What are these concepts, and how do they affect our daily economic activities and experiences?
The ‘subjective theory of value’ tells us that it is in the mind of the individual buyer that a relative value is established for anything that might be purchased. If one person really likes coffee, he’ll be willing to pay more for it than a person who doesn’t care that much for the coffee.
This shows that the ‘value’ of the coffee is not located in the coffee, but rather in the mind. It’s the same coffee, but one person might be willing to pay $1 for it, while another person is willing to pay $2 for it.
The ‘value’ is also not determined by relative scarcity or abundance. Two goods which are equally rare, or equally common, may yet fetch two different prices.
The ‘marginal utility theory’ tells us that the amount of practical use or please we obtain from each unit of a good varies. If I’m a student getting ready for a new academic year, the first pencil I buy is probably of great value to me: the second pencil less so. I might buy a package of ten pencils, but I probably won’t buy a package of 1,000 pencils. Why?
The difference between the first pencil and the second pencil is that the second pencil has less value to me, but only slightly less. The second pencil still adds significantly to my perceived utility, so I buy it.
At some point the value of an additional pencil is very small. The difference between having one pencil or having two is significant. The difference between having 999 pencils or having 1,000 pencils is not significant.
Carl Menger developed these ideas within the history of economics. As the Encyclopedia Britannica notes,
Goods are valuable because they serve various uses whose importance differs. Menger used this insight to resolve the diamond-water paradox that Adam Smith posed but never solved.
The ‘diamond-water paradox’ refers to the fact that, although water is necessary to life and diamonds are not, we usually pay much more for diamonds. But a man dying of thirst in the desert will reverse the relative prices, and pay more for a glass of water than for a diamond.
The notion of marginal utility applies not only to goods, but also to labor:
Menger also used it to refute the view, popularized by David Ricardo and Karl Marx, that the value of goods derives from the value of labour used to produce them. Menger proved just the opposite: that the value of labour derives from the value of the goods it produces, which is why, for example, the best professional basketball players or most popular actors are paid so much.
Before Menger, much of ‘classical’ economics focused on impersonal concepts such as aggregate supply and aggregate demand, relative scarcity and relative abundance, and the cost of labor and material required to produce a given good.
The work of Carl Menger supersedes the thought of Ricardo, Marx, and even Adam Smith, first because it offers an insight into the ‘diamond-water paradox,’ but also because, as Joseph Salerno writes, it transforms economic thought by introducing, and focusing upon, the psychology of the individual buyer or seller.
This brings us to the question of value which so vexed, and ultimately defeated, the Classical economists. Because they were tragically unable to grasp that specific quantities and not entire classes of goods were the object of human action, the Classical economists dropped ‘use value’ from their analysis. But Menger, with his unblinking focus on individual action, easily recognized the profound significance of the concept of the marginal unit - the quantity of a good relevant to choice - for the whole of economic theory.
Marginal utility theory also explains how and why marginal price changes: usually downward - after paying for one slice of cake, I’m full and I’m likely to offer a lower price for the second or third slice. It is important to note cases in which the marginal price goes up: I’m likely to offer a higher price for 32 chess figures than for 31 of them. I’m likely to offer a much higher price for 52 playing cards than for 51 of them.
Carl Menger’s economic writings have played a major role in the twentieth and twenty-first centuries.
