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In Economics , under the mainstream assumptions, the marginal utility of a Good Or Service is the increase in Utility obtained by consuming or using one more unit of that good or service. The concept grew out of attempts by economists to explain the determination of price. It has been common among economists to describe ) #3&4 (September). A definition that avoids any assumption of quantifiable utility is the following. First, let the ‘margin of feasible uses’ refer to the '' Highest Quantitative Utilizaton '' of Goods (including services), such that the total quantity of one available good is maximized for available total quantities of all but that good. Then the marginal utility for a quantity used of a good (say, the fifth unit) is the utility of ''that'' quantity at the margin of feasible uses.von Wieser, Friedrich; ''Über den Ursprung und die Hauptgesetze des wirtschaftlichen Wertes''. Under either of these conceptions, the same object may have different marginal utilities for different people, reflecting different “tastes” or individual circumstances. A ''marginal'' change is as large as the smallest relevant division. For reasons of tractability, it is often assumed in Neoclassical Analysis that goods and services are Continuously Divisible . In such context, a marginal change may be an Infinitesimal change or a Limit . However, strictly speaking, the smallest relevant division may be quite large. The , v. 4 (1987), p. 921. PLACEMENT OF MARGINS The location of the margin for any individual corresponds to his or her ''endowment'', broadly conceived to include opportunities. This endowment is determined by many things including physical laws (which constrain how forms of energy and matter may be transformed), accidents of nature (which determine the presence of natural resources), and the outcomes of past decisions made both by others and by the individual himself or herself. THE “LAW” OF DIMINISHING MARGINAL UTILITY An individual will typically be able to Partially Order the potential uses of a good or service. For example, a ration of water might be used to sustain oneself, a dog, or a rose bush. Say that a given person gives her own sustenance highest priority, that of the dog next highest priority, and lowest priority to saving the roses. In that case, if the individual has two rations of water, then the ''marginal'' utility of either of those rations is that of sustaining the dog. The marginal utility of a third gallon would be that of watering the roses. (The ''diminishing'' of utility should not necessarily be taken to be itself an ) #3&4 (September).) The notion that marginal utilities are diminishing across the ranges relevant to decision-making is called “the law of diminishing marginal utility” (and also known as a “ Gossen 's First Law”). However, it will not always hold. The case of the person, dog, and roses is one in which potential uses operate independently — there is no complementarity across the three uses. Sometimes an amount added brings things past a desired Tipping Point , or an amount subtracted causes them to fall short. In such cases, the marginal utility of a good or service might actually be ''increasing''. Independence of the “law” from presumptions of Self-interested Behavior While the above example conforms to ordinary notions of Self-interested Behavior , the concept and logic of marginal utility are independent of the presumption that people pursue self-interest. For example, a different person might give highest priority to the rose bush, next highest to the dog, and last to himself. In that case, if the individual has three rations of water, then the marginal utility of any one of those rations is that watering the person. With just two rations, the person is left unwatered and the marginal utility of either ration is that of the dog. Likewise, a person could give highest priority to the needs of one of her neighbors, next to another, and so forth, placing her own welfare last; the concept of diminishing marginal utility would still apply. MARGINALIST THEORY Marginalism explains choice with the hypothesis that people decide whether to effect any given change based on the marginal utility of that change, with rival alternatives being chosen based upon which has the greatest marginal utility. Market price and diminishing marginal utility If an individual has a stock or flow of a good or service whose marginal utility is less than would be that of some other good or service for which he or she could trade, then it is in his or her interest to effect that trade. Of course, as one thing is traded-away and another is acquired, the respective marginal gains or losses from further trades are now changed. On the assumption that the marginal utility of one is diminishing, and the other is not increasing, all else being equal, an individual will demand an increasing ratio of that which is acquired to that which is sacrificed. If any trader can better his or her own marginal position by offering a trade more favorable to complementary traders, then he or she will do so. In an economy with Money , the marginal utility of a quantity is simply that of the best good or service that it could purchase. Hence, the “law” of diminishing marginal utility provides an explanation for diminishing Marginal Rates Of Substitution and thus for the “laws” of Supply And Demand , as well as essential aspects of models of “imperfect” Competition . The paradox of water and diamonds See Also: Paradox of value The “law” of diminishing marginal utility is said to explain the “paradox of water and diamonds”, most commonly associated with Adam Smith Smith, Adam; ''An Inquiry into the Nature and Causes of the Wealth of Nations'' ( 1776 ) Chapter IV. “Of the Origin and Use of Money”. (though recognized by earlier thinkers).1 Human beings cannot even survive without water, whereas diamonds were in Smith's day mere ornamentation or engraving bits. Yet water had a very low price, and diamonds a very high price, by any normal measure. Marginalists explained that it is the ''marginal'' usefulness of any given quantity that determines its price, rather than the usefulness of a ''class'' or of a ''totality''. For most people, water was sufficiently abundant that the loss or gain of a gallon would withdraw or add only some very minor use if any; whereas diamonds were in much more restricted supply, so that the lost or gained use would be much greater. That is not to say that the price of any good or service is simply a function of the marginal utility that it has for any one individual nor for some ostensibly typical individual. Rather, individuals are willing to trade based upon the respective marginal utilities of the goods that they have or desire (with these marginal utilities being distinct for each potential trader), and prices thus develop constrained by these marginal utilities. The “law” does not tell us such things as why diamonds are naturally less abundant on the earth than is water, but helps us to understand how this affects the value imputed to a given diamond and the price of diamonds in a market. = Criticism of the marginalist explanation of the paradox of water and diamonds Many critics of marginalism would reply that the reason that diamonds are more expensive than water is not because of their relative natural abundance but because of their cost of production. The reason water is available abundantly and diamonds in relatively smaller quantities is because one is inexpensive to produce and one very expensive. Critics claim that thus the reason water is cheaper than diamonds is simply because it costs less to produce. If diamonds could be produced cheaply from carbon, as modern technology may make possible in the short term, then the price of diamonds will fall, even though the demand for their use has not altered. Therefore, as these critics would claim, it is the cost of production which determines price, not the marginal utility. Marginalists simply respond that if this were true then, rather than our seeing some goods and services not produced because their costs exceeded their prices, consumers would make a practice of seeking expensive wares without regard to their use. (As proto-marginalist Richard Whately put it, “It is not that pearls fetch a high price because men have dived for them; but on the contrary, men dive for them because they fetch a high price.”Whately, Richard; ''Introductory Lectures on Political Economy, Being part of a course delivered in the Easter term'' (1832).) Marginalists explain that ''costs of production'' may be what limit supply, but that these costs of production are themselves sacrificed marginal uses, and will not be borne when they are expected to exceed the marginal use of what is produced. In other words, the marginalist certainly does ''not'' explain ''price'' as a simple function of the marginal utility of a single good for one person or for some “average” person, but nonetheless insists that it results from the trade-offs that each participant would be willing to make for the various goods and services at stake, with those trade-offs being determined by marginal uses. The critics who believe that costs of production determine price, by assuming a demand that will bear the cost, have begged the essential question that the marginalists purport to answer. QUANTIFIED MARGINAL UTILITY Under the Special Case in which usefulness can be quantified, the change in utility of moving from state to state is : Moreover, if and are distinguishable by values of just one variable which is itself quantified, then it becomes possible to speak of the ratio of the marginal utility of the change in to the size of that change: |
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