Book 3, chapter 6: Value and Utility

§1. This chapter explores an important idea in economics that’s often confused in everyday life, i.e., the consumer surplus (CS) equal to the difference between a good’s price and someone’s value of that good. The greater the difference — which varies with individual values — the greater their satisfaction. CS is also captured in “value for money” or “it’s a steal,” but some people make the mistake of assigning CS (or value) to the price when the gap is what matters.

§2. Marshall gives a verbal description of how CS rises with quantity voluntarily purchased at the same price, i.e., CS(2 units) is greater than CS(1 unit) as well as how CS rises if the price per unit falls. Through a slightly exhausting example, he explains how one’s “demand schedule” (the units of quantity demanded at different prices) results from decisions based on marginal rather than average values. If you buy one pound of tea for 20 shillings (s.) but add another (buying two pounds) when the price is 14s. each, then we know you value the first at 20s. (or more) and the second at 14s. (or more), for a total of 34s. When comparing value (34s.) to price (28s.), the key is not to compare average value (17s.) but the marginal values of 20s and 14s implied by prices paid.

These ideas are much easier to convey with a picture…

§3. So it’s nice that Marshall draws that picture in a footnote:This demand curve is familiar to anyone who has taken Economics 1, but let me reinforce the lesson: The area DOHA represents value, COHA equals cost, and DCA represents consumer surplus.

Marshall then explains the difference between marginal and total utility, i.e., that the marginal utility of a pound of tea is greater than that of a pound of salt but the total utility of consuming many pounds of salt is greater than that of consuming a few pounds of [way more expensive] tea, adding that — given a choice between two gifts — the consumer would choose more tea over more salt.

In a footnote to this example, Marshall quotes Harris (1757):

“Water is of great use, and yet ordinarily of little or no value; because in most places, water flows spontaneously in such great plenty, as not to be withheld within the limits of private property; but all may have enough, without other expense than that of bringing or conducting it, when the case so requires. On the other hand, diamonds being very scarce, have upon that account a great value, though they are but little use.” [pp 107-8]

Although he’s not as direct as I’d like, it seems he quotes this example to show how marginal and total values differ, thereby showing how the Diamond-Water paradox offered by Adam Smith in his 1776 Wealth of Nations resulted from misunderstanding marginal values. This oversight  won Smith few admirers, and it was (again) corrected by the “Marginalists” upon whose late-19th-century shoulders Marshall stood.

Marshall cautions against comparing the utilities of individuals (especially from different classes) and explaining how the loss of utility from losing access to tea would be much greater if coffee were not available as a substitute. Put differently, “let them eat cake” works only if you have cake to replace lost bread!

§4. Marshall’s assumption that changes in price can be analyzed ceteris paribus (all things equal) will break down if that change in price has an appreciable impact on buying power for other items, by depleting limited income, a problem of those particular inferior goods known as Giffen goods. He also notes that a complete demand schedule is more assumed than real, since it’s hard to know how demand responds to big price changes. Bravo!

§5. Well being depends on personal income but also “external considerations,” i.e., non-excludable (public and common pooled) goods:

Some are free gifts of nature; and these might indeed be neglected without great harm if they were always the same for everybody; but in fact they vary much from place to place. More of them however are elements of collective wealth which are often omitted from the reckoning of individual wealth; but which become important when we compare different parts of the modern civilized world, and even more important when we compare our own age with earlier times. [p 111]

His note here pushes back my mental model for economists’ awareness of non-excludable goods from Ostrom and Ostrom (1977) and Samuelson (1954).

§6. Marshall defines happiness as beginning once one has “enough to support life,” and that happiness rises more quickly for the poor than the rich. He then explains how this [decreasing marginal utility of income] justifies lower (higher) taxes on the poor (rich), as well as how a gambling loss of £100 is more painful than a win of £100, since the value of £1 is greater to a poorer person. These ideas were made famous by Kahneman and Tversky (1979) [cf. my review of Thinking Fast and Slow], but it’s quite interesting to see Marshall citing Bernoulli (1738)!

The chapter ends with some comments on work, wealth, consumption and quality over quantity, to whose eloquence I defer:

In every civilized country there have been some followers of the Buddhist doctrine that a placid serenity is the highest ideal of life; that it is the part of the wise man to root out of his nature as many wants and desires as he can; that real riches consist not in the abundance of goods but in the paucity of wants. At the other extreme are those who maintain that the growth of new wants and desires is always beneficial because it stimulates people to increased exertions. They seem to have made the mistake, as Herbert Spencer says, of supposing that life is for working, instead of working for life.

The truth seems to be that as human nature is constituted, man rapidly degenerates unless he has some hard work to do, some difficulties to overcome; and that some strenuous exertion is necessary for physical and moral health. The fulness of life lies in the development and activity of as many and as high faculties as possible. There is intense pleasure in the ardent pursuit of any aim, whether it be success in business, the advancement of art and science, or the improvement of the condition of one’s fellow-beings. The highest constructive work of all kinds must often alternate between periods of over-strain and periods of lassitude and stagnation; but for ordinary people, for those who have no strong ambitions, whether of a lower or a higher kind, a moderate income earned by moderate and fairly steady work offers the best opportunity for the growth of those habits of body, mind, and spirit in which alone there is true happiness.

There is some misuse of wealth in all ranks of society. And though, speaking generally, we may say that every increase in the wealth of the working classes adds to the fulness and nobility of human life, because it is used chiefly in the satisfaction of real wants; yet even among the artisans in England, and perhaps still more in new countries, there are signs of the growth of that unwholesome desire for wealth as a means of display which has been the chief bane of the well-to-do classes in every civilized country. Laws against luxury have been futile; but it would be a gain if the moral sentiment of the community could induce people to avoid all sorts of display of individual wealth. There are indeed true and worthy pleasures to be got from wisely ordered magnificence: but they are at their best when free from any taint of personal vanity on the one side and envy on the other; as they are when they centre round public buildings, public parks, public collections of the fine arts, and public games and amusements. So long as wealth is applied to provide for every family the necessaries of life and culture, and an abundance of the higher forms of enjoyment for collective use, so long the pursuit of wealth is a noble aim; and the pleasures which it brings are likely to increase with the growth of those higher activities which it is used to promote.

When the necessaries of life are once provided, everyone should seek to increase the beauty of things in his possession rather than their number or their magnificence. An improvement in the artistic character of furniture and clothing trains the higher faculties of those who make them, and is a source of growing happiness to those who use them. But if instead of seeking for a higher standard of beauty, we spend our growing resources on increasing the complexity and intricacy of our domestic goods, we gain thereby no true benefit, no lasting happiness. The world would go much better if everyone would buy fewer and simpler things, and would take trouble in selecting them for their real beauty; being careful of course to get good value in return for his outlay, but preferring to buy a few things made well by highly paid labour rather than many made badly by low paid labour.

…and thus, Marshall channels Thoreau (1854) (“my needs are few, therefore I am rich”), extolls the value of work while denouncing vanity, calls for the rich to provide public goods to all, and suggests that a few beautiful things are worth more than many things of poor quality.

Those who engage in “retail therapy” need to read Marshall!

Author: David Zetland

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

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