This is part three of a three-part series reviewing the economic debate between marginalists and proponents of the labor theory of value. Click here to begin at the introduction and also find the table of contents/bibliography.

3.1. The Diamond-Water Paradox

Arguably, Menger’s number one contribution to mainstream economics is the concept of marginalism, so it is probably worth touching on.

Marginalism analyzes economic decisions on a unit-by-unit basis: a transaction involving X quantity of a good should not be understood as one decision, but rather instead a set of X decisions, as the cost/benefit for each successive purchase is not necessarily identical.

We see now, in addition, that the satisfaction of any one specific need has, up to a certain degree of completeness, relatively the highest importance, and that further satisfaction has a progressively smaller importance, until eventually a stage is reached at which a more complete satisfaction of that particular need is a matter of indifference. Ultimately a stage occurs at which every act having the external appearance of a satisfaction of this need not only has no further importance to the consumer but is rather a burden and a pain. (Menger 124)

He then applies this principle to provide a solution to the aforementioned diamond-water paradox:

If we ask, for example, why a pound of drinking water has no value whatsoever to us under ordinary circumstances, while a minute fraction of a pound of gold or diamonds generally exhibits a very high value, the answer is as follows: Diamonds and gold are so rare that all the diamonds available to mankind could be kept ina chest and all the gold in a single large room, as a simple calculation will show. Drinking water, on the other hand, is found in such large quantities on the earth that a reservoir can hardly be imagined large enough to hold it all…

All this holds only for the ordinary circumstances of life, when drinking water is available to us in copious quantities and gold and diamonds in very small quantities. In the desert, however, where the life of a traveller is often dependent on a drink of water, it can by all means be imagined that more important satisfactions depend, for an individual, on a pound of water than on even a pound of gold. In such a case, the value of a pound of water would consequently be greater, for the individual concerned, than the value of a pound of gold. (Menger 140-141)

And looking at this hypothetical alongside many others he illustrates, we begin to see why marginalism left such an impact. It is an incredibly adequate explanation of various types of elementary exchanges. It is through these scenarios that Menger is able to both characterize and demonstrate economic behavior.

In the previous section, I directed attention to the fact that price formation and the distribution of goods conform to definite laws by first considering the simplest possible case in which an exchange of goods takes place between two economizing individuals who are not influenced by the economic activity of other persons. This case, which could be termed isolated exchange, is the most common form of human trade in the early stages of the development of civilization. (Menger 197)

In our case of marginalism, Menger provides this principle of bottom-up reasoning as means of illustration:

Economizing individuals do not use the quantities of goods available to them without regard to differences in quality when these exist. A farmer who has grain of different grades at his disposal does not, for example, use the worst grade for seeding, grain of medium quality as cattle feed, and the best for food and the production of beverages. Nor does he use the grains of different grades indiscriminately for one purpose or another. Rather, with a view to his requirements, he employs the best grade for seeding, the best that remains for food and beverages, and the grain of poorest quality for fattening cattle. (Menger 144)

Suppose that A, an American frontiersman, owns several horses but no cow, while B, his neighbor, has a number of cows but no horses. Provided that A has requirements for milk and milk products and B for draft animals, it is easy to see that a basis for exchange operations is present. But no one will maintain that the exchange of one of A’s horses, for example, for one of B’s cows would necessarily exhaust the existing basis for economic exchange operations between A and B with respect to these goods. It is equally certain, however, that a basis need not necessarily exist for exchange of the total quantities they possess. A who owns (for example) six horses may be able to satisfy his needs better if he exchanges one, or two, or perhaps even three, of his horses for B’s cows. But from this it does not necessarily follow that he would derive an economic gain from the exchange transaction if he were to barter all his horses for all of B’s cows. Although the initial economic situation provides a basis for economic exchange operations between A and B, of carrying the exchange too far might be that the needs of the two contracting parties would be less well provided for than before the exchange. (Menger 181-182)

It is because marginalism is so rooted in this intense atomization, it fails to tackle more fundamental economic questions. Sure, the concept of marginal utility helps expand upon the deviations of supply and demand, but it still ends up anchored to the presuppositions associated with it.

As Marx states in Capital’s third volume, “The real difficulty in formulating the general definition of supply and demand is that it seems to take on the appearance of a tautology.”

Market Prices and Market Values

Further, in the study of money it had been assumed that the commodities are sold at their values because there was absolutely no reason to consider prices divergent from values, it being merely a matter of changes of form which commodities undergo in their transformation into money and their reconversion from money into commodities. As soon as a commodity has been sold and a new commodity bought with the receipts, we have before us the entire metamorphosis, and to this process as such it is immaterial whether the price of the commodity lies above or below its value. The value of the commodity remains important as a basis, because the concept of money cannot be developed on any other foundation, and price, in its general meaning, is but value in the form of money.

