Austrian Economics and Marginal Utility
G. Stolyarov II
A Journal for Western Man-- Issue XLII-- October 5, 2005
To understand a set of universal truths concerning diverse individuals’ valuations of economic goods and how these valuations are reflected in practice, one needs to turn to the Austrian School of Economics and its analysis of marginal utility.
The Austrian School considers utility from the viewpoint of the individual economic actor. That is, for the purposes of economic analysis, it views utility as subjective and dependent on the value hierarchy of the actor in question. An individual’s true hierarchy of values is demonstrated—in the Austrian view—not through his stated convictions, though these might affect the true manifestation of his values. Rather, the only way to discern an individual’s true values is through his actual choices. An individual, Jim, is confronted with a choice of whether to purchase an apple or a pear using his scarce resources. Though Jim might espouse in great depth the objective esthetic superiority of pears, his purchase of the apple will mean that he valued the apple more highly than the pear—within the context of the situation in which he made his economic decision. The reality of Jim’s actions demonstrates that, at the moment, he places a greater utility on the apple.
Furthermore, the utility a given actor attributes to a good can differ dramatically from the utility others attribute to the same good. Consider two computers—X and Y—priced, respectively, at $1000 and $2000. From the viewpoint of Murray Rothbard, economist of the Austrian tradition, the market prices of X and Y do not necessarily indicate the utility a given economic actor will attribute to them. Certainly, the prices do not imply that—to Jim, the actor in question—Y will have twice the utility of X. Although the market price of Y is twice that of X, Jim might attach a higher value to older model computers, like X, due to simple nostalgia. Or Jim might be a miser for whom utility in purchasing Y is outweighed by the disutility of the displeasure produced by his conscience nagging him about overspending. Utility is ultimately an individual consideration, and market prices for a good might only reflect the average of the widely differing utilities various customers attribute to that good. Prices do not themselves bestow on some goods an objectively higher utility independent of individual preferences. A scenario is even conceivable wherein not one of the customers interested in Y is also remotely interested in X, and vice versa. Nonetheless, a substantial number of customers is interested in each of the models. Under such circumstances no way exists to relate the value of Y to that of X since no individual exists on whose value scale both X and Y are hierarchically ordered.
The idea of utility as existing on the margin constitutes an immense contribution of the Austrian School to economic thought. Carl Menger, the intellectual progenitor of Austrian Economics, originated the insight that economic actors do not choose between whole available stockpiles of goods. Instead, they choose between individual units of different goods when their resources are insufficiently abundant to enable them to acquire every unit in question. Menger used the idea of marginal utility to address a paradox that had boggled Classical economists in the tradition of Adam Smith—the question of why a diamond is more highly priced on the market than water despite water’s crucial function in survival which diamonds lack. According to Menger, one does not choose between the entirety of the world’s water and the entirety of its diamonds. Instead, one chooses between a particular unit of water and a particular diamond. While water in general is far more valuable to survival than diamonds, economic actors will typically prefer a single diamond to a single unit of water since its marginal utility outweighs that of the unit of water.
A corollary of Menger’s insight is the law of diminishing marginal utility. An individual’s value hierarchy is demonstrated through his actions. It follows that he will devote his foremost action with regard to a given good to what he considers the most important use for that good. Thus, the first unit of any good is necessarily allocated to the actor’s most important available objective. The second unit of the good must, then, be allocated to the second most important objective. By definition, the second most important objective is less valued by the actor than the first. The same can be said for all subsequent allocations of units of that good with respect to prior allocations, the latter of which must necessarily be more valuable. Thus, each subsequent unit of a good will provide a lower marginal utility to the acting man than each prior unit of that good.
The law of diminishing marginal utility allows Austrian economists to dispose of the aforementioned water-diamond paradox. Since water is available in large quantities, most economic actors have enough units of it to devote to the basic uses of water—including survival, hygiene, and agriculture. The marginal utility of subsequent units of water is thus much lower than that of the first several available units. Meanwhile, though the first diamond has less marginal utility than the first unit of water, diamonds are rarer to come by. Thus, their value reflects the more subjectively important ends to which diamonds can be devoted; the marginal utility of the first diamond to an economic actor is likely to far outstrip that of the 1000th gallon of water.
When considering the law of diminishing marginal utility for a given good, one must distinguish the good not by its material characteristics, but by the function which the economic actor sees it as capable of fulfilling. For example, it is perfectly plausible that Jim might be willing to expend $10 for his first tire, $20 for two tires, $25 for three tires, but $100 for four tires. Murray Rothbard, in his book Man, Economy, and State, claims that the tire qua individual material tire is not a good in itself, outside the purpose the acting individual attributes to it. If one is building a new car, a single tire will not suffice. Four tires, however, will be enough to fulfill the purpose of building the car. Jim might purchase one tire simply to let it sit in his garage while he hopes to accumulate the other three tires from other buyers. Or Jim might use the tire as a backup in the event his older car’s tires expire. These uses for single tires are fundamentally different in kind from the use of the four-tire set in the creation of a new car. Thus, “one tire” is a fundamentally different good—in the Austrian sense—than a “set of four tires.” It still follows that each subsequent set of four tires will have a lower marginal utility to Jim than each prior one. Furthermore, each individual tire prior to the acquisition of the set of four has a lower marginal utility to Jim than the tire preceding it.
The rigorously logical, ubiquitously observable, and universally applicable insights of Austrian Economics with regard to utility provide useful tools for analyzing human action in the economic sense. The Austrian view of marginal utility disposes with age-old paradoxes and allows for a framework of generalizations accommodating the entire diversity of individual valuations.
Note: This essay was approved as an accurate representation of Austrian School economic ideas by Dr. Robert P. Murphy of Hillsdale College, one of the leading contemporary scholars of Austrian Economics.
G. Stolyarov II is a science fiction novelist, independent filosofical essayist, poet, amateur mathematician and composer, contributor to organizations such as Le Quebecois Libre, Enter Stage Right, the Autonomist, and The Liberal Institute. Mr. Stolyarov is the Editor-in-Chief of The Rational Argumentator. He can be contacted at firstname.lastname@example.org.
TRA feature has been edited in accordance with TRA's Statement
Visit TRA's Principal Index, a convenient way of navigating throughout the issues of the magazine. Click here.