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Marginal utility, in mainstream economics, describes the change in utility (pleasure or satisfaction resulting from the consumption) of one unit of a good or service. Marginal utility can be positive, negative, or zero. Negative marginal utility implies that every consumed additional unit of a commodity causes more harm than good, leading to a decrease in overall utility. In contrast, positive marginal utility indicates that every additional unit consumed increases overall utility.
In the context of cardinal utility, liberal economists postulate a law of diminishing marginal utility. This law states that the first unit of consumption of a good or service yields more satisfaction or utility than the subsequent units, and there is a continuing reduction in satisfaction or utility for greater amounts. As consumption increases, the additional satisfaction or utility gained from each additional unit consumed falls, a concept known as diminishing marginal utility. This idea is used by economics to determine the optimal quantity of a good or service that a consumer is willing to purchase.
Marginal considerations are considerations which concern a slight increase or diminution of the stock of anything which we possess or are considering.Philip Wicksteed; The Common Sense of Political Economy (1910), Bk I Ch 2 and elsewhere. Another way to think of the term marginal is the cost or benefit of the next unit used or consumed, for example the benefit that you might get from consuming a piece of chocolate. The key to understanding marginality is through marginal analysis. Marginal analysis examines the additional benefits of an activity compared to additional costs sustained by that same activity. In practice, companies use marginal analysis to assist them in maximizing their potential profits and often used when making decisions about expanding or reducing production.
Initially, the term utility equated usefulness with the production of pleasure and avoidance of pain by moral philosophers, Jeremy Bentham and John Stuart Mill.Jeremy Bentham. Introduction to the Principles of Morals and Legislation, Chapter I §I–III. In line with this philosophy, the concept of utility was defined as "the feelings of pleasure and pain"Jevons, William Stanley; "Brief Account of a General Mathematical Theory of Political Economy", Journal of the Royal Statistical Society v29 (June 1866) §2. and further as a " quantity of feeling".Jevons, William Stanley; Brief Account of a General Mathematical Theory of Political Economy, Journal of the Royal Statistical Society v29 (June 1866) §4.
Contemporary mainstream economic theory frequently defers metaphysical questions, and merely notes or assumes that preference structures conforming to certain rules can be usefully proxied by associating goods, services, or their uses with quantities, and defines "utility" as such a quantification.Kreps, David Marc; A Course in Microeconomic Theory, Chapter two: The theory of consumer choice and demand, Utility representations.
In any standard framework, the same object may have different marginal utilities for different people, reflecting different preferences or individual circumstances.Davenport, Herbert Joseph; The Economics of Enterprise (1913) Ch VII, pp. 86–87.
Assumptions -
Modern economics employs ordinal utility to model decision-making under certainty at a specific point in time. In this approach, the number assignment to an individual's utility for a particular situation hold no significance on their own. Rather, the significance lies in the comparison between two different circumstances and which one holds a higher utility. With ordinal utility, a person's preferences do not have a unique marginal utility, making the concept of diminishing marginal utility irrelevant. On the other hand, diminishing marginal utility is a significant concept in cardinal utility, which is used to analyse intertemporal choice, choice under uncertainty, and social welfare in modern economic theory.
The law of diminishing marginal utility is that subjective value changes most dynamically near the zero points and quickly levels off as gains (or losses) accumulate. And it is reflected in the concave shape of most subjective utility functions.
Given a concave relationship between objective gains (x-axis) and subjective value (y-axis), each one-unit gain produces a smaller increase in subjective value than the previous gain of an equal unit. The marginal utility, or the change in subjective value above the existing level, diminishes as gains increase.
As the rate of commodity acquisition increases, the marginal utility decreases. If commodity consumption continues to rise, the marginal utility will eventually reach zero, and the total utility will be at its maximum. Beyond that point, any further increase in commodity consumption leads to negative marginal utility, which represents dissatisfaction. For example, beyond some point, further doses of antibiotics would kill no pathogens at all and might even become harmful to the body. Diminishing marginal utility is traditionally a microeconomic concept and often holds for an individual, although the marginal utility of a good or service might be increasing as well. For example, dosages of antibiotics, where having too few pills would leave bacteria with greater resistance, but a full supply could affect a cure.
