Diminishing marginal utility
Overview
Diminishing marginal utility is the principle that each additional unit of a good provides less satisfaction than the one before. The first glass of water on a hot day is worth a great deal; the fifth is worth little; the tenth is a nuisance. The thousandth pound means more to someone who has one thousand than to someone who has one million.
The principle is the core of marginal utility theory, developed independently in the 1870s by William Stanley Jevons, Carl Menger, and Léon Walras (the "marginal revolution"). It holds that the value of a good is set by the usefulness of the next unit to the person deciding whether to buy it, not by the labour that went into producing it. It replaced the labour theory of value in mainstream economics and has not been seriously challenged since.
Notes
- It explains the diamond–water paradox that troubled Adam Smith: water is more useful than diamonds, yet diamonds cost more. Water is abundant, so the marginal glass is worth little; diamonds are scarce, so the marginal stone is worth a lot.
- It is the economic basis for progressive taxation and for a welfare floor: a pound taken from the rich reduces welfare less than a pound taken from the poor, and a pound given to the poor adds more than a pound given to the rich. See Wealth and Luck.
- Beyond a certain income, additional wealth stops buying well-being and starts buying only more wealth, or power (see Happiness). This is also why "the rich create jobs" is weaker than it sounds: the marginal pound in a rich person's hands is more likely to be saved than spent.