Marginalism V

By M. Northrup Buechner

June 1, 2013

Another in a series of essays elaborating Objective Economics: How Ayn Rand’s Philosophy Changes Everything about Economics by the author.

[Apologies for the long hiatus. I have been out of the country giving a paper at an economics conference.]

Marginalism and subjectivism are completely integrated and mutually interdependent in modern economics. Marginalism is the idea that the value people place on things is the value of the last one acquired, and subjectivism is the idea that the prices of things are determined by the value people place on them. Subjectivist economics gives priority and causal power to people’s preferences, but those preferences rule the economy in a definite pattern defined by the law of utility—that as one acquires additional units of a good, each additional unit is worth less and less. This is what keeps subjective preferences from being completely arbitrary. It is also what allows economists to say something more about the economy than “Who knows?”

Without marginalism, economic subjectivism would have nothing to say. People’s preferences could take any form whatever. They might want more when the price went up and still more if it came down, and there would be no limit on how much they wanted. Or, they might want less when the price fell and more when the price went up and everyone might be satisfied with the bare minimum possible or be happy to die of starvation in a week. Marginalism and subjectivism entered economics together in the solution to the diamond/water paradox, and they exist together in roles of mutual support. In the field of economics, neither could survive without the other.

Last time, we saw what is wrong with the subjectivism of modern economics. Now we will look at the marginalism of modern economics.

There was some truth in the discovery of Jevons, Walras, and Menger. Certainly, the explanation for the relative prices of water and diamonds has something to do with the value people place on them, and that in turn has something to do with their relative scarcity. As a broad generalization, it is true that people tend to put greater value on things that are scarce than on things that are abundant. But there is no specific relationship of the kind projected by the law of utility that applies to everything, and that can be taken as the basis for the whole economy.

The first problem with the law of utility is that, in order for it to hold, all the units under consideration must be identical. This point is well recognized. Suppose a farmer has three identical buckets for work around the farm. If he loses one, he will value each of the two remaining buckets more highly than before. Alternatively, if he acquires another bucket identical to the first three, the farmer will value each of the four buckets less than before. The fourth bucket is worth less to him, but so are each of the first three because they are all the same.

This analysis is completely dependent on the buckets being identical. Since they are all the same, the farmer values each of them the same, and that value goes down if he gains buckets and up if he loses buckets. But what if the buckets are not the same? What if he has three identical wooden buckets and then he gets a steel pail?

Sometimes we buy additional units that are identical to the previous units we have purchased. This is not the norm, but also it is not unusual. Everybody does it when they buy gasoline, heating oil, electricity, water, natural gas, and perhaps some food items like butter and milk. For almost everything else we buy, however, including most food items, the units are not identical—and usually we do not want more than one at a time. Examples are legion: a house, a car, an ipad, a shirt, a skirt, a steak, a bunch of bananas, a lamp, a rug, a TV set, a CD player, a computer, a movie ticket, a restaurant meal, and so forth. The complete list would embrace virtually the entire realm of the millions of consumer goods and services.

If additional units are not identical, the second unit is not a unit. It is something else. Or, to put it a little differently, if the additional units are not identical, the second unit may have more value than the first, and the law of utility is irrelevant. If you buy a 36-inch TV set and then you buy a 50-inch TV set, what does the law of utility tell us? Nothing! There is no law governing the relationship between the values people place on two different products, even if the products are very closely related. Only if they are the same can we say that the second unit will have less value than the first.

Next time we will see additional limitations in applying the law of utility to consumer goods and services.