December 10 - Marginalism

The theory of marginalism stands as one of the most important turning points in the history of economic thought. At its core, marginalism concerns the idea that economic decisions are made at the margin—that is, the value of goods, services, or productive factors is determined not by their total or average contribution, but by the incremental benefit or cost associated with a small change in their use. This approach, which gained prominence in the late nineteenth century, transformed classical political economy into modern economics by introducing a new analytical framework for understanding value, utility, and decision-making.

The origins of marginalism can be traced to what has been termed the "marginal revolution" of the 1870s, a period when three economists working independently—William Stanley Jevons in England, Carl Menger in Austria, and Léon Walras in Switzerland—laid the foundations of marginal utility theory. Each of them recognized that classical theories of value, rooted in labour or production costs, were inadequate in explaining phenomena such as the so-called "paradox of value," famously illustrated by Adam Smith. Smith had noted that water, essential to life, was typically cheap, while diamonds, of little practical use, were extremely expensive. The classical cost-of-production theory could not fully resolve this paradox. Marginalism offered a solution by shifting the focus away from aggregate usefulness to the additional utility gained from consuming one more unit of a good. Water, abundant in most settings, has a low marginal utility despite its vital importance, while diamonds, being scarce, have a high marginal utility, justifying their high price.

Jevons articulated this principle in his Theory of Political Economy (1871), asserting that "value depends entirely upon utility," but with the crucial refinement that it is the marginal utility, not total utility, that matters. Around the same time, Menger’s Principles of Economics (1871) developed a subjectivist framework in which the value of goods derives from their ability to satisfy individual wants at the margin, rather than from inherent properties or embodied labour. Walras, meanwhile, incorporated marginalism into a broader system of general equilibrium, formalising the interaction of supply and demand through mathematics in Éléments d’économie politique pure (1874). These contributions collectively reoriented economics, marking the decisive break from the classical tradition and setting the stage for the neoclassical school.

The implications of marginalism extend beyond consumption into production and distribution. The principle of diminishing marginal returns, first formalised in agricultural economics in the early nineteenth century by figures such as David Ricardo and Johann Heinrich von Thünen, was integrated into the marginalist framework to explain how firms allocate resources. In neoclassical production theory, factors of production—labour, capital, and land—are compensated according to their marginal productivity. This so-called marginal productivity theory of distribution, later refined by John Bates Clark, posited that wages, rents, and profits reflect the incremental contribution of each factor to output. While this theory was not without controversy, especially regarding its assumptions of competitive markets and factor mobility, it became foundational in modelling income distribution in neoclassical economics.

Marginalism also profoundly shaped the methodology of economics. By focusing on incremental changes, it encouraged the use of calculus and mathematical tools to model optimisation behaviour. Economic agents, whether consumers maximising utility or firms maximising profit, came to be understood as operating at the margin, where the additional benefit of an action equates to its additional cost. This analytical framework remains central to modern microeconomics, from consumer choice theory to cost-benefit analysis in public policy.

Despite its dominance, marginalism has faced critiques. The Austrian tradition, building on Menger, rejected the heavy reliance on mathematics favoured by Walras and later neoclassicals, insisting that marginal utility is subjective and not amenable to precise measurement. The Cambridge capital controversies of the 1960s also raised questions about the coherence of marginal productivity theory when applied to capital, a heterogeneous factor. Moreover, behavioural economics in recent decades has challenged the assumption that individuals consistently make marginal calculations, pointing instead to bounded rationality and cognitive biases.

Nevertheless, marginalism remains a cornerstone of economic thought. By reframing value in terms of marginal utility and marginal productivity, it resolved longstanding theoretical puzzles and provided economists with a powerful, flexible framework for analysing decision-making and resource allocation. The marginal revolution did not merely introduce a new concept; it reshaped the discipline into the form that still predominates today.

References

Clark, J. B. (1899). The Distribution of Wealth: A Theory of Wages, Interest and Profits. New York: Macmillan.

Jevons, W. S. (1871). The Theory of Political Economy. London: Macmillan.

Menger, C. (1871). Principles of Economics. Vienna: Wilhelm Braumüller.

Ricardo, D. (1817). On the Principles of Political Economy and Taxation. London: John Murray.

Walras, L. (1874). Éléments d’économie politique pure. Lausanne: Corbaz.

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Prompt: “Can you write a 600 essay on economic idea/theory of marginalism, what it means in economic models, where it comes from and who/what first identified this issue? Use academic sources if needed. Try to avoid bullet points, but write a free-flowing essay. Can you list all your sources at the end in classic Cambridge referencing.”