Classical vs. Austrian???

My friend asked me a question that I could not entirely answer: what were the main differences, if any, between classical and Austrian economics? I have not been learning about the Austrian view for long and apologize if this is very obvious.

Classicists used the labor theory of value (Adam Smith should have had a position similar to Marx because of the LTV). They also looked at aggregates instead of marginal units (Diamond-Water Paradox). Those are the two big ones.

To elaborate on DSnead's reply (because I'm not sure how familiar your friend is with economics in general), the Classicists were unable to explain why diamonds held a higher price than water when water was clearly more "valuable" to life. Austrians solved this by demonstrating that no actual choices are made between the abstracts of "water" and "diamonds." Rather, only particular quantities of goods are relevant to choice (2 diamonds / 4 bottles of water). From here, Carl Menger used the theory of diminishing marginal utility to show that, as the quantity of a good goes up, each successive unit lowers the value of all of the units in the group to the level of that new unit. This provided a way for economists to explain how diamonds, in their drastically lower quantities, were usually more valued than bottles of water.

 EDIT: I just saw that you said you were new to Austrian Econ. Maybe you're already familiar with Menger's theory, but I'll go ahead and give you an illustration anyway just in case you're not.

Let's say you have 0 iPods in your possession. Then I give you one. What use to you put that new iPod toward? You probably keep it with you in your backpack or something (I'm making an assumption about your age, but run with it!), which is how many people use it. Regardless, the first good in a collection is always used in the way that it is valued most. You could have hooked that iPod up to your car stereo but you put it in your backpack because that's the "use" that you value most for any iPod.

Now I give you a 2nd iPod. "Ah," you think, "now I can put one in my car!"  A car audio upgrade is the "use" that you value second most for an iPod.

Finally, I give you a 3rd iPod. You think this is a little overkill, but you decide to hook it up to your home stereo because...well, you might as well. A home audio upgrade is the "use" that you value third most for an iPod.

But something has happened. With each additional iPod that you've received, you've noticed that you're a little less careful with all of them. Why? Because any of the three of your iPods could be used for any of your three uses. They're interchangeable. And the 3rd use is not as valuable as the 1st use to you. You'd sooner sacrifice the iPod in your home stereo before you sacrificed the one in your backpack. But because the iPod in your home stereo could replace the one in your backpack in the event that the latter was stolen, the use value of all of your iPods must equal the value of the least important use because you don't have to sacrifice your 1st use if you lose one of them. You just switch your iPods! The iPod on the lowest rung of your ladder is your "marginal unit." Because the value of the marginal unit always shrinks when you add an additional unit to your quantity of goods (because you can't put two of the same good to exactly the same use), we say that the value of that good  "diminishes" with each additional unit in your possession. It's even possible for utility to diminish so far as to be negative. Can you imagine owning seven dogs in a town house? You'd be giving them away until the point that you valued the amount of dogs left more than the amount of space and money that they require to survive (in this case observing the marginal utility of dogs increasing, rather than diminishing, as your quantity shrinks).

Thus, diminishing marginal utility. It's a handy little theory that explains how value shifts in everything from money to steaks to back scratches.

Thank you for that explanation. Your guess about my age was right I suppose (22). I am actually an econ major and studied under Thomas DiLorenzo at Loyola College. At first I bought into what was said about him, most of the other teachers found him to be over the top and some actually did not believe he should be employed there. But he did a great job of introducing Austrian Economics without preaching. By the time I finished my second course with him I was more or less won over. But since graduating I have been trying to further my education and often get in debates with friends. Of course, the Ron Paul run has peaked my interest. I have just purchased "Human Action" and awaiting its delivery. I suspect I should have a much greater understanding of Austrian Economics when I am finished.

Thank you again for your help. Is it safe to say that Classical economists and Austrian economists agree on many fundamental principles?

As far as their political economy goes, classicists and Austrians do not diverge too much. One could say that the Austrians saved the faith in the market that the classicists held from ruin.

Inquisitor:

As far as their political economy goes, classicists and Austrians do not diverge too much.

 

The way it divurged greatly is the classical liberals were studying "political" economy (3 factor - land, labor, capital - production/distribution) which had a moral component around distributive justice (who and under what terms, conditions, obligations gets access to "land"). The Austrians as neo-classicals claimed that land was essentially no different than capital and converted to a 2 factor - labor vs. capital - production system that was solely focused on corrective justice as an amoral excercise (voluntarily trading subjectively determined like goods).

Yes, and on that I agree 100% with the Austrians.