Thursday, March 12, 2009

Mengerian Marginalism

This post is part of a series exploring Principles of Economics by Carl Menger.  The following explores content from chapter 3.

Previously in this series: Further Mengerian Insights on Value

The most important opening shot of the Marginal Revolution was fired with the following passage:

careful examination of the phenomena of life shows that these differences in the importance of different satisfactions can be observed not only with the satisfaction of needs of different kinds but also with the more or less complete satisfaction of one and the same need.

Less complete levels of satisfaction are always MORE important than more complete levels of satisfaction.

Let us imagine that a man lost in the desert, on the verge of dying of thirst, and carrying a pouch of diamonds comes upon a caravan. The man begs for water, but the caravan leader, seeing the diamonds, demands to be paid for it.

A first cup of water, necessary to keep the man from expiring right then, would obviously be tremendously important to him. That is the LEAST complete level of satisfaction possible for the man's need for water, and, as it is extremely important, he would be willing to give the caravan leader anything for it if necessary : even a pouch full of diamonds. Thus the great importance translates into great value.

A second cup, necessary to keep him from suffering permanent damage to his health, would also have great importance. That second cup is a more complete level of satisfaction than the first, and thus is less important, as not dying is a more important than avoiding permanent damage. Thereby, it would have less value: he might be willing to exchange the whole pouch minus one diamond for it (perhaps, to him, keeping that one diamond to keep his family out of destitution is worth the damage to his health).

Say a third cup of water would cure him of a small portion of the pain currently afflicting him; perhaps he would only pay one diamond for this yet more complete level of satisfaction.

Now let us say that any more than ten cups of water would actually harm the man's health. Thus, the tenth cup of water would provide the MOST complete level of satisfaction possible, and thus would have the LEAST importance and value possible. Perhaps he wouldn't pay any of his diamonds for a tenth cup, but only the spare change in his pocket. An eleventh cup would have no value whatsoever.

Though Menger himself never termed it thus, this insight is now known as the "law of diminishing marginal utility".

Next in this series: Menger's Value Scale

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