As mentioned earlier in this article, there are instances where marginal utility can increase on a macroeconomic level. For instance, offering a service may only be feasible if it is accessible to the majority or all of the population. At the point where this becomes a reality, the marginal utility of the raw material required to provide the service will increase significantly. This is akin to situations involving massive objects like aircraft carriers, where the quantity of such items is so small that the concept of marginal utility becomes irrelevant, and the decision to acquire them is a simple binary choice between "yes" or "no".
In an economy that uses money, the marginal utility of a given quantity of money is equivalent to the marginal utility of the best good or service that could be purchased with that money. This concept is helpful for explaining the principles of supply and demand, and is essential aspects of models of imperfect competition.
Price is determined by both marginal utility and marginal cost, and here is the key to the apparent paradox. The marginal cost of water is lower than the marginal cost of diamonds. 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 or 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 constrains by these marginal utilities.
Mainstream neoclassical economics will typically assume that the limit
There has been marked disagreement about the development and role of marginal considerations in Aristotle's value theory.Schumpeter, Joseph Alois; History of Economic Analysis (1954) Part II, Chapter 1 §3.Meikle, Scott; Aristoteles' Economic Thought (1995) Chapters 1, 2, & 6.
Numerous economists have established a connection between utility and rarity, which influences economic decisions and price determination. Diamonds are priced higher than water because their marginal utility is higher than water.Přibram, Karl; A History of Economic Reasoning (1983).
Eighteenth-century Italian Mercantilism, such as Antonio Genovesi, Giammaria Ortes, Pietro Verri, Marchese Cesare di Beccaria, and Giovanni Rinaldo, held that value was explained in terms of the general utility and of scarcity, though they did not typically work-out a theory of how these interacted.Pribram, Karl; A History of Economic Reasoning (1983), Chapter 5 "Refined Mercantilism", "Italian Mercantilists". In Della moneta (1751), Abbé Ferdinando Galiani, a pupil of Genovesi, attempted to explain value as a ratio of two ratios, utility and scarcity, with the latter component ratio being the ratio of quantity to use. Anne Robert Jacques Turgot, in Réflexions sur la formation et la distribution de richesse (1769), held that value derived from the general utility of the class to which a good belonged, from comparison of present and future wants, and from anticipated difficulties in procurement.
Like the Italian mercantists, Étienne Bonnot, Abbé de Condillac, saw value as determined by utility associated with the class to which the good belong, and by estimated scarcity. In De commerce et le gouvernement (1776), Condillac emphasized that value is not based upon cost but that costs were paid because of value.
This last point was famously restated by the Nineteenth Century proto-marginalist, Richard Whately, who in Introductory Lectures on Political Economy (1832) wrote: (Whatley's student Senior is noted below as an early marginalist.)
In "A Lecture on the Notion of Value as Distinguished Not Only from Utility, but also from Value in Exchange", delivered in 1833 and included in Lectures on Population, Value, Poor Laws and Rent (1837), William Forster Lloyd explicitly offered a general marginal utility theory, but did not offer its derivation nor elaborate its implications. The importance of his statement seems to have been lost on everyone (including Lloyd) until the early 20th century, by which time others had independently developed and popularized the same insight.
In An Outline of the Science of Political Economy (1836), Nassau William Senior asserted that marginal utilities were the ultimate determinant of demand, yet apparently did not pursue implications, though some interpret his work as indeed doing just that.
In " De la mesure de l'utilité des travaux publics" (1844), Jules Dupuit applied a conception of marginal utility to the problem of determining bridge tolls.
In 1854, Hermann Heinrich Gossen published Die Entwicklung der Gesetze des menschlichen Verkehrs und der daraus fließenden Regeln für menschliches Handeln, which presented a marginal utility theory and to a very large extent worked-out its implications for the behavior of a market economy. However, Gossen's work was not well received in the Germany of his time, most copies were destroyed unsold, and he was virtually forgotten until rediscovered after the so-called Marginal Revolution.
