The theory of diminishing marginal utility rests on one subtle trap, which, if identified, causes its whole structure to collapse.
The theory starts by posing a seemingly legitimate question: to which ends would one employ a good if he had X-1 units versus X units? And since humans typically prioritize different ends to various degrees, logic follows that the first units would be put to use to serve the highest priorities, with each subsequent unit serving lesser and lesser ends.
But note the use of the words “if he had.” This is a stolen concept fallacy.
The “stolen concept” fallacy, first identified by Ayn Rand, is the fallacy of using a concept while denying the validity of its genetic roots, i.e., of an earlier concept(s) on which it logically depends.
When one asserts “if he had,” one should ask: had how?—or, by what means?
Goods do not fall from the sky nor do they appear when one wishes them. Means, to be possessed, must be acquired. This is true of every material object, whether we are speaking about rocks that are naturally ubiquitous or diamonds that are extremely rare. The caveman on a hunting quest does not simply will a rock to his possession but must find one (with enough weight and sturdiness) before he can hurl it at his prey, which, by the same principle, must be actually caught, regardless of whether game is plentiful or scarce.
Every means presupposes action. One can never transition from one state of quantity to another without exerting effort. If we deny action, or production, through which different states of disposable quantities are made possible, then we implicitly adopt a premise of static quantities.
This premise divorces consumption from production, severing consumers from their productive past. When asked how many bags of rice would a consumer like to have, the full context is dropped. Granted, there are only so many employments each bag of rice could satisfy for so many ends; but since no means can be attained without action, the “utility” we should focus on is not the goods that a consumer covets but the money that he had earned through his productive work as his means to attain ends.
The causal order is as follows.
An employee goes to work and receives an income of $1,000. This allows him to live in a scrappy apartment in a dangerous neighborhood. He pays for rent, food and transportation. Our employee is an ambitious young man. Within a few months he is promoted to a managerial role with a $2,000 raise. Now he can rent a more spacious apartment on a better side of town. He can even allow himself a wider dietary menu that includes meat. Occasionally, he takes a girl out on an expensive date. Ten years down the line, he is earning $150,000 a year as a top salesman at his firm. He has a house to his name, a luxurious car, nice furniture, modern appliances, is well-dressed, dines in fine restaurants—in short, he has achieved a higher standard of living.
What we find when we are aware of the fact that one cannot consume without first producing is a reversal of the so-called law of declining marginal utility.
Each added dollar that one earns opens up more possibilities. A productive increase in quantity leads to the gaining of higher ends, not lesser ones.
Marginal utility “works” only if we treat quantities as static; as if one state of quantity can be transformed into another within a frozen, action-less context—which is a contradiction. The marginal utility trap is that it invokes a comparison between different states of hypothetical quantities, when the real comparison is between a current state and a future state, gained through action.
For example, it is often claimed that if one had $100, another $10 would be more important to him than if he had $1,000,000 and added another $10. But quantities are not added or subtracted in a void. If one earns $100, earning another $10 implies that he is working toward achieving more goals, not “securing” things less important. If he earns a million, surely he has the productive capacity to “add” more than $10. If he wants to buy a house worth $2 million, or raise another million for the sake of a new startup, another $10 is not a fragment but part of a larger investment or project that is far more valuable than $10 for a poor man.
The same is true for consumers. Consumers don’t compare 5 bags of rice to 6; they compare the money that they had earned with however many bags of rice they want. Initially, one does not have an extra $20 for 5 bags of rice. Only after earning $20, he can buy the rice. The consumer employs his earned money to attain ends—it is not hypothetical quantities that explain how he attains ends.
Marginal utility can occur only if production suddenly stopped; if after accumulating a fixed amount of goods, producing more quantities were impossible or production capacity fell drastically. Then, the question of employing available means according to a prioritized scale of values becomes relevant—as is inevitable under socialist regimes that destroy wealth and force its subjects to ration their means.
But even in this scenario, it is not that utility declines because units are used or allocated in successive order—it declines because values are being destroyed while value-creation activity is suspended or out of reach. The consumption of successive units extinguishes them with no substitutes coming into existence.
Marginal utility is a theory of rationing, applicable for cases such as famine, siege, shipwrecks and war. It is no accident that its “best” examples invoke emergencies, where one must allocate his resources—not act to gain values, as is applicable in normal times.
Think about what this theory means if we take it at face value: that, by definition, the gaining of new values makes them less valuable; that each additional possession or achievement is by its nature less valuable than the previous one. Life is viewed as a rationing problem by default. But evidence begs to differ. When men are free to act, they build, prosper and flourish. Their accomplishments keep growing on the back of their previous successes, each milestone enabling the next.
Marginal utility does not deny this; it states that new desires expand with a progressing economy[1]. But this is a concession. “New desires” do not randomly spawn under new conditions—it is the new conditions that make them possible.
