Book 3, chapter 5: Choice between different uses of the same thing. Immediate and deferred uses.

§1. This chapter begins with the housewife’s dilemma: when to switch between using wool for producing socks to using it for producing vests. Marshall then explains how the housewife wants to balance the marginal value of the last sock or vest, i.e.,

“If a person has a thing which he can put to several uses, he will distribute it among these uses in such a way that it has the same marginal utility in all. For if it had a greater marginal utility in one use than another, he would gain by taking away some of it from the second use and applying it to the first” [p 98].

§2. He then moves from the household to trade between producers of wool and wood, which goes on until both sides are happy with their wood/wool balances, i.e., where the marginal utilities they receive from each commodity are equal. Moving from barter to trade facilitated by money, Marshall states that consumers seek to balance the marginal benefits of all the goods they consume, using money to fine tune the mix. (He then adds an interesting footnote, to the effect that Anglo-American housewives are less able to maximize the benefits of their consumption than French housewives who are able to consume more because they are more skilled at maximizing their production from raw materials. Plus ça change!)

§3. Marshall then explores how we balance between present and future consumption, which depends on three factors. The first is “uncertainty (this is an objective property which all well-informed persons would estimate in the same way)” [p 100] or what economists have called “risk” since Frank Knight defined the difference between risk (measurable in terms of probabilities) and uncertainty (not measurable) in 1921. The second factor is how individuals apply personal discount rates in comparing future and present values. Marshall explicitly states that one’s personal discount rate varys with conditions, that children and impatient people pay less attention to the future (=low discount rates), and how discount rates affect one’s enjoyment of a long-lived good. This last use underlies basic savings and investment decisions. The third factor, often forgotten these days, is that we might be eager to possess something merely for the pleasure, ignoring financial considerations. Although such “possession utility” might be rolled into utility maximization, some people are not so accepting that others might really be better off consuming now rather than delaying their urges.

§4. Marshall ends the chapter cautioning against comparing present to future consumption, which ignores “uncertainty” (risk) and the fact that personal preferences change. That said, he does draw the useful connection between (individual) discount and (market) interest rates, i.e., that borrowers and lenders tend to have discount rates that are higher and lower than market rates, respectively. (Crazy that I am just teaching these ideas to my students!)

Author: David Zetland

I'm a political-economist from California who now lives in Amsterdam.

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