When the transaction has been completed, A has successfully pursued a course of action that has substituted a more valuable package for one less valuable. He was not called upon to choose between fish and fruit. He had no need to compare fish-in-general with fruit-in-general, nor even to compare all his own fish with all his own or B’s fruit. The only choice forced on A was to compare the significance of fish and fruit at the margin. At issue was the loss of some fish as compared with the gain of some fruit. What A was called upon to decide was whether the difference to him involved in the loss of the 3 lbs. of fish meant more or less to him than the difference involved in the gain of the 10 lbs. of fruit. The fact that A chose to exchange signifies that the marginal utility to him of 10 lbs. of fruit was greater than the marginal utility to him of the 3 lbs. of fish.
We can now develop a principle of far-reaching significance in economics generally and in demand theory in particular. This principle is usually referred to as diminishing marginal utility. A clear understanding of this principle will provide the key to much of the subsequent discussion.
Imagine a man who has had to decide how much of a particular commodity to buy. Let us suppose that he was able to obtain as many units of the commodity as he pleases at a fixed price of $ P per unit and that he has finally purchased N units. We say that his action demonstrates that he prefers N units of the commodity to the amount of $ P × N, which he has to pay for them. He has chosen between the alternatives of either paying the sum $ PN (and gaining N units) or going without the quantity N of the commodity.
This way of expressing the choice that faced the man, while correct as far as it goes, does not fully set forth the actual complexity of the decision he has made. Our buyer, who actually buys N units, could have bought, if he had desired, either more than N units or less than N units. The full range of alternatives open to him include:
| Buying Possibilities | Cost |
| Buying none of the commodity | no money |
| Buying 1 unit | $P |
| Buying 2 units | $2P |
| . . . | . . . |
| Buying N − 1 units | $(N − 1) P |
| Buying N units | $NP |
| Buying N + 1 units | $(N + 1) P |
| . . . | . . . |
In comparing these successive alternatives one with another, the prospective buyer assesses the differences (marginal utility) that successive additional units of the commodity would make to him; and he weighs these differences against those involved in the prospective loss of successive additional sums of money. The principle of diminishing marginal utility focuses attention on the marginal utility attached to successive additional units of the commodity.
The acquisition of additional units of a commodity enables the buyer to satisfy a successively larger number of wants. The acquisition of the m th unit of a commodity by one who already possesses m − 1 units means that he will now be able to satisfy a want that, if only m − 1 units would be possessed, must have gone unsatisfied. It is clear, upon reflection, that this want whose satisfaction is made possible by the acquisition of the m th unit must rank higher on the man’s scale of values than the want that depends for its satisfaction on the acquisition of the (m + 1)th unit. For when a man acquires the m th unit, he will have to choose—out of all the wants that must go unsatisfied when only m − 1 units are possessed—that particular want whose satisfaction the acquisition of this m th unit should, in fact, make possible. And, of course, it will be the most important of these wants that will be chosen. Furthermore, of the still remaining unsatisfied wants, it will be the next most important one that will be selected for satisfaction upon acquisition of the (m + 1)th unit.
Similarly, looking at the same situation from the opposite direction, it is obvious that if the man who possesses m − 1 units were to lose one of them, then he would see to it that the want that must now go unsatisfied will be the least important of all hitherto satisfied wants. Of the remaining yet satisfied wants, it must be the next least important that would be sacrificed, were yet another unit to be lost.
To restate the contents of the preceding paragraphs compactly, we can say that the
Marginal utility of the mth unit is lower than that of the (m – 1)th unit and higher than that of the (m + 1)th unit.
This conclusion is the principle of diminishing marginal utility.
The principle readily lends itself to illustration. Consider, for example, an air passenger packing his valise and allowed to take with him baggage of only limited weight. He surveys the articles he would like to take but which weigh, let us say, 5 lbs. in excess of the limit. Clearly, the 5 lbs. of his possessions that will be excluded will be those the passenger believes to be least urgently required for the trip, among all the 5-lb. groups of articles that can be removed. Suppose that a sudden change in regulations reduces the permitted weight by 5 lbs.; then yet another 5 lbs. of articles will have to be excluded. The latter will be possessions that, while more desired for the trip than those previously excluded, are yet not as indispensable as the articles still packed in the valise. The marginal utility of allowed baggage, in terms of 5-lb. units of impedimenta, increases as the baggage allowance dwindles and diminishes as the baggage allowance increases.
Some words of clarification are in order with respect to the meaning of “marginal.” Let us imagine six physically similar shirts each bearing a different number. A man owns the shirts numbered 1, 2, 3, and 4. He contemplates the purchase of the shirt numbered 5 and then of the shirt numbered 6. His decision requires the comparison of three situations: (a) possession of shirts 1, 2, 3, and 4; (b) possession of shirts 1, 2, 3, 4, and 5; and (c) possession of shirts 1, 2, 3, 4, 5, and 6. As discussed, such comparison involves the marginal utility of “a fifth” and of “a sixth” shirt. If each shirt is priced at $5, then the decision whether or not to purchase the fifth shirt will hinge on whether a fifth shirt has greater utility than $5 or not. The marginal shirt in this case happens to be the shirt bearing number 5. And similarly for the sixth shirt.
The law of diminishing utility tells us that the marginal utility of the sixth shirt will be lower than that of the fifth. The acquisition of the fifth shirt, let us say, enables the man to fulfill a particular engagement without appearing in a soiled or frayed shirt. The sixth shirt will obviously make no difference at all to this engagement; it can affect only some other occasion, less important than this engagement.
It