Economists sought to explain how prices are determined, and in this pursuit, they developed the concept of marginal utility. The term "marginal utility", credited to the
Austrian economist
Friedrich von Wieser by
Alfred Marshall, was a translation of Wieser's term ("border-use").
Proto-marginalist approaches Perhaps the essence of a notion of diminishing marginal utility can be found in
Aristotle's
Politics, wherein he writes There has been marked disagreement about the development and role of marginal considerations in Aristotle's value theory. Numerous economists have established a connection between utility and rarity, which influences economic decisions and price determination. Diamonds are priced higher than water because their marginal utility is higher than water. Eighteenth-century Italian
mercantilists, such as
Antonio Genovesi,
Giammaria Ortes,
Pietro Verri,
Marchese Cesare di Beccaria, and
Count Giovanni Rinaldo Carli, held that value was explained in terms of the general utility and of scarcity, though they did not typically work-out a theory of how these interacted. In
Della moneta (1751), Abbé
Ferdinando Galiani, a pupil of Genovesi, attempted to explain value as a ratio of two ratios,
utility and
scarcity, with the latter component ratio being the ratio of quantity to use.
Anne Robert Jacques Turgot, in '''' (1769), held that value derived from the general utility of the class to which a good belonged, from comparison of present and future wants, and from anticipated difficulties in procurement. Like the Italian mercantists,
Étienne Bonnot, Abbé de Condillac, saw value as determined by utility associated with the class to which the good belong, and by estimated scarcity. In '''' (1776), Condillac emphasized that value is not based upon cost but that costs were paid because of value. This last point was famously restated by the Nineteenth Century proto-marginalist,
Richard Whately, who in
Introductory Lectures on Political Economy (1832) wrote: (Whatley's student
Senior is noted below as an early marginalist.)
Marginalists before the Revolution Daniel Bernoulli, is credited with publishing the first clear statement on the theory of marginal utility in his paper "Specimen theoriae novae de mensura sortis", which was released in 1738, although he had drafted it in 1731 or 1732.
Gabriel Cramer had developed a similar theory in a private letter in 1728, aimed at resolving the
St. Petersburg paradox. Both Bernoulli and Cramer concluded that the desirability of money decreases as it accumulates, with the
natural logarithm (Bernoulli) or
square root (Cramer) serving as the measure of a sum's desirability. However, the broader implications of this hypothesis were not explored, and the work faded into obscurity. In "A Lecture on the Notion of Value as Distinguished Not Only from Utility, but also from Value in Exchange", delivered in 1833 and included in
Lectures on Population, Value, Poor Laws and Rent (1837),
William Forster Lloyd explicitly offered a general marginal utility theory, but did not offer its derivation nor elaborate its implications. The importance of his statement seems to have been lost on everyone (including Lloyd) until the early 20th century, by which time others had independently developed and popularized the same insight. In
An Outline of the Science of Political Economy (1836),
Nassau William Senior asserted that marginal utilities were the ultimate determinant of demand, yet apparently did not pursue implications, though some interpret his work as indeed doing just that. In "''''" (1844),
Jules Dupuit applied a conception of marginal utility to the problem of determining bridge tolls. In 1854,
Hermann Heinrich Gossen published , which presented a marginal utility theory and to a very large extent worked-out its implications for the behavior of a market economy. However, Gossen's work was not well received in the Germany of his time, most copies were destroyed unsold, and he was virtually forgotten until rediscovered after the so-called Marginal Revolution.
Marginal Revolution Marginalism eventually found a foothold by way of the work of three economists,
Jevons in England,
Menger in Austria, and
Walras in Switzerland.
William Stanley Jevons first proposed the theory in "A General Mathematical Theory of Political Economy", a paper presented in 1862 and published in 1863, followed by a series of works culminating in his book
The Theory of Political Economy in 1871 that established his reputation as a leading political economist and logician of the time. Jevons' conception of utility was in the
utilitarian tradition of
Jeremy Bentham and of
John Stuart Mill, but he differed from his
classical predecessors in emphasizing that "value depends entirely upon utility", in particular, on "
final utility upon which the theory of Economics will be found to turn." He later qualified this in deriving the result that in a model of exchange equilibrium, price ratios would be proportional not only to ratios of "final degrees of utility", but also to costs of production.