Carl Menger presented the theory in Grundsätze der Volkswirtschaftslehre (translated as Principles of Economics) in 1871. Menger's presentation is peculiarly notable on two points. First, he took special pains to explain why individuals should be expected to rank possible uses and then to use marginal utility to decide amongst trade-offs. (For this reason, Menger and his followers are sometimes called the Psychological School, though they are more frequently known as the Austrian School or as the Vienna School.) Second, while his illustrative examples present utility as quantified, his essential assumptions do not.Georgescu-Roegen, Nicholas; Utility, International Encyclopedia of the Social Sciences (1968). (Menger in fact crossed-out the numerical tables in his own copy of the published Grundsätze.Kauder, Emil; A History of Marginal Utility Theory (1965), p. 76.) Menger also developed the law of diminishing marginal utility.Polleit, Thorsten (2011-02-11) What Can the Law of Diminishing Marginal Utility Teach Us?, Mises Institute. Menger's work found a significant and appreciative audience.
Marie-Esprit-Léon Walras introduced the theory in Éléments d'économie politique pure, the first part of which was published in 1874 in a relatively mathematical exposition. Walras's work found relatively few readers at the time but was recognized and incorporated two decades later in the work of Vilfredo Pareto and Enrico Barone.Donald A. Walker (1987), "Walras, Léon" ''The New Palgrave: A Dictionary of Economics, v. 4, p. 862.
An American, John Bates Clark, is sometimes also mentioned. But, while Clark independently arrived at a marginal utility theory, he did little to advance it until it was clear that the followers of Jevons, Menger, and Walras were revolutionizing economics. Nonetheless, his contributions thereafter were profound.
While the approaches of Jevons, Menger, and Walras had notable differences, the second generation of economists did not maintain these distinctions based on national or linguistic boundaries. Von Wieser's work was significantly influenced by Walras, while Wicksteed was strongly influenced by Menger. Fetter and Davenport identified themselves as part of the "American Psychological School", named after the "Austrian Psychological School", while Clark's work during this period was also heavily influenced by Menger. William Smart initially served as a conduit for Austrian School ideas to English-speaking readers but gradually came under the sway of Marshall's ideas.Salerno, Joseph T. 1999; "The Place of Mises's Human Action in the Development of Modern Economic Thought". Quarterly Journal of Economic Thought v. 2 (1).
Böhm-Bawerk was perhaps the most able expositor of Menger's conception.Böhm-Bawerk, Eugen Ritter von. "Grundzüge der Theorie des wirtschaftlichen Güterwerthes", Jahrbüche für Nationalökonomie und Statistik v 13 (1886). Translated as Basic Principles of Economic Value. He was further noted for producing a theory of interest and of profit in equilibrium based upon the interaction of diminishing marginal utility with diminishing of time and with time preference.Böhm-Bawerk, Eugen Ritter von; Kapital und Kapitalizns. Zweite Abteilung: Positive Theorie des Kapitales (1889). Translated as Capital and Interest. II: Positive Theory of Capital with appendices rendered as Further Essays on Capital and Interest. This theory was adopted in full and then further developed by Knut WicksellWicksell, Johan Gustaf Knut; Über Wert, Kapital unde Rente (1893). Translated as Value, Capital and Rent. and with modifications including formal disregard for time-preference by Wicksell's American rival Irving Fisher.Fisher, Irving; Theory of Interest (1930).
Marshall was the second-generation marginalist whose work on marginal utility came most to inform the mainstream of neoclassical economics, especially by way of his Principles of Economics, the first volume of which was published in 1890. Marshall constructed the demand curve with the aid of assumptions that utility was quantified, and that the marginal utility of money was constant (or nearly so). Like Jevons, Marshall did not see an explanation for supply in the theory of marginal utility, so he synthesized an explanation of demand thus explained with supply explained in a more classical manner, determined by costs which were taken to be objectively determined. Marshall later actively mischaracterized the criticism that these costs were themselves ultimately determined by marginal utilities.Schumpeter, Joseph Alois; History of Economic Analysis (1954) Part IV, Chapter 6, §4.
