Praxeology - Episode 10

Translations of this material:

into Russian: Праксиология Эпизод 10 — Закон убывающей предельной полезности. Translated in draft, editing and proof-reading required.
Submitted for translation by IrinaChernykh 15.06.2015
into Spanish: Praxeología - Episodio 10. private, 41% translated in draft.
Submitted for translation by inmanez 10.03.2012

Text

Why are diamonds worth more than water?

Why do people pay more for one good and less for another?

Can we measure a person’s utility?

Hi guys, Praxgirl here.

In our last lesson I talked about the uncertainty inherent in all human actions. I showed the logical way of categorizing the risk undertaken by different types of action, and I addressed the nature of predictions in both the natural sciences and Praxeology.

In this lesson I’d like to talk the nature of Praxeological valuation known as Utility, understanding the nature of marginal choosing, and how goods of the same class get ranked by acting individuals.

WHAT IS UTILITY?

As we have covered previously, man acts to remove some felt uneasiness. He believes that the services a thing can render are appropriate to improve his own well-being. The importance attached to a thing on account of the belief that it can remove uneasiness can be called a thing’s Utility.

What makes one thing’s Utility greater than another, can only be determined by an acting man’s action, and therefore logically, any reference to Utility in terms of action must refer to man’s subjective valuation.

Things in the real world have an objective and measurable use-value. Some people call this Utility. But this is not the same Utility on which a man acts. A man only acts on his opinion of the use-value a thing will bring him. Subjective use-value is what we call Utility.

An example can help explain the difference:

Jack wants to warm his house using coal . Six pieces of coal may have the objective effect or heating power enough to warm a small room. But to Jack, the believed use-value (Utility) is that the six pieces of coal will warm his entire house. Because he believes that the six pieces of coal will remove his uneasiness, he uses the coal as a means to achieve his end.

Praxeological Utility is not always based on Technological Utility because we know there are many times when man fails to take into account all the relevant information needed when performing an action. He often acts in error and fails to achieve the removal of his uneasiness. In our example Jack will never achieve warming his whole house. He will not obtain his satisfaction.

Likewise, just as a man can wrongly believe a thing has the power to bring a desired effect, he can fall into situations where he completely ignores--and thus does not value-- a thing he doesn’t understand. Suppose that Jack has no idea that coal can be used to create heat. He thus won’t employ coal as means at all.

Or lastly, a man can value a thing in a way that has no bearing with it’s Technological Utility while fully knowing it’s use-value.

Praxeological Utility cannot be measured from the viewpoint of an individual or compared among different people. Utility can only be ranked as higher or lower from a person’s viewpoint.

For example:

We could say that Robert values watching television more than listening to the radio.

But no one could say that he values watching television 2.3 times more than listening to the radio. All that one can say is that there is a rank between the two alternatives. For us to be able to measure anything, there must be a fixed and objectively given unit against which other units can be measured. And there is no such objective unit in the field of human valuation. Robert must determine for himself whether he is better or worse off as the result of any change.

MARGINAL UTILITY

Now that we’ve explained what Utility is, here’s an interesting question:

Why is a diamond more valuable than a cup of water? Water is something that we all need to live, while we can surely live without diamonds. Shouldn’t people be willing to offer far more for a unit of water than for a unit of diamond?

The answer lies simply in the fact that we are never in the position of choosing between all the diamonds in the world and all the water in the world. We only choose between the next unit of water and next unit of diamond. Our choice is made on the margin. We are only comparing the marginal utility of diamonds and the marginal utility of water, not the total utility of diamonds and total utility of water.

Marginal utility means the utility of enjoying an additional unit of a good.

DIMINISHING MARGINAL UTILITY

Action implies the scarcity of means. Because of this, we must economize the employment of our means to achieve our ends. Logically, our scarce means must be allocated to serve the most desired end first. The next means will serve our second most desired end and so on. This means that each additional unit of a homogeneous good will go towards fulfilling a lesser desired end and therefore providing us with a lesser marginal utility.

This is known as the Law of Diminishing Marginal Utility.

Let me elaborate with an example:

Let’s look at Taylor family. They buy their first car which goes to the breadwinner, Mr. Taylor. He uses it to go the office, as this is their most urgent use of a car. Now let’s say they decide to buy a second car. This car would go to Mrs. Taylor who it to go to the grocery store and run errands. This is their second most urgent use a car. They now buy a third car, and they decide to give it to junior who would use it to go to school. This is the third most urgent use of a car. This demonstrates that the Taylor family values each additional unit of a car less than the previous unit, because it goes to serve a lesser urgent end.

Now lets suppose Mr. Taylor’s car breaks down, do you think he would be the one who goes without a car? No, its Junior who will go without a car, because the third car is being used for the least urgent end.

The Law of Diminishing Marginal Utility is one of the most fundamental principles of Praxeology. We must keep it in mind that this principle does not in any way rely on psychology or behavioral assumptions, but follows logically from the irrefutable true axiom of human action, and is true before empirical testing. The Law of Diminishing Marginal Utility can give us the power to understand that prices of goods are not set mechanically supply and demand, by goal-seeking choices of individuals.

I’ll see you guys in the next lesson.