Marginal utility - Wikipedia, the free encyclopedia
The term "marginal utility", credited to the Austrian economist Friedrich von ... 4.1 Market price and diminishing marginal utility. 4.1.1 The paradox of water ...
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Economics Basics: Utility
Marginal utility is the additional satisfaction, or amount of utility, gained ... This decrease demonstrates the law of diminishing marginal utility. ...
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marginalism: Definition from Answers.com
Marginal Utility The additional satisfaction a consumer gains from consuming one more unit of a good or service ... Britannica Concise Encyclopedia: marginal utility ...
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Marginal Utility
Marginal Utility. This example makes several points. ... Let's see how the marginal utility of diamonds and water vary depending on how ...
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Law of Diminishing Marginal Utility
Law of Diminishing Marginal Utility - Definition of Law of Diminishing Marginal Utility on Investopedia - A law of economics stating that as a person increases ...
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Marginalism - Wikipedia, the free encyclopedia
... proper is that of marginal utility, but marginalists following the lead ... 1.3.2 The "law" of diminishing marginal utility. 1.4 Marginal rate of substitution ...
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Definition of Marginal Utility
Marginal utility is an important concept because the theory of the consumer ... Marginal utility plays an important role in the Theory of the Consumer, which ...
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Diminishing Marginal Utility 1
In economics, we speak of a law or principle of diminishing marginal utility. ... For example, the marginal utility of golf clubs might increase until you have ...
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David Friedman, Price Theory: Chapter 4: Marginal Value, Marginal ...
The Consumer: Marginal Value, Marginal Utility, and Consumer ... For example, 20 is the average of marginal utility between 1 and 2 (oranges)--bundles B and C. ...
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Marginal Utility
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“Marginal revolution” redirects here. For the economics weblog, see Marginal Revolution (blog). In economics, under the mainstream assumptions, the marginal utility of a Good (economics) is the posited 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. The Austrian School economist Friedrich von Wieser coined the term “Grenznutzen” (“border-use”).von Wieser, Friedrich; Über den Ursprung und die Hauptgesetze des wirtschaftlichen Wertes.''The Nature and Essence of Theoretical Economics'' ()Wieser, Friedrich von; ''Der natürliche Werth'' ''Natural Value'' (), Bk I Ch V “Marginal Utility” (http://praxeology.net/FW-NV-I-5.htm HTML). It was translated “marginal utility” in 1889 and credited to Wieser by [Alfred Marshall.Streissler, E., “Wieser, Friedrich, Freiherr von”, [The New Palgrave: A Dictionary of Economics, v. 4 (1987), p. 921. It has been common among economists to describe utility as corresponding to a [Measure (mathematics), that is to say, as being ''quantifiable''.[George Stigler; “The Development of Utility Theory”, I and II, ''Journal of Political Economy'' ([), issues 3 and 4.George Stigler; “The Adoption of Marginal Utility Theory” ''History of Political Economy'' ([). This has significantly affected the development and reception of theories of marginal utility. However, not all conceptions of marginal utility entail quantification of any sort,Ludwig von Mises; ''Theorie des Geldes und der Umlaufsmittel'' ([).Nicholas Georgescu-Roegen; “Utility”, ''International Encyclopedia of the Social Sciences'' ([). and those which do not are able to consider rational preferences that would otherwise be excluded.Mc Culloch, James Huston; http://www.mises.org/etexts/mcCulloch.pdf “The Austrian Theory of the Marginal Use and of Ordinal Marginal Utility”, ''Zeitschrift für Nationalökonomie'' 37 () #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 ''Production possibilities frontier#Productive efficiency, opportunity cost, and allocative efficiency'' of [Good (economics) (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''.[''The Nature and Essence of Theoretical Economics'' (), p. 128. From the margin of feasible uses, quantities of a good are then posited as selected for successive quantities to the point of ''equilibrium'', beyond which no more feasible quantities would be selected. This may proceed from most-valued (urgent) quantity to successive less-valued quantities (if any). The process ensures that no less-valued quantity will be selected at equilibrium compared to quantities not selected. Marginal utility for the quantity of the good at that point corresponds to the least-valued use that would be selected compared to preceding quantities. Under any standard conception, the same object may have different marginal utilities for different people, reflecting different “tastes” or individual circumstances. The term 'marginal change' refers as large a change as the smallest relevant division. For reasons of tractability, it is often assumed in [Neoclassical economics that goods and services are [Continuum (theory). In such context, a marginal change may be an [infinitesimal change or a [Limit (mathematics). However, strictly speaking, the smallest relevant division may be quite large. == 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 ordered set 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 unit would be that of watering the roses. It may be no more than a purely Ordinal number change.