Why Are Stock Prices so Volatile?

???Since David Ricardo???s Principles there has been no book??? which has exercised such great influence on the development of economics as Carl Menger???s Grundsätze [Principles].???

–Knut Wicksell

At the invitation of Jan Fijor, a publisher of free-market books in Warsaw, Poland, I just completed writing an introduction to the Polish edition of Carl Menger’s ???Grundsätze,??? translated ???Principles of Economics??? in English. I follow in the footsteps of introductions in previous editions by the iconoclastic Chicago economist, Frank Knight, and the Austrian economist Friedrich Hayek.

Carl Menger (1840-1921) was the founder of the Austrian school of economics when he published his ???Grundsätze der Volkswirtschaftslehre??? in 1871 and ushered in the “marginalist” revolution in economics. This is the idea that prices are determined by a marginal number of buyers and sellers, not the cost of production or labor inputs.

There’s no better example of this marginalist principle than in the stock market. In fact, not surprisingly, Menger discovered this concept when he was a reporter on the Vienna stock exchange. He observed that security prices were determined by a marginal (small) number of buyers and sellers, and therefore had nothing to do with their cost of production, or even book value, as the classical economists had claimed.

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