Diminishing Marginal Utility
This article is part of the Basic Course on Libertarianism and the Austrian School of Economics-> Module 5: Austrian Economics and Free Market
Last updated: 2026-05-02
Definition
Marginal utility is one of the most revolutionary concepts of the Austrian School of Economics; it is the concept that revolutionized economics by resolving the old “paradox of value” (why water, being vital, is cheap, while diamonds, being dispensable, are expensive).
Unlike other currents, the Austrians emphasize that utility is not something that can be measured in numbers (as if they were “units of pleasure”), but a subjective scale of preferences. (Subjectivism)
Marginal utility = the satisfaction (or value) that the individual attributes to the last unit of a good he possesses or is considering acquiring.
The Law of Diminishing Marginal Utility
Carl Menger (1840–1921), founder of the Austrian School, established that:
- The greater the quantity of a good that a person already possesses, the lower the subjective utility he assigns to each additional unit (one more) of the same good.
- As an individual possesses more units of an identical good, the value he assigns to each additional unit is lower.
This happens because the human being is a being who acts to satisfy ends. When he has the first unit of a good, he assigns it to his most urgent need. The second unit is assigned to the next need on his list of priorities, and so on.
Classic example (The settler and his sacks of wheat): Imagine a farmer who harvests 5 sacks of wheat:
- The 1st sack he uses so as not to starve (life).
- The 2nd to strengthen himself (health).
- The 3rd to feed his animals and have meat (protein).
- The 4th to make whiskey (leisure).
- The 5th to feed his parrots (pure aesthetic pleasure).
If the farmer loses one sack, he will not stop eating; he will simply stop feeding his parrots. Therefore, the value of any sack of wheat is equal to the value of the least important end (the 5th).
Value Is Subjective and Ordinal
Historically, utility began as cardinal (it was thought it could be measured in units or “utils”). For the Austrians, utility is not cardinal (you cannot say “this gives me 10 points of utility/satisfaction/emotion/pleasure”), but ordinal (you can say “I prefer A over B”).
Subjective:
It depends entirely on the individual’s valuation at a specific moment and context. Water has little marginal utility in the city, but very high marginal utility if you are lost in the desert.
Ordinal:
- Utility is not measured in cardinal units.
- Only the order of preference matters: the individual prefers an additional unit of a good less than the previous unit on his subjective scale of values.
- That is: the first unit of water in the desert is worth more than the second, the second more than the third, etc., but we cannot say “it is worth exactly double” or “it is worth 15 units.” We only know the ranking.
Marginal:
It refers to the unit that is “at the margin,” that is, the unit the individual is considering acquiring or of which he must divest himself.
The Solution to the Paradox of Value
The Austrian School (with Carl Menger (1840–1921) at its head) explained that the price of goods does not depend on their “total” utility for humanity, but on their marginal utility.
- Because water is abundant, the “marginal unit” of water is used for very unimportant ends (washing the car, watering the lawn). That is why its price is low.
- Because diamonds are scarce, the available “marginal unit” is still assigned to highly valued ends. That is why its price is high.
Importance for Human Action
Marginal utility is the foundation of all Austrian economics because it explains how prices form in the market.
Exchanges occur because both parties value what they receive more than what they give up at the margin—that is, the additional or one more.
If you buy a coffee for $2, it is because for you the marginal utility of that coffee is greater than the marginal utility of those $2. The seller thinks exactly the opposite. Both improve their subjective situation.
This article is part of the Basic Course on Libertarianism and the Austrian School of Economics-> Module 5: Austrian Economics and Free Market
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