MARGINALISM VII

By M. Northrup Buechner

June 24, 2013

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

I concluded my last post with: “next time we will take up what I think is the truth about why and how people decide what to buy.” That subject is still on my agenda, but I have thought of some other issues that should be covered first.

In previous posts, I have identified a small number of products that satisfy the necessary condition to validly apply the law of utility. That condition can be called the uniformity requirement. It means that the additional units of each product that consumers choose to buy, use, and consume are identical—that they are uniform in nature, structure, composition, performance, and any other attribute that consumers want to possess. If this is not true, then the second unit acquired may be better than the first, and the consumer would get more utility from the second unit than from the first unit.

Products meeting the uniformity requirement are gasoline, electricity, water, heating oil, natural gas, and perhaps some food staples such as butter, eggs, and milk. (If there are others, I am unable to think of them.) The point is that only a very tiny fraction of the millions of consumer goods individuals buy in a free economy are uniform and therefore governed by the law of diminishing marginal utility. In addition, people value those goods that are uniform at their price. If this were the whole story, the status of the law of utility in economics would be as the solution to the diamond/water paradox, and otherwise, as an irrelevant, historical curiosity (which is the way I treated it in my book, with the following exception).

However, that is not the whole story. There is a huge, enormous, towering exception to the preceding view of the law of utility. That exception is money. Money is uniform. Each dollar or hundred dollars is identical to every other dollar or hundred dollars. Consequently, money satisfies the uniformity requirement for the law of utility. But what exactly does the law of utility mean in relation to money?

First, let us dispense with the word “utility.” In economics, utility has no definite meaning. Sometimes it is interpreted as a synonym for “usefulness,” such as the utility of a hammer to pound nails. Sometimes it is used to mean a feeling or emotion, such as the enjoyment derived from buying a new TV set. In the first case, economists have found it impossible to explain the utility of all those activities that have no physical product (which includes the whole entertainment industry). In the second case, it is impossible to identify a unit of psychic utility (a util), and therefore economists view the feeling of utility as nonobjective.

In economics, application of the law of utility to money is called “the diminishing marginal utility of income.” Since we are dispensing with “utility,” and one can acquire money in forms other than income, we will call this principle “the diminishing marginal value of money (DMVM).” The marginal value is the additional value. Thus, this principle means that as you acquire more and more money, you value any given sum less and less. Obviously, more money is always worth more. The issue here is the value you place on a given sum (say one hundred dollars), now and after you win the lottery.

Because the DMVM is defined in terms of the margin (marginal utility in the original version), and the marginal unit is almost always interpreted as one more or one less, economists typically take the relevant sum of money as one dollar. Thus, the meaning of the DMVM is that as one acquires additional dollars, one values each additional dollar less and less. Why? The standard answer is that as we acquire additional dollars, we use them to buy things that we value less and less.

Thus, whatever the amount of money you have at your disposal, you spend it on the goods and services that you value most. Suppose there is a lamp in a store window that you walk by every day. You love the lamp, but the price is a hundred dollars, and you have decided that you cannot afford it. You estimate that you would have to eat spaghetti every meal for two months in order to save an extra hundred dollars and variety in your diet is worth more to you than the lamp.

Then suppose that you win a hundred dollars at the racetrack. The additional hundred dollars is worth less to you than the lamp, and you buy the lamp. But before you won the hundred dollars, the lamp had less value to you than any of the other things that you were buying. If that were not true, you would not have needed to win one hundred dollars in order to buy the lamp. That is the argument, and in the context created here, it is unanswerable.

The implication of this interpretation of the DMVM is that, as we get more and more money, we work our way down our hierarchy of economic values, buying things of less and less value, of lower and lower importance, until, if we have a lot of money, we buy things which have no value to us at all and without which we would be no worse off. (One may observe that this is exactly the view held by the Left of consumption spending by the “one percent”—that is, the one percent of the population with the most wealth.)

The preceding paragraph pushes the argument a little further than it is usually pushed in order to make a point—that there is something horribly wrong with this thinking. This interpretation of the DMVM obliterates the value to people of more money. It is impossible to reconcile with the scramble to buy lottery tickets for one chance in twenty-six million to win a lot of money. Next time, we will see in detail where it goes wrong.