Premise #2: The Imputed Value of “Higher-Order” Goods

Part I showed that the starting point both of the goods-character and the value of goods is subjective. The conception of a good, in other words, begins in the minds of thinking and acting human beings and radiates outward towards their physical surroundings. In this context a second premise, also drawn from Menger’s Principles, is relevant: human action is purposeful and thus tends to concentrate upon the establishment of the goods-character and value of things that most directly satisfy consumers’ wants. Menger categorises these things, such as food, clothing, shelter, domestic appliances, leisure and entertainment, as “consumers’ goods” (which are also known as “lower order” goods and “goods of the first order”). More generally, lower-order goods are goods that are consumed by their final users. 

Clearly, however, consumer goods must be produced, and Menger dubs the intermediate and capital goods required to produce consumer goods as “producers’ goods” (also known as “higher order goods” or “goods of the second and higher orders”). Steel provides a vastly simplified example. Consumers neither desire, consume nor value steel per se; instead, they desire, consume and value certain goods of which steel is a component. Consider a consumer good, such as a motor car, which contains much steel. The machines (i.e., welders, riveters, etc.) required to assemble a car’s steel components, as well as the components themselves, can be regarded as second-order producers’ goods. Taking the process of manufacturing back one stage, the machines, machine tools and materials required to produce the components (such as moulds, blast furnaces, pre-fabricated steel, etc.) can be conceived as third-order producers’ goods; and the materials required to produce these goods, such as processed iron ore and coal, are fourth-order producers’ goods, and so on. 

Menger’s insight is that the goods – characters – and, as we shall see, values and prices – of consumers’ goods radiate outward from human beings and their subjective wants towards external things more remote from the direct satisfaction of those wants. Accordingly, given a particular supply of (say) iron ore the more valued by consumers are the consumers’ goods whose manufacture requires iron then the more valuable is the supply of ore. Further, the greater the value imputed to iron ore the greater the incentive to transform a given “thing” (such as an unextracted deposit of ore) into higher-level producers’ goods (mined ore, processed ore, pig iron and steel) and ultimately into lower-level consumers’ goods (motor cars, refrigerators and washing machines). 

By means of this process of value imputation, then, the prices of producers’ goods are derived from the prices of consumers’ goods; and the prices of consumers’ goods are inferred from the value which consumers impute to those lower-order goods’ ability to satisfy their wants. In the view of Menger (which modern Austrians have inherited), the technical process of production proceeds forwards, i.e., from goods of higher order to goods of lower order; and at each stage there occurs a transformation of the good into another good which more directly satisfies consumers’ wants. For this reason, and to use a much-bastardised phrase, the creation of value is envisaged at each stage. Production thus proceeds from goods relatively remote from the direct satisfaction of human wants and towards goods relatively close to the satisfaction of those wants. The economic process of valuation, on the other hand, proceeds backwards, i.e., from goods of lower order to goods of higher order. The imputation of value, in other words, proceeds from more refined goods back to the less refined goods required to produce them.

Individuals, then, demand neither iron ore and petroleum nor smelters and refineries; nor do they value iron and crude oil per se. Rather, they demand (for example) motor cars and the convenience that personal transport provides; and the prices of the motor car and its associated higher-order goods are derived from the value which consumers attach to the convenience of personal transport. Similarly, and strictly speaking, individuals do not demand heating oil, natural gas or electricity directly: instead, they demand and value the comfort and convenience which oil-, gas- and electrical-powered consumers’ goods (such as heaters and air conditioners) furnish. It is in this manner that the prices and values of these lower-order producers’ goods are derived from and depend upon the satisfaction consumers derive from their associated consumers’ goods.