Carl Menger presented the theory in
Grundsätze der Volkswirtschaftslehre (translated as
Principles of Economics) in 1871. Menger's presentation is peculiarly notable on two points. First, he took special pains to explain
why individuals should be expected to rank possible uses and then to use marginal utility to decide amongst trade-offs. (For this reason, Menger and his followers are sometimes called the Psychological School, though they are more frequently known as the
Austrian School or as the Vienna School.) Second, while his illustrative examples present utility as quantified, his essential assumptions do not. (Menger in fact crossed-out the numerical tables in his own copy of the published
Grundsätze.) Menger also developed the
law of diminishing marginal utility. Menger's work found a significant and appreciative audience.
Marie-Esprit-Léon Walras introduced the theory in '''', the first part of which was published in 1874 in a relatively mathematical exposition. Walras's work found relatively few readers at the time but was recognized and incorporated two decades later in the work of
Pareto and
Barone. An American,
John Bates Clark, is sometimes also mentioned. But, while Clark independently arrived at a marginal utility theory, he did little to advance it until it was clear that the followers of Jevons, Menger, and Walras were revolutionizing economics. Nonetheless, his contributions thereafter were profound.
Second generation Although the Marginal Revolution flowed from the work of Jevons, Menger, and Walras, their work might have failed to enter the mainstream were it not for a second generation of economists. In England, the second generation were exemplified by
Philip Henry Wicksteed, by
William Smart, and by
Alfred Marshall; in Austria by
Eugen von Böhm-Bawerk and by
Friedrich von Wieser; in Switzerland by
Vilfredo Pareto; and in America by
Herbert Joseph Davenport and by
Frank A. Fetter. While the approaches of Jevons, Menger, and Walras had notable differences, the second generation of economists did not maintain these distinctions based on national or linguistic boundaries. Von Wieser's work was significantly influenced by Walras, while Wicksteed was strongly influenced by Menger. Fetter and Davenport identified themselves as part of the "American Psychological School", named after the "Austrian Psychological School", while Clark's work during this period was also heavily influenced by Menger. William Smart initially served as a conduit for Austrian School ideas to English-speaking readers but gradually came under the sway of Marshall's ideas. Böhm-Bawerk was perhaps the most able expositor of Menger's conception. He was further noted for producing a theory of interest and of profit in equilibrium based upon the interaction of diminishing marginal utility with diminishing
marginal productivity of time and with
time preference. This theory was adopted in full and then further developed by
Knut Wicksell and with modifications including formal disregard for time-preference by Wicksell's American rival
Irving Fisher. Marshall was the second-generation marginalist whose work on marginal utility came most to inform the mainstream of neoclassical economics, especially by way of his
Principles of Economics, the first volume of which was published in 1890. Marshall constructed the demand curve with the aid of assumptions that utility was quantified, and that the marginal utility of money was constant (or nearly so). Like Jevons, Marshall did not see an explanation for supply in the theory of marginal utility, so he synthesized an explanation of demand thus explained with supply explained in a more
classical manner, determined by costs which were taken to be objectively determined. Marshall later actively mischaracterized the criticism that these costs were themselves ultimately determined by marginal utilities.
Marginal Revolution and Marxism Karl Marx acknowledged that "nothing can have value, without being an object of utility", but in his analysis "use-value as such lies outside the sphere of investigation of political economy", with labor being the principal determinant of value under capitalism.