Contrary to the key tenet of modern economics, we don’t start with “scarce means.” We start with no means at all. The default is zero. The human problem is building up from scratch, moving away from death, not allocating that which we did not earn. Action (guided by reason) is the fundamental cause that facilitates means for the sake of ends, which enable further means for further ends. Means are a link in a complementary chain; their value never declines.
Let us take the classic example of sacks of grain to demonstrate this. Every sack that the farmer produces is complementary to the previous one. The units work as integrated values, not as disintegrated marginal positions.
If the first sack enables survival for two months, the second extends life to four. The second sack is neither separated from the first nor is it experienced as a lesser value. It is experienced as an extension of life and reduction of existential threat. The farmer does not think: “Which sack would I least want to lose?”—he thinks: “This opens new doors. My life is improving.”
The third sack he trades for chickens. Now the farmer can eat meat and eggs, an upgrade over an all-bread menu. The fourth sack he uses to feed the chickens, so he can reproduce more and ensure meat into the future.
The fifth through tenth sacks he saves for harvesting. These he does not view as a “less important” future concern. Harvesting grain for next season ensures his farming operation altogether. Without it, his life’s work is ruined. These sacks are his asset. Is this asset less valuable than the first sack? I think the answer is clear.
Further still, the farmer can trade additional sacks for cows and horses, he can employ laborers and purchase capital goods to yield more wheat, as he keeps growing and flourishing, attaining more ends through more means.
Can we say that securing the present is more urgent than securing the future? Yes, but only when one must sacrifice one for the other. If no such sacrifice is required, the question is irrelevant under normal circumstances. (If the farmer produced only one sack, he would have to quit farming.)
It is important to note that utility does not rise to infinity. Rather, it is limited by reality-based constraints. There are thresholds such as how many hours a day the farmer can work, space for storage, the grain’s spoilage, and how many buyers can be found in the market. Utility rises with additional produced units but is limited by objective constraints.
The law of “utility” is one of complementarity. Utility with each added unit can remain flat (e.g., the second bag of rice in the kitchen is valued as much as the first), rise in qualitative jumps (e.g., three logs can be used for a fire to keep one warm and 100 logs can be used to build a cabin), or hit thresholds. Utility may also rise incrementally, but this is largely unimportant. There is no law of marginal ordering. Means can sustain, expand, or transform ends.
If a person at old age cannot produce with the same intensity or effectiveness of his younger days, this does not mean that his utility “declines.” His context changed, and he is now pursuing less ambitious ends. To the extent that he still produces means, although more modest in scope, they are still complementary to his newly formed ends.
A proper definition of “utility” will help grasp this issue better. Utility is the effectiveness of earned means to gain one’s pursued ends. It is the gaining of means-for-ends. If one’s ambitions diminish in scope, it does not follow that his newly created values will decline along a curve[2]. Means and ends belong to the same causal process, not to two independent axes—one “material” (goods) and the other “mental” (rankings in the mind).
We can conceptualize means as productive inputs that enable us to extend or stabilize our productive efforts. This is true in every context. Only in emergencies does the complementary nature of means change; but this is because production is thwarted—not due to any (intrinsic) law of diminishing value.
We shall end on a note that the law of complementary utility does not explain economic value. It is a law of production and growth. Just as diminishing marginal utility never explained value, neither does this law. Its objective is to demonstrate that means are complementary, i.e., that they augment values; complementarity does not pretend to be a law that shows by how much value increases or how it is appraised. (For this question, you will have to read my essay on economic value.)
Our main aim here was to restore the Law of Causality to its rightful place in economics; namely, that consumption may never be divorced from production.
[1] Alfred Marshall said that “There seems to be no good reason for believing that we are anywhere near a stationary state in which there will be no new important wants to be satisfied… The whole history of man shows that his wants expand with the growth of his wealth and knowledge.” Principles of Economics, pp. 127-128.
[2] Traditional curves show total utility rising at a decreasing rate and marginal utility falling. But these curves freeze action at an arbitrary point, treating means as a static stock to be allocated rather than the latest part of an integrated whole of ongoing production.
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Read my long-form essay on the nature and definition of economic value below.
What Is Economics?
In the 19th century, John Stuart Mill wrote that economics is concerned with man “solely as a being who desires to possess wealth[1].”
You identify a serious problem with the theory of marginal utility. Examples of the theory that I have run across typically view economic actors as mere consumers, hence the use of the example of a hamburger. "How many hamburgers would a person like to consume?" is the starting point. Obviously, one hamburger satisfies one's hunger, a second one makes him uncomfortably full, and a third one might cause him to throw up. This, it is claimed, demonstrates that each additional unit of a good must necessarily fall in terms of utility. I always found this example very strange. When you frame the issue in terms of economic actors as producers, there's no conceivable reason why additional units of output would fall in terms of utility. They would rise, in fact, since they increase one's standard of living.
Economic actors, being producers, have earned the means to be consumers as well. The hamburger example disingenuously ignores the issue of time; more specifically, that consumption does not occur all at once, but takes place over a period of time. If one eats one hamburger a week, instead of three all at once, then there's no reason for the marginal utility of a hamburger to decline.