Economics Beginner

Marginal Utility

The value of the first glass of water and the tenth glass of water are different. The most important insight in economics.

· 6min

What is Marginal Utility?

Marginal Utility refers to the satisfaction (utility) provided by one additional unit of a good. More precisely, it is the additional value you feel when you add one more unit to what you already have.

The word “marginal” is key. In economics, marginal means “the last unit” or “the next unit”. It’s about focusing not on the total quantity of a good, but on the very last unit — this is the insight that changed the history of economics.

The Water-Diamond Paradox

For over 2,000 years, there was a riddle that puzzled economists.

Water is essential for survival but has a low price, while diamonds are unnecessary for survival but have a high price. Why?

This is called the “water-diamond paradox” or “paradox of value.” Even Adam Smith raised this problem in “The Wealth of Nations” but could not solve it. It could not be explained by labor value theory — because drawing water often requires no less labor than mining diamonds.

Marginal utility theory solves this paradox clearly.

The total utility of water is enormous. You cannot survive without water. But water is abundant. When you already have enough water, the value of one additional glass (the marginal unit) is very low. With that glass, you might water a plant or simply pour it away.

The total utility of diamonds is much lower than that of water. You can live well without diamonds. But diamonds are extremely scarce. The value of one additional diamond (the marginal unit) is very high.

It is marginal utility, not total utility, that determines price. This is the key point.

The Marginal Revolution: A Turning Point in Economics

In 1871, almost simultaneously, three economists independently arrived at this insight:

  • Carl Menger (Austria) — “Principles of Economics”
  • William Stanley Jevons (Britain) — “The Theory of Political Economy”
  • Léon Walras (France) — “Elements of Pure Economics”

This is called the “Marginal Revolution” in the history of economics. This revolution completely reconstructed the foundations of economics. It shifted the source of value from “production costs” or “labor input” to “the subjective evaluation of consumers”.

Among the three scholars, Menger’s approach later developed into the Austrian School of Economics. Unlike Jevons and Walras, Menger did not attempt to model marginal utility mathematically. He saw value as inherently subjective and ordinal — having order but not comparable in magnitude.

The Law of Diminishing Marginal Utility

The most important characteristic of marginal utility is that it diminishes.

Everyday Examples

Bread: For someone who has eaten nothing all day, the first loaf of bread is a lifeline. The second loaf is also very valuable. The third is good but less urgent. By the fifth loaf, you wonder “should I eat this or not?” The tenth loaf becomes a burden. The same bread, yet the value of each additional unit continues to decrease.

Smartphones: The first smartphone changes your life. The second smartphone can be useful as a backup. A third smartphone? For most people, it has almost no value.

Money: An additional 10 million won to someone earning 20 million won per year dramatically changes their quality of life. An additional 10 million won to someone earning 1 billion won per year makes barely any difference. The same 10 million won, but the marginal utility differs.

Menger’s Table of Want Satisfaction

Menger systematically explained this by analyzing the priority of use for goods. Using water as an example:

  1. First unit: Drinking (survival) — very high value
  2. Second unit: Cooking — high value
  3. Third unit: Laundry — medium value
  4. Fourth unit: Cleaning — low value
  5. Fifth unit: Garden irrigation — even lower value
  6. Sixth unit: Playing in water — lowest value

Each additional unit is assigned to a less urgent use. The use to which the last unit (marginal unit) is assigned determines the market value of that good.

Why Marginal Utility Matters

The Principle of Price Formation

Market prices are determined by marginal utility. The reason a cup of coffee costs 5,000 won is not because it costs 5,000 won to produce coffee. It is because enough consumers assign about 5,000 won of value to one additional cup of coffee.

The reason rice prices fall during a bumper harvest is also explained by marginal utility. When the total quantity of rice increases, the urgency of the use to which the last unit (marginal unit) is assigned decreases, so marginal utility falls, and therefore the price declines.

The Logic of Exchange

Marginal utility also explains why two people trade. Imagine a person with 10 apples and a person with 10 bananas. For the person with 10 apples, the marginal utility of the tenth apple is very low. But the marginal utility of the first banana is high. The same logic applies to the person with 10 bananas.

When the two exchange apples and bananas, both increase their marginal utility. This is why voluntary exchange always benefits both parties. It is not a zero-sum game with a fixed pie size.

Implications for Economic Policy

The law of diminishing marginal utility is often cited as justification for progressive taxation — “since the marginal utility of 10,000 won to the rich is lower than to the poor, we can apply a higher tax rate to the rich.” However, the Austrian School of Economics rejects this logic. Because utility is subjective and ordinal, it is impossible to compare utility between different people. The proposition “the utility of 10,000 won to A is greater than the utility of 10,000 won to B” is scientifically unverifiable.

Bitcoin and Marginal Utility

The supply of Bitcoin is fixed at 21 million coins, and new supply continues to decrease through halving. Meanwhile, demand for Bitcoin (users, transaction volume, institutional adoption) is on an upward trend.

In the case of fiat money, the marginal utility of newly issued currency units continues to diminish — this is the essence of inflation. Bitcoin has a structure where additional supply decreases continuously, so if demand remains constant, the scarcity and value of each marginal unit is maintained or increases.

This is one of the economic reasons why Bitcoin can function as sound money.

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