Ernesto Screpanti and
Stefano Zamagni interpret the doctrines of marginalism and the Marginal Revolution as a response to
Marxist economics. However, this view is somewhat flawed, as the first volume of
Das Kapital was not published until July 1867, which was after the works of Jevons, Menger, and Walras had either been written or were under way (Walras published in 1874 and Carl Menger published
Principles of Economics in 1871); Marx was still a relatively minor figure when these works were completed and it is unlikely that any of these economists knew anything about him. Some scholars, such as
Friedrich Hayek and
W. W. Bartley III, have speculated that Marx may have come across the works of one or more of these economists while reading at the
British Museum. Despite the fact the Marxist economics was not an immediate target for the marginalists, it is possible to argue that the new generation of economists succeeded partly because they were able to provide simple responses to Marxist economic theory. One of the best known responses was Böhm-Bawerk, (1896), but the first response was actually Wicksteed's "The Marxian Theory of Value.
Das Kapital: A Criticism" (1884), followed by "The Jevonian Criticism of Marx: A Rejoinder" in 1885. At first, there were only a few Marxist responses to marginalism, including
Rudolf Hilferding's
Böhm-Bawerks Marx-Kritik (1904) and
Politicheskoy ekonomii rante (1914) by
Nikolai Bukharin. However, over the course of the 20th century, a significant body of literature emerged on the conflict between marginalism and labour theory of value. One important critique of marginalism came from neo-Ricardian economist
Piero Sraffa. Followers of
Henry George's ideas such as
Mason Gaffney view marginalism and neoclassical economics as a response to
Progress and Poverty, which was published in 1879. In the 1980s
John Roemer and other
analytical Marxists have worked to rebuild Marxian theses on a marginalist foundation.
Reformulation In his 1881 work
Mathematical Psychics,
Francis Ysidro Edgeworth presented the
indifference curve, deriving its properties from marginalist theory which assumed utility to be a differentiable function of quantified goods and services. Later work attempted to generalize to the indifference curve formulations of utility and marginal utility in avoiding unobservable measures of utility. In 1915,
Eugen Slutsky derived a theory of
consumer choice solely from properties of indifference curves. Because of the
World War, the
Bolshevik Revolution, and his own subsequent loss of interest, Slutsky's work drew almost no notice, but similar work in 1934 by
John Richard Hicks and
R. G. D. Allen derived largely the same results and found a significant audience. (Allen subsequently drew attention to Slutsky's earlier accomplishment.) Although some of the third generation of Austrian School economists had by 1911 rejected the quantification of utility while continuing to think in terms of marginal utility, most economists presumed that utility must be a sort of quantity. Indifference curve analysis seemed to represent a way to dispense with presumptions of quantification, albeit that a seemingly arbitrary assumption (admitted by Hicks to be a "rabbit out of a hat") about decreasing marginal rates of substitution would then have to be introduced to have convexity of indifference curves. For those who accepted that indifference curve analysis superseded earlier marginal utility analysis, the latter became at best perhaps pedagogically useful, but "old fashioned" and observationally unnecessary.
Revival When Cramer and Bernoulli introduced the notion of diminishing marginal utility, it had been to address a
paradox of gambling, rather than the
paradox of value. The marginalists of the revolution, however, had been formally concerned with problems in which there was neither
risk nor
uncertainty. So too with the indifference curve analysis of Slutsky, Hicks, and Allen. The
expected utility hypothesis of Bernoulli and others was revived by various 20th century thinkers, with early contributions by
Ramsey (1926),
von Neumann and
Morgenstern (1944), and
Savage (1954). Although this hypothesis remains controversial, it brings not only utility, but a quantified conception of utility (cardinal utility), back into the mainstream of economic thought. A major reason why quantified models of utility are influential today is that risk and uncertainty have been recognized as central topics in contemporary economic theory. Quantified utility models provide a simplified approach to analysing risky decision by establishing a link between diminishing marginal utility and
risk aversion. In fact, many contemporary analyses of saving and portfolio choice require stronger assumptions than diminishing marginal utility, such as the assumption of
prudence, which means
convex marginal utility. Meanwhile, the Austrian School continued to develop its ordinalist notions of marginal utility analysis, formally demonstrating that from them proceed the decreasing marginal rates of substitution of indifference curves. == See also ==