[Nicholas Georgescu-Roegen; “Utility”, ''International Encyclopedia of the Social Sciences'' ([).Mc Culloch, James Huston; http://www.mises.org/etexts/mcCulloch.pdf “The Austrian Theory of the Marginal Use and of Ordinal Marginal Utility”, ''Zeitschrift für Nationalökonomie'' 37 () #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 “[Hermann Heinrich 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 [Selfishness === While the above example conforms to ordinary notions of [Selfishness, 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 rate 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 ==== {{main|Paradox of value--> The “law” of diminishing marginal utility is said to explain the “paradox of water and diamonds”, most commonly associated with Adam SmithSmith, Adam; ''An Inquiry into the Nature and Causes of the Wealth of Nations'' ([) Chapter IV. “Of the Origin and Use of Money”. (though recognized by earlier thinkers).{{cite book|id = ISBN 0-415-09670-7|--> 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 S_1 to state S_2 is :\Delta U=U(S_2)-U(S_1)\, Moreover, if S_1 and S_2 are distinguishable by values of just one variable g\, which is itself quantified, then it becomes possible to speak of the ratio of the marginal utility of the change in g\, to the size of that change: :\left.\frac{\Delta U}{\Delta g}\right|_{c.p.} (where “[ceteris paribus” indicates that the ''only'' [Dependent and independent variables to change is g\,). Mainstream neoclassical economics will typically assume that :\lim_{\Delta g\to 0}{\left.\frac{\Delta U}{\Delta g}\right|_{c.p.--> is well defined, and use “marginal utility” to refer to a [partial derivative :\frac{\partial U}{\partial g}\approx\left.\frac{\Delta U}{\Delta g}\right|_{c.p.} and diminishing marginal utility is similarly taken to correspond to :\frac{\partial^2 U}{\partial g^2} In his critique of [political economy, Marx discussed “use-value”, a concept analogous to utility: :A use-value has value only in use, and is realized only in the process of consumption. One and the same use-value can be used in various ways. But the extent of its possible application is limited by its existence as an object with distinct properties. It is, moreover, determined not only qualitatively but also quantitatively. Different use-values have different measures appropriate to their physical characteristics; for example, a bushel of wheat, a quire of paper, a yard of linen.Marx, Karl; http://www.marxists.org/archive/marx/works/1859/critique-pol-economy/ch01.htm ''Critique of Political Economy'' (). He acknowledged that the value of a commodity is dependent on the use that can be garnered from it,Marx, Karl; http://www.marxists.org/archive/marx/works/1857/grundrisse/f239-289.htm ''Grundrisse'' (completed in though not published until much later). but, in his analysis, utility was considered as all or nothing; it was unnecessary to describe variable use-value; to Marx labor was the ultimate source of value. The doctrines of marginalism and the Marginal Revolution are often interpreted as somehow a response to Marxism. In fact, the first volume of ''[Das Kapital'' was not published until [, after the works of Jevons, Menger, and Walras were written or well under way; and Marx was still a relatively obscure figure when these works were completed. It is unlikely that any of them knew anything of him. (On the other hand, [Friedrich Hayek or [William Warren Bartley has suggested that [Karl Marx, voraciously reading at the [British Museum, may have come across the works of one or more of these figures, and that his inability to formulate a viable critique may account for his failure to complete any further volumes of ''Kapital'' before his death.Hayek, Friedrich August von, with [William Warren Bartley; ''The Fatal Conceit: The Errors of Socialism'' (1988) p150.) Nonetheless, it is not unreasonable to suggest that part of what contributed to the success of the generation who followed the preceptors of the Revolution was their ability to formulate straight-forward responses to Marxist economic theory. The most famous of these was that of Böhm-Bawerk, “Zum Abschluss des Marxschen Systems” (),Böhm-Bawerk, Eugen Ritter von; “Zum Abschluss des Marxschen Systems” “On the Closure of the Marxist System”, Staatswiss. Arbeiten. Festgabe für Karl Knies (1896). but the first was Wicksteed's “The Marxian Theory of Value. Das Kapital: a criticism” (1884,Wicksteed, Philip Henry; “Das Kapital: A Criticism”, To-day 2 (1884) p. 388-409. followed by “The Jevonian criticism of Marx: a rejoinder” in 1885Wicksteed, Philip Henry; “The Jevonian criticism of Marx: a rejoinder”, To-day 3 (1885) p. 177-9.). Only a few Marxist replies were made to marginalism, of which the most famous were Rudolf Hilferding's Böhm-Bawerks Marx-Kritik (1904)Hilferding, Rudolf; Böhm-Bawerks Marx-Kritik (1904). Translated as Böhm-Bawerk's Criticism of Marx. and Политической экономии рантье (1914) by Nikolai Bukharin.Nikolai Bukharin; Политической экономии рантье (1914). Translated as The Economic Theory of the Leisure Class.

