Menger's Principle of Imputation

✅ Introduction

At the end of the 19th century, economics underwent a theoretical revolution with the emergence of the Austrian School, led by Carl Menger. His work Principles of Economics (1871) broke away from the classical labor-value theories of Smith and Marx.

Menger proposed that value is not inherent in goods, nor does it directly depend on the effort required to produce them; instead, it depends on the utility the good provides to the individual.

This perspective gave rise to the subjective theory of value and to his famous concept: the Principle of Imputation.

📌 What is the Principle of Imputation?

Menger’s principle of imputation states that:

"The value of higher-order goods (such as factors of production) is derived from the value of lower-order goods (consumer goods that directly satisfy human needs)."

🧩 In other words:
Value does not flow from inputs to the final product, but the other way around.

The perceived utility by the consumer determines how much value is assigned to the factors involved in its production.

🧠 Foundations of the Subjective Value Theory

To understand imputation, you must first understand Menger’s three key concepts:

A. Lower-order and higher-order goods

Lower-order goods (first-order goods): Consumer goods (bread, water, a computer).
Higher-order goods (second, third-order): Resources and tools used in production (flour, wheat, ovens, design computers, etc.).

B. Marginal utility
The utility obtained from the last unit consumed of a good. As more is consumed, marginal utility decreases (law of diminishing marginal utility).

C. Subjective value
There is no such thing as “objective value” in goods. Each person assigns value according to the intensity of their need and the capacity of the good to meet it.

🔄 The Process of Imputation in Economics

Let’s see how the value of higher-order goods is determined:

If a final product (e.g., a cake) has value because it satisfies a need, then its components (flour, sugar, oven, baker’s labor) only have value insofar as they contribute to that final outcome.

❗ The key point:
If the final product has no value, the resources used in its production have no value either.

This invalidates Marx’s labor theory of value: no matter how much work is put into something, if nobody wants it, it’s worth nothing.

🧰 Practical Examples and Simple Cases

📦 Example 1: Cake production
➡️ If the cake rots on the display shelf, how much are the sugar and flour used worth?
Nothing.

🧱 Example 2: Real estate market
A vacant lot in the Amazon jungle has little value if no one wants to live there.

That same lot in the middle of a city becomes valuable because it can be used to build homes or businesses that are highly valued by consumers.

💼 Application of the Principle in Investment Decisions

As investors, this principle is vital to understanding which companies and assets have real value:

✅ Application cases:

Tech startups: Many investors confuse investment in R&D (higher-order) with value. But if the final product is not wanted by the market, the investment doesn’t matter.
Financial assets: A stock’s value does not depend on the “effort to create it” but on the expected profit flow (present value of future cash flows).
Project evaluation: In cost-benefit analyses, resources should not be assigned value if the final product won’t be valued in the market.

🚫 Common Mistakes in Interpreting Economic Value

Confusing cost with value: “It cost me a lot to produce it” ≠ “It’s worth a lot”.
Believing labor creates value on its own.
Evaluating companies based on physical assets instead of their value flows (utility expected by consumers).
Thinking resource value is independent from the final market.

🧪 Application Exercises

🔸 Question 1:
A company invests $1 million in machinery to produce a product no one wants to buy. What’s the value of that machinery according to the principle of imputation?
Answer: Practically zero. If the final good has no value, neither do the factors used to produce it.

🔸 Question 2:
A farm produces high-quality avocados, but no one in the region consumes them, and there’s no infrastructure to export. Do they have economic value?
Answer: No. Even if the product is “objectively good,” it has no economic value without a subjective need to satisfy.