Demand and supply imply the conversion of value into market-value, and so far as they proceed on a capitalist basis, so far as the commodities are products of capital, they are based on capitalist production processes, i.e., on quite different relationships than the mere purchase and sale of goods. Here it is not a question of the formal conversion of the value of commodities into prices, i.e., not of a mere change of form. It is a question of definite deviations in quantity of the market-prices from the market-values, and, further, from the prices of production. In simple purchase and sale it suffices to have the producers of commodities as such counterposed to one another. In further analysis supply and demand presuppose the existence of different classes and sections of classes which divide the total revenue of a society and consume it among themselves as revenue, and, therefore, make up the demand created by revenue. While on the other hand it requires an insight into the over-all structure of the capitalist production process for an understanding of the supply and demand created among themselves by producers as such. (Capital Vol. 3 Section 2, Chapter 10)

On Demand

It would seem, then, that there is on the side of demand a certain magnitude of definite social wants which require for their satisfaction a definite quantity of a commodity on the market. But quantitatively, the definite social wants are very elastic and changing. Their fixedness is only apparent. If the means of subsistence were cheaper, or money-wages higher, the labourers would buy more of them, and a greater social need would arise for them, leaving aside the paupers, etc., whose demand is even below the narrowest limits of their physical wants.

On the other hand, if cotton were cheaper, for example, the capitalists’ demand for it would increase, more additional capital would be thrown into the cotton industry, etc. We must never forget that the demand for productive consumption is, under our assumption, a demand of the capitalist, whose essential purpose is the production of surplus-value, so that he produces a particular commodity to this sole end… But this does exert a considerable influence on the kind of buyer the capitalist is. His demand for cotton is substantially modified by the fact that it disguises his real need for making profit.

The limits within which the need for commodities in the market, the demand, differs quantitatively from the actual social need, naturally vary considerably for different commodities; what I mean is the difference between the demanded quantity of commodities and the quantity which would have been in demand at other money-prices or other money or living conditions of the buyers. (Capital Vol. 3 Section 2, Chapter 10)

On The Intersection of Supply and Demand [section in-progress]

If supply equals demand, they cease to act, and for this very reason commodities are sold at their market-values. Whenever two forces operate equally in opposite directions, they balance one another, exert no outside influence, and any phenomena taking place in these circumstances must be explained by causes other than the effect of these two forces. If supply and demand balance one another, they cease to explain anything, do not affect market-values, and therefore leave us so much more in the dark about the reasons why the market-value is expressed in just this sum of money and no other. It is evident that the real inner laws of capitalist production cannot be explained by the interaction of supply and demand (quite aside from a deeper analysis of these two social motive forces, which would be out of place here), because these laws cannot be observed in their pure state, until supply and demand cease to act, i.e., are equated. In reality, supply and demand never coincide, or, if they do, it is by mere accident, hence scientifically = 0, and to be regarded as not having occurred.

But political economy assumes that supply and demand coincide with one another. Why? To be able to study phenomena in their fundamental relations, in the form corresponding to their conception, that is, is to study them independent of the appearances caused by the movement of supply and demand.

On the one hand, the relation of demand and supply, therefore, only explains the deviations of market-prices from market-values. On the other, it explains the tendency to eliminate these deviations, i.e., to eliminate the effect of the relation of demand and supply. (Capital Vol. 3 Section 2, Chapter 10)

These questions regarding supply and demand are less visible when considered purely on the microeconomic scale, as Menger does; the isolated exchanges he cites hold an inherent blind spot to these problems. When you’re considering a hypothetical, embedded into it are various assumptions about the conditions that form it.

This is not to say that hypotheticals are necessarily misleading (after all, Marx uses them too), but rather instead, this blind spot has to be taken into consideration when drawing conclusions:

Do not let us go back to a fictitious primordial condition as the political economist does, when he tries to explain. Such a primordial condition explains nothing; it merely pushes the question away into a grey nebulous distance. The economist assumes in the form of a fact, of an event, what he is supposed to deduce – namely, the necessary relationship between two things – between, for example, division of labor and exchange. Thus the theologian explains the origin of evil by the fall of Man – that is, he assumes as a fact, in historical form, what has to be explained.

We proceed from an actual economic fact. (1844 Manuscripts)

Yet, Menger seems to neglect this quite a bit:

3.2. Economizing Individuals [section in-progress]

At the center of Menger’s thought, continuously echoed throughout his work, is the idea of the economizing individual. It is through the economizing behavior of various people that the rest of his theory comes together. He defines the economizing individual as such:

Economizing individuals strive to better their economic positions as much as possible. To this end they engage in economic activity in general. And to this end also, whenever it can be attained by means of trade, they exchange goods. (Menger 191)

Menger himself acknowledges this, using this concept to fill the void left behind by his rejection of price theory:

However much prices, or in other words, the quantities of goods actually exchanged, may impress themselves on our senses, and on this account form the usual object of scientific investigation, they are by no means the most fundamental feature of the economic phenomenon of exchange. This central feature lies rather in the better provision two persons can make for the satisfaction of their needs by means of trade…

If the locks between two still bodies of water at different levels are opened, the surface will become ruffled with waves that will gradually subside until the water is still once more. The waves are only symptoms of the operation of the forces we call gravity and friction. The prices of goods, which are symptoms of an economic equilibrium in the distribution of possessions between the economies of individuals, resemble these waves. The force that drives them to the surface is the ultimate and general cause of all economic activity, the endeavor of men to satisfy their needs as completely as possible, to better their economic positions. (Menger 191-192)

3.3. Consumer Sovereignty [section to-do]

1: https://mises.org/library/ludwig-von-mises-scholar-who-would-not-compromise

2: https://www.marxists.org/archive/mandel/works/marxist-economic-theory/marginalists.htm