(It might also be noted that some followers of Henry George similarly consider marginalism and neoclassical economics a reaction to Progress and Poverty, which was published in 1879.Mason Gaffney, and Fred Harrison; The Corruption of Economics (1994).)

Eclipse In his 1881 work Mathematical Psychics, Francis Ysidro Edgeworth presented the indifference curve, deriving its properties from marginalist theory which assumed utility to be a differentiable function of quantified goods and services. Later work attempted to generalize the indifference-curve formulation of utility and marginal utility.

In 1915, Eugen Slutsky derived a theory of consumer choice solely from properties of indifference curves.Eugen Slutsky; “Sulla teoria del bilancio del consumatore”, Giornale degli Economisti 51 (1915). Because of World War I, the October Revolution, and his own subsequent loss of interest, Slutsky's work drew almost no notice, but similar work in 1934 by John Hicks and R. G. D. AllenHicks, John Richard, and Roy George Douglas Allen; “A Reconsideration of the Theory of Value”, Economica 54 (1934). derived much the same results and found a significant audience. (Allen subsequently drew attention to Slutksy's earlier accomplishment.)

Although some of the third generation of Austrian School economists had by 1911 rejected the quantification of utility while continuing to think in terms of marginal utility,Ludwig von Mises; Theorie des Geldes und der Umlaufsmittel (1912). most economists presumed that utility must be a sort of quantity. Indifference curve analysis seemed to represent a way of dispensing with quantification, with decreasing marginal rates of substitution (in convex preferences) replacing the notion of diminishing marginal utility to describe the average agent as preferring non-extreme bundles of commodities for changes in relative prices.

For those who accepted that indifference curve analysis superseded marginal utility analysis, the latter became at best perhaps pedagogically useful, but unnecessary and ultimately meaningless.

Revival When Cramer and Bernoulli introduced the notion of diminishing marginal utility, it had been to address St. Petersburg paradox, rather than the paradox of value. The marginalists of the revolution, however, had been formally concerned with problems in which there was neither risk nor uncertainty. So too with the indifference curve analysis of Slutsky, Hicks, and Allen.

The expected utility hypothesis of Bernoulli et alii was revived by various 20th century thinkers, with early contributions by Frank P. Ramsey (1926),Ramsey, Frank Plumpton; “Truth and Probability” ( PDF), Chapter VII in The Foundations of Mathematics and other Logical Essays (1931). John von Neumann and Oskar Morgenstern (1944),von Neumann, John and Oskar Morgenstern; Theory of Games and Economic Behavior (1944). and Leonard Jimmie Savage (1954).Savage, Leonard Jimmie; Foundations of Statistics (1954). Although this hypothesis remains controversial, it not only brings utility, but a quantified conception of utility, back into the mainstream of economic thought.

A major reason why quantified models of utility are influential today is that risk and uncertainty have been recognized as central topics in contemporary economic theory.Diamond, Peter, and Michael Rothschild, eds.; Uncertainty in Economics (1989). Academic Press. Quantified utility models simplify the analysis of risky decisions, because under quantified utility, diminishing marginal utility is equivalent to “risk aversion”.Demange, Gabriel, and Guy Laroque; Finance and the Economics of Uncertainty (2006), Ch. 3, pp. 71-72. Blackwell Publishing. In fact, many contemporary analyses of saving and portfolio choice require stronger assumptions than diminishing marginal utility, such as the assumption of “Prudence (economics)”, which means convex function marginal utility.Kimball, Miles (1990), “Precautionary Saving in the Small and in the Large”, Econometrica, 58 (1) pp. 53-73.

Meanwhile, the Austrian School continues to develop its ordinalist notions of marginal utility analysis, formally demonstrating that from them proceed the decreasing marginal rates of substitution of indifference curves.

References See also works named in body of article.

See also

• Economics
• Microeconomics
• Diminishing returns
• Utility
• Marginalism
• Human nature
• Economic subjectivism

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