Ernesto Screpanti and Stefano Zamagni interpret the doctrines of marginalism and the Marginal Revolution as a response to Marxism. However, this view is somewhat flawed, as the first volume of Das Kapital was not published until July 1867, which was after the works of Jevons, Menger, and Walras had either been written or were under way (Walras published Éléments d'économie politique pure in 1874 and Carl Menger published Principles of Economics in 1871); Marx was still a relatively minor figure when these works were completed and it is unlikely that any of these economists knew anything about him. Some scholars, such as Friedrich Hayek and W. W. Bartley III, have speculated that Marx may have come across the works of one or more of these economists while reading at the British Museum.
Despite the fact the Marxist economics was not an immediate target for the marginalists, it is possible to argue that the new generation of economists succeeded partly because they were able to provide simple responses to Marxist economic theory. One of the best known responses was Böhm-Bawerk, Zum Abschluss des Marxschen Systems (1896),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 response was actually Wicksteed's "The Marxian Theory of Value. Das Kapital: A Criticism" (1884),Wicksteed, Philip Henry; "Das Kapital: A Criticism", To-Day 2 (1884) pp. 388–409. followed by "The Jevonian Criticism of Marx: A Rejoinder" in 1885.Wicksteed, Philip Henry; "The Jevonian Criticism of Marx: A Rejoinder", To-Day 3 (1885) pp. 177–9. At first, there were only a few Marxist responses to marginalism, including Rudolf Hilferding's Böhm-Bawerks Marx-Kritik (1904)Hilferding, Rudolf: Böhm-Bawerks Marx-Kritik (1904). Translated as Böhm-Bawerk's Criticism of Marx. and Politicheskoy ekonomii rante (1914) by Nikolai Bukharin.Nikolai Bukharin; Политической экономии рантье (1914). Translated as The Economic Theory of the Leisure Class. However, over the course of the 20th century, a significant body of literature emerged on the conflict between marginalism and labour theory of value. One important critique of marginalism came from neo-Ricardian economist Piero Sraffa.
Followers of Henry George's ideas such as Mason Gaffney view marginalism and neoclassical economics as a response to Progress and Poverty, which was published in 1879.
In the 1980s John Roemer and other analytical Marxists have worked to rebuild Marxian theses on a marginalist foundation.
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 the World War, the Bolshevik 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 largely the same results and found a significant audience. (Allen subsequently drew attention to Slutsky'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,von Mises, Ludwig Heinrich; 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 to dispense with presumptions of quantification, albeit that a seemingly arbitrary assumption (admitted by Hicks to be a "rabbit out of a hat"Hicks, Sir John Richard; Value and Capital, Chapter I. "Utility and Preference" §8, p. 23 in the 2nd edition.) about decreasing marginal rates of substitutionHicks, Sir John Richard; Value and Capital, Chapter I. "Utility and Preference" §7–8. would then have to be introduced to have convexity of indifference curves.
For those who accepted that indifference curve analysis superseded earlier marginal utility analysis, the latter became at best perhaps pedagogically useful, but "old fashioned" and observationally unnecessary.Samuelson, Paul Anthony; "Complementarity: An Essay on the 40th Anniversary of the Hicks-Allen Revolution in Demand Theory", Journal of Economic Literature vol 12 (1974).
The expected utility hypothesis of Bernoulli and others was revived by various 20th century thinkers, with early contributions by Ramsey (1926),Ramsey, Frank Plumpton; "Truth and Probability" ( PDF ), Chapter VII in The Foundations of Mathematics and Other Logical Essays (1931). von Neumann and Morgenstern (1944),von Neumann, John and Oskar Morgenstern; Theory of Games and Economic Behavior (1944). and Savage (1954).Savage, Leonard Jimmie: Foundations of Statistics (1954), New York: John Wiley & Sons. Although this hypothesis remains controversial, it brings not only utility, but a quantified conception of utility (cardinal 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 provide a simplified approach to analysing risky decision by establishing a link between diminishing marginal utility and 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, 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 continued to develop its ordinalist notions of marginal utility analysis, formally demonstrating that from them proceed the decreasing marginal rates of substitution of indifference curves.
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