoin through the lens of Austrian economics. This part is a short primer on some of the core study methodologies used in the Austrian school of economics.

Austrian economics is a school of economic thought and a way of economic thinking. Like all other schools of economic thought, Austrian economics aims to describe the social world. Austrian economics is a framework for economic analysis: it is a set of analytical assumptions about how markets and economies fundamentally work. At the root level, the Austrian analytical framework analyzes phenomena from specific beliefs and assesses whether various claims hold any truth or are based on flawed logic. From these assumptions, one can start logically deducting conclusions for multiple topics. This makes Austrian economics a science of human action based on deductive reasoning. Deductive thinking is something an individual can think about without relying on the external world and without ever experiencing it personally. This thinking is used to discover universally applicable economic laws that govern the social world, which consists of people and their interaction with each other.

One needs to understand some core assumptions in Austrian economics to apply the Austrian analysis framework to the phenomenon of money more broadly and bitcoin more specifically.

Human action and praxeology

The core premise is that economics stems from praxeology, which studies human action. Praxeology is a deductive study methodology where knowledge comes from the power of reasoning. Specific topics are best explored with a logical, verbal deduction from observed or previously deduced premises. This can be contrasted with natural sciences, where the most basic analysis method is an experiment. Assumptions taken as truths can be called axioms (hypotheses), self-evident statements. The core hypothesis of praxeology is human action, which is the premise that humans act purposefully to achieve their goals, i.e., satisfy their wants.

Using praxeology and deductive reasoning with the hypothesis of human action as the starting point makes it possible to create universal and objective conclusions about human behavior. In Austrian economics, praxeology is used because economics is considered a social science and thus, should not rely on methods of natural sciences because they deal with fundamentally different matters.

Methodological individualism

All economizing is based on methodological individualism, the principle that subjective individual motivation, not group dynamics, explains social phenomena. This implies that the actions of groups cannot explain social phenomena and markets; groups do not think, feel, value, and act. Individuals do. To adequately describe the actions of a group of people, one should focus on the individuals who operate within a group; all economic life begins and ends with the individual. Thus, all markets result from human action and spontaneous occurrences and are not human design. Markets are evolutionary processes that emerge from individual choices over time. Following this logic, markets are self-organizing and adaptive organisms, and we, as humans, cannot construct and reconstruct them as we wish. Another related principle is methodological singularism, which focuses on single concrete actions instead of wholes and universals.

Methodological subjectivism

Praxeology and economics do not offer value judgment about an individual's goals and whether they are good or bad. It accepts subjective ends as true and does not judge them. It only looks at individuals' tools to achieve their individual end goals. Goals are diverse, just as individuals are diverse beings. Methodological subjectivism explains how individuals make judgments and choices based on whatever knowledge they have or think they have and the expectations they entertain concerning their decisions and choices. Methodological subjectivism dictates how tastes, preferences, cost, value, and utility are subjective. Only the recipient of a product or a service can evaluate how valuable said product or service is. To understand the actions of an individual, one should try looking at his actions only by reference to the knowledge, belief, perception, and expectations of this individual.

Methodological subjectivism is closely tied to another vital concept: opportunity costs, the costs with which economic actors evaluate the alternatives that must be sacrificed. Austrian economics dictate that opportunity cost is subjective as only the individual himself can know what they imagine they would have gotten out of the choice they did not make. This is because the cost is never experienced. After all, we give it up for another opportunity and, therefore, another unknown cost. Just like opportunity costs, the value of everything is subjective.

Marginalism

The central concept of the theory of marginal analysis is the theory of marginal utility. This theory states that an individual's overall utility is determined by the significance of the last unit added or subtracted from the total amount of units. This results in either positive or negative marginal utility, depending on whether the added unit increases or decreases overall utility. The theory of marginal utility is closely tied to subjective value, which explains the value of all things in the social world. This is linked to the law of diminishing marginal utility, which dictates that with an increase in the number of goods, their subjective value diminishes in an individual's mind.

Time preference

Another key concept is the time structure of production and consumption, i.e., time preference, the ratio at which individuals value the present compared to the future. The assumption is that all things being equal, individuals prefer their goals to be achieved sooner rather than later. All individuals have a positive time preference, which can be observed that if they always preferred to reach their goals later than sooner, they would never act. Whenever individuals delay satisfying their wants, it is because of the future anticipation of higher satisfaction than what is available immediately. Future satisfaction needs to be sufficiently valued higher than the present in the individuals' minds for it to compensate for the delay. The subjective cost of delay is compared with the subjective valuation of higher future satisfaction. The delay thus dictates the degree of time preference.

The very essence of economic science is to discover the laws governing economizing individuals, which is to understand the phenomena we observe in economic life resulting from individuals' purposeful economic actions. To sum up, the scientific approach of Austrian economics is to accept the foundational praxeological reasoning, which assumes that individuals engage in purposeful behavior instead of being reflexive to exogenous triggers. And from this axiomatic statement, economics focuses not on how humans should act but on what tools they should use to reach their end goals.

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